Tougher for Jay

The Fed once again will convey
Inflation just ain’t here to stay
But every release
That shows an increase
Makes life that much tougher for Jay

Meanwhile, Chinese comments last night
Explained everything was alright
They further suggested
That more be invested
To underscore risk appetite

As we await the FOMC meeting’s conclusion this afternoon, markets have generally remained calm, even those in China.  Apparently, 20% is the limit as to how far any government will allow equity markets to decline. After three raucous sessions in China and Hong Kong, as investors fled from those companies under attack review by the Chinese government for their alleged regulatory transgressions, the Chinese press was out in force explaining that there were no long term problems and that both the economy and stock markets were just fine and quite safe.  “Recent declines are unsustainable” claimed the Securities Daily, a state-owned financial paper.  We shall see if that is the case, especially since there is no indication that the government has finished its regulatory crackdown across different industries.

However, the carnage of the past several sessions was not evident last night as the Hang Seng (+1.5%) rebounded nicely while Shanghai (-0.6%) managed to close 1.5% above the lows seen early in the session.  It hardly seems coincidental that the Chinese reacted to the declines after a 20% fall as that seems to be the number that defines concern.  Recall, in Q4 2018, Chairman Powell, who had been adamant there were no issues and was blissfully allowing the Fed’s balance sheet to slowly shrink while simultaneously raising interest rates made a quick 180˚ turn on Boxing Day when the S&P’s decline had reached 20%.  It seems that no central banker or government is willing to allow a bear market on their watch, even those that need never face the voters.

While forecasting the future is extremely difficult, it seems likely that if President Xi turns his sights on another industry, (Real Estate anyone?) then we could easily see another wave lower across these markets.  While instability is not desired, when push comes to shove, Xi’s ideology trumps all other concerns, and if he believes it is being threatened by the growth and power of an industry, you can be certain that industry will be targeted.  Caveat investor!

As to the Fed, the universal expectation is there will be no policy changes, so interest rates will remain the same and the asset purchase program will continue at its monthly pace of $120 billion.  The real questions center around tapering (will they mention it in the statement and how will Powell address it in the press conference) and the nature of inflation.  While clearly the latter will be described as transitory, will there be some acknowledgement that it is running hotter than they ever expected?

At Powell’s Congressional testimony several weeks ago, he was clear that “substantial further progress” toward their goals of maximum employment and average inflation stably at 2.0%, had not yet been made.  Has that progress been made in the interim?  I think not.  This implies, to me at least, that there is no policy change in the offing for a long time to come.  While there are many analysts who are looking for a more hawkish turn from the Fed in response to the clearly rising price pressures, the hallmark of this (and every previous) committee is that they will stick to their narrative regardless of the situation on the ground.  I expect they will ignore the much higher than expected inflation prints and that when asked at the press conference, Powell will strongly maintain inflation is transitory and will be falling soon.  Monday, I explained my concern that CPI is likely to moderate for a short period of time before heading sharply higher again, and that Powell and the Fed will take that moderation as victory.  Nothing has changed that view, nor the view that the Fed will fall far behind the curve when it comes to fighting inflation.  But that is the future.  For now, the Fed is very likely to remain calm and stick to their story.

OK, with that out of the way, we can peruse the markets, which, as I mentioned above, have been vey quiet awaiting the FOMC.  The other key Asian market, the Nikkei (-1.4%) fell overnight after having rallied during the Chinese fireworks, as the spread of the delta variant of Covid-19 and ongoing lockdowns in Japan have started to concern investors.

Europe, on the other hand, is all green on the screen led by the CAC (+0.75%) with both the DAX (+0.2%) and FTSE 100 (+0.2%) up similar but lesser amounts.  You’re hard pressed to point to the data as a driver as the little we saw showed German Import prices rise 12.9%, the highest level since September 1981, while French Consumer Confidence fell a tick to 101.  Hardly the stuff of bullish sentiment.  US futures, currently, sit essentially unchanged as traders and investors await Powell’s pronouncements.

