Monthly Archives: April 2021

Desperate Straits

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In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded

Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits

There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today.  In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020.  This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020.  In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound.  If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.

But that is all backward-looking stuff.  Our concerns are what lies ahead.  In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along.  As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment.  Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns.  (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)

At the same time, the fiscal stimulus taps in Europe are only beginning to drip open.  While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level.  This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy.  Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion.  But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval.  This is the very definition of a day late and a dollar euro short.

Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity.  But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st.  Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be.  But we also know that the monetary story is critical to financial markets, so cannot ignore that.  On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar.  Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease.  This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.

The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form.  In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse.  Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.

Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today.  Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session.  Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there.  At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.

European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus.  Looking at smaller country indices shows lots of red as well.  Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.

Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly.  European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.

Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well.  The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies.  Stuff is in demand!

In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners.  We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%).  The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again.  The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.

On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5).  Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number.  That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.

In the end, though, it is still the Treasury market that continues to drive all others.  If yields resume their rise, look for a stronger dollar and pressure on equities and commodities.  If they were to head back down, so would the dollar while equities would find support.

Good luck, good weekend and stay safe
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Filled With Froth

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Said Jay, markets seem filled with froth
But let me tell you, we are loth
To even discuss
The tapering fuss.
To ZIRP and QE we are troth

Now, ask yourself what markets heard
Jay cooed like his favorite white bird
So, dollars were sold
Investors bought gold
With equity bulls undeterred

The Chairman was very clear yesterday afternoon in his press conference, the Fed is not anywhere near thinking about changing their current policy mix.  While paying lip service to the idea that if inflation turns out not to be ‘transitory’ they have the tools to address it, the overwhelming belief in the Mariner Eccles Building appears to be that by autumn, inflation will be a thing of the past and the Fed will still have their foot on the proverbial accelerator.

This does raise the question that, if economic growth is rebounding so smartly, why does the Fed need to buy $120 billion of assets each month and maintain their policy rate at 0.00%?  While I am just an FX guy, it seems to me that the current policy stance is more appropriate for an apocalyptic economic crisis, something like we suffered last year or in 2008-9, rather than for an economy that is growing at 7.0% or more.  But that’s just me.  Clearly, Chairman Powell and his committee are concerned that the economy cannot continue to grow on its own, else they wouldn’t be doing what they are doing.

When it comes to the tapering of asset purchases, Powell was also explicit that it is not nearly time to consider the idea.  Yes, we had one good NFP number, but we need a string of them to convince the Fed that we are past the worst of things.  Remember, the opening two lines of the Fed statement continue to be about Covid.  “The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.  The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world.”  Until such time as that statement changes, we don’t need to hear the press conference to know that nothing is going to change.

With this in mind, let us consider the potential impact on markets.  Starting with Treasuries, it seems reasonable to assume that yields are reflective of investors collective view on inflation going forward.  The Fed has been purchasing $120 billion / month since last June and is not about to change.  At this stage, it would appear the market has factored those purchases into the current yield.  This means, future movements are far more likely to be indicative of the evolving view on inflation.  Yesterday, after the press conference, 10-year yields slipped by 4bps, but this morning, they have recouped those losses and we currently sit at 1.65%.  With commodity prices clearly still on a massive roll (WTI +1.4%, Cu +0.8%), while the Fed is convinced that any inflation will be transitory, it is not obvious that the rest of the market agrees.  Powell said the Fed would need to see a string of strong data.  Well, next week the early expectations for NFP are 888K, which would be two very strong months in a row.  Is that a string?  Certainly, it’s a line.  But I doubt it will move the needle at the Fed.  Maximum employment is still a long way off, and there will be no changes until then.  As inflation readings climb, and they will, Treasury yields will continue to climb as well.  There is nothing magical about 1.75%, the level reached at the end of March, and I expect that by the end of Q2, we will be looking at 10-year yields close to, or above 2.0%.

If Treasury yields are at 2.0%, what happens to equity markets?  In this case, it is not as clear cut as one might think.  First off, this Fed clearly has a different reaction function to data than previous iterations as they have been explicit that pre-emptive tightening to prevent potential future inflation is not going to happen.  This implies that any rise in yields is not reflective of expected Fed policy changes, but rather as a response to rising inflationary pressures.  History has shown that when inflation rises but stays below 3.0%, equity markets can remain buoyant, but once that threshold has been breached, it is a different story.  Remember, especially in the tech sector, but in truth quite generally, the reason low rates boost the stock market is because any discount cash flow model, when discounting at ultra-low rates means current values should be higher.  This is why rising yields become a problem for equity prices. In fact, it is reasonable to analogize being long growth stocks to being long bond duration, so when bond prices fall and yields rise accordingly the same thing happens to those stocks.  If this relationship holds going forward, and inflationary concerns do continue to percolate in the market, it would appear equity prices could be in for a bumpy ride.

Clearly, that is not yet the case (after all, inflation hasn’t yet reared its ugly head), as evidenced by the overnight price action in the wake of Powell’s comments.  Asia was strong (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +0.5%) and most of Europe is as well (CAC +0.55%, FTSE 100 +0.7%) although the German DAX (-0.25%) is a bit of a laggard this morning as concerns over Q1 GDP rise due to the third Covid wave.  US futures, though, are all-in with Jay, rising between 0.5% (Dow) and 1.0% (NASDAQ).  That makes sense given the assurances that there will be no tapering forever the foreseeable future.

As to the dollar, there are two different narratives at odds here.  On the one hand, the fundamentalists continue to point to a weaker dollar in the future as rising inflation tends to devalue a currency, and when combined with the massive fiscal deficit policy, a dollar decline becomes the only outlet available for pressure on the economy.  On the other hand, rising yields tend to support the dollar, so as Treasury yields continue to rise, if they stay ahead of the inflation statistics, there is reason to believe that the dollar has further to gain from here.  Of course, if inflation outstrips the rise in nominal yields such that real yields decline, we could easily have a situation with higher nominal Treasury yields and a much weaker dollar.  For now, the inflation data is lagging the Treasury market, but I suspect that by the end of May, that will not be the case, meaning the long-awaited dollar decline has a much better chance to get started then.

