Prices Are Rising

While Jay and the Fed are persuaded
Inflation won’t soon be upgraded
The press keeps advising
That prices are rising
How long can rate hikes be evaded?

Chairman Powell gave yet another interview this weekend, this time to a national audience on 60 Minutes last night.  A cynic might believe that the Chairman is concerned the Fed’s message, inflation is still quite low and will not present any problems, is not getting across to the general public.  While those of us in the financial markets are well aware of everything he utters, his fame amongst the general populace is far less significant.  (After all, I’m pretty certain he doesn’t have either an Instagram or TikTok presence!)  The problem for the Fed if they are unable to get their message across is that people might start to believe their own eyes what they read in the papers and lately, that is not synching well with the Fed’s message.  The number of stories on inflation has been inflating along with a clearly growing interest by the general population, at least as evidenced by the number of Google searches on the subject.  The fear here is that all of this talk of rising prices might result in a change in inflation expectations by the general population, and according to the Fed’s models, that is when inflation starts to rise.

The Fed is not the only central bank in this position as evidenced by comments this morning from Banca’d’Italia, and ECB Executive Board Member, Fabio Panetta’s comments, “We cannot be satisfied with inflation at 1.2% in 2022 and 1.4% in 2023.”  Here, too, the concern is over too low inflation although, in fairness, the inflationary impulse on the Continent is far less consistent than in the US.

One need not look too deep beneath the surface to find a viable explanation for this lack of concern over rising prices.  Clearly the ongoing need for central banks to continue to monetize purchase government debt issuance in order to support the government in power economy is the catalyst.  And there is no better rationale for a central bank to continue QE than a strong belief that inflation is too low along with a commitment to raise it.

That cynic might also question the timing of this 60 Minutes interview as it was aired just two days before the CPI data is to be released.  We are all aware that CPI prints for the next several months will be quite a bit higher than the Fed’s 2.0% target as the base effects from the initial impacts of the Covid-inspired lockdowns are now the comparison.  The month-on-month rate of CPI in March 2020 was -0.4% with it declining to -0.8% in April 2020.  Given the very real increases in price pressures we have observed in the past months, you can be sure that CPI tomorrow, currently expected at 0.5% M/M, 2.5% Y/Y will be quite high.  All told, Powell and the Fed will have to work overtime in order to ensure their message on inflation gets across, because if the general population starts to anticipate rising prices, even though the Fed ‘has tools’ to combat inflation, given the fragility of the economy, their ability to use those tools is highly suspect.  Inflation, once it gets rolling, has a history of being more persistent than desired, and as much as the Fed claimed to fear deflation, I’m pretty sure they are not looking forward to having to fight inflation either.  Especially as that would require actions that will slow the economy down, meaning they will be an easy political target for both sides of the aisle.

But CPI is tomorrow’s release, despite the fact that there are no less than ten stories on major media sites on the subject today.  In the meantime, markets are starting the week generally on their back foot, with risk definitely under some pressure today.  Equity markets in Asia, for instance, were all red (Nikkei -0.8%, Hang Seng -0.9%, Shanghai -1.1%) while European markets have been more mixed, but the mix is flat to down (DAX +0.1%, CAC 0.0%, FTSE 100 -0.4%).  US futures markets are also pointing slightly lower, with all three major indices off by about 0.15% as I type.

Bond market activity has been fairly quiet, with the 10-year Treasury yield unchanged on the day, although we are seeing very modest gains (yield declines) in most of Europe (Bunds -1.3bps, OATs -1.5bps).  Gilts are the lone exception here, with yields rising 1.0 basis point as the UK economy, despite a surprise spring snowstorm, welcomes the reopening of pubs for outdoor drinking/dining.  As the UK economy reopens, there is a great deal of focus on the £150 billion of savings that have accrued during the lockdown and how much of that will be quickly spent.  After all, that represents nearly 7% of GDP in the UK, and obviously, if spent would have a remarkable impact on growth there.

Commodity prices show oil rebounding from its recent lows (WTI +1.1%) as it pushes back to $60/bbl.  Metals prices, however, have been far more mixed with precious largely unchanged, and base metals showing both gains and losses (Cu -0.4%, Al +0.2%).

Finally, the dollar is edging lower this morning in general, but by no means universally.  G10 markets are led by GBP (+0.4%) on the economy reopening news and corresponding growth in confidence there, as well as JPY (+0.4%) which some will attribute to haven demand as equity markets suffered in Asia overnight, but I might attribute to Hideki Matsuyama’s fantastic win at the Masters yesterday.  On the downside, SEK (-0.25%) is the weakest of the bunch, which looks more like position trading than fundamentally driven activity.

