Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls
There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel. In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come. On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’. I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future. After all, the Fed’s forecasting record is unparalleled…in its futility.
However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.
The problem with this attitude is that it seems to ignore the reality on the ground. Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014. In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump. But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least. At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.
It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020. Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation. The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited. There is a growing belief that we are embarking on a so-called commodity super-cycle. This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.
This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise. Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y. The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand. As such, the market seems entirely prepared for a very large number. From my vantage point, the Y/Y number is not so important today, but the M/M number is. Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.
We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy. We continue to hear them explain that any inflation readings will be transitory. And maybe they are correct. However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply. Talk about a Hobson’s Choice!
Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%). US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).
Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level. There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case. European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts). Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.
Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%). The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.
The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own. NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought. However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected). EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst. KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data. Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.
Other than the CPI data and the Treasury auction, there is no other news or data. Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately. The one thing we know is that they are unlikely to change their tune.
Which brings us back to the 10-year Treasury. It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa. I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact. My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late. In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar. Just beware.
Good luck and stay safe