An Untimely End

Should risk appetite ever fall
The asset price rally could stall
And that could portend
An untimely end
To trust in the Fed overall

Yesterday afternoon the Fed released their annual financial stability report.  In what may well be the most unintended ironic statement of all time, on the topic of asset valuations the report stated, “However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.” [Author’s emphasis.]  Essentially, the Fed seems to be trying to imply that for some reason, having nothing to do with their policy framework, asset prices have risen and now they are in a vulnerable place.  But for the fact that this is very serious, it is extraordinary that they could make such a disingenuous statement.  The reason asset prices are elevated is SOLELY BECAUSE THE FED CONTINUES TO PURCHASE TREASURIES VIA QE AND FORCE INVESTORS OUT THE RISK CURVE TO SEEK RETURN.  This is the design of QE, it is the portfolio rebalance channel that Ben Bernanke described a decade ago, and now they have the unmitigated gall to try to describe the direct outcome of their actions as some exogenous phenomenon.  If you wondered why the Fed, and truly most central banks, are subject to so much criticism, you need look no further than this.

In Europe, a little-known voice
From Latvia outlined a choice
The ECB may
Decide on one day
In June, and then hawks will rejoice

In a bit of a surprise, this morning Latvian central bank president, and ECB Governing Council member, Martins Kazaks, explained that the ECB could decide as early as their June meeting to begin to scale back PEPP purchases.  His view was that given the strengthening rebound in the economy as well as the significant progress being made with respect to vaccinations of the European population, overall financial conditions may remain favorable enough so they can start to taper their purchases.  This would then be the third major central bank that is on the taper trail with Canada already reducing purchases and the BOE slowing the rate of weekly purchases, although maintaining, for now, the full target.

This is a sharp contrast to the Fed, where other than Dallas Fed president Kaplan, who is becoming almost frantic in his insistence that it is time for the Fed to begin discussing the tapering of asset purchases, essentially every other FOMC member is adhering to the line that the US economy needs more monetary support and any inflation will merely be transitory.  As if to reaffirm this view, erstwhile uber-hawk Loretta Mester, once again yesterday explained that any inflation was of no concern due to its likely temporary nature, and that the Fed has a long way to go to achieve its new mission of maximum employment.

A quick look at the Treasury market this morning, and over the past several sessions, shows that the 10-year yield (currently 1.577%, +0.7bps on the day) seems to have found a new equilibrium.  Essentially, it has remained between 1.54% and 1.63% for about the last month despite the fact that virtually every data release over that timespan has been better than expected.  Thus, despite a powerful growth impulse, yields are not following along.  It is almost as if the market is beginning to price in YCC, which is, of course, exactly the opposite of tapering.  Given the concerns reflected in the Financial Stability Report, maybe the only way to prevent that asset price decline would be to cap yields and let inflation fly.  History has shown bond investors tend to be pretty savvy in these situations, so do not ignore this, especially because YCC would most likely result in a sharply weaker dollar and sharply higher commodity and equity prices.

This morning the market will see
The labor report, NFP
Expecting one mill
The Fed’s likely, still,
To say they’ll continue QE

Finally, it is payroll day with the following current expectations according to Bloomberg:

Nonfarm Payrolls 1000K
Private Payrolls 938K
Manufacturing Payrolls 57K
Unemployment Rate 5.8%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%

The range of forecasts for the headline number is extremely wide, from 700K to 2.1 million, just showing how little certainty exists with respect to econometric models more than a year removed from the initial impact of Covid-induced shutdowns.  As well, remember, even if we get 1 million new jobs, based on Chairman Powell’s goal of finding 10 million, as he stated back in January, there are still another 7+ million to find, meaning the Fed seems unlikely to respond to the report in any manner other than maintaining current policy.  In fact, it seems to me the bigger risk today is a disappointing number which would encourage the Fed to double down!  We shall learn more at 8:30.

