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