The bond market is mixed this morning, with Treasury yields edging higher by 1 basis point while most of Europe is seeing a very modest decline in yields, less than 1bp.  Essentially, this is the price action of positions being adjusted ahead of key data.

Commodity prices show oil rising (+0.5%) but very little movement anywhere else in the space with both metals and agricultural prices either side of unchanged on the day.

Lastly, the dollar is ever so slightly stronger vs. most G10 counterparts, with AUD (-0.25%) and NZD (-0.2%) the laggards as concern grows over the economic impact of the ongoing spread of the delta variant.  CAD (+0.25%) is the one gainer of note, seemingly following oil’s lead.  EMG currencies have had a more mixed session with KRW (-0.4%) the worst performer on the back of rising Covid cases and ongoing concerns over what is happening in China.  The only other laggard of note is HUF (-0.3%) which is still suffering from its ongoing political fight with the EU and the result that EU Covid aid has been indefinitely delayed.  On the plus side, RUB (+0.35%) is following oil while CNY (+0.2%) seems to be benefitting from the calm imposed on markets last night.  Otherwise, movement in this space has been minimal.

All eyes are on the FOMC at 2:00 this afternoon, with only very minor data releases before then.  My read is that the market is looking for a slightly hawkish tilt to the Fed as a response to the rapidly rising inflation.  However, I disagree, and feel the risk is a more dovish than expected outcome. The fact that US economic data continues to mildly disappoint will weigh on any decision.  If I am correct, I think the dollar will have the opportunity to sink a bit further, but only a bit.

Good luck and stay safe
Adf

A Small Crisis Grows

Investors are starting to feel
That China has lost its appeal
So, capital flees
From all stocks, Chinese
As Xi brings exploiters to heel

While, thus far the impact’s been small
On markets elsewhere, please recall
That history shows
A small crisis grows
Quite quickly with each margin call

Giving credit where it is due, the Chinese have successfully distracted almost every market participant from tomorrow’s FOMC meeting.  The ongoing rout in Chinese equity markets (Shanghai -2.5%, Hang Seng -4.2%) has been fueled by the government’s hardline stance against several different industries that had become investor favorites.  If you think of the progression of events, it began with private financial firms (remember the Ant IPO that was squashed when Jack Ma was disappeared for a while?) and has continued as the evolution of the DC/EP (China’s digital yuan or CBDC) has forced the two big private payment firms, Alipay and WeChat Pay to fall into line and restrict their offerings going forward.

We have also seen the government address concerns over other tech companies and their capitalist intentions and actions, which has taken the form of questions over data security in Didi Global, the ride hailing app, and Meituan, the food service company.  After all, both of these companies are clarion calls for people to be independent, choosing their work schedule and effort, as opposed to toiling for a proper, state-owned firm.  Naturally, this is anathema to President Xi as he continues to remold the nation into his preferred view.

The latest attack has been on the private education industry, which while nominally teaching the approved curriculum, were clearly seen as an impediment to government control, and more importantly, the appropriate spread of communism.  Remember, the CCP rules the roost in China and President Xi is General Secretary of the Chinese Communist Party.  It was certainly dichotomous that an area of such immense social importance, that preached communism, would be offered by capitalist firms.

The takeaway here, though, is not that things are getting tougher for investors in China, but that history has shown that most financial crises start small and gather momentum.  While many of you may not remember the Asia crisis of 1997, it started as an issue solely confined to Thailand and the Thai baht.  Questions over the country’s ability to repay its creditors, especially as its USD reserves had shrunk and the dollar’s rally was becoming a major problem locally.  But Thailand is not a very large country from an economic perspective, and so it was initially thought this would amount to very little.  Within a month or two of the initial concerns, however, the entire region was in turmoil as it turned out virtually none of the countries there had sufficient USD reserves, and all had borrowed heavily in dollars and were having difficulty repaying those loans.  There was a huge swoon in markets, which ultimately led to Russia defaulting on its debt while Long Term Capital, a famed hedge fund of the time, wound up on the brink and was only saved by the Fed forcing the entire Wall Street community to put up money to save it.  (Ironically, Bear Stearns is the one bank that wouldn’t participate in that rescue and we know what happened to them 10 years later!)

