Despite all the tapering talk
The market did not walk the walk
Now sovereigns worldwide
Have seen their yields slide
While stocks are where people all flock
Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing? That was so two days ago. With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion. Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion. Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals. In other words, tapering is still a long way in the future.
This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so. Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals. Do not be misled into believing the Fed is on the cusp of removing accommodation. They are not!
A quick look at yesterday’s data highlights why they are still a long way off. While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth. As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever. But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem. Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.
Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon. While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.
Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing. The interesting thing is the contrast between the data from Asia and that from Europe. It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5. While a slight decline from the previous month, it is still well into growth territory. However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7. There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.
European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end. As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength. Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact. While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.
Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening. The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.
Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.
Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%). Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there. Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day. US futures are all modestly higher at this point, by roughly 0.25%.
As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps. But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads. The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.
Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer. However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.
Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above. In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May). But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4. In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.
On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00. Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.
Nothing has changed my view that as go 10-year yields, so goes the dollar. If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain. If, however, yields reverse higher, the dollar will find its footing immediately.
Good luck, good weekend and stay safe