Said Madame Lagarde, don’t misread
The fact that our PEPP has lost speed
The quarter to come
A good rule of thumb
Is twice as much is guaranteed
This morning, though, markets have said
That’s just not enough to imbed
The idea your actions
Of frequent transactions
Will offset our fears and our dread
As we walk in this morning, there is a distinct change in tone in the markets from yesterday. It seems that the initial impressions of yesterday’s two big events, the ECB meeting and the 30-year auction, were fleeting, and fear, once again, has taken over.
A quick recap shows that ECB President Lagarde, in responding to the growing questions about the reduced pace of ECB PEPP purchases, promised to significantly increase them during the next quarter. While she refused to quantify ‘significantly’, the analyst community is moving toward the idea that means at least doubling the weekly purchase amounts to ~€25 billion. At the same time, we heard from several ECB members this morning that this action did not presage increasing the size of the PEPP, which still has approximately €1 trillion in firepower remaining. Lagarde emphasized the flexible nature of the program and explained that varying the speed of purchases is exactly why that flexibility was created. However, despite today’s comments, Lagarde also assured us that, if necessary, the ECB could recalibrate the program, which is lawyer/central bank speak for increase the size.
The market liked what it heard, and the result was a bond rally on both sides of the Atlantic. Several hours later, the results of the Treasury’s 30-year auction were released and, while not fantastic, were also not as disastrous as the 7-year auction from two weeks ago. In the end, bond yields basically ended the day flat, equities rallied, and the dollar was under pressure all day. Risk had regained its allure and the bulls were back in command.
Aahh, the good old days. This morning, it is almost as though Madame Lagarde never said a word, or perhaps said too many. Bond markets are selling off sharply, with 10-year Treasury yields higher by 7 basis points and above 1.60%, while European sovereigns are weaker across the board, led by UK gilts (+5.4bps), but with most continental bonds showing yield gains of 2.0-3.0 basis points. So, what happened to all the goodwill from yesterday?
Perhaps that goodwill has fled from fears of rising inflation after President Biden (sort of) laid out his plan for vaccinating the entire nation by May and reopening the economy by summer. Many analysts have pointed to the massive increase in savings and combined that with the newest stimulus checks to come (as soon as this weekend according to Treasury Secretary Yellen) and forecast a huge spending surge, significant economic growth and rising inflation. After all, the Atlanta Fed’s GDPNow forecast is at 8.35%, which while slightly lower than a few weeks ago, is still an extremely rapid pace for the US economy. This pundit, however, questions whether or not that spending surge will materialize. Historically, after a deeply shocking financial event like we have just experienced, behaviors tend to change, with the most common being a tendency to maintain a higher savings ratio. As such, expectations for a massive consumer boom may be a bit optimistic.
Or, perhaps the goodwill has disappeared after further crackdowns by Chinese authorities on its most successful companies, with TenCent now under the gun, receiving fines and being reined in following their efforts to crush Ant Financial. The Hang Seng certainly felt it, falling 2.2% overnight, although Shanghai (+0.5%) and the Nikkei (+1.7%) were still euphoric from yesterday’s US equity rally. Rapidly rising Brazilian inflation (5.2% vs. 3.0% target) could be the cause, as concerns now increase that the central bank, when it meets next week, will be raising rates 0.50% to battle that, despite the economic weakness and ongoing Covid related stresses.
There is, however, one other potential cause of the bond market’s poor performance, which I believe is leading to the general risk-off attitude; but it is a sort of inside baseball issue. The Supplementary Leverage Ratio (SLR) is part of bank regulation that was designed to insure banks would remain stable during hard times and not need to be bailed out, a la 2008. However, during the initial stresses of the Covid crisis, the Fed suspended the need for banks to count Treasury securities and bank reserves as part of that ratio, thus allowing banks to hold more of those assets on their books while remaining within the regulations. But this exemption is due to expire on March 31, which means banks either need a LOT more equity capital, or they need to shrink their balance sheet by selling off those excess Treasuries. And, of course, selling Treasuries is much easier and exactly what we have seen in the past two weeks. If the Fed does not give further guidance on this issue, and lets it expire, bonds probably have further to fall. Ironically, that doesn’t seem to fit with what the Fed really wants to happen, as the higher yields would result in tighter financial conditions, especially if equity markets sold off in sync. So, my guess is the Fed blinks and rolls the exemption over for at least 6 months, but until we know, look for bouts of selling in bonds and all the ensuing market reactions that come with that.
Just like today’s, where European markets are lower (DAX -0.6%, CAC -0.1%, FTSE 100 -0.1%) although in the latter two cases not by much and US futures are also lower, especially the tech laden NASDAQ (-1.4%) although also SPX (-0.4%).
Commodity prices are also under a bit of pressure with oil (-0.25%) slipping a bit as well as precious (gold -1.0%) and base (copper -1.25%) metals. In fact, today is also seeing weakness throughout the agricultural sector, with declines of the 0.75%-1.75% range across the board.
And what of the dollar, you ask? Stronger across the board, with yesterday’s leading gainers showing the way lower today. NZD (-0.75%), SEK (-0.7%) and CHF (-0.7%) are in the worst shape, but in truth, the entire G10 is under pretty significant pressure with only CAD (-0.15%) showing any signs of holding up as Canadian government bond yields rise right along with US yields.
Emerging market currencies are also under significant pressure this morning, led by TRY (-1.5%) but seeing MXN (-1.3%) and ZAR (-1.0%) also suffering greatly. In fact, all of LATAM and the CE4 are under significant pressure today but then all of them had seen substantial strength yesterday. In fact, the two-day movement in many of these currencies is virtually nil. Their futures will depend on a combination of the ongoing evolution of US interest rates and their unique domestic situation. If rising inflation is ignored in order to support these economies, look for much further weakness in that nation’s currency. In other words, there is every chance that the dollar gains strength broadly against this bloc in the next several months.
On the data front, today brings PPI (exp 2.7%, 2.6% core) and Michigan Sentiment (78.5). Certainly, that PPI data looks like inflation is in the pipeline, but the relationship between PPI and CPI is not nearly as strong as you might think, with just a 0.079% correlation over the past 5 years, although it does have a stronger relationship to core PCE (0.228%). But if history is any guide, the market will not be flustered by any print at all.
So, today is shaping up as risk-off with both bonds and stocks selling and no commentary from the Fed coming. Just like yesterday’s risk appetite fed stronger currencies, it appears the opposite is true today. I don’t expect to see substantial further gains, but a modest continuation of the dollar rally does feel like it is in the cards.
Good luck, good weekend and stay safe
Our Fear and Our Dread
Said Madame Lagarde, don’t misread