As to markets ahead of the release, Asian equities were mixed (Nikkei +0.1%, Hang Seng -0.1%, Shanghai -0.65%) although Europe is going gangbusters led by Germany’s DAX (+1.3%), with the CAC (+0.3%) and FTSE 100 (+0.8%) also having good days.  German IP data (+2.5% M/M) was released better than expected and has clearly been a catalyst for good.  At the same time, French IP (+0.8% M/M) was softer than expected, arguably weighing on the CAC.

Away from Treasuries, European sovereign bonds are all selling off as risk appetite grows, or so it seems.  Bunds (+1.0bps) and OATs (+2.8bps) are feeling pressure, although not as much as Italian BTPs (+4.8bps).  Gilts, on the other hand, are little changed on the day.

Commodity prices continue to rally sharply, at least in the metals space, with gold (+0.3%, +1.5% yesterday), silver (+0.1%, +3.5% yesterday), copper (+2.6%), aluminum (+1.0%) and nickel (+0.2%) all pushing higher.  Interestingly, oil prices are essentially unchanged on the day.

Lastly the dollar is mixed on the session, at least vs. the G10.  SEK (+0.35%) is the leading gainer on what appears to be positive risk appetite, while NZD (-0.25%) is the laggard after inflation expectations rose to a 3-year high.  The other eight are all within that range and split pretty evenly as to gainers and losers.

EMG currencies, though, are showing more positivity with only two small losers (ZAR -0.25%, PLN -0.15%) and the rest of the bloc firmer.  APAC currencies are leading (KRW +0.4%, INR +0.35%, TWD +0.3%) with all of them benefitting from much stronger than forecast Chinese data. We saw Caixin PMI Services rise to 56.3 and their trade balance expand to $42.85B amid large growth in both exports and imports.  Models now point to Chinese GDP growing at 9.0% in 2021 after these releases.

At this point, we are all in thrall to the NFP release later this morning.  The dollar response is unclear to me, although I feel like a strong number may be met with a falling dollar unless Treasury yields start to climb.  Given their recent inability to do so, I continue to believe that is the key market signal to watch.

Good luck, good weekend and stay safe
Adf

A Kettle of Hawks

There once was a kettle of hawks
Who regularly gave earnest talks
When prices would rise
They would then surmise
T’was time to forget Goldilocks

But now they’re a bevy of doves
The type every borrower loves
Who, if prices rose
Would never propose
That they would give rates, up, a shove

While today’s activity roster includes the Bank of England rate decision (no change) and QE target (possible change), I want to review yesterday’s Fedspeak as I believe it is crucial to continue our understanding of the policy evolution.

Three Fed regional presidents spoke; Chicago’s Mike Evans, a known dove; Boston’s Eric Rosengren, historically slightly more hawkish than centrist; and Cleveland’s Loretta Mester, historically one of the most hawkish Fed members.  All three made clear that they are unconcerned over the almost certain rise in inflation in the short-term, with all three convinced this is a ‘transitory’ phenomenon that will work itself out by the end of 2022.  Rosengren was particularly colorful in his description as he compared his view of general price increases upcoming to the situation right at the beginning of the pandemic shutdowns regarding toilet paper.  “My view is that this acceleration in the rate of price increases is likely to prove temporary,” he said.  He continued, “Toilet paper and Clorox were in short supply at the outset of the pandemic, but manufacturers eventually increased supply, and those items are no longer scarce.  Many of the factors raising prices this spring are also likely to be similarly short-lived.”

Now, I don’t know about you, but I would beg to differ with his assessment, specifically on the two items he mentioned, toilet paper and Clorox.  While there is no question that both items are readily available today as opposed to the situation twelve months ago, it is also very clear that the prices of both items have risen substantially.  In fact, my anecdotal evidence from the local Shop-Rite is that prices of these two items have risen at least 35% in the past twelve months, and there is no evidence that these prices are going to decline anytime soon.  After all, as a manufacturer, why would you reduce prices if customers are still buying your product?  So, while supply has improved, it has done so at the expense of higher prices.  In my book, this is the very definition of inflation.

