In Europe, the ECB hawks
Explained in their most recent talks
The rising of late
In THE 10-year rate
Was normal and no paradox
At home, hawks are also reduced
To cheering the 10-year yield’s boost
Since Powell’s a dove
And rules from above
The hawks can’t shake him from his roost
In a world where every central bank is adding massive amounts of liquidity, how can you determine which central bankers are hawks and which are doves? Since no one is allowed to make the case that short-term rates should be raised to try to slow down rising inflation, the next best thing for the hawks to do is to cheer on the rise in longer term yields. And that continues to be the number one story in markets around the world, rising bond yields. Yesterday saw Treasury yields rise 9 basis points as investors continue to see US data point to rising inflationary pressures. The ISM Services Price Index rose to its highest level since 2008, just like we saw in the Manufacturing Index on Monday. Even official inflation measures continue to print a bit higher than forecast, a sign that underlying price pressures are quite widespread.
In the past, this type of economic data would encourage the hawkish contingent of every central bank to argue for raising the short-term rate. But hawkish views appear to have been written by Dr Seuss, as they have been removed from the canon of financial discussion. Which leaves the back end of the curve the only place where they can express their views. And so, we now hear from Klaas Knot, Dutch central bank president that rising government bond yields are a “positive story”, while Jens Weidmann, Bundesbank president explained that these moves are not “a particularly worrisome development.” We have heard the same thing from Fed speakers as well, although not universally, as the doves, notably Lael Brainerd, hint at Fed action to prevent an unruly market. My take is an unruly market is one that goes in the opposite direction to their desires.
But despite the central bank commentary, it is becoming ever clearer that inflationary pressures are rising around the world. We have spent the past 40 years in an environment of constantly decreasing inflation as a combination of globalization and technological advancement have reduced the cost of so many things. And while technology continues to march forward, globalization is under severe attack, even from its previous political cheerleaders. This is evident in the current US administration, where strengthening and localizing supply chains is a goal, something that will clearly increase costs. Add to that increased shipping costs alongside capacity shortages and rising energy costs, and you have the makings of a higher price regime. (An anecdote on rising price pressures: a friend of mine who lives in Paris told me the prices of the following foods; fresh salmon €60/kg, 1 grapefruit €2.25 and 1 avocado €2.65. I checked my supermarket app and found the following prices here in New Jersey; fresh salmon $9.99/lb, 1 grapefruit $1.00 and 1 avocado $2.50. Prices are high and rising everywhere!)
The final piece of this puzzle is broad economic activity, which the data continues to show has seen a real burst in the US, although there is still concern over the employment situation. Every survey has shown the US economy growing rapidly in Q1 with the Atlanta Fed’s GDPNow forecast currently at 10%. Adding it all up leads to the following understanding; it is not only the Fed that is willing to run the economy hot, but every G10 central bank, which means that monetary support will continue to flow for years to come. Combining that activity with the massive fiscal support and the still significant supply bottlenecks that were a result of the government shutdowns in response to Covid brings about a scenario where there is a ton of money in the system and not enough goods to satisfy the demand. If central banks don’t tap the breaks, rising prices and price expectations will lead to rising yields, and ultimately to declining equities. The only asset class that will continue to perform is commodities, because owning “stuff” will be a better trade than owning paper assets. And that’s enough of those cheery thoughts.
On to today’s markets, where, alas, risk is being jettisoned around the world. After yesterday’s tech led selloff in the US, Asian equity markets really got hammered (Nikkei -2.1%, Hang Seng -2.1%, Shanghai -2.1%) and European markets are also under the gun (DAX -0.45%, CAC -0.3%, FTSE 100 -1.0%). US futures? All red at this hour, down about 0.3%, although that is off the lows seen earlier this morning.
Bond yields, meanwhile, despite my discussion of how they are rising, have actually slipped back a bit this morning in classic risk-off price action. So, Treasuries (-1.9bps), Bunds (-2.6bps), OATs (-2.1bps) and Gilts (-4.1bps) are all rallying. But this is not a trend change, it is merely indicative of the fact that now that yields have backed up substantially, the concept of government bonds as an effective risk mitigant is coming back in vogue. After all, when 10-yr Treasuries yield 0.7%, it hardly offers protection to a portfolio, but at more than double that rate, it is starting to help a little in times of stress.
Commodity prices are mixed this morning with oil taking back early session losses to sit unchanged as I type, but base metals in the midst of a modest correction after a remarkable rally for the past several months. This morning copper (-4.1%) and Nickel (-8.2%) are leading the way lower, but with the ongoing economic activity and absence of new capacity, these are almost certainly temporary moves. Gold, which has been under significant pressure lately seems to have found a floor, perhaps only temporarily, at $1700, but given the dollar’s ongoing strength, it cannot be surprising gold remains under pressure.
As to the dollar, I would say it is very modestly stronger today, although what had earlier been virtually universal has now ebbed back a bit. In the G10, CHF (-0.4%) and JPY (-0.3%) are the worst performers, which given the risk attitude is actually quite surprising. I think the Swiss story is actually a Polish one, where Poland has refused to support local banks who took out CHF loans and have been suffering from currency strength far outstripping the interest rate benefits. It seems, concern is growing that these loans may be restructured and ultimately impact the Swiss banks and Swiss economy. Meanwhile, the yen’s weakness stems from a poor response to a 30-year bond sale last night, where yields rose 3.5 bps amid a very weak bid-to-cover ratio for the sale. Perhaps even the Japanese are getting tired of zero rates! But away from those two currencies, the rest of the bloc is +/- 0.2% or less, indicating nothing of real interest is going on.
EMG currencies are also mixed with Asian currencies suffering amid the broad risk off environment overnight and CE4 currencies lower on the back of euro weakness. On the plus side, BRL (+0.7%) and MXN (+0.6%) are the leading gainers, which appears to be an ongoing reaction to aggressive central bank of Brazil intervention to try to prevent further weakness there. In this space too, the broad risk appetite will continue to remain key.
On the data front we see a bunch of stuff starting with Initial Claims (exp 750K) and Continuing Claims (4.3M), but we also see Nonfarm Productivity (-4.7%), Unit Labor Costs (6.6%) and Factory Orders (2.1%) this morning. Perhaps of more importance we hear from Chairman Powell today, right at noon, and all eyes and ears will be focused on how he describes recent market activity as well as to see if he hints at any type of Fed response. Many pundits, this one included, believe there is a cap to how high the Fed will allow yields to rise, the question is, what is that cap. I have heard several compelling arguments that 2.0% is where things start to become uncomfortable for the Fed, but ultimately, I believe that it will depend on the data. If the data starts to show that the economy is under pressure before 2.0% is reached, the Fed will step in at that time and stop the madness. Until then, as we have heard from central bankers worldwide, higher yields in the back end are a good thing, so they will continue to be with us for the foreseeable future. And yes, that means that until US inflation data starts to print higher, and real yields start to decline, the dollar is very likely to retain its bid.
Good luck and stay safe