Speaking of the GFC, this too, was seen as a minor problem at the start.  As the housing bubble inflated, the working assumption was that the entire national housing market could never fall all at once, so all of those mortgage-backed derivatives were created and sold as low risk, high return investments throughout the world.  When the first concerns were raised, none other than Fed Chair Bernanke explained that “…the troubles in the subprime sector on the broader housing market will likely be limited.”  We know how that worked out and of course, the problems quickly became global in nature and forced the first invocation of a new emergency program known as QE.

One last example of the ability of seemingly distant events to impact the entire global financial structure comes from China in 2015.  That summer, just 6 years ago, the PBOC surprised markets with a mini-devaluation of the yuan, about 2%, as a relief valve for an equity market that had started to come under pressure several months previously.  But once the PBOC acted, risk appetite disappeared and we saw a severe contraction in global equity markets, a huge bond rally and strength in the dollar as the haven of choice.

The point is that while you may consider the fact that the Chinese government is cracking down on companies that it considers to be ideologically impure, and that it will have nothing to do with your investments in the FANGMAN group of stocks, there is every chance that this action serves as the catalyst for, at the very least, a short-term price adjustment in equity indices around the world. After all, China’s growth has been a key pillar of the global growth scenario.  If that is slipping, there are likely to be problems everywhere.  Be warned and wary.

OK, on to today’s activity where the Chinese rout continues to be ignored by Japan (Nikkei +0.5%), but continues to pressure European indices lower (DAX -0.4%, CAC -0.3%, FTSE 100 -0.4%) as well as US futures, all of which are down around -0.2% at this hour.

Bond markets are a bit more uniform this morning, led by Treasury yields (-2.9bps) although European sovereigns have not rallied as much, with most seeing yield declines of roughly 1 basis point.  (As an aside, yesterday’s price action, which saw US equity markets ultimately rebound, saw Treasuries give up their early gains and close with slightly higher yields on the day.)

In the commodity space, oil is essentially unchanged on the day, as is gold, with neither moving even 0.1%.  Copper is the biggest mover, falling 1.0%, although there is lesser weakness in other base metals.  Agricultural products are mixed with both Soybean and Corn higher by 1.0% while Wheat has slipped 0.4%.

As to the dollar, on this broadly risk-off day, it is broadly higher.  In the G10 bloc, the commodity currencies are the worst performers (NZD -0.7%, NOK -0.5%, AUD -0.4%) while the rest of the bloc has seen less pressure.  Naturally, JPY (+0.25%) is bucking the dollar trend in this type of session.  In the emerging markets, ZAR (-0.7%) is the laggard as traders digest the post-riot relief act from the government and give it two thumbs down.  The next biggest loser is CNY (-0.35%), although at this point, I’ve already described the reasons capital is leaving the country.  Otherwise, most of these currencies are lower, but the movement has been on the order of -0.1% to -0.2%, so not very dramatic.  There is one outlier on the plus side, KRW (+0.4%) which seems to have been on the back of exporters selling dollars after yesterday’s won decline to its lowest level in almost a year.  However, if CNY continues to weaken, I believe KRW will ultimately follow it.

On the data front this morning we see Durable Goods (exp 2.2%, 0.8% ex transport) as well as Case Shiller House Prices (16.33%) and Consumer Confidence (123.8).  The real information overload starts tomorrow with the FOMC and on through the rest of the week with Q2 GDP and Core PCE.

The dollar is back in risk mode.  If equities continue to suffer, look for the dollar to remain bid.  If they rebound, the dollar is likely to soften by the end of the day.