In the meantime, the dollar has softened ever so slightly this morning.  Versus G10 currencies, only JPY (-0.25%) has declined as the rebound in Treasury yields this morning seems to be garnering interest in the Japanese investment community.  But, while the dollar is softer vs. everything else, nothing has even moved 0.2%, which implies there is no news beyond the Fed.  In the EMG space, the dollar is also largely softer, led by HUF (+0.5%), THB (+0.45%) and INR (+0.45%).  HUF continues to benefit from the relatively hawkish stance of the central bank, while the baht rallied despite a reduction in the 2021 GDP estimate to 2.3% as Covid infections increase in the nation.  Meanwhile, INR appears to be the beneficiary of the Fed’s stance as clearly, the ongoing domestic disaster regarding its response to the latest wave of Covid infections cannot be seen as a positive.

On the data front, we start with Initial Claims (exp 540K) and Continuing Claims (3.59M) but also see the first look at Q1 GDP (6.6%), with a range of estimates from 4.5% to 10.0%!  With the Fed meeting behind us, we should start to hear from FOMC members again, but today only has Governor Quarles discussing financial regulation, a much drier subject than inflation.  Tomorrow, however, we will see the latest Core PCE data, and that has the chance to move things around.

As of now, the dollar remains on its back foot given the Fed’s clear message that tapering is a long way off and easy money is here for now.  However, if Treasury yields start to rise further, especially if they get back toward the 1.75% level, I expect the dollar will rebound.  On the other hand, if Treasuries remain quiet, the dollar probably has further to fall.

Good luck and stay safe
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Lower Forever’s Outdated

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A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away

The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated

Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm.  Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.

What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today.  Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities.  So, what’s all the hubbub?

Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward.  In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus.  As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data.  Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year.  And they well could do so.

However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it.  And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%.  No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial.  In fact, I doubt two months will qualify.  If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases.  I think the market is way ahead of itself on this issue.

Consider, as well, this puzzle.  The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money.  As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields.  Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt.  One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds.  So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases?  Personally, I cannot do so, it is one or the other.

Which brings us to what can we expect today?  Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement.  As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.

Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets.  If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure.  However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price.  We shall see starting at 2:00 today.

As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals.  Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions.  Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.

Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday.  In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps).  There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates.  By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.

On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level.  While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.

The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%).  The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth.  Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.

EMG currencies are a bit more mixed, with a spread of gainers and losers this morning.  On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty.  A negative ruling could have a major impact on Poland’s banking sector and by extension the economy.  Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news.  On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.

Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact.  Equity futures are biding their time as are most market participants as we all await Mr Powell.  Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.

Good luck and stay safe
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Ephemeral

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Inflation remains
Ephemeral in Japan
Will Suga as well?

Leadership in Japan remains a fraught situation as highlighted this week.  First, three by-elections were held over the weekend and the governing LDP lost all three convincingly.  PM Yoshihide Suga is looking more and more like the prototypical Japanese PM, a one-year caretaker of the seat.  Previous PM, Shinzo Abe, was the exception in Japanese politics, getting elected and reelected several times and overseeing the country for more than 8 years.  But, since 2000, Suga-san is the 9th PM (counting Abe as 1 despite the fact he held office at two different times).  In fact, if you remove Abe-san from the equation, the average tenor of a Japanese PM is roughly 1 year.  Running a large country is a very difficult job, and in the first year, most leaders are barely beginning to understand all the issues, let alone trying to address whichever they deem important.  In Japan, not unlike Italy, the rapid turnover has left the nation in a less favorable position than ought to have been the case.

Of course, long tenure is no guarantee of success in a leadership role, just ask BOJ Governor Haruhiko Kuroda.  He was appointed to the role in February 2013 and has been a strong proponent of ultra-easy monetary policy as a means to stoke inflation in Japan.  The stated target is 2.0%, and for the past 8 years, the BOJ has not even come close except for the period from March 2013-March 2014 when a large hike in the Goods and Services Tax raised prices on everyday items and saw measured inflation peak at 3.7% in August.  Alas for Kuroda-san, once the base effects of the tax hike disappeared, the underlying lack of inflationary impulse reasserted itself and in the wake of the Covid-19 pandemic lockdowns, CPI currently sits at -0.2%.

Last night, the BOJ met and left policy on hold, as expected, but released its latest economic and inflation forecasts, including the first look at their views for 2023.  Despite rapidly rising commodity prices as well as a slightly upgraded GDP growth forecast, the BOJ projects that even by 2023, CPI will only rise to 1.0%.  Thus, a decade of monetary policy largesse in Japan will have singularly failed to achieve the only target of concern, CPI at 2.0%.

Personally, I think the people of Japan should be thankful that the BOJ remains unsuccessful in this effort as the value of their savings remains intact despite ZIRP having been in place since, essentially, 1999.  While they may not be earning much interest, at least their purchasing power remains available.  But the current central bank zeitgeist is that 2.0% inflation is the holy grail and that designing monetary policy to achieve that end is the essence of the job.  The remarkable thing about this mindset is that every nation has a completely different underlying situation with respect to its demographics, debt load, fiscal accounts and growth capabilities, which argues that perhaps the one size fits all approach of 2.0% CPI may not be universally appropriate.

In the end, though, 2.0% is the only number that matters to a central banker, and for now, virtually everyone worldwide is trying to design their policy to achieve it.  As I have repeatedly discussed previously, here at home I expect that soon enough, Chairman Powell and friends will find themselves having to dampen inflation to achieve their goal, but for now, pretty much every G10 central bank remains all-in on their attempts to push price increases higher.  That means that ZIRP, NIRP and QE will not be ending anytime soon.  Do not believe the tapering talk here in the US, the Fed is extremely unlikely to consider it until late next year, I believe, at the earliest.

Delving into Japanese monetary policy seemed appropriate as central banks are this week’s story line and we await the FOMC outcome tomorrow afternoon.  In addition to the BOJ, early this morning Sweden’s Riksbank also met and left policy unchanged with their base rate at 0.0% and maintained its QE program of purchasing a total of SEK 700 billion to help keep liquidity flowing into the market.  But there, too, the inflation target of 2.0% is not expected to be achieved until 2024 now, a year later than previous views, and there is no expectation that interest rates will be raised until then.

