Not On His Watch

Rumors were rampant
Kuroda would let yields rise
Oops! Not on his watch
Perhaps Chairman Powell should look east for clues on how to manage bond market expectations, as his efforts yesterday can only be termed a disaster.  However, Haruhiko Kuroda was quite successful in talking down the back end of the JGB curve, and the BOJ didn’t have to spend a single dime yen. 
Last night, Kuroda-san was speaking to parliament on a number of issues when he was asked, point blank, if the BOJ was considering widening the yield band on 10-year JGB’s.  He replied, “Personally, I believe it’s neither necessary nor appropriate to expand the band.  There’s no change in the importance of keeping the yield curve stable at a lower level.”  And just like that, JGB yields tumbled across the board with 10-year yields falling 5bps to 0.05%.  The genesis of the question came about as rumors have been constant that during the ongoing BOJ policy review, with conclusions set to be announced later this month, the BOJ would allow a wider band around their 10-year YCC target of 0.0% as a means of steepening the yield curve to help the banking sector.  But clearly, that is not on the cards, so whatever changes may be announced next month, it seems that portion of the current policy is remaining unchanged. The market response was immediate in bond markets, but also in FX as the yen quickly fell 0.5% and is now trading at its weakest level since last June.  Perhaps what is more interesting about the yen’s move is the trajectory of its declines, which are starting to go parabolic.  Beware a much weaker yen, with a short-term test of 110 seemingly on the cards.
Chair Jay tried quite hard to explain
That joblessness is still the bane
Of policy goals
Thus, rising payrolls
Are needed ere rates rise again
But what he said, and markets heard
Was different and that is what spurred
A bond market rout
And stock buying drought
While dollar buys were undeterred
Meanwhile, back at the ranch…Chairman Powell made his last comments yesterday before the quiet period begins ahead of the mid-March FOMC meeting.  In an interview he explained that the FOMC remains quite far from its goals of maximum employment and stable (2% inflation) prices and that they would not be altering policy until those goals are achieved.  However, he did not indicate that they would be expanding their current easy money stance, either by expanding QE or extending the tenor of purchases, and he remained sanguine when asked about the steepening of the yield curve, explaining that it was a positive sign of growth expectations.
Alas, it is not that simple for the Fed as they have put themselves in a very difficult position.  Financial conditions, while seemingly an amorphous term, actually has some precision.  The Chicago Fed has an index with 105 variables but Goldman Sachs has created a much simpler version with just 4 variables; riskless interest rates (10-year yields), equity valuations (S&P 500), Credit Spreads (CDX) and the exchange rate (DXY).  Directionally, conditions are tightening when yields rise, stocks fall, credit spreads widen and the dollar rises, which is exactly what is happening right now!  In fact, in the wake of the Powell comments, they all got tighter.  Now, I’m pretty sure that was not Powell’s intention, but nonetheless, it was the result. 
The problem Powell and the Fed have is that, like Pavlov’s dogs, markets begin to drool at the sound of a Powell speech in anticipation of further easy money to prop things up.  But the market has extended this concept to the back end of the curve, not just the front, and the Fed, unless they change policy, has far less control out there.  It was this setup that put the pressure on Powell to ease policy further, and when he did not change his tune, the market had a little fit. 
Now, remember, the Fed is in its quiet period for the next 12 days, 8 of which will see markets open and trading.  Markets have a history of testing the Fed when they want something, and the Fed’s reaction function, ever since Maestro Alan Greenspan was Fed Chair in 1987 during the Black Monday stock market rout, has been to flood the market with more liquidity when markets sell off.  With that in mind, I would not be surprised to see 10-year yields test 2.0% in the next two weeks as the market tries to force the Fed’s hand.  Be prepared for more volatility and tighter financial conditions as defined by the index I described above.
Which leads us to today’s market activity, where risk is clearly under some pressure ahead of the payroll report this morning.  In Asia, equities were broadly, but not deeply, lower (Nikkei -0.25%, Hang Seng -0.5%, Shanghai -0.1%) while in Europe, early losses every where have eased and the picture is now mixed (DAX -0.6%, CAC -0.3%, FTSE 100 +0.4%).  US futures, which had been in negative territory all evening have turned higher and are currently up by roughly 0.15%.
Bonds, however, are universally softer with yields rising everywhere (except JGB’s last night).  So, Bunds (+1.2bps), OATs (+1.5bps) and Gilts (+4.2bps) lead the yield parade higher with Treasuries currently unchanged, although this is after yesterday’s 8bp rout.  Australian ACGBs continue to sell off sharply with yields higher by another 6bps overnight which takes that move to 63bps in the past month.
On the commodity front, OPEC+ surprised markets yesterday by leaving production unchanged vs. an expectation that they would increase it by 1 million bpd, which resulted in a sharp rally in oil prices which has continued this morning.  WTI (+2.5%) is now above $65/bbl for the first time since October 2018.  Base metals have rallied as well while precious metals are still suffering from the higher real yields attached to higher nominal yields.
And finally, the dollar, which is higher vs. almost every one of its counterparts this morning, with only NOK (+0.2%) and RUB (+0.3%) benefitting from the oil rally enough to overcome the dollar’s yield effect.  But elsewhere in the G10, AUD (-0.7%) and NZD -0.75%) are leading the way lower with GBP (-0.55%) also under the gun.  Now, we are seeing yields rise in all these currencies, but a big part of this move is clearly position unwinding as the massive short dollar positions that have been evident since Q4 2020 are starting to feel more pressure and getting unwound.  The euro, too, is softer, -0.3%, which has taken it below its previous correction lows, and technically opens up a test of the 200-day moving average at 1.1825.
In the EMG bloc, the weakness is widespread with CE4 currencies leading the euro lower, LATAM currencies (CLP -0.65%, MXN -0.6%, BRL -0.25%) all under pressure and most APAC currencies having performed poorly overnight, including CNY (-0.3%) which fell despite the new Five Year plan forecasting GDP growth above 6.0% this year.
And finally, the data story where we have payrolls this morning:

Nonfarm Payrolls


Private Payrolls


Manufacturing Payrolls


Unemployment Rate


Participation Rate


Average Hourly Earnings

0.2% (5.3% Y/Y)

Average Weekly Hours


Trade Balance


Source: Bloomberg
The thing is, while this number usually means a lot, I think there is asymmetric risk attached today.  A weak number will not do anything, while a strong number could well see the next leg of the bond market rout and ensuing stock market weakness.  Traders, when they are in the mood to test the Fed, will jump on any excuse, and this would be a good one.
For right now, the dollar has the upper hand, and I see no reason for that to change until we hear something different from the Fed.  And that is two weeks away!
Good luck, good weekend and stay safe