Good luck and stay safe
Adf

Time to Flee

No longer will President Xi
Allow billionaires to run free
His edict last night
Proved his grip is tight
And showed traders t’was time to flee

The biggest story overnight was the continued crackdown by Chinese authorities on any private industry that has developed a measure of power in the Chinese economy.  While the tale of Didi Chuxing, the Chinese Uber, was seen as a warning, apparently, the government is becoming more impatient over the pace of adherence to the new view.  Briefly, Didi went public and then several days later the Chinese government forced them to remove their app from public availability and crushed their business under the pretext of data security.  Didi shares fell sharply.  Last night the government explained that private education companies, which were teaching the CCP curriculum, were to cease being profit-making companies “hijacked by capitalism”, and essentially will be forced to delist.  It can be no surprise that the prices of these shares fell dramatically, in one case by 98/%, as investors flee as quickly as possible.  This resulted in sharp declines across all indices there with the Hang Seng (-4.1%) and Shanghai (-2.35%) and led to a general risk-off tone.

Apparently, President Xi is no longer willing to accept that anybody else in China can have some measure of power or influence beyond his control.  Other changes involve the payment networks Alipay and Wechat, which are on the verge of being subsumed by China’s upcoming CBDC, the e-yuan.  Exclusive rights for things like music licenses are being removed and essentially, it appears that capitalism with Chinese characteristics is morphing into a full-blown state-owned economy.  We cannot be too surprised by this; after all, Xi Jinping has been ruling with an increasingly tighter grip on all segments of the economy and he is a clear adherent to strict communism.  Remember, the definition of communism is that all property is publicly (read government) owned.  We have not seen the last of this process so be careful going forward.

The ECB told us that they
Would no longer stand in the way
Of prices that rise
Until they surmise
That growth has made major headway

Now later this week from the Fed
Some pundits think, shortly ahead,
They’ll slow down their buying
Of bonds, as they’re trying,
To counter, inflation, widespread

Inflation (whether CPI or PCE), is a price series that demonstrates characteristics similar to every other price series like stocks or bonds or currencies.  There are trend movements, there are overshoots in both directions that tend to correct and there are periods of consolidation.  One of the best definitions of a trend is a series that makes either higher lows and higher highs, or conversely, lower highs and lower lows.  In other words, something that is trending higher will typically trade to a new high level and then after a period, pull back somewhat, a normal correction, before moving on to further new highs.  When the uptrend is in force, each high is higher than the last, and, more importantly, each low is higher than the last.  I make this point because I am concerned that when looking at the backgrounds of all the FOMC members, not one of them has any trading history.

This is important because, my sense on the inflation story is that it is quite realistic that we see a slowdown in price growth in the next several months, where 5.4% headline CPI falls to 4.8% and 4.5% and so forth, as this price series goes through a correction just like the stock, bond and currency markets.  Of course, if this is what we see, it is almost guaranteed that Chairman Powell, and his band of merry men (and women) will be all over the tape crowing over the transitory nature of inflation.

Alas, my concern is that given what I believe is a strong uptrend in inflation, this retracement in CPI (and PCE) will stop at a higher level than the previous lows and set itself up for another, more powerful move higher.  In the meantime, the Fed will have waved away any concerns over inflation as they continue to pump unlimited liquidity into the system to run the economy as hot as possible.  After all, in their collective mind, they will have proven inflation is transitory.  However, the next leg higher in CPI and PCE is liable to be far more severe, occurring far more quickly than the Fed expects, and lead to a more permanent unanchoring of inflation expectations.

It will also put the Fed in an even tighter bind than they currently find themselves.  This is because if CPI prints 6%, or 7% or more, the market is far less likely to accept their jawboning as a reason to maintain low yields and high stock prices.  Rather, they will be forced to decide between addressing inflation, which means raising interest rates sharply and significantly impacting, in a very negative way, the real economy, as well as asset markets; or they will have to come up with some other way to measure inflation such that it is not rising at such a ferocious clip but is still seen as credible.  One of their dilemmas is that, politically, inflation is already becoming a problem for the Biden administration, and that is at 5%.  Be prepared for the Misery Index (a Ronald Reagan invention that was the sum of CPI and the Unemployment Rate) to become a popular meme from all of President Biden’s opponents going forward.