What have these latest policy statements done for markets?  Not very much.  Overall, risk appetite is modestly under pressure this morning as Japan’s Nikkei (-0.5%) was the worst performer in Asia with both the Hang Seng and Shanghai indices essentially unchanged on the day.  I would not ascribe the Nikkei’s weakness to the BOJ, but rather to the general tone of malaise in today’s markets.  European equity markets have also been underwhelming with red numbers across the board (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%) albeit not excessively so.  Here, too, apathy seems the best explanation, although one can’t help but be impressed with the fact that yet another bank, this time UBS, reported significant losses ($774M) due to their relationship with Archegos.  As to US futures, their current miniscule gains of 0.1% really don’t offer much information.

Bond prices are also under very modest pressure with 10-year Treasury yields higher by 1.1bps and most of Europe’s sovereign market seeing yield rises of between 0.5bps and 1.0bps.  In other words, activity remains light as investors and traders await the word of god Powell tomorrow.

Commodity prices, on the other hand, are not waiting for anything as they continue to march higher across the board.  Oil (+0.8%) is leading the energy space higher, while copper (+1.1%) is leading the base metals space higher.  Gold and silver have also edged slightly higher, although they continue to lag the pace of the overall commodity rally.

The dollar, which had been uniformly higher earlier this morning is now a bit more mixed, although regardless of the direction of the move, the magnitude has been fairly small.  In the G10 space, the leading decliner is AUD (-0.2%) which is happening despite the commodity rally, although it is well off its lows for the session.  That said, it is difficult to get too excited about any currency movement of such modest magnitude.  Away from Aussie, JPY (-0.2%) is also a touch softer and the rest of the G10 is +/- 0.1% changed from yesterday’s closing levels, tantamount to unchanged.

EMG currencies have seen a bit more movement, but only TRY (+0.75%) is showing a substantial change from yesterday.  it seems that there is a growing belief that the tension between the US and Turkey regarding the Armenian genocide announcement by the Biden administration seems to be ebbing as Turkish President Erdogan refrained from escalating things.  This has encouraged traders to believe that the impact will be small and return their focus to the highest real yields around.  But away from the lira, gainers remain modest (KRW +0.25%, TWD +0.2%) with both of these currencies benefitting from equity inflows.  On the downside, ZAR (-0.35%) is the laggard as despite commodity price strength, focus seems to be shifting to the broader economic problems in the nation, especially with regard to a lack of power generation capacity.

Data this morning brings Case Shiller Home Prices (exp 11.8%) and Consumer Confidence (113.0), neither of which is likely to have a big impact although the Case Shiller number certainly calls into question the concept of low inflation. With the FOMC tomorrow, there are no Fed speakers today, so I anticipate a relatively dull session.  Treasury yields continue to be the underlying driver for the dollar in my view, so keep your eyes there.

Good luck and stay safe
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QE Will Wane

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Some pundits have come to believe
That sometime before New Year’s Eve
The Fed will explain
That QE will wane
Though others are sure they’re naïve

So, let’s listen to what the Fed
Has very consistently said
Without hard statistics,
Not simple heuristics,
The idea of tapering’s dead

As a new week begins, all eyes are turning to the central bank conclaves scheduled for the latest clues in monetary policy activity.  Recall last week, the Bank of Canada surprised almost everyone by explaining they would reduce the amount of QE by 25% (C$1 billion/week) as they see stronger growth and incipient inflationary pressures beyond the widely discussed base effects that are coming soon to a screen near you.  This has clearly inspired the punditry, as evidenced by a recent survey of economists carried out by Bloomberg, showing more than 60% of those surveyed expect the Fed to begin to taper QE before the end of this year.  When the same questions were asked in March, less than 50% of those surveyed expected a tapering this year.  Obviously, we have seen a run of very strong survey data, as well as a very strong payroll report at the beginning of this month.  In addition, the vaccine rate has increased substantially, with the combination of these things leading to significantly upgraded economic forecasts for the US this year.

And yet, everything we have heard from Chairman Powell and the rest of the FOMC has been incredibly consistent; they are not even thinking about thinking about tapering monetary policy and will not do so until substantial further progress toward their goals of maximum employment and average inflation of 2.0% are achieved.  In addition, Powell has promised to communicate very clearly, well in advance, that changes are in the offing.  While we have had two strong employment reports in a row, the combined job gains remain a fraction of the 10 million that Powell has repeatedly explained need to be regained.  Arguably, we will need to see NFP numbers north of 750K for the next 6-9 months before the Fed is even close to their target and will consider taking their foot off the proverbial accelerator.

Of course, there is one thing that could force earlier action by the Fed, inflation rising more quickly than anticipated.  As of now, the Fed remains unconcerned over price rises and have made it clear that while the data for the next several months will be rising quickly, it is a transitory impact from the now famous base effects caused by the Covid induced swoon this time last year.  Even then, given the new framework of average inflation targeting, rather than a hard numeric target, a few more months of above 2.0% core PCE will hardly dissuade them from their views as they have nearly a decade of lower than 2.0% core PCE to offset.

But what if inflation is more than a transitory event?  While the plural of anecdote is not data, it certainly must mean something when every week we hear from another major consumer brand that prices will be rising later this year.  Personal care products, food and beverages have all been tipped for higher prices this year.  The same is true with autos and many manufactured goods as the consistent rise in input prices (read commodities) is forcing the hands of manufacturers.  While it is true that, by definition, core PCE removes food & energy prices, to my knowledge, neither toothpaste nor Teslas are core purchases.

The medium-term risk appears to be that inflation runs, not only hotter than the Fed expects, but hot enough that they begin to become uncomfortable with its impact.  While the natural response would be to simply raise rates, given Jay’s effective promise not to raise rates until 2023, as well as the fact that the Treasury can ill afford higher interest rates (nor for that matter can the rest of the economy given the amount of leverage that is outstanding), the Fed may well find themselves in quite a bind later this year.  One cannot look at the price of copper (+1.9% today, 25.6% YTD), aluminum (+1.2%, 21.1%) or iron ore (+0.4%, 16.0%) without considering that those critical inputs, neither food nor energy, are going to drive price pressures higher.  And, by the way, food and energy prices have been rocketing as well (Corn +38% YTD, Wheat +13.1%, Soybeans +18.2%, WTI +26.1%).  Chairman of the Fed may not be that attractive a position by the time Powell’s term ends in February.