EMG currencies are also mixed this morning, but most of the movement remains modest at best.  HUF (+0.6%) is the leading gainer followed by RUB (+0.3%) and PLN (+0.3%).  The HUF seems to be rallying on the news that the central bank will be buying the soon to be issued government green bonds as part of their QE exercise, helping to add demand there.  As to the other two, given the euro’s modest climb, it is no surprise to see EEMEA currencies rise.  On the downside, it is all APAC currencies that fell last night, led by INR (-0.4%) and KRW (-0.35%), which were victims of local equity market disposals by international investors.

Data wise, there is important information beyond tomorrow’s CPI as follows:

Today Monthly Budget Statement -$658B
Tuesday CPI 0.5% (2.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Wednesday Fed Beige Book
Thursday Initial Claims 700K
Continuing Claims 3700K
Retail Sales 5.5%
-ex autos 4.8%
Empire Manufacturing 18.8
Philly Fed 40.0
IP 2.5%
Capacity Utilization 75.6%
Business Inventories 0.5%
Friday Housing Starts 1600K
Building Permits 1750K
Michigan Sentiment 89.0

Source: Bloomberg

So, there is much to learn this week, especially on Thursday, although if the CPI data is large enough, it is likely to dominate conversation for a while.  The FOMC is back on tour this week with ten more speakers, including Chairman Powell on Wednesday, across at least 15 different venues.  I expect there will be a great deal of effort downplaying any thoughts that inflation is making a permanent comeback and that current policy is perfect for right now.

In the end, though, the dollar remains beholden to the Treasury bond, as do most markets, and so all eyes will continue to be on its movement going forward.  Strong data that pushes it to its recent high yield at 1.75% or beyond will result in the dollar rallying.  On the other hand, if the data goes the other way, look for the dollar to retreat a bit further.

Good luck and stay safe
Adf

Central Banks Scoff

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
Adf

Inflation Be Damned

The Minutes revealed that the Fed
Cares not about outlooks, instead
Inflation be damned
They now are programmed
To wait until growth is widespread

There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh?  Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time.  We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around.  And that’s great!  Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis.  Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive.  And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come.  A cynic might think that those central banks don’t actually believe their own forecasts.

Yesterday’s FOMC Minutes revealed this exact situation.  “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.”  In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates.  On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves.  After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”

It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations.  For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano.  I’ve been sitting on that volcano for many, many years.  It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices.  Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever.  And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.

Thus, the conundrum.  Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue.  Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy.  But every central bank has essentially promised they will be falling behind the curve to fight the current battle.

So, let’s follow this line of thought to some potential conclusions.  Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse.  Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation.  (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!)  Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money.  Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter?  This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B.  And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below).  Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.

So, with that in mind, let’s take a quick tour of the markets.  Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day.  In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher.  As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.

As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs.  European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point.  A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year!  Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget.  Imagine what would happen if yields there rose, even 100 basis points.  And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.

Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector.  And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline.  But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.

In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today.  Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week.  As described above, inflation s clearly not going to be a major policy driver in most economies for now.  But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.

On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon.  But what can the Fed tell us that we don’t already know?

As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well.  And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.

Good luck and stay safe
Adf

Will a New Normal Emerge?

Recovery this year is set
To be best in decades, and yet
The central bank’s thumb
Will drive the outcome
By buying quadrillions in debt

The question is, after this surge
Will there be a natural urge
For things to go back
To pre-Covid’s track
Or will a new normal emerge?

The Wall Street aphorism, buy the rumor, sell the news, remains as valid today as it ever was.  The idea behind this concept, something to which I regularly point, is that by the time a particular piece of information has been released, the market has already absorbed the information in the price and is looking forward to the next price driver.  The result is that markets rally into good news and fall upon the release, and vice versa.  The most recent evidence that this remains a key to price action was Friday’s payroll report, where the outcome, in an illiquid market, was a much better than expected 916K NFP number with upward revisions of the previous two months.  And yet Treasury yields, which might have been expected to rise further on the news, have done nothing but decline since then.  Including today’s 1 basis point decline, the 10-year yield is lower by 6bps from the release and is now 10bps lower than the peak hit on March 30.  Is this the end of the yield rally?  Almost certainly not, but no market moves in a straight line.

I highlight this idea to discuss the latest forecast by the IMF and how this news may impact markets going forward.  Yesterday the IMF raised its global growth forecasts again, this time up to 6.0% in 2021 and 4.4% in 2022, representing increases of 0.5% and 0.2% respectively from their January analysis. The leadership in this growth is the US, now forecast to grow 6.4% by the IMF, and China, now forecast to grow 8.4% this year.  These are the fastest GDP growth numbers for the US since 1984, and we certainly all hope they are accurate.  After all, life is certainly better for everyone when the economy is growing rapidly.