Oh yeah, if you think that letting inflation run hot like that is going to goose equity market returns, especially when starting from such incredibly steep valuations, you would be wrong.  History shows that when inflation rises above 5%, equity markets do not provide any type of real hedge.  Let me be clear that this is not going to play out by autumn 2021, but could very well be the case come summer or autumn 2022, a particularly difficult time for the incumbent party in Washington as mid-term elections will be upcoming and the party in power tends to get the blame for economic problems.

What about the dollar you may ask?  In this scenario, the dollar is very likely to suffer greatly, so keep that in mind as you look ahead to your hedging needs for next year and beyond.

In the meantime, the Chinese inspired sell-off has led to some risk concerns, but not (yet) a widespread sell-off.  For instance, the Nikkei (+1.0%) managed to rally in the face of the Chinese equity market declines although, outside Japan, the screens are basically all red in Asia.  European bourses are somewhat lower (DAX -0.4%, CAC -0.25%, FTSE 100 -0.25%) as they respond to the general negative tone in risk as well as a much weaker than expected German IFO reading of 101.2, well down from last month’s reading.  However, these levels are well off the session lows, as are US futures, which are down on the order of -0.25%, although were much lower earlier.

Bond markets are a little more mixed as Treasury yields fall 3.2bps (taking real yields to historic lows of -1.12%) but European sovereigns are more mixed with Bunds unchanged and OATs (+0.8bps) and Gilts (-0.8bps) not giving us any direction.

Commodity prices are mostly lower led by oil (-0.8%), although gold (+0.3%) is showing some positive haven characteristics.  Clearly, declining real yields are also supporting the precious metals.  Foodstuffs are softer (about which everyone except farmers are happy) and base metals are mixed with copper (+1.35%) leading the way higher although both Al (-0.4%) and Sn (-0.3%) are under pressure.

Finally, the dollar is not exhibiting its ordinary risk-off attitude this morning, as it is broadly softer vs. its G10 counterparts with only AUD (-0.1%) down on the day, arguably given concerns of changes with the Chinese economy.  But the rest of the bloc is marginally higher as I type led by SEK (+0.35%) and GBP (+0.3%), both of which are seeming to respond to reopening economies.

In the EMG space, however, there are many more decliners than gainers, led by RUB (-0.45%) on the back of oil’s weakness, but also KRW (-0.4%) which is feeling the pinch of the change in tone from China.  This story is going to be the second biggest driver, after the Fed, for a while, I think.

Of course, this week brings the FOMC meeting, but also Q2 GDP and Core PCE, so there is much to look forward to here.

Today New Home Sales 800K
Tuesday Durable Goods 2.0%
-ex Transport 0.8%
Case Shiller Home Prices 16.2%
Consumer Confidence 124.0
Wednesday FOMC Rate Decision 0.00% – 0.25%
IOER 0.15%
Thursday Q2GDP 8.5%
Initial Claims 380K
Continuing Claims 3192K
Friday Personal Income -0.4%
Personal Spending 0.7%
Core PCE 0.6% (3.7% Y/Y)
Chicago PMI 63.3
Michigan Sentiment 80.8

Source: Bloomberg

Obviously, the Fed is the big story as the data that comes before will not be seen as critical.  The GDP print will be quite interesting, but it is widely accepted that this is the peak and we will be slowing down from here.  However, Friday’s Core PCE number will really be scrutinized as another high print will make Powell’s task that much harder with respect to convincing people that inflation is transitory, especially if their favorite indicator keeps running higher.  Ultimately, I expect we will see a short-term retracement on the rate of inflation before the next leg up and that is the one about which we should all be concerned.