Turning to the markets, if I had to characterize them in a theme, it would be idle.  Equity markets are generally flat to lower with the odd exception in Asia (Nikkei +0.4%, Hang Seng -0.4%, Shanghai -1.0%) and Europe (DAX -0.2%, CAC 0.0%, FTSE 100 0.0%).  US futures are also noncommittal this morning, with the NASDAQ (-0.3%) the only one having really moved.

In the bond market, the rally we had seen over the past three weeks has stalled and is starting to cede some ground.  For instance, Treasuries (+3.7bps) are leading the way higher but we are seeing higher yields throughout Europe (Bunds +2.3bps, OATs +2.5bps, Gilts +3.0bps) and even saw gains overnight in Australia (+1.8bps) and Japan (+0.5bps).  Historically, that would have seemed to be a risk-on phenomenon, but given the lack of equity strength, this feels a lot more like an inflationary call.

While the metals space is strong today, oil is actually softer (-1.7%) as concerns over the rampant spread of Covid in India and other emerging markets undermines the vaccine news in the West.

As to the dollar, it is generally, but not universally, weaker this morning.  In the G10, AUD (+0.6%), NZD (+0.3%) and CAD (+0.3%) are the leaders, with all benefitting from the metals rally, which has been sufficient to offset weaker oil prices for the Loonie.  On the downside, NOK (-0.1%) is clearly feeling a bit of pressure from oil, although 0.1% hardly makes a statement.  EMG currencies are showing the same type of price action with TRY (+1.2%) the leading gainer as it rebounds from near-record lows amid hopes the tension with the US will be temporary.  Away from the lira, TWD (+0.5%) rallied on concerns that the Taiwanese government would be pressured by the US with respect to its currency and competition concerns.  We saw similar, but lesser pressure on KRW (+0.4%).  Meanwhile, the modest declines seen in HUF (-0.2%) and MXN (-0.1%) define the other side of the spectrum.

Clearly, the FOMC meeting is the highlight of the week, but there is other important data as well, including the BOJ tonight.

Today Durable Goods 2.5%
-ex transport 1.6%
Tuesday Case Shiller Home Prices 11.8%
Consumer Confidence 112.0
Wednesday FOMC Decision 0.00% – 0.25%
IOER 0.12%
Thursday Initial Claims 550K
Continuing Claims 3.59M
GDP Q1 6.9%
Personal Consumption 10.3%
Friday Personal Income 20.0%
Personal Spending 4.2%
Core PCE 1.8%
Chicago PMI 64.2
Michigan Sentiment 87.5

Source: Bloomberg

The end of the week is where all the action will be, assuming Chairman Powell doesn’t shake things up Wednesday afternoon.  Core PCE is forecast to print at its highest level since February 2020, but if you recall the CPI data, it was a tick higher than forecast as well.  Of course, for now, it doesn’t matter.  This is all transitory.

Nothing has changed my opinion with respect to the relationship between the dollar and the 10-year Treasury yield.  While it is not actually tick for tick, if yields do back up, I would look for the dollar to find its footing in the near term.  I know the dollar bears are back in force, but we need to see a break above the 1.2350 level in the euro to really turn the tide in my view.  Otherwise, we are simply at the bottom of the dollar’s range.

Good luck and stay safe
Adf

So Slyly

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The stock market’s feeling some pains
As word is that capital gains
Will soon be taxed highly
As Biden, so slyly
Pays tribute to John Maynard Keynes

It can be no surprise that the Biden administration has begun to float trial balloons regarding higher tax rates as they were a key plank in Biden’s presidential campaign.  Given the remarkable amount of money that this administration seems to want to spend, there needs to be some additional revenue to help pay for things, although the gap between the spending plans and forecast revenue enhancements remains extremely wide.  For instance, while the mooted price tag for the American Jobs Plan, the latest proposal, is on the order of $2.3 trillion, the estimated revenues of the capital gains tax rise is somewhere in the $500 billion to $1 trillion zone.  That’s still a pretty big gap that needs to be filled.  Of course, we know that the Treasury will simply borrow the difference, and based on current form, the Fed will buy most of that.  Who knows, maybe MMT really does work, and everything will work out fine.

Investors, though, seeing the world through a slightly different prism than policymakers, may decide that while the extraordinary equity market rally has been lots of fun, it might be time to take some money off the table.  When the first headlines about a doubling of capital gains taxes hit the tape, US markets fell about 1.3% and finished lower on the day.  Now, we are still a long way from those tax laws being enacted, but do not be surprised if equity markets have more difficulty making new highs going forward.  After all, if the government is going to tax away your gains, the risk/reward equation will change for the worse.  (While on the subject of taxes, there was a rumor that the Treasury was talking about 70% marginal tax rates on Bitcoin and other cryptocurrency gains.  It should be no surprise they suffered as well.)

Attempting, us all, to assure
Lagarde said, t’would be “premature”
To taper our buying
Since we are still trying
To help the recovery endure

Yesterday’s other big story was the ECB meeting where, while policies were left unchanged as expected, there was a great deal of anticipation that Madame Lagarde might offer some hints as to the structural reforms due to be announced in June, or even give a bit more guidance on the current situation within the PEPP.  Alas, the information quotient from this meeting was pretty limited.  Lagarde insisted that increased buying in the PEPP, which was a key outcome from the March meeting, would remain in place, although the pace of purchases does not seem to have increased all that much.  Yet when asked directly about the probability of tapering those purchases, Lagarde was adamant that it was “simply premature” to discuss that subject.

What is becoming apparent at the ECB is that there is a growing divide between the hawks and doves regarding how policy should evolve.  The Frugal four are clearly seeing improved economic activity and the beginnings of rising prices while the more profligate southern countries continue to lag in both economic activity and rate of vaccinations.  It is becoming clear that a single monetary policy is no longer going to be efficient for both groups of countries simultaneously.  When Super Mario was ECB President, he simply ran roughshod over the hawks, but then he had the policy chops to do so on his own.  It remains to be seen if Madame Lagarde will have the same ability.  The upshot is that we could be looking at some more volatility in Eurozone markets if the hawks start speaking in concert and do not back Lagarde.  We shall see.