But we have now seen a wave of higher forecasts for US GDP from official sources, like the Fed and IMF, and from private forecasters like Wall Street firms, with a strong consensus that the US is looking at GDP expansion this year well in excess of 6.0% and possibly as high as 7.0% or more.  And so I ask, isn’t that already in the price of most assets?

The broad bullish argument for risk is that global GDP growth is going to be much stronger in 2021 as the world’s economy rebounds from the Covid inspired recession of 2020.  And we have seen remarkable rallies in risk assets during this time, with the S&P 500 rising just a bit more than 80% in the twelve months following its nadir on March 24 last year.  All that occurred during a period where the virus was rampant but hopes for a vaccine would lead to an end to the government ordered shutdowns and a return to pre-covid type of economic activity.  While I grant that we have not seen all the shutdowns ended, the vaccine rollout has been impressive and is speeding up every day.  In fact, despite a pretty horrendous start to the process for Europe, the European Commission now believes that the continent will achieve herd immunity by the end of June!

So, if we know that all this is going to happen, haven’t risky assets already priced in this good news?  The other question that hangs over the current situation is the fact that this growth is entirely a product of the multiple trillions of dollars of government stimulus led by the US $5 trillion of fiscal injections, but also inclusive of QE, PEPP and QQE from the Fed, ECB and BOJ respectively, which totaled trillions more dollars of support.  Again, it begs the question, how much better can things be expected to get?

For instance, it is not unreasonable to expect that there will be permanent changes in the economy, specifically in the types of jobs that are available, especially for lower skilled workers.  If anything, the pandemic and resulting government lockdowns will have accelerated this process.  Remember, Chairman Powell has been clear that the Fed’s task will not be complete until the 10 million jobs that were lost as a result of government edicts are replaced. But what if that takes 5 years due to the structural changes in the economy?  Can the Fed maintain ZIRP while GDP growth is surging and inflation is rising alongside?  Historically, the answer would be no, but in the post-Covid world, that is no longer clear.  In fact, the one thing that has been truly consistent is that every government and supranational organization has warned every central bank to make sure they do not remove policy ease too soon.  The entire global political leadership is ‘all-in’ on the idea that printing money and spending it has no negative consequences.  In other words, it is no longer appropriate to worry we might wind up in an MMT world, we are already there!

This leads to the final question, will risk acquisition be unstoppable as a result of this new global thesis?  The famous American economist, Herbert Stein (Ben Stein’s father) made the statement, “if something cannot go on forever, it will stop.”  My observation is that printing money and the illusory growth that it brings cannot go on forever.  When this music stops, it will be a devastating fall.  But, as policymakers will do everything they can to prevent the stopping, this can go on for a while longer.  Simply be careful to not fall into the trap of believing stock prices are at “a permanently high plateau,” a comment another famous economist, Irving Fisher, made just weeks before the Wall Street Crash of 1929.

Ok, a super brief recap of markets shows that both Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.1%) and Europe (DAX -0.1%, CAC 0.0%, FTSE 100 +0.6%) were mixed with modest movement.  US futures are essentially unchanged at 8:00 as I finish typing.  Sovereign yields in Europe have edged lower by roughly 1 basis point, matching the Treasury market, but really not showing much in the way of activity.  Commodity prices are mixed with oil (+0.9%) rallying while metals (Au -0.6%, Cu -1.0%) are softer.

Finally, the dollar is showing little direction today with G10 currencies showing gains (NOK +0.3%) on oil’s rally and losses (AUD -0.5%) on metals price weakness.  But there is no dollar trend here.  In emerging markets, INR (-1.5%) was the biggest loser after the RBI left policy rates on hold, but not merely increased QE, but put a number on it where they will be buying INR1 trillion over the next quarter, driving Indian bond yields lower along with the rupee.  But away from that story, here, too, there is nothing of note with a mixed picture in the space.

On the data front, we see the Trade Balance (exp -$70.5B) this morning and then the FOMC Minutes are released at 2:00.  Today also brings a great deal of Fedspeak, but I remain highly confident that nothing from that story is going to change.

The dollar is wandering aimlessly today but remains closely tied to Treasury yields.  If yields resume their rally, look for the dollar to rebound.  However, if this correction in yields continues, the dollar has further to fall.

