While measured inflation has jumped
And stock markets, Powell has pumped
The dollar is queasy
As money this easy
Has bulls concerned they’ll get gazumped
But its not just Powell who’s saying
That QE and ZIRP will be staying
Almost to a man
The Fed’s master plan
Is printing and buying…and praying
Once again, yesterday, we heard from several FOMC members and each of them highlighted that the data has not yet come close to describing the “substantial progress” they are seeking with respect to reduced unemployment and so it is not nearly time to begin even thinking about tapering. Well, except for the lone quasi-hawkish voice of Dallas Fed President Robert Kaplan, who did express concern that the Fed’s actions were part of the reason that asset prices are so high. But not to worry, Mr Kaplan will not be a voter until 2023, so will not even be able to officially register his disagreement with policy for two more years. In other words, based on everything we continue to hear, we can expect a series of 9-0 votes every six weeks to maintain current policy.
It is this ongoing messaging, which comes not only from the Fed but from the ECB and BOJ as well, that continues to drive the narrative as well as market prices. Inflation? Bah, it’s transitory and while 2021 may see some higher readings, it will all disappear by 2022. Bubbles? Bah, central banks cannot detect them and, even if they could, it is not their job to deflate them. It has become abundantly clear that the three big central banks have jointly decided that the only thing that matters is the unemployment rate, and until that data is back at record low levels, regardless of what else is happening in the economy, the current state of QE and ZIRP/NIRP is going to remain in place.
Thus, it cannot be that surprising this morning that the dollar has begun to slide a bit more in earnest, while risk appetite, as measured by equity prices remains robust. A very large segment of the punditry continue to harp on concerns over rising inflation and how the Fed and other central banks will be forced to adjust their policy to prevent it from getting out of hand. But simply listening to virtually every central banker tells us that nothing is going to change.
“Through that April employment report, we have not made substantial further progress,” said Fed Vice-Chair Richard Clarida yesterday. Meanwhile, from the ECB, Francois Villeroy de Galhau explained this morning, “Today there’s no risk of a return of lasting inflation in the euro area, and so there’s no doubt that the ECB’s monetary policy will remain very accommodative for a long time. I want to say that very clearly.” I don’t know about you, but it seems pretty clear that the concept of tapering QE purchases, let alone raising interest rates, is not even on the table.
Now, smaller central banks have changed their tune, notably the Bank of Canada and Sweden’s Riksbank, with the former actually reducing QE purchases while the latter has promised to do so shortly. As well, the Bank of England has begun the discussion about reducing policy support as the economy there continues to open rapidly, and growth picks up. As such, it should not be that surprising that those three currencies (GBP +2.75%, CAD +2.1%, SEK +1.9%) are the leading gainers vs. the dollar so far this month.
Perhaps what is also interesting is that the euro is strengthening so clearly vs. the dollar despite the strong words by ECB members regarding the maintenance of easy money. It appears that the market has a stronger belief in the Fed’s willingness to ignore the repercussions of their policy choices than that of the ECB. Remember, in the end, Europe remains reliant on Germany as its engine of growth and largest economy, and German DNA, ever since the Weimar hyperinflation in the 1920’s favors tighter policy, not looser. Madame Lagarde will have a tougher battle to maintain easy policy if the data starts to point higher than will Chairman Powell. Right now, however, that is all theoretical regarding both banks. Easy money is here for the foreseeable future, which means that risk appetite is likely to remain strong, driving up stock and commodity prices while the dollar sinks.
What about bonds, you may ask? Haven’t they been the key driver? The answer is that they have been the key driver, but a close look at statistics like inflation breakevens, and more importantly, the shape of the breakeven curve, offer indications that even though near-term expectations are for much higher inflation, more and more investors are buying the transitory story. If that is, in fact, the case, then there is ample room for bonds to rally as well, which would be quite the shock to all the inflationistas out there.
This morning is exhibit A regarding the impact of increased risk appetite. Equity markets around the world are higher with Asia (Nikkei +2.1%, Hang Seng +1.4%, Shanghai +0.3%) putting in some very strong performances while Europe (DAX +0.25%, CAC +0.2%, FTSE 100 +0.4%) are all green, but have come off their best levels of the morning. US futures are also pointing higher, with gains ranging from 0.2% (Dow) to 0.7% (Nasdaq).
The bond market, meanwhile, is directionless, with yields for Treasuries (-0.5bps) and European sovereigns (Bunds 0.0bps, OATs -0.7bps, Gilts +0.7bps) all trading in narrow ranges. If you consider that given the increase in risk appetite as evidence by stocks, commodities and the dollar, the very fact that bonds are not selling off is actually a bullish sign.
Speaking of commodities, Brent crude (+0.6%) traded above $70/bbl for the first time since November 2018 this morning and WTI is firmer by a similar amount. Metals prices continue to rally (Au 0.0%, Ag +0.8%, Cu +1.0%, Al +0.7%), as do foodstuffs (Soybeans +0.6%, Wheat +0.75%, Corn +1.7%). While it is not clear how much longer commodity prices will rally, it seems abundantly clear, based on their price action, that the rally has more legs.
And finally, the dollar, which as mentioned above is under pressure, is having a really bad day. Versus its G10 counterparts, the dollar is softer across the board with NZD (+0.7%), NOK (+0.6%) and CHF (+0.55%) leading the way. But the euro (+0.45%) is also much firmer and now trading above 1.22 for the first time since early February. If you recall, 1.2350 was the high seen the first week of January, and in order to truly change opinions, the euro will have to trade through that level. With the dollar so weak, it certainly seems like there is a good chance to get there soon.
EMG markets are also seeing pretty uniform gains with ZAR (+0.7%), HUF (+0.65%) and PLN (+0.6%) leading the way, the former on the back of commodity price strength while the two CE4 currencies are benefitting from the belief that both central banks may be tightening policy shortly as well as the euro’s strength. But we saw strength overnight in the APAC currencies as well (KRW +0.4%, SGD +0.4%, TWD +0.35%) as they all are responding to the broad-based dollar weakness.
On the data front, today brings Housing Starts (exp 1702K) and Building Permits (1770K), with both simply showing that the housing market remains on fire. Meanwhile, only Robert Kaplan is scheduled to speak, but we already know what he thinks (tapering needs to start soon) and we also know his is a lone voice in the wilderness. It would not surprise me if we had a surprise series of comments from another FOMC member just to counter his views.
Looking ahead to the session, there is no reason to believe that the dollar’s weakness is going to change anytime soon. Unless Treasury yields start to back up smartly, risk appetite is the dominant story today, and that bodes ill for the dollar.
Good luck and stay safe