As to today’s market, if equity markets manage to shake off their concerns over Chinese activities, the dollar seems likely to continue with today’s soft tone.  If not, though, look for a rebound.

Good luck and stay safe
Adf

Jay’s Watershed

The PMI data released
This morning show prices increased
As bottlenecks build
With orders unfilled
Inflation has shown it’s a beast

The question is, how will the Fed
Respond as they’re looking ahead
Will prices be tamed
Or else be inflamed
This may well be Jay’s watershed

Yesterday’s ECB meeting pretty much went according to plan.  There is exactly zero expectation that Lagarde and her crew will be tightening policy at any point in the remote future.  In fact, while she tried to be diplomatic over a description of when they would consider tightening policy; when they see inflation achieving their 2.0% target at the “midpoint” of their forecast horizon of two to three years, this morning Banque de France Governor Villeroy was quite explicit in saying the ECB’s projections must show inflation stable at 2.0% in 12-18 months.  In truth, it is rare for a central banker to give an explicit timeframe on anything, so this is a bit unusual.  But, in the end, the ECB essentially promised that they are not going to consider tightening policy anytime soon.  They will deal with the asset purchase programs at the next meeting, but there is no indication they are going to reduce the pace of purchases, whatever name they call the program.

One cannot be surprised that the euro fell in the wake of the ECB meeting as the market received confirmation of their previous bias that the Fed will be tightening policy before the ECB.  But will they?

Before we speak of the Fed let’s take a quick look at this morning’s PMI data out of Europe.  The most notable feature of the releases, for Germany France and the Eurozone as a whole was the rapid increase in prices.  Remember, this is a diffusion index, where the outcome is the difference between the number of companies saying they are doing something (in this case raising prices) and the number saying they are not.  In Europe, the input price index was 89, while the selling price index rose to 71.  Both of these are record high levels and both indicate that price pressures are very real in Europe despite much less robust growth than in the US.  And remember, the ECB has promised not to tighten until they see stable inflation in their forecasts 18 months ahead.  (I wonder what they will do if they see sharply rising inflation in that time frame?)

While the latest CPI reading from the Eurozone was relatively modest at 2.0%, it strikes me that price pressures of the type described by the PMI data will change those numbers pretty quickly.  Will the ECB respond if growth is still lagging?  My money is on, no, they will let prices fly, but who knows, maybe Madame Lagarde is closer in temperament to Paul Volcker than Arthur Burns.

Which brings us back to the Fed and their meeting next week.  The market discussion continues to be on the timing of any tapering of asset purchases as well as the details of how they will taper (stop buying MBS first or everything in proportion).  But I wonder if the market is missing the boat on this question.  It seems to me the question is not when will they taper but will they taper at all?  While we have not heard from any FOMC member for a week, this week’s data continues to paint a picture of an economy that has topped out and is beginning to roll over.  The most concerning number was yesterday’s Initial Claims at a much higher than expected 419K.  Not only does that break the recent downtrend, but it came in the week of the monthly survey which means there is some likelihood that the July NFP report will be quite disappointing.  Given the Fed’s hyper focus on employment, that will certainly not encourage tapering.  The other disappointing data release was the Chicago Fed National Activity Index, a number that does not get a huge amount of play, but one that is a pretty good descriptor of overall activity.  It fell sharply, to 0.09, well below both expectations and last month’s reading, again indicating slowing growth momentum.

This morning we will see the flash PMI data for the US (exp 62.0 Mfg, 64.5 Services) but of more interest will be the price components here.  Something tells me they will be in the 80’s or 90’s as prices continue to rise everywhere.  While I believe the Fed should be tapering, and raising rates too, I continue to expect them to do nothing of the sort.  History has shown that when put in these circumstances, the Fed, and most major central banks, respond far too slowly to prevent inflation getting out of hand and then ultimately are required to become very aggressive, à la Paul Volcker from 1979-82, to turn things around.  But that is a long way off in the future.

