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:
|Average Hourly Earnings||0.0% (-0.4% Y/Y)|
|Average Weekly Hours||34.9|
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