To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression
“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity. Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.
No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything. So, is this really as hawkish as the commentariat would have us believe? Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report. Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy. Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time. Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).
The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis. That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”
Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do. The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion. In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco. Of that group, Chicago’s Evans and SF’s Daly are uber-dovish. Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all. This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months. Do not get overexcited about the Fed tapering.
Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive. Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released. Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session. In other words, it was hardly a rout based on the Minutes. The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit. Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.
As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%. But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps. This is hardly the sign of a market preparing for a Fed change of heart. European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps). Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.
Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%). However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions. The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day. Agricultural products, though, maintain their bids with small gains across the board.
Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April. This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.
Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes. Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%). Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night. However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.
Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%). All of these are benefitting from the broad based, but mild, dollar weakness. The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.
Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0). Then at 10:00 we see Leading Indicators (1.3%). On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.
Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment. Look for the dollar to drift lower on the day.
Good luck and stay safe