But for now, we wait for Wednesday’s FOMC statement and the following press conference.  Until then, the narrative remains the Fed is going to begin tapering sometime in 2022 and raising rates in 2023.  With that narrative, the dollar is going to remain well-bid.

Ok, on a summer Friday, it should be no surprise that markets are not very exciting.  We did see some weakness in Asia (Hang Seng -1.45%, Shanghai -0.7%, Nikkei still closed) but Europe feels good about the ECB’s promise of easy money forever with indices there all nicely higher (DAX +1.0%, CAC /-1.0%, FTSE 100 +0.8%).  US futures are higher by about 0.5% at this hour, adding to yesterday’s modest gains.

Bond markets are behaving as one would expect in a risk-on session, with yields edging higher.  Treasuries are seeing a gain of 1.3bps while Europe has seen a bit more selling pressure with yields higher by about 2bps across the board.

Commodity price are broadly higher this morning with oil (+0.1%) consolidating its recent rebound but base metals (Cu +0.4%, Al +0.7% and Sn +1.1%) all performing well.  All that manufacturing activity is driving those metals higher.  Precious metals, meanwhile, are under pressure (Au -0.5%. Ag -1.1%).

Finally, the dollar is doing well this morning despite the positive risk attitude.  In the G10, JPY (-0.3%) is the laggard as Covid infections spread, notably in the Olympic village, and concerns over the situation grow.  But both GBP (-0.25%) and CHF (-0.25%) are also under pressure, largely for the same reasons as Covid infections continue to mount.  The only gainer of note is NZD (+0.2%) which is the beneficiary of short covering going into the weekend.

In the emerging markets, ZAR (-0.55%) is the worst performer, falling as concerns grow that the SARB will remain too dovish as inflation rises there.  Recall, they just saw a higher than expected CPI print, but there is no indication that policy tightening is on the way.  HUF (-0.5%) is the other noteworthy laggard as the ongoing philosophical differences between President Orban and the EU have resulted in delays for Hungary to receive further Covid related aid that is clearly needed in the country.  The forint remains weak despite a much more hawkish tone from the central bank as well.

Other than the PMI data, there is nothing else to be released and we remain in the Fed’s quiet period, so no comments either.  Right now, the market is accumulating dollars on the basis of the idea the Fed will begin tapering soon.  If equities continue to rally, this goldilocks narrative could well help the dollar into the weekend.

Good luck, good weekend and stay safe
Adf

Christine Lagarde’s Goal

This morning, Christine Lagarde’s goal
Is focused on how to cajole
The market to see
That her ECB
Has total command and control

Ahead of the ECB statement and the subsequent press conference this morning, markets are mostly biding their time.  Monday’s risk-off session is but a hazy memory and everyone is completely back on board for the reflation trade despite rising numbers of Covid cases as well as newly imposed lockdowns by governments throughout the world.  While that may seem incongruous, apparently, the belief is that any such lockdowns will be for a much shorter period this time than we saw last year, and so the impact on economic activity will be much smaller.

With a benign backdrop, it is worthwhile, I believe, to consider what we are likely to see and hear from the ECB and how it may impact markets.  We already know that they have changed their inflation target from, “close to, but below 2.0%” to ‘2.0%’.  In addition, we have been told that there is a willingness to accept a period of time where inflation runs above their target as the ECB seeks to fine-tune both the message and the outcome.  Of course, when you think about what CPI measures, it is designed to measure the average rate of price increases for the population as a whole, the idea of fine-tuning something of this nature is ridiculous.  Add to that the extreme difficulty in measuring the data (after all, what exactly makes up the consumer basket? and how does it change over time?  and isn’t it different for literally every person?) and the fact that central banks are concerned if inflation prints at 1.7% or 2.0% is ludicrous.  As my friend @inflation_guy (you should follow him on Twitter) always explains, you cannot reject the null hypothesis that 1.7% and 2.0% are essentially the same thing in this context.  In other words, there is no difference between 2.0% inflation, where central bankers apparently feel comfortable, and 1.7% inflation, where central bankers bemoan the impending deflationary crisis.