Regarding the topic of tapering, Evans was dismissive of the idea at all and surprisingly, Mester showed no interest in the discussion in the near term.  Rosengren, however, did indicate that it was possible the situation by the end of this year could warrant a discussion, although he would sooner halt purchases of mortgage bonds than Treasuries as he mentioned the possibility that housing prices could get ‘frothy’.  Ya think?  A quick look at the recent Case Shiller House Price Index shows it has risen by nearly 12% in the past year nationwide, the fastest level since March 2006, right in the middle of the housing bubble whose bursting caused the GFC.  Perhaps this is what is meant by “frothy” in Chairman Powell’s eyes.

From London, the market’s awaiting
The Old Lady’s econ re-rating
While wondering if
She’ll offer a sniff
Of when QE might start abating

The UK’s post-pandemic growth trajectory has been far closer to the US than of the EU as PM Johnson’s government has done an excellent job of getting a large proportion of its population inoculated allowing for a reopening of the economy.  Recent data has been strong and as more restrictions are eased; prospects continue to be relatively bright.  Not dissimilar to the Fed’s situation, the Bank of England will find themselves raising their GDP growth forecasts while maintaining their ongoing monetary policy support.  Or will they?  There is talk in the market that the BOE may well discuss the initial timing of tapering purchases while they upgrade their forecasts.  Precedent was set last week when the Bank of Canada did just that, not merely discussing tapering, but actually cutting the amount of purchases by 25%.  Will the BOE follow suit?

Analyst expectations are that they will not change policy at all and explain it in the same manner as the Fed, that while inflation in the near-term may rise above their 2.0% target, this will be a temporary phenomenon and is no cause for concern.  However, any hint that tapering may be coming sooner than the current program’s target end date later this year is likely to be quite supportive of the pound, so keep that in mind.  That said, ahead of the meeting, the pound is essentially unchanged on the day at 1.3900.

Stronger growth forecasts, as well as strong earnings numbers, continue to support equity markets, although while they are not falling, rallies have been modest at best.  In fact, there is growing concern that the tech sector, which has clearly been the leader in the post pandemic equity rally, is starting to falter more seriously.  Last night saw gains in the Nikkei (+1.8%) and Hang Seng (+0.8%) but a modest decline in Shanghai (-0.2%) on its return from Golden Week.  Europe, despite strong German Factory Orders (+3.0%) and Eurozone Retail Sales (+2.7%) has been unable to make any real headway (DAX 0.0%, CAC 0.0%, FTSE 100 +0.2%).  US futures are similarly lackluster, with all three major indices higher by 0.1% at this hour.  Could it be that economic and earnings strength is fully priced in at these levels?

**BOE leaves policy unchanged, as expected**

Bond markets, on the other hand, are holding their own overall.  While Treasury yields are unchanged on the day, they slid 2.5bps yesterday and are now closer to their recent lows than highs.  In Europe, sovereigns are showing the smallest of rallies with yields in both Bunds and OATs lower by 0.5bps while Gilt yields are unchanged.  At this point, it appears that bond traders and investors are starting to believe the central banks regarding the idea of transitory inflation.  While that would be a wonderful outcome, I fear that there is far more permanent inflation scenario unfolding.

Commodity prices are mixed this morning with oil (-0.75%) soft but metals, both base and precious firmer.  In fact, iron ore has reached record high levels, rising 6.5% this week, and approaching $200/ton.  Again, rising input prices are not disappearing.

As to the dollar, it is generally softer this morning, albeit not substantially so.  In the G10, CHF (+0.4%) is the leading gainer but the European currencies are all solidly higher, between 0.2% and 0.3%, although the pound’s move occurred just since the BOE announcement.  However, commodity currencies have underperformed here and are little changed on the day.