Good luck and stay safe
Adf

Central Bank Dreams

The story that’s now being told
Is growth worldwide’s now taking hold
So real rates are rising
And it’s not surprising
That havens are now being sold

Thus, this explains why sovereign debt
Is being sold, and is a threat
To central bank dreams
Or really, their schemes
Inflation to truly beget

Treasury yields, or perhaps more accurately, sovereign yields, remain the top story in markets as their movement continues to underpin most other action.  The very sharp rise in yields seen year-to-date had been driven by rising inflation expectations.  This is clear when looking at breakevens where the 5yr-5yr has climbed from 1.93% at the beginning of the year to 2.60% as of yesterday.  This rise makes up the bulk of the rise in the 10-year Treasury yield, which has gone from 0.91% to 1.70% during the same time frame.  And it has been the rise in inflation expectations that has been a key feature in many of the forecasts for rising inflation beyond the next several months, where base effects from the initial pandemic shutdowns will be seen.

Given the run of very strong data that has been recently released, with yesterday’s ISM Services print of 63.7 being the highest in the series’ 25-year history as the latest example, the narrative is starting to adjust slightly. Recently there have been a number of analyst reports discussing the idea that rising yields represent rising growth expectations and not rising inflation expectations.  If this is true, it certainly alters the calculus of future market activity.  It is also likely to alter the reaction functions of central banks.

Consider what we have heard from the major central banks since the GFC; the greatest threat to economic activity is deflation and each and every one of them has gone out of their way to try to stoke inflation.  Of course, the underlying reason for a central bank to stoke inflation is to help debase the value of their government’s outstanding debt.  This concept has grown dramatically in importance as the amount of government debt outstanding has skyrocketed during the past decade while trend growth has slowed.  Thus, the only way to escape this debt trap was to inflate away the real value of that debt.  This logic is part and parcel of the current central bank guidance regarding maintaining ZIRP or NIRP until inflation and employment goals are actually met, rather than acting when they are anticipated to be met.

Understand, monetary policy acts with a lag, generally considered to be in the 6mo-1yr time frame, so if a central bank does not adjust policy until a target is reached, the likelihood is that variable will continue on its recent trend for many months once the central bank acts.  For example, if the Fed waits for inflation to average 2.0% for a period of time before tightening policy, inflation is likely to continue rising beyond that target for upwards of a year or more before beginning to slow down.  It is for this reason that central banks pay such close attention to expectations data as it gives them clues to potential market responses to their actions.  And it is for this reason that a change in the underlying driver of increasing yields will alter so much.

A key feature of the equity market rally has been the fact that real yields have been negative for quite a while driving investors to seek positive real returns.  This is the TINA concept, there is no alternative.  But if real yields start to climb because growth expectations are climbing with less concern over potential inflationary effects, suddenly there is an alternative to owning equities, especially for pension-type investors who generally seek the least risk available for a return.  If there is an alternative, then a rethinking of the current multiples for equity markets is quite reasonable.  In other words, stock prices could easily fall a fair amount.  Now, declining stock prices have been a key signal to central banks that policy ease is in order, at least since October 1987 in the aftermath of Black Monday.  But this begs the question, what if this process unfolds before central banks have begun raising rates?

As you can see, if this change in the narrative is accurate, and real yields begin climbing, central banks will simply find themselves in a different predicament but with the same tools available.  In other words, policy ease may have a different nominal rationale, but that doesn’t help the fixed income investor.  And how will this impact the FX market?  That is probably the easiest short-term answer, the dollar will follow real yields higher, and if the Fed steps in to cap those yields, via YCC or expanded QE, then the dollar will reverse course lower.  So, watch the movement in real yields for clues as to the dollar’s next steps.

Enough of that and on to markets.  Risk is largely in vogue this morning, at least in Europe, although Asian equities had a more mixed session.  Last night saw the Nikkei (-1.30%) soften while Shanghai (0.0%) went nowhere.  The Hang Seng was closed, although we did see the ASX 200 rise 0.8% Down Under.  Europe, however, is all green all the time, with the DAX (+1.2%) and FTSE 100 (+1.1%) leading the way while the CAC (+0.6%) is lagging but still having a good time. Interestingly, after more record highs yesterday in the US, futures markets are all pointing slightly lower, with the three main indices showing declines of -0.1% to -0.2%.

Bond markets, as would be expected in a risk-on session, are mostly declining, with European sovereigns trading with yields higher by about 2.5 basis points in the big three markets.  Treasury yields are little changed at this time but remain right on that 1.70% yield level.  There is much discussion as to whether the next leg higher in yields is coming soon, or if we have exhausted the drive higher.  Arguably, if growth expectations continue to increase, the case for higher Treasury yields will be inexorable.

In the commodity space, oil prices (+1.35%) are rebounding but WTI has had trouble holding the $60/bbl level ever since its sharp decline two weeks ago.  Precious metals are a bit firmer (Au +0.3%, Ag +0.4%), although Cu (-1.5%) has softened a bit on the day.

