In Italy more cash is needed
Or so Super Mario pleaded
The virus is raging
And Mario’s waging
A war so its spread is impeded
Meanwhile Chairman Jay and his mates
Remain steadfast that in the States
Though forecasts are nice
They will not suffice
It’s hard growth they need to raise rates
And lastly, from China we learned
Inflation just might have returned
Though central banks scoff
Bond markets sold off
As clearly some folks are concerned
In the financial world these days, there is only one true constant, the Fed remains as dovish as possible. Yesterday, Chairman Powell, speaking at an IMF sponsored event, explained that the Fed would continue to aggressively support the economy until it is once again “great”. (And here I thought that description of America was verboten.) He harped on the 9 million to 10 million jobs that are still missing from before the Covid-induced crisis and said any inflationary pressures this year would be temporary. His colleague, SF Fed President Daly doubled down on those comments, once again explaining that the Fed will not react to mere forecasts of growth, they will wait until they see hard data describing that growth is real, before considering tightening policy.
Regarding inflation, Powell, when asked specifically on the subject, explained, “We would be monitoring inflation expectations very carefully. If we see them moving persistently and materially above levels we’re comfortable with, then we’d react to that.” Remember, the Fed constantly reminds us they have the tools to deal with rising inflation. But talk is cheap. It remains an open question as to whether they have the fortitude to address rising inflation in an economy that has not come close to reaching full employment, let alone maximum employment. Recall Q4 2018, when a modest increase in interest rates and gradual reduction in the size of the balance sheet led to a sharp stock market sell-off and a reversal of Fed policies via the “Powell Pivot.” And the economy then was clearly in better shape than now.
There is another inflation issue I find puzzling as well, and that is the Fed’s inexorable faith that the Core PCE number is the right way to measure inflation. This is especially true since a number of Fed members, including Powell, have been vocal in their view that the U-3 Unemployment Rate, the one published the first Friday of each month, is a very imperfect indicator of the overall jobless situation despite its long history as a key indicator. So, happily, they are willing to question the totality of the information available from a single data point. And yet, while they pay some lip service to inflation expectations, they are absolutely beholden to a single inflation data point, and one that has very little in common with most people’s reality. One would think that given their broad-mindedness regarding unemployment, that same attitude might extend to inflation. Alas, my understanding is that their econometric models don’t work well with any other data point, and so rather than building models based on reality, they create their reality from the data that works.
While on the subject of inflation, Chinese data overnight showed that, while CPI rose only 0.4% Y/Y, PPI rose a much greater than expected 4.4%. This matters because China remains the world’s major manufacturing center and if prices at the factory are rising there, the implication is that those higher prices are coming to a product near you soon. Another sign of pending inflation comes from an IHS Markit report explaining that the PMI price data is running at its highest level since 2008 and is showing no signs of slowing down. Add to this the increases in shipping costs, and rising prices for every day items seem in store. Thank goodness the Fed has tools!
A quick look at Europe shows a tale of two countries, with Italy heading into its fourth wave of lockdowns and PM Draghi putting together a €40 billion support package following on from a €30 billion package a few months ago. The vaccine rollout remains slow and insufficient and the government has closed bars and restaurants (and that’s really a crime, given just how good the food is there!) Germany, on the other hand, is leading the hawkish contingent of the ECB along with the Dutch, in pushing for tapering the PEPP activity as those economies have been far more resilient to the virus and are starting to see some price pressures. Granted, this morning’s German IP data (-6.4% Y/Y) was much worse than expected, but forecasts remain quite positive there. Unlike the Fed, the ECB seems to be turning a bit more hawkish, indicating the Frugal Four are gaining in power. ECB PEPP purchases declined to just €10.2 billion last week, far below their average in Q1 and even more surprising given Madame Lagarde’s comments in the wake of the ECB meeting that they would be far more active in Q2.
Adding all the new information together brings us to a market situation this morning where Treasury bonds have sold off, yields are higher by 5 basis points in the US and about 4 basis points in the major European markets except Italy, where they are 8 basis points higher. Equity markets are mixed in Europe (DAX +0.1%, CAC +0.25%, FTSE -0.1%) after broad weakness in Asia (Hang Seng -1.1%, Shanghai -0.9%) and US futures are little changed to slightly higher at this time.
Rather, it is the dollar that is today’s big winner, rallying against all its G10 counterparts with NOK (-0.6%) the laggard on still soft oil prices, but weakness seen in JPY (-0.3%) and AUD (-0.25%) with smaller declines elsewhere. The yen’s weakness appears corrective in nature, as it had strengthened 1.7% in the past week. While Aussie is simply chopping about in its recent 0.7550/0.7675 trading range and slipping today.
In the EMG bloc, CZK (-0.65%) is the worst performer, followed by RUB (-0.5%) and KRW (-0.3%), although the bulk of the bloc is somewhat softer this morning. Here, too, we appear to be seeing some trading reactions to the past week’s dollar weakness, although the bigger trend remains for dollar strength.
On the data front, PPI (exp 0.5%, 3.8% Y/Y) is the only release with the core expectations (0.2%, 2.7% Y/Y) also well above the Fed target. Of course, the relationship between PPI and Core PCE is limited at best, however, it is certainly indicative of the fact that there are rising price pressures throughout many sectors of the economy. It is not unreasonable to expect them to show up in PCE soon, as they will certainly begin to show up in CPI next week.
Only one Fed speaker is on the docket today, Dallas Fed President Kaplan, but it would be beyond shocking if he said anything that was different than what we have both read and heard this week; nothing will change until the hard data achieves their targets.
Despite new information this morning, or perhaps because of it, the market theme remains the same, Treasury yields are the key driver of markets, with the dollar following in step while equities will have an inverse relationship. And, while Treasury yields are off their recent highs, they appear to have finished this short-term correction. I have a feeling the dollar will be firmer today and continue with that into next week, at least.
Good luck, good weekend and stay safe