Away from those stories, though, the market this morning is ostensibly focused on the better than expected PMI data that we have seen around the world.  Starting with Australia last night, and on to Japan and most of Europe and the UK, the big gainer was Services PMI, which is back above 50 everywhere except Japan, which printed at 48.3.  But Australia, the Eurozone and the UK are all back in expansionary territory as anticipation of the great reopening takes hold.  In this regard, the Japanese data makes sense as the nation is about to impose lockdowns again for the next two weeks in Tokyo, Kyoto and two other prefectures, closing bars and restaurants and banning public gatherings.

In addition to the PMI data, UK Retail Sales was quite strong, rising 4.9% M/M ex fuel, as were Japanese Department Store Sales (+21.8%).  With all of this positive data, it can be no surprise that the dollar is under pressure this morning, but it is a bit surprising that equity markets in Europe are under pressure (DAX -0.3%, CAC -0.2%, FTSE 100 -0.4%) and sovereign bond yields are softer (Bunds -1.3bps, OATs -1.2bps, Gilts -0.7bps).  While buy the rumor, sell the news is always a viable thought process, it strikes me that there were no rumors of this type of economic strength.

Finishing the market recap, commodities are firmer (WTI +0.5%, Au +0.1%, Cu +0.8%), which syncs well with the dollar’s weakness.  In the G10 space, the dollar is softer versus the entire spectrum of currencies, with EUR (+0.3%) and GBP (+0.3%) leading the way while JPY (+0.1%) is the laggard today.  In the EMG space, RUB (+0.6%) is the leading gainer after the Bank of Russia raised their base rate by 0.50% to 5.00% in a surprise as only 25bps was expected.  Away from that, the CE4 are all following the euro higher and then commodity currencies are also edging higher, but by much lesser amounts (ZAR +0.2%, MXN +0.2%).  There are a few decliners here, TRY (-0.2%), INR (-0.1%) but the size of the move is indicative of the lack of general interest.  Certainly, both those nations have been suffering more significantly with Covid lately, and it would not be a surprise to see both currencies continue to lag until that situation changes.

On the data front this morning, New Home Sales (exp 885K) is the major number, although preliminary PMI data (61.0 Mfg, 61.5 Services) is also due.  In the US, though, there is far more focus on ISM than PMI.  With the Fed coming up next week, there is no Fedspeak to be had, so as we head into the weekend, it is reasonable to expect a quiet session.  Equity futures are currently slightly in the green, roughly 0.15%, so perhaps the gut reaction to the tax news has passed and won’t have an impact.  But the one thing of which we can be certain appears to be that higher taxes are on the way.  That is a double whammy for equities as higher corporate tax rates will reduce earnings while higher cap gains taxes will encourage selling before those taxes come into effect.

In the end, though, nothing has changed the underlying market driver, the 10-year Treasury.  If yields there continue to slide, the dollar will remain weak across the board.  If they reverse, look for the dollar to rebound.  Next week, after the Fed, we see Core PCE data on Friday.  Currently, that is forecast to rise 1.8%.  a high side surprise there could well shake things up with regard to views on tapering with a corresponding impact on all markets.  But until the Fed on Wednesday, it seems we are in for some slow times.

Good luck, good weekend and stay safe
Adf

Powell Won’t Waver

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The story last quarter was prices
Would rise, leading up to a crisis
So, bond markets dropped
The dollar, she popped
And gold bugs all made sacrifices

But now a new narrative line
Explains that inflation’s benign
So, bonds are in favor
As Powell won’t waver
While dollars resume their decline

All year long the market story has been driven by the yield on the 10-year Treasury bond.  Ever since the run-off elections in Georgia in the beginning of January, market anticipation has been for significant growth in the US on the heels of increased vaccination rates and increased fiscal stimulus.  In Q1, Treasury yields rose dramatically, touching as high as 1.77% at their top toward the end of March.  Meanwhile, the dollar, which had been slated to decline all year, rallied versus every emerging market currency and all but CAD, GBP and NOK in the G10.

But, as of the first of this month, the world appears to be a different place, as Treasury bonds have rallied driving yields lower and supporting equity and commodity markets.  At the same time, the dollar has come under broad-based pressure and reversed a large portion of its Q1 gains.

Currently, the narrative appears to be along the following lines: US GDP growth in 2021 is going to be spectacular, well above 6.0% and its strongest since 1984.  Inflation, meanwhile, will print at higher levels for Q2 purely as a result of base effects, but will then resume its long-term downtrend and the Fed will be required to continue to support the economy aggressively in order to meet their goals.  By the way, the Fed’s newly articulated goal is for maximum employment, not full employment, and they have promised to become completely reactive, waiting for hard data to confirm positive results in employment and wages, before considering any efforts to rein in rising prices.

Equity markets still love the story as the implication is that interest rates will not be rising at all this year, nor next year for that matter, at least in the front end of the curve.  Treasury markets, which appeared to get a little panicked in Q1 have reverted to form and seem to be pricing one of two things; either less impressive economic growth, or anticipation that the Fed will expand QE or YCC as Powell and friends seek to prevent any significant rise in yields.  Meanwhile, the dollar is falling again, gold is rising and commodity prices (the one true constant) remain firm.

Have we reached economic nirvana?  Some skepticism might be in order given the myriad issues that can undermine this narrative.  The primary issue is, of course, another wave of Covid spreading throughout the US and the world.  As the virus mutates, it is not clear that the current vaccines are going to be effective preventatives to new strains.  While the vaccination progress in the US and UK has been excellent, with 40% and 50% of their respective populations receiving at least the first dose, the same cannot be said elsewhere in the world.  In fact, the newsworthy item of the day is that India reported 315,800 new cases just yesterday!  Alongside Brazil and Turkey, these three nations, with a combined population of nearly 1.7 billion find themselves in the midst of another serious wave of infection.  Remember that a huge part of the reopening and growth narrative is the ending of the pandemic.  It is still too early to make that claim, and so, perhaps a bit early to count the 2021 GDP growth figures as a given.

However, there is a second issue of note that cannot be ignored, and that is the inflation story.  While it is clear that the Fed has convinced themselves inflation is not a concern, that the elevated readings that are almost certain to come over the next three months will be ‘transitory’, there is a case to be made that rising inflation may have a more lasting impact.

