It seems that a popular view
Explains that the Fed will pursue
A slowdown in buying
More bonds as they’re trying
To bid, fondly, QE adieu
At least that’s what pundits all thought
The Powell press conference had wrought
They talked about talking
But are not yet walking
The path to where policy’s taut
It appears virtually unanimous that the punditry believes the FOMC is going to be tightening policy (i.e. tapering) in the ‘near future’. Of course, the near future is just as imprecise as transitory, the Fed’s favorite word. Neither of these words convey any specificity, which makes them very powerful in the narrative game, but perhaps not so powerful when directly addressed. My take on transitory is as follows: initial expectations were it meant 2 or 3 quarters of price pressures which would then dissipate as supply chains were quickly reconnected. However, it has since morphed into as much as 2 to 3 years given the reality that certain shortages, notably semiconductors, may take much longer to abate as the timeline to build out new capacity is typically 2 to 3 years. I guess it all depends on your frame of reference as to what transitory means. For instance, to a tortoise, 2 to 3 year is clearly but a blip in their lives, but to a fruit fly, it is beyond an eternity. Sadly, the market’s attention span is much closer to that of a fruit fly’s than a tortoise’s so 2 to 3 years feels a lot more permanent than not. This is especially so since there is no way to know if other, more persistent inflationary issues may arise in the interim.
As to the ‘near future’, that seems to mean somewhere between the middle of 2022 and the middle of 2024. Here too, the timeline is extremely flexible to accommodate whatever story is trying to be
sold told. When puffing up the strength of the economic recovery, expectations tend toward the earliest estimates. In fact, we continue to hear from several FOMC members that tapering will soon be appropriate. However, if we look at who is making those comments (Bullard, Kaplan, Rosengren and Bostic), we find that only Raphael Bostic from Atlanta currently has a vote. At the same time, those who are least interested in the idea of tapering include the leadership (Powell, Clarida and Williams) as well as the other governors (Bowman, Brainard, Quarles and Waller), and they have permanent votes. In other words, my take on the FOMC meeting is it was far less hawkish than much of the punditry has described. And there is one group, which really matters, that is apparently in agreement with me; the bond market! Treasury prices after an initial sell-off (yield rally) have reversed that move and are essentially unchanged with a flatter yield curve. It strikes me that if the Fed were to taper, yields would start to rise in the long end as the removal of that support would have a significant negative price impact.
So, if I were to piece together the narrative now it appears to be the following: inflation is still transitory if it remains well above target for the next 2 years and the bond market is convinced that is the case (ostensibly a survey showed that 70% of fixed income managers believe the transitory story). Meanwhile, despite the transitory nature of inflation, the Fed is going to tighten its monetary policy sometime next year and potentially even raise the Fed Funds rate in 2023. Personally, that seems somewhat contradictory to me, but apparently cognitive dissonance is a prerequisite to becoming an FOMC member these days.
At any rate, given the lack of actual policy changes by the Fed, all we have is the narrative. This week we will have four more Fed speakers to continue to reiterate that narrative, that despite the transitory nature of inflation we are going to tighten policy in the future. Of course, that begs the question, Why? Why tighten policy if there is no inflation? Cognitive dissonance indeed.
In the meantime, as markets continue to try to figure out what exactly is happening, we wind up with paralysis by analysis and relatively limited movement. For instance, equity markets in Asia were all essentially unchanged overnight, with not one of them moving even 0.1%. Europe, on the other hand is having a tougher go this morning with red across the screen (DAX -0.1%, CAC -0.5% and FTSE 100 -0.5%) with a real outlier as Spain’s IBEX (-1.5%). There has been no data released but there is growing concern that the Delta variant of Covid is going to cause another lockdown in Europe before they finished reopening the first time. This is based on the fact that we have seen lockdowns reimposed in Australia, Japan, Singapore and Israel after all those nations seemed to be moving forward. As to US futures, they are either side of unchanged at this hour awaiting some clarity on anything.
It can be no surprise that bond markets are rallying slightly with Treasuries (-1.7bps) leading the way but small yield declines in Europe as well (Bunds -0.8bps, OATs -1.1bps, Gilts -1.8bps). With equity markets under pressure, this is a natural reaction. And if you consider the reasoning, worries over another Covid wave, then slower growth would be expected.
Funnily enough, Covid is having a currency impact today as well. In the G10, the new Health Minister, Sajid Javid, has said he wants to see the country return to normal “as soon and as quickly as possible.” Despite the equity market concerns, the FX market saw that as bullish and the pound (+0.2%) is the leading gainer in the G10 this morning. But as the morning has progressed and risk sentiment has become less positive, the dollar is starting to asset itself against most of the rest of the bloc with NZD (-0.35%) and NOK (-0.3%) the laggards. Both of these are under pressure from declining commodity prices as oil (-0.1%) is sagging a bit.
In the EMG bloc, ZAR (-0.8%) is in the worst condition this morning as the Delta Covid variant has increased its spread and the government is behind the curve in treating the issue. But we saw weakness overnight in THB (-0.6%), and this morning the CE4 are all under the gun as well. And the story seems to be the same everywhere, tighter Covid restrictions are undermining currencies while positivity is helping them.
It is a big data week as it culminates in the payroll report on Friday:
|Tuesday||Case Shiller Home Prices||14.85%|
|ISM Prices Paid||86.0|
|Average Hourly Earnings||0.3% (3.6% y/Y)|
|Average Weekly Hours||34.9|
Obviously, all eyes will be on the payroll data as the Fed has made it clear that employment is their key focus for now. There was an interesting story in the WSJ this morning highlighting how the states that have ended the Federal Unemployment Insurance bonus have seen an immediate pickup in employment with jobs suddenly being filled. That bodes well for the future, but it also means we will have this issue for another quarter if all the states that maintain the bonuses continue to do so.
As mentioned above, several Fed speakers will be out selling the narrative that inflation is transitory, but tapering may be coming anyway. (A cynic might think they are not being totally honest in what they are saying, but only a cynic.)
A quick top down look at the FX market leads me to believe that individual national stories are currently the real drivers. So those nations that are raising interest rates to fight inflation (Mexico, Brazil, Hungary, Russia) are likely to see their currencies hold up. Those nations that are having serious relapses in Covid infections (South Africa, much of Europe) are likely to see their currencies come under pressure. Where the two meet (South Korea), it seems to depend on the day as to which way the currency goes. With that in mind, though, I would bet the monetary policy story will have more permanence will be the ultimate driver.
Today, the dollar seems to be in fine fettle as risk is on the back foot given the increasing Covid concerns over the Delta variant. But do not be surprised if tomorrow is different.
Good luck and stay safe