Finally, the dollar is broadly stronger this morning despite the increased risk appetite in equity markets.  While the euro is little changed, we are seeing sharp declines in NZD (-0.6%), GBP (-0.5%) and NOK (-0.4%) with Kiwi simply retracing gains made in yesterday’s illiquid markets with similar price action seen in both Sterling and Nokkie.  There is little fundamental driving these moves right now.

Emerging market currencies had a more mixed performance with KRW (+0.7%) as the big winner benefitting from an increase in foreign inflows to both the KOSPI and Korean bond markets.  CNY (+0.25%) has responded to word from the PBOC that they are asking the major commercial banks to reduce their lending to prevent bubbles and other possible financial dislocations.  This helped push Chinese interest rates a touch higher supporting the currency.  On the downside, TRY (-0.4%) continues to be the worst performer in the space as inflation worries continue to grow in the country, but elsewhere, movement has been fairly tame.

On the Data front, we only see JOLTs Job Opening (exp 6.9M) which has not gained many market adherents as an important data point despite the Fed’s focus on employment, likely because the data is quite old, with this morning’s release describing February activity.  As to Fed speakers, only Richmond’s Thomas Barkin is on the tape today, but there still seems little chance of a change in Fed expectations.

Many are claiming the dollar has put in a short-term top, although as discussed above, if real US yields continue to rise, I expect the dollar will rise right alongside them.  And in truth, that remains the single key driver in the FX markets for now.  Higher Treasury yields still portend a higher dollar and vice versa.

Good luck and stay safe
Adf

Clearly Reviving

The positive news keeps arriving
Explaining the ‘conomy’s thriving
Last Friday’s report
Was of such a sort
That showed growth is clearly reviving

The Nonfarm data on Friday was a generally spectacular report that was released into a near vacuum.  All of Europe was closed for the Good Friday holiday as were US equity markets.  The Treasury market was open for an abbreviated session and there were some futures markets open, but otherwise, it was extremely quiet.  And the thing is, this morning is little different, as Europe remains completely closed and in Asia, only Japan, South Korea and India had market activity.  Granted, US markets are fully open today, but as yet, we have not seen much activity.

A quick recap of the report showed Nonfarm Payrolls rose by 916K with revisions higher to the past two months of 156K.  The Unemployment Rate fell to 6.0%, its lowest post pandemic print and the Participation Rate continues to edge higher, now at 61.5%, although that remains a far cry from the 64% readings that had existed for the previous decade.  Arguably, this is one of the biggest concerns for the economy, the fact that the labor force may have permanently shrunk.  This is key because, remember, economic growth is simply the product of population growth and productivity gains.  In this case, population growth means the labor force population, so if that segment has shrunk, it bodes ill for the future of the economy.  But that is a longer-term issue.

Let’s try to put the employment situation into context regarding the Fed and its perceived reaction functions.  It was less than two months ago, February 23 to be exact, when Chairman Powell testified to Congress about the 10 million payroll jobs that had been lost and needed to be recovered before the Fed would consider they have achieved their maximum employment mandate.  At that time, expectations were this would not be accomplished before a minimum of two more years which was what helped inform the Fed’s broad belief that ZIRP would be appropriate through the end of 2023.  And this was the FOMC consensus view, with only a small minority of members expecting even a single rate hike before that time.

But since then, 1.6 million jobs have been created, a remarkable pace and arguably quite a bit faster than anticipated.  The bond market has seen this data, along with the other US economic information and determined that the recovery is moving along far faster than previously expected.  This is evident in the fact that the 10-year yield continues to climb.  Even in Friday’s abbreviated session, yields rose 5 basis points, and as NY is waking up, they have maintained those gains and appear to be edging higher still.  Similarly, the Fed Funds futures market is now pricing in its first full rate hike in December 2022, a full year before the Fed’s verbal guidance would have us believe.

The point here is the tension between the Fed and the markets is growing and the eventual outcome, meaning how the Fed responds, will impact every market significantly.  So, not only will the bond market have an opportunity to gyrate, but we will see increased volatility in stocks, commodities and the FX markets.  The Fed, however, has made it abundantly clear they are uninterested in inflation readings as they strongly believe not only will any inflation be ‘transitory’, but that if it should appear, they have the tools to thwart it quickly (they don’t). More importantly, they have a very specific view of what constitutes maximum employment.  And they have been explicit in their verbal guidance that they will give plenty of warning before they start to alter policy in any way.  The problem with this thesis is that economic surprises, by their very nature, tend to happen more quickly than expected.