Consider that oil prices have risen dramatically from their levels this time last year and continue to trend higher.  Now, while the Fed looks at core prices, ex food & energy, the reality is that rising energy prices feed into everyday items beyond the cost of filling your gas tank.  Given that virtually everything produced and consumed requires energy to create, eventually higher energy prices feed into the cost of all those products.  It can be even more direct for services such as shipping, where energy price surcharges are common.  But just because something is labeled a surcharge doesn’t mean it hasn’t raised the price of the item consumed.  The point is, rising energy prices and rising commodity prices in general, are leading to higher input costs which will eventually lead to higher prices.  We continue to see the evidence in data like PPI and the price indices in the PMI and ISM data.

And these are just the two largest known issues.  Less probable, but potentially highly significant, we could see increased tension in US-China relations, with a stepped-up trade war, or even a confrontation over the situation in Taiwan.  Neither can one rule out more mischief from Russia, or Middle Eastern strife that could easily impact the supply of oil and hence its price.  The point is, it seems early to declare that the worst is behind us and price securities and risk as though that is the case.

Market activity today is relatively muted as investors and traders await the latest word(s) from Madame Lagarde and the ECB.  Expectations are there will be no changes to policy, but the real hope is that she will give clearer guidance on their plans going forward.  You may recall at the last meeting they expressed some dismay that bond yields had risen as much as they had and promised to increase PEPP purchases.  Since then, while they have increased those purchases, the amount of increase has been less than impressive and yields in Europe, while not rising further, have not returned to previous lower levels.  At the same time, as US yields have fallen back more than 20bps from their recent highs, the euro (+0.2%) has resumed its climb and is back above 1.20 for the first time since early March.  One thing we know is that the ECB can ill afford a stronger euro, so some type of response may be forthcoming.

Speaking of central banks, yesterday’s big surprise came from north of the border as the Bank of Canada, while leaving policy on hold, changed their tune on the timing for the end of QE.  They brought forward their tapering timeline and the market brought forward the rate hike timeline in response.  It seems that the employment situation in Canada has returned far closer to pre-Covid levels than in the US, with more than 90% of the jobs lost having been regained.  While CAD has given up 0.1% this morning, this is after a nearly 1.0% rise yesterday in the wake of the BOC announcement.

A quick look at equity markets around the world shows that Asia had a pretty good session (Nikkei +2.4%, Hang Seng +0.5%, Shanghai -0.25%) while Europe is all green and has been steadily climbing all day (DAX +0.45%, CAC +0.6%, FTSE 100 +0.1%).  US futures, however, are ever so slightly softer, down about 0.15% across the board, although this was after solid rallies yesterday afternoon.  Meanwhile, bond markets are under the barest of pressures with yields edging higher in the US (+0.5bps) and Europe (Bunds +0.4bps, OATs +0.8bps, Gilts -0.4bps), really showing a market waiting for the next piece of data.

Energy prices are under modest pressure this morning (WTI -0.5%), as are precious metals (Au -0.3%, Ag -0.6%) and industrials (Cu 0.0%, Zn -0.2%, Al -0.2%).

It can be little surprise that the dollar is mixed this morning, given the lack of a coherent market theme, although there are some modest surprises.  NOK (+0.25%) for example is stronger in the face of weaker oil prices.  Meanwhile NZD (-0.3%) is the weak link in the G10, on the back of market internals and stop-loss selling.  EMG currencies have a few more substantial movers with RUB (+1.25%) the leading gainer by far after President Putin’s state of the nation address focused entirely on domestic issues rather than feared saber rattling.  This encouraged bond buying and strength in the ruble.  On the other end of the spectrum is TRY (-0.8%) which has seen further investor outflow after reports that the US administration is prepared to raise the issue of the Armenian genocide and put further pressure to isolate President Erdogan.  However, away from those two movers, the rest of the bloc is +/- 0.2% or less.

Aside from the ECB meeting, the US data slate brings Initial Claims (exp 610K), Continuing Claims (3.6M), Leading Indicators (1.0%) and Existing Home Sales (6.11M).  Clearly the Claims data is the most important of the bunch with a strong number possibly helping to halt the Treasury rally and potentially support the dollar.  We are in the Fed quiet period, so no speakers there.

The rest of the day will take its tone from Madame Lagarde, but if she is less than forceful, I would expect the current trend (modestly lower yields, modestly higher equities and modestly weaker dollar) to continue.

Good luck and stay safe
Adf

We’ll Be Behind

Posted on by

The Chair and the Vice-Chair both said
Before we raise rates at the Fed
We’ll taper our buying
While we’re verifying
If growth can keep moving ahead

So, don’t look at forecasts ‘cause we
Care only for hard stats we see
Thus, we’ll be behind
The curve, but you’ll find
Inflation we’ll welcome with glee

The Fed has made clear they are driving the bus looking only in the rearview mirror.  This is a pretty dramatic change in their modus operandi.  Historically, given the widespread understanding that monetary policy works with a lag of anywhere from 6 months to 1 year, the Fed would base policy actions on their forecasts of future activity.  This process was designed to prevent inflation from rising too high or allowing growth to lag too far from trend.  One of the problems they encountered, though, was that they were terrible forecasters, with their models often significantly understating or overstating expectations of future outcomes.

So, kudos to Chairman Powell for recognizing they have no special insight into the future of the economy.  It is always difficult for an institution, especially one as hidebound as the Federal Reserve, to recognize its shortcomings.  This does beg the question, though, if they are going to mechanically respond to data with policy moves, why do they even need to be involved at all?  Certainly, an algorithm can be programmed to make those decisions without the added risk of making policy errors. Instead, the Fed could concentrate on its role as banking supervisor, an area in which they have clearly fallen behind.  But I digress.

Back in the real world, this change, which they have been discussing for some time, is truly important.  It seems to be premised on the idea that measured inflation remains far below their target, so running the economy ‘hot’ is a desirable way to achieve that target.  And running the economy hot has the added benefit of helping to encourage maximum employment in the economy, their restated goal on that half of the mandate.  It also appears to assume that they have both the tools, and the wherewithal to use them, in case inflation gets hotter than currently expected.  It is this last assumption that I fear will come back to haunt them.  But for now, this week’s CPI data did nothing to scare anybody and they are feeling pretty good.

