The Chairman said, now’s not the time
To offer a new paradigm
More debt we will buy
Til we certify
The data is truly sublime
Then later, with, kudos, widespread
The new president clearly said
He’d give out more dough
To soften the blow
We’ll suffer from lockdowns ahead
It appears that the question of whether or not the Fed will consider tapering bond purchases by the end of this year has been answered…No! Yesterday, Fed Chair Powell made it crystal clear that it was way too early to consider the idea of reducing QE purchases, and that eventually, if such time arrives, the Fed would be signaling their actions well in advance of any changes. This is broadly the message that we heard from vice-Chairman Clarida two days ago, as well as from Governor Brainerd and some of the more dovish regional presidents. Thus, the comments of the four regional presidents from earlier this week, indicating that tapering could happen as soon as the end of 2021, are likely to seem diminished in the eyes of the market, and the idea of a much more rapid sell-off in Treasuries needs to be rethought.
Beyond that specific question, the Chairman waxed about the good job the Fed has been doing, all the tools they have available to address any future issues, and, remarkably, that the record high levels of debt in the non-financial sector are really no big deal at all given the current level of interest rates. Low rates obviously allow more debt to be serviced easily. The problem, of course, is that if rates do rise in the future, servicing that debt will not be so easy, and the ramifications for the economy would be quite negative. This is the primary factor in the thought that the Fed may never raise rates again, because doing so would result in significant economic stress throughout the country, and truly, the world.
The market response to Powell’s comments was modest at best, with the dollar softening a bit, while equity and bond markets didn’t really react at all. Then last night, President-elect Biden made his first policy speech promising a new approach to things. But one thing that is clearly not set to change is the political view that spending more money is always the right action. He thus unveiled a $1.9 trillion spending program designed to address the ongoing economic impacts of Covid and the concurrent lockdowns around the country. As well, he talked about another $3 trillion program for longer term needs like infrastructure and environmental issues that need to be addressed.
Interestingly, the market appears a bit disappointed in this proposed spending bill, and not because it is going to increase the debt load. Rather, it appears expectations were high for more immediate spending to help goose the economy and by extension, the profit profile of the market. However, the combination of Fed confirmation only that they would not be tightening, rather than expanding programs, and the disappointing cash outlay in the Biden proposal has forced a bit of reconsideration about the future trajectory of the economy and equity markets. After all, if the Fed is not adding to the size of its balance sheet, where is the money going to come from to support buying more stocks? Of course, it could simply be that the Friday before a holiday weekend has encouraged a bit of profit-taking by traders, who will be back in force on Tuesday, but whatever the cause, this morning is opening with a clear risk-off tone.
Looking at equity markets in Asia, the Nikkei (-0.6%) was the laggard, but Shanghai (0.0%) and the Hang Seng (+0.3%) hardly inspired. Meanwhile, European screens are filled with red, led by the CAC (-0.95%) but seeing both the DAX and FTSE 100 falling -0.8%. It is interesting to note that there was a bit of data this morning which arguably could have been construed as positive, yet clearly has not been seen that way. UK November GDP fell only -2.6% M/M, a better than expected performance, especially given the ravages of Covid on that economy. While IP was a bit softer than forecast Services was clearly better, which for the UK economy will be crucial going forward. The other data point showed French CPI at 0.0% in December, which remarkably, helps raise the Eurozone number! But equity investors are having none of it today, and shedding positions into the weekend. As to US futures markets, they are pointing lower as well, between -0.35% and -0.5% at this hour.
One cannot be surprised that Treasury prices are rallying given the risk stance, with the 10-year up ¼ of a point and yields lower by 2.7bps. While I continue to believe that there is a near term cap in yields, at least at 1.1%, the idea of the bond offering safety makes a bit more sense than when the yield was 0.7% like most of the summer. Remember, part of the safety of the bond is that it pays a steady income stream. As to European markets, the big 3 are essentially unchanged at this hour, although all of them have rallied from early session lows where yields had climbed a bit. This behavior is a bit unusual as I would have expected increased demand for these havens, but markets can be perverse on a regular basis.
Oil prices are under pressure this morning, with WTI lower by 1.3%, although that remains simply a consolidation of the large move higher we had seen over the past two plus months. As to gold, it is little changed on the day, firmly in the middle of its recent trading range.
Finally, the dollar is definitely the beneficiary of today’s risk stance, rising against most currencies, with only the havens of JPY (+0.1%) and CHF (+0.05%) managing to eke out any gains. However, the commodity bloc is weak; NOK (-0.6%), AUD (-0.6%) and CAD (-0.5%), and the euro (-0.3%) and pound (-0.45%) are under pressure as well. There doesn’t need to be a more specific story than risk-off to explain these movements.
Emergers, too, are broadly under pressure led by the commodity linked currencies there. ZAR (-0.9%), BRL (-0.8%) and CLP (-0.6%) are leading the charge lower, although pretty much every currency in the space has fallen except IDR (+0.3%). The story here was that exports climbed a more than expected 14.6% leading to a larger trade surplus. The indication that the economy could weather then Covid storm better than many peers has increased the attractiveness of the rupiah, especially given the yield there, which is amongst the highest in the world these days at 3.75%.
On the data front, yesterday saw much worse than expected Initial Claims data, a potential harbinger of weaker data to come. This morning brings PPI (exp 0.8% Y/Y, 1.3% Y/Y -ex food & energy), Retail Sales (0.0%, -0.2% -ex autos), Capacity Utilization (73.6%), IP (0.5%), and Michigan Sentiment (79.5). So, lots of things, but really Retail Sales is the one that matters most here, I think. Certainly, yesterday’s Claims data has put the market on notice that things slowed down in Q4 and are likely starting Q1 in the same state. However, do not be too surprised if a bad number is met with a rally as expectations grow that the Fed could, in fact, step up the pace of purchases. We shall see.
Beyond that, Minneapolis Fed president Kashkari, the uber-dove, is the last Fed speaker before the quiet period begins ahead of the January 27 meeting. But we already know he is going to say not enough is being done.
As long as risk remains on the back foot, the dollar can certainly maintain its modest bid here. However, if things turn around, notably if equities climb into the green, look for the dollar to give up its gains. At this point, the dollar’s strength does not seem to be built on a strong foundation.
Good luck, good weekend and stay safe