This combination of facts has created the very real possibility of putting the Fed in a position where they need to choose between acting in a timely fashion or giving all that warning before acting.  If they choose door number one, they risk impugning their credibility and weakening their toolkit while door number two leaves them even further behind the curve than normal with negative economic consequences for us all.  If you wondered why many pundits have used the metaphor of the Fed painting itself into a corner, this is exactly what they are describing.

For now, though, there is precious little chance the Fed is going to change their stance or commentary until forced to do so, which means that we are going to continue to hear that they believe current policy is appropriate and they will give plenty of warning before any changes.  I hope they are right, but I fear they are not.

Markets take less time to discuss this morning as most of them are closed.  Of the major equity indices, only the Nikkei (+0.7%) was open last night as Commonwealth countries were closed for Easter Monday while China was closed for Tomb Sweeping Day (the Chinese version of Memorial Day).  US futures are pointing higher, which given Friday’s data should be no surprise.  So right now, we are looking at gains between 0.4% and 0.7%, with both the Dow and S&P sitting at all-time highs.

Bond markets were similarly closed pretty much everywhere, with the US market now edging higher by 0.4bps as traders sit down at their desks.  The current 10-year yield of 1.725% is at its highest level since January 2020, but remember, it remains far below the average seen during the past decade and even further below levels seen prior to that.  The point is yields are not constrained on the high side in any real way.

Oil prices (-1.7%) are under pressure this morning after OPEC+ indicated they would be increasing production somewhat thus taking pressure off of supplies.  However, given the speed of recovery in the US and China, the two largest consumers of oil, I expect that there is more upside here as well.

As to the dollar, it is a pretty dull session overall.  That is mostly because so many financial centers have been closed, so trading volumes and activity has been extremely light.  In the G10 space, there is a mix of gainers (GBP +0.25%, AUD +0.2%) and losers (SEK -0.25%, NOK -0.15%) but as can be seen by the limited movement, this is really just a bit of position adjustment.  In the EMG bloc, TRY (+0.6%) is the leading gainer after a slightly higher than expected inflation print and more hawkish words from the new central bank governor.  Otherwise, these currencies are also trading in a range with limited movement in either direction.  We will need to wait until tomorrow to see how other markets react to the US data.

Speaking of data, this week sees a mix of indicators as well as the FOMC Minutes.

Today ISM Services 59.0
Factory Orders -0.5%
Tuesday JOLTs Job Openings 6.9M
Wednesday Trade Balance -$70.5B
FOMC Minutes
Thursday Initial Claims 690K
Continuing Claims 3638K
Friday PPI 0.5% (3.8% Y/Y)
-ex food & energy 0.2% (2.7% Y/Y)

Source: Bloomberg

Away from this data, we hear from a handful of Fed speakers, including Chair Powell.  Powell, however, will be speaking at the virtual IMF/World Bank meetings being held this week.  In fact, that should remind us to all be aware of the tape, as we will be hearing from many global financial policymakers this week, and you never know what may come from that.

In the end, the bond market continues to be the key driver of markets, and the US Treasury market remains the driver of global bond markets.  I see no reason for US yields to back off given the consistent data story and the increased price pressures.  And that, my friends, means the dollar has further room to rise.

Good luck and stay safe
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Kept at Bay

The key for investors today
Is payrolls and how they portray
The jobs situation
Thus, whether inflation
Will rocket, or be kept at bay

It’s Payrolls day, generally a session where there is a great deal of anticipation leading up to the release, often followed by a burst of activity and then a very slow afternoon.  However, given today also happens to be Good Friday, with all European markets closed in observation, as well as US equity markets, it is likely the burst activity, assuming one comes, will be compressed into an even shorter timeline than usual.  Of course, what makes this potentially unnerving is that market liquidity will be significantly impaired relative to most sessions, and any surprising outcome could result in a much larger move than would normally be the case.

It is not a bank holiday, which means the bond market will be trading, and that is, in truth, the market that continues to drive the action.  As evidenced by yesterday’s price action, the bond rally, with 10-year Treasury yields sliding 7 basis points, led to a declining dollar and new record highs in the stock market.  We also saw gold and other commodities rally as the combination of strong data (ISM at 64.7) and lower yields was a double-barreled benefit.

With that in mind, here are the latest expectations:

Nonfarm Payrolls 660K
Private Payrolls 643K
Manufacturing Payrolls 35K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

All that seems fine, but it is worth a look at the individual forecasts that make up that NFP number.  There is a wide dispersion of views ranging from a gain of just 350K to eight forecasts greater than 900K and three of those at a cool million each.

