There once was a time when reflation
Was cause for widespread celebration
Because it implied
That growth nationwide
Recovered from Covid’s predation
But lately concerns have been rising
That markets are destabilizing
As data that’s good
Does more than it should
To raise yields, thus need tranquilizing
There is an ongoing battle in markets these days, between the G10 central banks, led by the Fed, and the bond market and its investors and traders. What we know with certainty is that the central banks are keen to maintain their easy money policies for a much longer period of time as they await clear economic recovery and a higher, but steady, inflation level. In the past week we have heard from a number of different central bank speakers, notably Jay Powell and Christine Lagarde, that current policy settings are appropriate, and that while the sharp move higher in 10-year yields has “caught their eye” there is no indication they will respond.
But the other thing of which we are pretty certain is that markets love to test central banks when they think they have an edge. And while the equity market mantra for the past decade has been, ‘don’t fight the Fed’, that is not really a bond market sentiment. Rather, bond investors and traders will frequently make their collective views known via significant selling pressure driving interest rates up to a point where the central bank blinks. And it certainly feels like that is an apt description of the current market price action.
The problem for the central banks is that they currently find themselves fighting this battle with one hand tied behind their back, and it is their own fault. Remember, one of the key ‘tools’ that central banks use is forward guidance and verbal intervention to sway market opinion. But the current timing is such that both the ECB and Fed have meetings upcoming and are in their self-imposed quiet periods, where central bank members are not supposed to make public comments that could impact markets. And this means that they are unable to make comments implying imminent action if markets continue to misbehave. Of course, the Fed could simply start buying longer dated debt in the market without announcing that is what they are doing, but while that may have been an acceptable methodology thirty years ago, the Fed’s MO these days is that they feel they must explain everything they do, so seems highly unlikely.
Thus we have a situation where bond investors see news stories like the passage by the Senate of the $1.9 trillion stimulus bill, the increased rate of vaccinations throughout the US population and the rapidly declining pace of infection and have jumped to the conclusion that the recovery in the US is going to be both sooner and more robust than earlier forecasts. This, in turn, has them believing that inflation is going to pick up and that the Fed will be forced to raise rates to cool the economy. At the same time, Powell (and Lagarde) could not have been more explicit in their comments that current policy is appropriate, and they have no intention of adjusting it until they achieve their goals. And, by the way, those goalposts have moved quite a bit since the last tightening cycle, such that headline gains in economic data is not nearly good enough, instead they are focused on subsectors of that data like minority employment and wage growth, historically the last part of the economy to benefit from a recovery.
Add it all up and you have a situation where the bond market is observing much faster growth and raising rates accordingly while the Fed is looking at the pockets of the economy where things move more slowly and trying to boost them. The Fed’s problem is higher rates are not helping their cause, nor are they helping to maintain easy financial conditions. And their other current problem is they can’t even talk about it for another 9 days. Markets can wreak a great deal of havoc in a period that long as evidenced by this morning’s rising 10-year yields and declining stock futures during the first day of that quiet period.
Which is a perfect segue into today’s session, where risk is largely under pressure. Last night saw weakness throughout Asian equity indices with the Nikkei (-0.4%), Hang Seng (-1.9%) and Shanghai (-2.3%) all lower although there were pockets of strength in the commodity producing countries. Europe, on the other hand, is broadly higher this morning led by Italy’s FTSE MIB (+2.0%) but seeing strength elsewhere (DAX +1.3%, CAC +0.9%) on news that the European vaccination program is scheduled to pick up the pace. US futures, though, are continuing to feel the pressure from higher US yields, especially in the tech space as the NASDAQ (-1.5%) leads the decline with the S&P (-0.5%) and DOW (-0.1%) not nearly as badly impacted.
But Treasury yields continue to rise with the 10-year higher by another 2.5 basis point this morning and pressing 1.60% again, a level it touched Friday after the much better than expected payroll report. However, in Europe, bonds are mixed with Bunds (+0.7bps) a bit softer while OATs and Gilts have both seen yields edge lower by 0.5bps.
Commodity prices continue to perform well in response to the improving data and increasing vaccination rates with oil (+0.3%) modestly higher and maintaining the highest levels seen in more than 2 years. In the metals markets, base metals are mixed while precious metals continue to suffer from rising US yields. And finally, agricultural products continue their steady rise higher.
Lastly, the dollar continues to benefit from higher yields as it is higher vs. literally every one of its counterparts in both the G10 and EMG. There is no need to discuss specific stories here as this is a universal dollar strength situation, where investors are beginning to unwind emerging market positions as well as their short dollar views. While those positions remain elevated in comparison to historical levels, they have been reduced by about 40% from the peak shorts seen last
On the data front, arguably the most important data point this week is Wednesday’s CPI, but there is a bit more than that coming out.
|Tuesday||NFIB Small Biz Optimism||96.5|
|Wednesday||CPI||0.4% (1.7% Y/Y)|
|-ex food & energy||0.2% (1.4% Y/Y)|
|Thursday||ECB meeting||-0.5% (unchanged)|
|JOLTs Job Openings||6650K|
|Friday||PPI||0.4% (2.7% Y/Y)|
|-ex food & energy||0.2% (2.6% Y/Y)|
I think it could be instructive to see that PPI data as well, which could be a harbinger of CPI in the coming months. Now I know that Jay has explained this will be transient, and he may well be right, but history shows the bond market will need to see proof inflation is transient before calming down.
Obviously, there are no Fed speakers scheduled and we don’t hear from the ECB until Thursday, so market participants have free reign to do what they see is correct. Currently, rising rates has called into question the validity of the tech stock boom and seen a rotation into value stocks. Meanwhile, rising rates has also seen general pressure on stock indices and the dollar continues to benefit from that scenario. As I have written many times, historically a steeper US yield curve meant a strong dollar, and as the curve continues to bear steepen, it is hard to call a top for the greenback.
Good luck and stay safe