One other thing they both made clear was that the timing of any rate hike was absolutely going to be after QE purchases are completed.  So, the tapering will begin at some point, and only when they stop expanding the balance sheet will they consider raising the Fed Funds rate.  Right now, the best guess is late 2023, but clearly, since they are data driven, that is subject to change.

There is a conundrum, though, in the markets.  Despite this very clear policy direction, and despite the fact that bond investors are typically quite sensitive to potential inflation, Treasury yields have seemingly peaked for the time being and continue to slide lower.  Certainly, the auctions this week, where the Treasury issued $120 billion in new debt were all well received, so concerns over a buyer’s strike were overblown.  In fact, overnight data showed that Japanese buyers soaked up nearly $16 billion in bonds, the largest amount since last November.  But, depending on how you choose to measure real interest rates, they remain somewhere between 0.0% and -1.0% based on either Core or Headline CPI vs. the 10-year.  Traditionally, headline has been the measure since it represents everything, and for a bond investor, they still need to eat and drive so those costs matter.

Summing this all up tells us 1) the Fed is 100% reactive to data now, so overshooting in their targets is a virtual given; 2) interest rates are not going to rise for at least another two years as they made clear they will begin tapering their QE purchases long before they consider raising interest rates; and 3) the opportunity for increased volatility of outcomes has grown significantly with this new policy stance since, by definition, they will always be reactive.  To my mind, this situation is one where the current market calm is very likely preceding what will be a very large storm.  If central banks handcuff themselves to waiting for data to print (and remember, hard data is, by definition, backwards looking, generally at least one month and frequently two months), trends will be able to establish themselves such that the Fed will need to respond in a MUCH greater manner to regain control.  Markets will not take kindly to that situation.  But that situation is not yet upon us, so the bulls can continue to run.

And run they have, albeit not as quickly as they have been recently.  In Asia overnight, it was actually a mixed performance with the Nikkei (+0.1%) eking out a small gain while the Hang Seng (-0.4%) and Shanghai (-0.5%) both stumbled slightly.  Europe, on the other hand, is all green with gains ranging between 0.2% and 0.4% across the major markets.  US futures are actually looking even better, with gains of 0.45%-0.6% at this hour.  Earnings season started yesterday, and the big banks all killed it in Q1, helping the overall market.

Bond yields, meanwhile, are continuing to slide, with Treasuries (-1.9bps) continuing to show the way to virtually all Western bond markets.  Bunds (-1.6bps), OATs (-2.0bps ) and Gilts (-2.7bps) are rallying as well despite the generally upbeat economic news.  There was, however, one negative release, where the German economic Institutes have cut their GDP forecast by 1.0%, to 3.7%, after the third wave and concomitant lockdowns.

Oil prices, which have had a huge runup this week, have slipped a bit, down 0.5%, but the metals markets are all in the green with Au (+0.6%), Ag (+0.6%), Cu (+1.5%) and Al (+0.25%) all in fine fettle.

It can be no surprise that with Treasury yields lower and commodity prices generally higher, the dollar is under further pressure this morning.  In the G10, the commodity bloc is leading the way with NZD (+0.25%), CAD (+0.2%) and AUD (+0.2%) all performing well.  There are a few laggards, but the movement there is so small, it is hardly a sign of anything noteworthy.  The euro, for instance, is lower by 0.1%, truly unremarkable.  In the EMG bloc, RUB (-1.2%) is the biggest mover, suffering on the news that the Biden Administration is slapping yet more sanctions on Russia for their election meddling efforts.  After that, HUF (-0.4%) has suffered as the central bank maintains its rate stance despite quickening inflation readings.  On the plus side, ZAR (+0.65%) and MXN (+0.3%) are the leading gainers, both clearly benefitting from the commodity story today.

One thing to watch here is the technical picture as despite the slow-motion decline in the dollar since the beginning of the month, it is starting to approach key technical support levels with many traders looking for a breakout should we breach those levels.  We shall see, but certainly if Treasury yields continue to slide, the dollar is likely to slide further.

We have a bunch of data today led by Initial Claims (exp 700K), Continuing Claims (3.7M), Retail Sales (+5.8%, +5.0% ex autos) and then Empire Manufacturing (20.0), Philly Fed (41.5), IP (2.5%) and Capacity Utilization (75.6%).  The Retail Sales data is based on the second stimulus check being spent, and the Claims data is assuming strength based on the NFP from last month.    We also hear from a bunch more speakers, but Powell and Clarida are done, so it would be surprising to see anything new from this group of three.

All told, nothing has changed my view that as goes the 10-year Treasury yield, so goes the dollar.  That will need to be proven wrong consistently before we seek another narrative.

Finally, I will be taking a few, very needed, days off so there will be no poetry until I return on Thursday April 22.

Good luck, good weekend and stay safe
Adf

Not If But When

Posted on by

Eight years ago, when Chairman Ben
Suggested t’was not if but when
The Fed would reduce
Its purchase, profuse,
Of bonds, traders sold bonds, bought yen

But these days when taper’s discussed
The bond market doesn’t seem fussed
The reason could be
There’s now nobody
The market invests with its trust

Yesterday’s CPI data printed a tick higher than forecast indicating that, yes, prices are rising relative to last year.  The headline print of 2.6% was the beneficiary of a substantial rise in energy prices compared to last year, but the core price index indicated that both goods and services prices are rising in price.  One data point is not enough to make any claims in either direction, but it will certainly keep the discussion going for a while.  The market response was somewhat counterintuitive as by the end of the day, 10-year Treasury yields had fallen 6 basis points and the dollar was softer amid modestly firmer equity prices.  While the link between the dollar and Treasuries remains intact, the question is why would bonds rally (yields decline) if inflation was rising?

One possible answer is that the market had gotten far ahead of itself with respect to pricing in rising inflation.  Historically, inflation takes time to manifest itself as prices on many things are sticky, meaning they remain stable for a time amid broad pressures and then shift in a relatively large step, rather than a gradual daily or weekly increase.  We are all familiar with the situation when an item regularly purchased suddenly rises in price to catch up to the broad underlying price pressures.  But when taken over the totality of all goods purchased, while any given good or service may see prices rise in discrete steps, the index moves up in a relatively smooth manner.  This fact is why yesterday’s data are interesting, because the headline jump of 0.6% M/M certainly tests the definition of smooth.  Consider that a monthly increase of 0.6% would result in annual inflation of 7.4%, a level that even the Fed would consider too hot.  FYI, yesterday’s core print, which was actually 0.34%, would represent 4.2% core CPI over a year.  So, yes, the base effects were instrumental in the much higher Y/Y data, but the monthly increases were pretty high in any accounting.

