Down Under, the RBA bought
Four billion in bonds as they fought
Their bond vigilantes
Who came back from Dante’s
Ninth circle with havoc they wrought
Investors responded by buying
More bonds and more stocks fortifying
The view central banks
All still deserve thanks
For making sure markets keep flying
Atop the reading list of every G10 central banker is the book written by Mario Draghi in 2012 and titled, How to Keep Interest Rates Lower for Longer*, and every one of those bankers is glued to page one. At this point, there is no indication that higher interest rates will be tolerated for any length of time, and while jawboning is always the preferred method of moving markets in the desired direction, sometimes these bankers realize they must act. And act they did, well at least Phillip Lowe, the RBA Governor, did. Last night, the RBA bought $4 billion in 3-year ACGB’s, doubling the normal and expected amount of purchases as he fought back against the idea that the RBA would not be able to maintain control of the yield curve as they have announced. The response must have been quite gratifying as not only did 3-year yields nose back below 0.10%, the target, but 10-year yields tumbled 0.25% as investors regained their confidence and took advantage of the sudden increase in yields available to increase their holdings.
So, last week’s price action is now deemed to have been nothing more than a hiccup, or a bad dream, with market activity today seen as the reality. At least that is the story all the world’s central banks keep telling themselves, and arguably will continue to do for as long as possible. It seems that the fact the RBA was willing to be so aggressive was seen by investors as a harbinger of what other central banks are willing and capable of enacting with the result being a massive asset rally worldwide. Think about that for a moment, the purchase of an extra $1.5 billion of ACGBs has resulted in asset price increases on the order of $1 trillion worldwide. That, my friends, is bang for your buck!
Of course, the question that remains is, will investors continue to accept this worldview, or will data, and ever-increasing debt supply, return us to last week’s market volatility and force a much bigger response by much bigger players? My money is on the latter, as there is no sign that deficit spending is being reined in, and the signs of higher inflation remain clear, even in Europe!
But clearly, today is not one for calling out central bankers. While ongoing conversations in Tokyo highlight the question of whether the BOJ needs to intervene ahead of their mid-month meeting when they are to present their Policy Review, and ECB members continue to warn about unwarranted tightening of financial conditions, thus far, we have not seen any increase in activity by either central bank. However, at 9:45 this morning we will see the latest data from the ECB regarding their purchases during the last week in the PEPP, and it will be instructive to see if those purchases increased, or if they simply maintained their regular pace of activity. An increase could be taken positively, shoring up investor belief that the ECB has their back, but given how poorly the European government bond market performed last week, it could also be seen as a sign that the ECB is losing its sway in markets.
The one truism is that market volatility, despite central banks’ fervent desire for it to decrease, remains on a higher trajectory as the possible economic outcomes for the world as a whole, as well as for individual countries, diverge. And this is, perhaps, the hardest thing for investors to accept and understand; after a forty year period of declining inflation and volatility, if the cycle is turning back higher for both of these characteristics, which have a high correlation, then the future will be more difficult to navigate than the recent past.
So, just how impressive was the RBA’s action? Pretty impressive. For instance, equity markets in Asia all rose sharply (Nikkei +2.4%, Hang Sent +1.6%, Shanghai +1.2%) and are all higher in Europe as well (DAX +0.7%, CAC +1.1%, FTSE 100 +1.0%). US futures, meanwhile, are powering ahead by approximately 1.0% across the board.
As to bonds, while the ACGB move was the most impressive, we did see a halt to the rise in 10-year JGB yields, and in Europe, the rally is powerful with Bunds (-5.0bps), OATs (-5.5bps) and Gilts (-4.1bps) all paring back those yield hikes from last week. Interestingly, Treasury yields (+2.2bps) are not holding to this analysis, as perhaps the news that the $1.9 trillion stimulus package passed the House this weekend has investors a bit more nervous. After all, passage implies increased issuance of $1.9 trillion, and it remains an open question as to how much demand there will be for these new bonds, especially after last week’s disastrous 7-year auction. And that’s really the key question, will there be natural demand for all this additional paper, or will the Fed need to expand QE in order to prevent yields from rising further?
On the commodity front, we are seeing strength across the board with oil (+1.0%) leading energy higher on the reflation idea, both base and precious metals markets rallying and agricultural products seeing their ongoing rallies continue. Stuff continues to cost more, despite the Fed’s claims of low inflation.
As to the dollar, it is mixed this morning, with commodity currencies performing well (NOK +0.4%, CAD +0.35%, AUD +0.3%) while the European commodity users are all under pressure (SEK -0.5%, CHF -0.5%, EUR -0.25%). The euro’s weakness seems a bit strange given the manufacturing PMI data released this morning was positive and better than expected. As well, German CPI, which is released on a state by state basis, is showing a continued gradual increase.
In the emerging markets, TRY (+2.5%) is the runaway leader as the lira offers the highest real yields around and as fear recedes, hot money flows there quickest. But away from that, RUB (+0.6%) on the back of oil’s rally, and CLP (+0.45%) on the back of copper’s ongoing rally are the best performers. With the euro softer, the CE4 are all weaker and we saw desultory price action in Asian currencies overnight.
On the data front, this is a big week, culminating in the payroll report.
|ISM Prices Paid||80.0|
|Fed’s Beige Book|
|Unit Labor Costs||6.7%|
|Average Hourly Earnings||0.2% (5.3% Y/Y)|
|Average Weekly Hours||34.9|
In addition to all this, we hear from Chairman Powell on Thursday, as well as six other Fed speakers a total of nine times this week. But we already know what they are going to say, rising long end yields are a positive sign of growth and with unemployment so high, we are a long way from changing our policy. History shows that the market will test those comments, especially once the Fed goes into its quiet period at the end of the week.
As for today, risk is quite clearly ‘on’ and it seems unlikely that will change without a completely new catalyst. The RBA has fired the shot across the bow of the pessimists, and for now it is working. While the euro seems to be under pressure on the assumption the ECB will act as well, as long as commodities continue to rally, that is likely to support the growth story and commodity currencies.
Good luck and stay safe
*a fictional work conceived by the author