Let’s consider, for a moment, if the optimists are correct.  Harking back to Chairman Powell’s constant refrain regarding the recovery of the 10 million lost jobs, the expected timeline for that to happen remains sometime in late 2023.  But if this morning’s release is 1000K or more, that would seem to potentially shorten the timeline for those jobs to return.  And following that logic, it seems likely that the Fed may find themselves in a situation where ZIRP is no longer appropriate somewhat earlier in 2023 than currently expected as inflation rises, and unemployment falls back to their new goal of 3.5%-4.0%.  The implication here is that the bond market will anticipate this activity and we could see the 10-year yield break through to new highs quite quickly.  Based on broad market behavior as seen yesterday, a sharp decline in the bond market would likely result in the dollar rebounding sharply and equity futures, which are trading, retreating.  And all this on a day when there is much less liquidity than normal.

Of course, a weak number is likely to have just the opposite effect, with the bond bulls making the case that we have seen the high in yields, and dollar bears back in the saddle making the case the dollar’s run higher has ended.

And that’s really what we have in store for the day.  The two markets that were open overnight saw equities rally on the heels of the US equity rally, with the Nikkei (+1.6%) and Shanghai (+0.5%) both performing well.  Every European market is closed for the holiday and will be on Monday as well.  Meanwhile, US futures are all pointing modestly higher, roughly 0.25%, ahead of the payroll report.

As NY is walking in, we are seeing the first movement in Treasury yields and they have edged higher by 1.1bps at this point.  But as I highlight above, this is all about the data today.

In the commodity markets, only precious metals are trading but both gold and silver are essentially unchanged at this hour ahead of the data.  This follows yesterday’s strong performance with both rallying more than 1% in the session.

And finally, in the FX market, except for TRY (+0.7%) and KRW (+0.4%) there is no movement more than 0.2%, which is indicative of the fact that some positions are being adjusted but there is no news driving things.  In the case of TRY, the new central bank governor, in a speech today, made clear that he was not going to cut rates and that he was likely to raise them again in an effort to combat the rising inflation in the country.  This was well received by the market and has helped TRY recover much of its initial losses upon the sacking of the previous central bank chief.  As to KRW, they released CPI data last night, 1.5%, which was the highest print since January 2020, indicating that growth was persistent, and the BOK would be more vigilant going forward.  This also encouraged equity inflows resulting in the won’s modest appreciation.

So, now we wait for the payroll data.  Based on the releases that we have seen during the past couple of weeks, where the economy is clearly pushing ahead, I suspect this number will be somewhere above 800K, although 1000K is clearly not out of the question.  As such, my view is we will see the bonds sell off and the dollar retest its recent highs, if not break through them.

Good luck, good weekend and stay safe
Adf

Disinflation’s Deceased

The plan that the Prez just released
Has taxes and spending increased
As well as what’s planned
There’s pent up demand
As such, disinflation’s deceased

Risk remains in vogue this morning as the details of the $2.3 trillion spending plan released last evening by President Biden were more than enough to keep the risk train rolling.  While there was no mention of ‘shovel ready’ projects, and expectations are that it won’t be until sometime in the summer that any bill will make it to the president’s desk, it is full speed ahead for the investor community.  Certainly, there are no concerns over either financing the new bill nor with the prospect that adding more stimulus demand is likely to drive up prices even more rapidly than currently seen.  In other words, everything is great!

But is it really that great?  It is hard to live in the real world and not have noticed that the cost of living is rising, and seemingly faster than the data indicates.  By now, we have all heard about the shortage of microprocessors causing a reduction in auto production and even iPhones.  I’m pretty sure that less supply in these products will not lead to lower prices.  And if you still drive at all, you are aware of how much the price of gasoline has risen during the past year.  But lately we have heard from a number of companies on more mundane products and how prices are being raised there as well.  Kimberly-Clark, General Mills, J.M. Smucker and Hormel Foods have all announced price hikes in the past week or two, and they all make things we buy in the supermarket each week.  So, while the rising price of a once every 3-6 year purchase of an automobile is not likely to impact any individual regularly, when your toilet paper goes up in price, you notice.  The Fed must be thrilled.

In that vein, I often wonder how the Fed considers its relationship with inflation.  Perhaps Powell rehearses discussions with an anthropomorphized version of inflation.  Maybe it would sound like this:

Inflation: Jay, I have to tell you, I’m feeling pretty strong lately.  I’ve been resting for the past 12 years and have a lot of energy available to jump pretty high.

Chairman Powell: That’s awfully nice, but let me warn you, ‘we have tools.’

Inflation: Tools?  What does that even mean?  Are you going to build a house?  (Nah, too expensive with prices rising 10% annually).  Repair the infrastructure?  (That will certainly drive up raw material prices even further.)