In the emerging markets, THB (-0.45%) was the laggard after the central bank left rates on hold amid a surge in reported Covid infections.  KRW (-0.25%) was next worst as there were a surprisingly large amount of equity outflows from the KOSPI.  On the positive side, IDR (+0.8%) was the biggest mover as Indonesia saw significant equity inflows as well as increased interest in the carry trade.  ZAR (+0.7%) is benefitting from the rise in gold (+0.25%) as well as the metals complex generally.  Otherwise, while gains have been broad-based, they have been shallow.

This morning’s data brings Initial Claims (exp 538K), Continuing Claims (3.62M), Nonfarm Productivity (4.3%) and Unit Labor Costs (-1.0%).  However, all eyes are turned to tomorrow’s NFP report, which despite a slightly softer than expected ADP Employment number yesterday (742K, exp 850K), has seen the forecast rise to essentially 1.0 million.

Treasury bond yields have lost their mojo for now and have been able to ignore any signs of imminent inflation.  It seems that the Fed chorus of transitory inflation is having the desired impact and preventing yields from running away higher.  As long as Treasury yields remain under control, especially if they drift lower, then the dollar will remain under modest pressure.  So far, nothing has occurred to change that equation.

Good luck and stay safe
Adf

Rates May Have to Rise

Said Janet, “rates may have to rise”
Which really should be no surprise
The money we’ve spent
Has markets hell bent
On constantly making new highs

But right after this bit of diction
The market ran into some friction
So quick as a wink
She had a rethink
And said “this is not a prediction”

Just kidding!  What was amply demonstrated yesterday is that the Fed, and by extension the US government, has completely lost control of the narrative.  The ongoing financialization of the US economy has resulted in the single most powerful force being the stock market.  Policymakers are now in the position of doing whatever it takes, to steal a phrase, to prevent a decline of any severity.  This includes actual policy decisions as well as comments about potential future decisions.

A brief recap of yesterday’s events shows that Treasury Secretary Yellen, at a virtual event on the economy said, “rates may have to rise to stop the economy from overheating.”  Now, on its surface, this doesn’t seem like an outrageous statement as it hews directly to macroeconomic theory and is widely accepted as a reasonable idea. However, Janet Yellen is no longer a paid consultant for BlackRock, but US Treasury Secretary.  And the only market fundamental that matters currently is the idea that the Fed is not going to raise interest rates for at least another two years.  Thus, when a senior administration financial official (has a Freudian slip and) talks about rates needing to rise, investors take notice.

So, in a scene we have observed numerous times in the past, immediately after the comments equity markets started to sell off even more sharply than their early declines and the market discussion started to turn to when rates may be raised.  But a declining stock market is unacceptable, so in a later WSJ interview, Yellen recanted clarified those remarks explaining that she was neither predicting nor recommending rate hikes.  It was merely an observation.

However, what was made clear was just how few degrees of freedom the Fed has to implement the policy they see fit.  It is for this reason that every time an official explains the Fed ‘has the tools’ necessary to fight inflation should it arise, there is a great deal of eye-rolling.  The first tool in fighting inflation is raising interest rates, and that will not go down well in the equity world, regardless of the level of inflation.  And what we know is that the Fed clearly doesn’t have the stomach to watch stocks decline by 10% or 20%, let alone more, in the wake of their policy decisions to raise interest rates.  We know this because in Q4 2018, when they were attempting to normalize policy, raising rates and shrinking the balance sheet simultaneously, the stock market fell 20% and was starting to gain serious downside momentum.  This begat the Powell Shift on Boxing Day, which saw the Fed stop tightening and stocks stop falling.

It is with this in mind that we view the comments of other Fed speakers.  Most are hewing to the party line, with NY’s Williams and SF’s Daly both right on script explaining that while growth will be strong this year, there is still a great deal of slack in the economy and supportive (read easy) monetary policy is still critical in achieving their goals.  It is also why Dallas Fed president Kaplan is roundly ignored when he explains that tapering purchases later this year may be sensible given the strength of the economy.  But Kaplan isn’t a voter nor will he be one until 2023, so no matter how passionate his pleas are in the FOMC meeting room, it will never be known as he cannot even dissent on a policy choice.

