A storm in the bond market’s brewing
As some central banks start eschewing
The idea QE
Forever, should be
Thus, traders, their longs are undoing
Meanwhile, in the markets for stuff
The Chinese have had ‘bout enough
As prices there soar
Xi’s minions call for
Restraint, or they’ll have to get tough
Heading into the Memorial Day weekend in the US, there are two stories making the rounds this morning. The first is the latest discussion regarding tapering of QE by central banks around the world while the second is a growing discussion on the commodity markets and the impact the Chinese are having via both economic growth and governmental efforts to prevent prices from rising further.
During the past month we have gained more clarity from four key central banks on their future QE activities, but the big three (Fed, ECB and BOJ) have not yet come out with any real guidance. Certainly, we have heard several members of the FOMC opining that the time is coming soon where they will start to consider the idea, if growth continues at its current accelerated pace and if the employment situation improves dramatically. This is, however, by no means the universal view in Washington, at least not yet. With respect to the BOJ, the next MPC member who talks about tapering JGB buying will be the first one to do so. The Japanese have been so invested in this strategy for more than 20 years it will be extraordinarily difficult to even consider a change.
In Frankfurt, however, there is far more disagreement as to the proper steps forward. Unfortunately for the ECB, the lack of a common fiscal framework in the Eurozone is becoming a bigger problem as they remain the only institution capable of supporting the entire group of nations. This is made clear by recent data, which shows that there are very different growth and inflation scenarios, potentially requiring different monetary policy responses, in different countries.
For instance, inflation in Germany, at 2.3% is running a lot hotter than in Italy, at 1.0%. And while the Continent’s average may be around 1.6% right now, it is the Germans that see things as more problematic. Consider that while the Weimar hyperinflation of nearly 100 years ago may seem ancient to most, it was the most searing economic event in the nation’s history and has informed the entire German zeitgeist of thrift and frugality. (Contrast this to the Great Depression, with the concomitant deflation that occurred in the US, and which has informed the US zeitgeist with respect to fear of prices and the economy collapsing.) Remember, the only way to get the Germans to agree to the euro was to promise that the ECB would essentially be a clone of the Bundesbank. That meant keeping a lid on inflation at all times. However, the current situation, where the economic circumstances across the continent are so widely disparate, has put the ECB in a bind. Efforts to support those economies that remain weak with a low inflationary impulse, like Italy, Ireland and Greece, will result in increasing price pressures on those economies that are further ahead in the economic rebound like Germany and the Netherlands.
It is this conundrum that has different ECB speakers saying different things. On the one hand, we have recently heard from Italy’s Panetta, France’s Villeroy and Madame Lagarde that tapering is not appropriate. Yet this morning, Germany’s Isabel Schnabel was far more circumspect with respect to maintaining current policy as she commented, “Rising yields are precisely what we want to see.” That does not seem the comment of someone keen to keep buying bonds. However, for now, the Germans remain in the minority and so the idea that the ECB will mention the tapering of asset purchases at the June meeting seems unlikely.
As to the commodity story, in the past two weeks we have heard from at least seven different Chinese officials and key organizations about the need for both reducing upward pressure on commodities as well as reducing upward pressure on the renminbi. For the past twenty years, China has been the marginal buyer of most commodities as their economy has grown at a remarkable pace and they have built up extraordinary infrastructure of roads, airports and cities. Thus, they have consumed countless tons of steel, copper and other industrial materials. However, a little considered impact of the pandemic was the dramatic reduction in the capex of mining for industrial metals, which means that future supplies are likely to be less available as the world continues to reopen and growth expands. The natural result has been rising prices as markets anticipate surplus demand relative to forecast supply.
Apparently, the powers that be in China have figured out that rising prices are not conducive to their domestic plans and are now caught between a situation where they benefit from a stronger currency if it puts downward pressure on inflation, but suffer from a stronger currency if it reduces the attractiveness of their export sector. They seem to believe that if they can prevent further strength in CNY while simultaneously talking down commodity prices, they can achieve both their ends. While they have had some success over the past several weeks on the commodity front, CNY has steadily appreciated, gaining more than 3.25% since April 1st. I guess this is one of the difficulties of trying to manage growth, inflation and your currency’s value simultaneously. Something’s gotta give. Right now, it looks like the currency and further strength there should not be a surprise.
As to our holiday shortened session, European equity markets are uniformly higher this morning (DAX +0.6%, CAC +0.7%, FTSE100 +0.3%) although Asia had a more mixed picture with the Nikkei (+2.1%) quite strong but the Hang Seng (0.0%) and Shanghai (-0.2%) less enthusiastic about things. US futures are all green to the tune of about 0.5%, so pending this morning’s data, the rally should continue.
Bond markets are little changed this morning with Treasuries, which saw yields rise 3.5bps yesterday essentially unchanged this morning. EGB’s are generally a tick or two higher with yields lower by less than 1 basis point, as there is much more focus on stocks today.
In the commodity space, oil (+0.5%) continues to rebound from last week’s dip while precious metals are modestly softer this morning (Au -0.2%, Ag -0.8%). The Chinese seem to be having some success in their efforts to push down metals prices with Cu (-1.0%) and Al (-0.4%) leading the way lower.
The dollar, despite the positive risk sentiment in equities, is stronger vs. all its G10 peers, with NZD (-0.85%) and AUD (-0.6%) the worst performers on the day. In truth, the magnitude of this move smacks of position adjustments after the RBNZ’s surprisingly hawkish tone earlier this week led to significant buying in both currencies. But the dollar’s strength is universal as generally positive data releases throughout Europe have not been able to encourage currency buying.
Emerging markets have seen a different picture as the dollar was universally soft overnight and APAC currencies all showed strength while those markets were open, but since then, EEMEA and LATAM currencies have come under pressure. The most notable mover here has been TRY (-0.95%) as ongoing inflation worries continue to undermine faith in the currency both at home and internationally.
The data story today has the chance to be quite interesting with Personal Income (exp -14.2%), Personal Spending (0.5%) and Core PCE (0.6% M/M, 2.9% Y/Y) all coming at 8:30. Then at 10:00 we see Chicago PMI (68.0) and Michigan Sentiment (83.0). In my mind, Core PCE is the number that matters. Given the current market discussion on tapering, a higher than anticipated number there could easily see a bond market sell-off and further support for the dollar. Frankly, based on the fact that every inflation reading this month has been higher than forecast, I see no reason for this to be any different. Look for a high print and the dollar to remain well-bid into the weekend.
Good luck, good weekend and stay safe