Chairman Powell:  Just what I said, we have tools.  My dear friend Paul Volcker, may he rest in peace, taught us how to deal with you 40 years ago.  We can stop you anytime we want.

Inflation:  Well, 40 years ago, was a different time and place.  The amount of outstanding debt was a fraction of where it is today.  Since you haven’t used those ‘tools’ in 40 years, I suspect they are rusty and ineffective now.  And even if you have them, I’m willing to bet you are either afraid to use them, or don’t know how.  I’m looking forward to our next conversation when I will be bigger, stronger and higher!

Chairman Powell:  Don’t mess with me, I told you, ‘we have tools!’

As Powell awakes shaking from this nightmare, he repeats to himself, we have tools, just like Christine has tools.  It will all be fine.

But seriously, it is very difficult to see the ongoing data releases, especially in the US, where GDP is clearly going to see a very big jump in Q2 and analysts are fighting to forecast the biggest GDP growth number in decades, and not wonder how prices are not going to rise even more rapidly.  In fact, we seem to be approaching a perfect storm, increased demand meets supply shortages.  The Fed is going to get their inflation, as will most central banks, and it is ultimately going to have a big impact on financial markets.  But not today.  Today, investors continue to see only the positives.

After yesterday’s Tech led rally in the US stock markets, Asia performed well (Nikkei +0.7%, Hang Seng +2.0%, Shanghai +0.7%) and Europe is largely green as well (DAX +0.3%, CAC +0.2%, FTSE 100 +0.4%).  As it is the first day of a new month and quarter, we saw PMI and Tankan data overnight, all of which continues to show positive vibes for the near future (although the Japanese data has been lagging that of the US and even Europe on these measures.)  US futures, meanwhile, are also looking good with the NASDAQ (+0.9%) once again leading things higher with lesser gains in the other two main indices.

Bond markets, interestingly, are also in fine fettle this morning, with yields declining in Treasuries (-2.1bps), bunds (-1.2bps), OATs (-1.2bps) and Gilts (-2.1bps).  But 10-year Treasury yields remain firmly above 1.7% and their spread to bunds and JGBs remain right at recent highs.  It appears to me as though bond traders are taking a rest ahead of tomorrow’s payroll report, which will be released on Good Friday, a day of limited liquidity.  If the economic bulls are right, and there is a print above 1 million jobs in NFP, I would expect that we will test 1.8% in the 10-year before the weekend arrives.  However, until then, it looks like the growing short position in bonds is getting adjusted.

Oil prices are firmer this morning with WTI up by 1.1%, alongside gains in gold (+0.25%) and the agricultural space.  Meanwhile, base metals are mixed with Cu (-0.65%) and Zn (-0.2%) softer while Al (+0.65%) and Ni (+0.8%) are firmer.

Lastly, the dollar is mixed today as well, with most of the G10 softer led by AUD (-0.4%) and CHF (-0.3%), although the euro has stopped its freefall, at least temporarily, and is currently 0.1% firmer on the session.  Aussie seems to be slipping on the view that the RBA’s first QE plan, A$100 billion, is complete but that there will be a second one announced next Tuesday.  The Swiss franc, on the other hand, seems to be developing some momentum on a technical view and is responding to market internals rather than fundamentals.

EMG currencies have had a much more mixed picture with both gainers and losers evident.  On the plus side, TRY (+0.8%) and ZAR (+0.5%) lead the way higher, while we are seeing RUB (-0.6%) and CNY (-0.3%) as the key laggards.  The rand seems to be benefitting from seasonal factors as technicians look at recent history when the ZAR has rallied consistently in April.  TRY is simply so volatile these days given the ongoing mess at the central bank, that it is difficult to ascribe any move less than 2% to a specific issue.  As to the negatives, RUB, despite oil’s gains, is suffering from news of a surprising new bond offering of RUB 1 trillion, while CNY seems to have been guided lower by the PBOC as the Chinese government has decided that a weaker currency is clearly going to be necessary to support their economy for now and the current US administration isn’t going to make a big deal about it.

Data this morning brings Initial Claims (exp 675K), Continuing Claims (3.75M) and ISM Manufacturing (61.5) and Prices Paid (85.0).  FYI, that Prices Paid index is back at levels seen during the 50’s, 60’s and 70’s, all times when CPI inflation was far higher than 1.3%!

Frankly, with the payroll data tomorrow, I anticipate a generally quiet session, especially as much of Europe will be taking a long Easter holiday weekend starting quite soon.  The dollar’s trend remains firmly higher, but I don’t expect much movement today.

Good luck
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