In summary, yesterday’s Yellen comments and corrections simply reinforce the idea that the Fed is not going to raise rates for at least another two years and that tapering of asset purchases is not on Powell’s mind, nor that of most of his FOMC colleagues.  So…party on!

And that is exactly what we are seeing today in markets.  While the Hang Seng had a poor showing (-0.5%) which followed yesterday’s tech heavy selloff in the US, Europe, which of course lacks any tech sector to speak of, is sharply higher this morning (DAX +1.35%, CAC +0.9%, FTSE 100 +1.1%) as a combination of Services PMI data strength and optimism about the ending of lockdowns has investors expecting superior profit growth going forward.  US futures are also pointing higher (DOW +0.3%, SPX +0.4%, NASDAQ +0.5%) as confirmation that rates will remain low added to rising growth forecasts continue to underpin the equity case.  As an example of the growth optimism, the Atlanta Fed’s GDPNow forecast tool has risen to 13.567% as of yesterday, up from just 7.869% a week earlier!  Now, as more data is released, that will fluctuate, but if that data continues to be as strong as recent outcomes, do not be surprised to see Q2 GDP forecasts move a lot higher everywhere.

Turning to the bond markets, Treasury yields this morning are higher by 1.3 basis points, although that is after having slipped 3 bps on Monday and ultimately remaining unchanged yesterday.  But in this risk-on meme, bonds do lose their appeal.  European sovereigns are also generally lower with Bunds (+1.9bps), OATs (+2.3bps) and Gilts (+3.0bps), all seeing sellers converting their haven money into stock purchases.

Risk appetite in commodities remains robust this morning as oil prices continue to escalate (+1.1%) and are pushing back near their recent highs above $67/bbl.  While precious metals continue to lack traction, the base metal space is back in high gear this morning (Cu +0.5%, Al +0.65%, Sn +1.1%).  Agriculturals?  Wheat +0.3%, Soybeans +1.0%, Corn +0.85%.  It’s a good thing the price of what we eat has nothing to do with inflation!  As an example, Corn is currently $7.50/bushel, a price which has only been exceeded once in the data set going back to 1912, when it touched $8.00 in July 2012.  And looking at the chart, there is no indication that it is running out of steam.

Finally, the dollar has evolved from a mixed session to one where it is now largely under pressure.  This fits with the risk-on theme so should be no surprise.  NZD (+0.65%) leads the way higher but the commodity bloc is all firmer (AUD +0.4%, NOK +0.35%, CAD +0.3%) on the back of the commodity rally.  The rest of the G10, though, is little changed overall.  In the EMG space, PLN (-0.4%) is the outlier, falling ahead of the central bank’s rate announcement, although there is no expectation for a rate move, there is concern over a change in the dovish tone.  As well, the Swiss franc mortgage issue continues to weigh on the nation as a decision is due to be released next week and could result in significant bank losses and concerns over the financial system there.  But away from the zloty, there are a handful of currencies that are ever so slightly weaker, and the gainers are unimpressive as well (ZAR +0.35%, RUB +0.2%), both of which are commodity driven.

Two data points this morning show ADP Employment (exp 850K) and ISM Services (64.1) with more attention to be paid to the former than the latter.  We also have three more Fed speakers, Evans, Rosengren and Mester, with the previously hawkish Mester being the one most likely to discuss things like tapering being appropriate.  But in the end, there remains a very clear majority on the FOMC that there is no reason to change policy for a long time to come.

It is difficult to develop a new narrative on the dollar at this stage.  Rising Treasury yields on the back of rising inflation expectations are likely to offer short term support for the buck but can undermine it over time.  For today, however, it seems that the traditional risk-on theme is pushing back on its modest gains from yesterday.

