The narrative now seems to be
That tapering’s what we will see
The meeting in June
Is likely too soon
By autumn, though, Jay may agree
“transitory periods of medieval greatness”
continuing to exist or endure over a prolonged period.
“persistent rain will affect many areas”
Forgive my pedanticism this morning but I couldn’t help but notice the following comment from former NY Fed President William Dudley. “The recent spike in US inflation is likely transitory for now – but it could become more persistent in the coming years as more people return to work.” Now, I don’t know about you, but I would describe the words ‘transitory’ and ‘persistent’ as antonyms. And, of course, we all know that the Fed has assured us that recent rises in inflation are transitory. In fact, they assure us multiple times each day. And yet, here is a former FOMC member, from one of the most important seats, NY Fed president, explaining that this transitory phenomenon could well be persistent. If you ever wondered why the term ‘Fedspeak’ was coined, it was because ‘doublespeak’ was already taken by George Orwell in his classic ‘1984’. Apparently, one does not regain one’s intellectual honesty when leaving a government institution where mendacity is the coin of the realm.
However, let us now turn to today’s main story; tapering. The discussion on tapering of QE continues apace and the market is settling on a narrative that the Fed will reduce the amount of its monthly purchases by the end of the year. Certainly, there are a minority of Fed governors who want to get the conversation going in earnest, with St Louis’ James Bullard the latest. And this idea fits smoothly with the concept that the US economy is expanding rapidly with price pressures, even if transitory, building just as rapidly. Just yesterday, Elon Musk compared the shortage in microprocessors needed to build Teslas to the shortage of toilet paper at the beginning of the pandemic last year. (As an aside, one, more permanent, result of that TP shortage is that prices in my local Shop-Rite are significantly higher today than pre-pandemic, at least 40% higher, even though the shortage was transitory no longer persists.)
The point is that the combination of shortages of specific items, bottlenecks in shipping and dramatically increasing demand fed by massive government stimulus programs are all feeding into higher prices, i.e. inflation. Even the most committed central bank doves around the world have noticed this situation, and while most are unwilling to alter policy yet, the discussion is clearly beginning. Last night, the RBA omitted their promise “to undertake further bond purchases to assist with progress goals,” despite maintaining their YCC target of 0.10% for 3-year AGB’s. As well, yesterday Fed Governor Lael Brainerd, arguably the most dovish FOMC member, explained, “while the level of inflation in my near-term outlook has moved somewhat higher, my expectation for the contour of inflation moving back towards its underlying trend in the period beyond the reopening remains broadly unchanged.” Apparently, Lael attended the Alan Greenspan school of Fedspeak.
Add it all up and you get a market that is convinced that tapering is visible on the horizon and will begin before Christmas 2021. While I don’t doubt it is appropriate, as I believe inflation is not actually transitory, I am also skeptical that the Fed is ready to alter its policy until it sees data showing the employment situation has reached its newly formed goals. I fear that, as usual, the Fed will be late to the tightening party and the outcome will be a far more dramatic policy reversal and much bigger market impact (read stock market decline) than desired.
How, you may ask, has this impacted markets today? The big winner has been the dollar, which is firmer against virtually all its counterparts this morning. For instance, NZD (-0.5%) is the laggard in the G10 space after RBNZ comments explaining the balance sheet will remain large for a long time. In other words, while they may stop buying new securities, they will replace maturing debt and so maintain a significant presence in their bond market. Meanwhile, CHF (-0.5%) is under pressure after SNB Vice-president Zurbruegg explained that the bank’s expansive monetary policy, consisting of NIRP and FX intervention is still necessary. The rest of the bloc is also softer, but not quite to that extent with AUD (-0.35%) under pressure from commodity price pullbacks and JPY (-0.35%) suffering after odd comments by a BOJ member that they would respond to any untoward JPY strength in the event the Fed does begin to taper.
Emerging market currencies have also been under pressure all evening led by TRY (-0.9%) and KRW (-0.65%). The latter’s movement was a clear response to the PBOC setting its fixing rate for a weaker CNY than the market had anticipated, thus opening the way for a weaker KRW. Given the fact that South Korea both competes aggressively in some markets with Chinese manufacturers, and has China as its largest market, the intricacies of the KRW/CNY relationship are many and complex. But in a broad dollar on scenario, it is not too surprising to see both currencies weaken, and given KRW’s recent strong performance, it had much further to fall. But currency weakness in this bloc is across EEMEA, APAC and LATAM, which tells us it is much more about the dollar than about any particular idiosyncratic stories.
In the rest of the markets, equities were mixed in Asia (Nikkei +0.45%, Hang Seng -0.6%, Shanghai -0.75%) while Europe is green, but only just (DAX +0.15%, CAC +0.3%, FTSE 100 +0.1%). US futures are either side of unchanged at this hour as the market tries to digest the tapering story. Remember, much of the valuation premium that exists in the US is predicated on lower forever interest rates. If they start to climb, that could easily spell trouble.
Speaking of interest rates, they have edged lower in the session with 10-year Treasury yields down 0.3bps while in Europe, yields have fallen a bit faster (bunds -1.4bps, OATs -1.5bps, gilts -1.2bps). Certainly, there is no keen inflationary scare in this market as of yet.
Interestingly, oil prices continue to rise, despite the stronger dollar, with WTI (+1.0%) trading to new highs for the move. But the rest of the commodity space finds itself under pressure this morning as the dollar’s strength takes its toll. Precious metals are softer (Au -0.25%, Ag -0.5%) as are base metals (Cu -0.8%, Al -0.5%) although the ags are holding up. But if dollar strength is persistent, I expect that commodity prices will remain on the back foot.
On the data front, today brings only the Fed’s Beige Book this afternoon, as the ADP employment number is delayed due to the Memorial Day holiday Monday. As well, we hear from four Fed speakers, including three, Harker, Kaplan and Bostic, who have been in the tapering camp for several weeks now. However, until we start to see the Treasury market sell off more aggressively, I think tapering will be a nice talking point, but not yet deemed a foregone conclusion. As such, that link between Treasury yields and the dollar remains solid, with the dollar likely to respond well to further discussions of tapering and higher yields. We shall see if that is what comes to pass regardless of the current narrative.
Good luck and stay safe