And yet, the bond market ultimately rallied all day, having touched 1.7% in early European trading and closing the session at 1.615%.  If this wasn’t a classic case of buy the rumor, sell the news, I don’t know what is.  And, as we have seen consistently all year, the dollar dutifully followed yields lower while equity markets ultimately rallied, although the euphoria over the value trade seems to be waning.

Perhaps of more interest is the fact that we have now had 3 key central bankers, two from the ECB, Knot and Villeroy, and the Fed’s Bullard all start to discuss the idea of tapering bond purchases.  This seems incongruous given the adamant claims on both sides of the pond that current monetary policy is necessary and appropriate to ensure the respective economies return to form.  And yet each of these discussed how tapering of QE could begin before the year is out.  You may recall that Bullard wanted to tie the idea of tapering to the level of vaccinations in the economy, indicating that when 75% of the population is vaccinated, it could be time to start slowing purchases with the implication being the economy would then be able to stand on its own two feet.

This morning, Banque de France Governor Villeroy de Galhau explained that there could be an evolution in monetary policy at the ECB, which while remaining accommodative would shift the burden back to the APP (the original QE plan) from PEPP, which will ostensibly run its course in March 2022.  Last week, Knot, the Dutch Central Bank president expressed his view that the current expectations of robust growth in the second half of the year could be a signal to begin tapering asset purchases.  Now, understand that there were members from both central bank committees pushing back on the idea, but the fact remains that there is some consideration of tapering.  Today, we hear from Chairman Powell again, but we will not hear from Madame Lagarde until her press conference after the ECB meeting next week.

Adding up the disparate facts is quite difficult.  On the one hand, we have the first trial balloons floated regarding tapering of asset purchases as a response to the forecasts for extremely robust growth this year.  On the other hand, the market appears to have indicated that, at least for now, the idea of much faster growth leading to much higher inflation has run its course.  It strikes me that the market is unlikely to worry too much about these trial balloons until they hear from Powell and/or Lagarde.  Until then, it appears that a short period of higher inflation readings is on the cards and unless they really start to spike, that is unlikely to have a big impact on either equities or bonds.

Speaking of equities, yesterday saw the S&P 500 close at yet another new all-time high with the NASDAQ pushing back to within 1% of its February record.  Clearly, there is no inflation scare there.  Rather, all eyes are turning to the first earnings releases due today.  Overnight saw the Nikkei slide (-0.4%) but elsewhere in Asia equities rallied (Hang Seng +1.4%, Shanghai +0.5%).  European markets are mixed with the DAX (-0.1%) lagging while both the CAC (+0.4%) and FTSE 100 (+0.3%) continue to grind higher.  Apparently, Villeroy’s comments about tapering have not been seen as a danger.  US futures are modestly higher at this point, just 0.2% or so as the market bides its time ahead of Powell’s comments at noon.

In the bond market, after a big rally yesterday, the 10-year has seen yields back up slightly, by 1.1 bps, although European bonds are all looking at modest yield declines (Bunds -1.0bps, OATs -1.2bps, Gilts -0.3bps).  It has become pretty clear that the rush higher in yields has stalled for now, with important implications for all the other markets, especially the dollar.

Oil prices are continuing their recent rebound, with WTI +1.6%, although the price action in the metals markets remains confusing.  Precious metals rallied sharply yesterday but are little changed this morning.  Base metals continue to trade both ways with Cu (+1.1%) leading the way higher, but Al (-0.3%) lagging.  It all seems very much like a consolidation period ahead of the next leg higher.

As to the dollar, after sliding all day yesterday alongside Treasury yields, it is continuing lower this morning.  The leading gainer is NZD (+0.8%) which has rallied based on the market’s interpretation that standing pat by the RBNZ last night was actually hawkish, which has helped drag AUD (+0.65%) higher as well.  Oil is supporting NOK (+0.45%) but the rest of the moves are far less significant.  EMG currencies are also performing well this morning, led by KRW (+0.85%) and TRY (+0.5%).  The won was a beneficiary of the generally falling dollar as well as foreign inflows into the KOSPI.  TRY, on the other hand, simply offers yields that are too high to resist for certain investors, despite rising inflation there.

The only data today is the Fed’s Beige Book, to be released at 2:00, but aside from Powell at noon, we hear from four other Fed speakers including vice-chairman Clarida at 3:45 this afternoon.  Come Friday, the Fed will enter their quiet period ahead of the next FOMC meeting, so it seems everyone wants to get their thoughts aired ahead of that.

In the end, the dollar remains beholden to 10-year Treasury yields, so we could be in for a period of very limited movement, if Treasuries have found a new home.  Unless we hear something new from the Chairman today, I expect we are looking at a period of quiet for the next two weeks.  The calm before the storm.

Good luck and stay safe
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A Simple Statistic

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There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic

But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided

The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning.  At that time, CPI will be released with the following median forecasts according to Bloomberg:

CPI MoM 0.5%
-ex food & energy MoM 0.2%
CPI YoY 2.5%
-ex food & energy YoY 1.5%

The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018.  As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high.  After all, last month CPI YoY printed at 1.7%, so this is a big jump.  We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs.  Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.

Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA.  My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data.  What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation.  And I can’t help but notice how the price of things that I buy seem to continue to rise as well.  While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning.  Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price.  Certainly not gasoline, and even tech items cost more.  If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.

Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future.  In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all.  If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.

Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices.  We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities.  Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance.  Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year.  The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions.  Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low.  However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.

Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon.  This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality.  In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.

As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus.  So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.

Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets.  The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder.  We also saw yields rise in Australia overnight.

Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains.  Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way.  In other words, pretty much every market is waiting for CPI to take their cues.

FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data.  This is especially odd given oil’s gains in the session.  But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number.  EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.

The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week.  Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option.  While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.

At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver.  If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck.  These days, it is truly binary.

Good luck and stay safe
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