Good luck and stay safe
Adf

The Specter of Growth

The specter of growth’s in the air
So, pundits now try to compare
Which central bank will
Be next to instill
The discipline they did forswear

In Canada, they moved last week
On Thursday, Sir Bailey will speak
Now some pundits wonder
In June, from Down Under
The RBA will, easing, tweak

But what of Lagarde and Chair Jay
Will either of them ever say
Our goals are achieved
And so, we’re relieved
We’ve no need to buy bonds each day

On lips around the world is the question du jour, has growth rebounded enough for central banks to consider tapering QE and reining in monetary policy?  Certainly, the data continues to be impressive, even when considering that Y/Y comparisons are distorted by the government-imposed shutdowns last Spring.  PMI data points to robust growth ahead, as well as robust price rises.  Hard data, like Retail Sales and Personal Consumption show that as more and more lockdowns end, people are spending at least some portion of the savings accumulated during the past year. Meanwhile, bottlenecks in supply chains and lack of investment in capacity expansion has resulted in steadily rising prices adding the specter of inflation to that of growth.

While no developed market central bank head has yet displayed any concern over rising prices, at some point, that discussion will be forced by the investor community.  The only question is at what level yields will be sitting when central banks can no longer sidestep the question.  But after the Bank of Canada’s surprise move to reduce the amount of weekly purchases at their last meeting, analysts are now focusing on the Bank of England’s meeting this Thursday as the next potential shoe to drop.  Between the impressive rate of vaccination and the substantial amount of government stimulus, the UK data has been amongst the best in the world.  Add to that the imminent prospect of the ending of the lockdowns on individual movement and you have the makings of an overheating economy.  The current consensus is that the BOE may slow the pace of purchases but will not reduce the promised amount.  Baby steps.

Last night, the RBA left policy on hold, as universally expected, but the analyst community there is now looking for some changes as well.  Again, the economy continues to rebound sharply, with job growth outstripping estimates, PMI data pointing to a robust future and inflation starting to edge higher.  While the inoculation rate in Australia has been surprisingly low, the case rate Down Under has been miniscule, with less than 30,000 confirmed cases amid a population of nearly 26 million. The point is, the economy is clearly rebounding and, as elsewhere, the question of whether the RBA needs to continue to add such massive support has been raised.  Remember, the RBA is also engaged in YCC, holding 3-year yields to 0.10%, exactly the same as the O/N rate.  The current guidance is this will remain the case until 2024, but with growth rebounding so quickly, the market is unlikely to continue to accept that as reality.

These peripheral economies are interesting, especially for those who have exposures in them, but the big question remains here in the US, how long can the Fed ignore rising prices and surging growth.  Just last week Chairman Powell was clear that a key part of his belief that any inflation would be transitory was because inflation expectations were well anchored.  Well, Jay, about that…5-year Inflation breakevens just printed at 2.6%, their highest level since 2008.  A look at the chart shows a near vertical line indicating that they have further to run.  I fear the Fed’s inflation anchor has become unmoored.  While 10-year Treasury yields (+2.3bps today) have been rangebound for the past two months, the combination of rising prices and massively increased debt issuance implies one of two things, either yields have further to climb (2.0% anyone?) or the Fed is going to step in to prevent that from occurring.  If the former, look for the dollar to resume its Q1 climb.  If the latter, Katy bar the door as the dollar will fall sharply as any long positions will look to exit as quickly as possible.  Pressure on the Fed seems set to increase over the next several months, so increased volatility may well result.  Be aware.

As to today’s session, market movement is mostly risk-on but the dollar seems to be iconoclastic this morning.  For instance, equity markets are generally in good shape (Hang Seng +0.7%, CAC+0.5%, FTSE 100 +0.6%) although the DAX (-0.35%) is lagging.  China and Japan remain on holiday.  US futures, however, are a bit under the weather with NASDAQ (-0.4%) unable to shake yesterday’s weak performance while the other two main indices hover around unchanged.

Sovereign bond markets have latched onto the risk-on theme by selling off a bit.  While Treasuries lead the way, we are seeing small yield gains in Europe (Bunds +0.5bps, OATs +0.6bps, Gilts +0.5bps) after similar gains in Australia overnight.

Commodity markets continue to power higher with oil (+1.9%), Aluminum (+0.4%) and Tin (+1.0%) all strong although Copper (-0.1%) is taking a breather.  Agricultural products are also firmer but precious metals are suffering this morning, after a massive rally yesterday, with gold (-0.5%) the worst of the bunch.

Of course, the gold story can be no surprise when looking at the FX markets, where the dollar is significantly stronger across the board.  For instance, despite ongoing commodity strength, and the rally in oil, NZD (-0.9%), AUD (-0.6%) and NOK (-0.5%) are leading the way down, with GBP (-0.25%) the best performer of the day.  The pound’s outperformance seems linked to the story of a modest tapering of monetary policy, but overall, the dollar is just quite strong today.

The same is true versus the EMG bloc, where TRY (-1.0%) is the worst performer, but the CE4 are all weaker by at least 0.4% and SGD (-0.5%) has fallen after announcing plans for a super strict 3-week lockdown period in an effort to halt the recent spread of Covid in its tracks.  The only gainer of note is RUB (+0.4%) which is simply following oil higher.

Data this morning brings the Trade Balance (exp -$74.3B) as well as Factory Orders (1.3%, 1.8% ex transport), both of which continue to show economic strength and neither of which is likely to cause any market ructions.

Two more Fed speakers today, Daly and Kaplan, round out the messaging, with the possibility of Mr Kaplan shaking things up, in my view.  He has been one of the more hawkish views on the FOMC and is on record as describing the rise in yields as justified and perhaps a harbinger of less Fed activity.  However, he is not a current voter, and Powell has just told us clearly that there are no changes in the offing.  Ultimately, this is the $64 trillion question, will the Fed blink in the face of rising Treasury yields?  Answer that correctly and you have a good idea what to expect going forward.  At this point, I continue to take Powell at his word, meaning no change to policy, but if things continue in this direction, that could certainly change.  In the meantime, nothing has changed my view that the dollar will follow Treasury yields for the foreseeable future.

Good luck and stay safe
Adf

The Seeds of Inflation

Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory

But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone

Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation.  It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip.  The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives.  But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed.  (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)

For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%.  While both those results were exactly as forecast, the trend for both remains sharply higher.  The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation?  After all, it is not as though the data comes with a disclaimer.  Ultimately, a decision is going to have to be made that rising prices are becoming a problem.  Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.

For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession.  The June data will be the first test as that monthly CPI print last year was a robust 0.5%.  Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities.  But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand.  In fact, it is this uncertainty that is the primary rationale for corporate hedging.  There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results.  FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.

This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing.  Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%.  Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector.  In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday.  The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency.  Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.

Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds.  So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged.  Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets.  Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.

Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%).  The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs.  Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.

It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher.  Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today.  Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength.  There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.

As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.

Today ISM Manufacturing 65.0
ISM Prices Paid 86.1
Construction Spending 1.7%
Tuesday Trade Balance -$74.3B
Factory Orders 1.3%
-ex transport 1.8%
Wednesday ADP Employment 875K
ISM Services 64.1
Thursday Initial Claims 540K
Continuing Claims 3.62M
Nonfarm Productivity 4..2%
Unit Labor Costs -1.0%
Friday Nonfarm Payrolls 978K
Private Payrolls 900K
Manufacturing Payrolls 60K
Unemployment Rate 5.7%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%
Consumer Credit $20.0B

Source: Bloomberg

As well, we hear from five Fed speakers, including Chairman Powell this afternoon.  Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.

Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future.  Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact.  Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar.  We shall see.  As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast.  While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.

Good luck and stay safe
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