As well, the ECB is going to explain their new asset purchase process.  Currently, there are two programs, the Public Sector Purchase Program (PSPP) which is the original QE program and had rules about adhering to the capital key and not purchasing more than 33% of the outstanding debt of any nation in order to prevent monetizing that debt.  Covid brought a second program, the Pandemic Emergency Purchase Program (PEPP), which had no such restrictions regarding what was eligible and how much of any particular nation’s bonds could be acquired but was limited in size and time.  Granted they both expanded the size of the program twice and extended its maturity, but at least they tried to make believe it was temporary.  The recent framework review is likely to allow PEPP to expire in March 2022, as currently planned, but at the same time expand the PSPP and its pace of purchases so that there will be no difference at all to the market.  In other words, though they will attempt to describe their policies as ‘new’, nothing is likely to change at all.

Finally, they apparently will be altering their forward guidance to promise interest rates will remain unchanged at current levels until inflation is forecast to reach or slightly surpass 2% and remain there for some time within the central bank’s projection period of two to three years.  Given the decades long lack of inflationary impulse in the Eurozone due to anemic underlying economic growth and ongoing high unemployment, this essentially means that the ECB will never raise rates again.  The ongoing financial repression being practiced by central banks shows no sign of abating and the ECB’s big framework adjustment will do nothing to change that outcome.

Will any of this matter?  That is debatable.  First, the market is already fully aware of all these mooted changes, so any price impact has arguably already been seen.  And second, have they really changed anything?  I would argue the answer to that is no.  While the descriptions of policies may have changed, the actions forthcoming will remain identical.  Interest rates will not move, and they will continue to purchase the same number of bonds that they are buying now.  As such, despite a lot of tongue wagging, I expect that the impact on the euro will be exactly zero.  Instead, the single currency will remain focused on the Fed’s (remember the FOMC meets next week), interest rate policy and the overall risk appetite in the market.

Turning to markets ahead of the ECB announcement we see that risk remains in vogue with strong gains in Asia (Hang Seng +1.85, Shanghai +0.35%, Nikkei closed) and Europe (DAX +0.9%, CAC +0.8%) although the FTSE 100 is barely changed on the day.  US futures are all green and higher by about 0.2% at this hour.

Bond markets have calmed down after a few very choppy days with Treasury yields backing up 1bp and now back to 1.30%, nearly 18 basis points above the low print seen Monday.  European sovereigns are mixed with Gilts seeing yields edge up by 0.8bps, while OATs have seen yields slide 0.8bps and Bunds are unchanged on the day.  Of course, with the ECB imminent, traders are waiting to see if there is any surprise forthcoming so are being cautious.

Oil prices continue their sharp rebound from Monday’s virtual collapse, rising another 0.6% and now firmly back above $70/bbl.  It turns out that Monday was a great opportunity to buy oil on the cheap!  Precious metals continue to disappoint with gold (-0.4%) slipping back below $1800/oz, although really just chopping around in a range.  Copper is firmer by 0.8% this morning but the rest of the non-ferrous group is slightly softer.

As to the dollar, it is under pressure virtually across the board this morning as there is certainly no fear visible in markets.  In the G10, NOK (+0.9%) is the leader on the back of oil’s rebound with the rest of the bloc seeing broad-based, but shallow, gains.  In the emerging markets, HUF (+0.55%) is the leader after recent comments from a central banker that they will be raising rates until their inflation goal is met.  (So old school!)  Meanwhile, overnight saw strength in APAC currencies (PHP +0.45%, IDR +0.4%, KRW +0.35%) as positive risk sentiment saw foreign inflows into the entire region’s stock markets.

We do get some data this morning starting with Initial (exp 350K) and Continuing (3.1M) Claims at 8:30 as well as Leading Indicators (0.8%) and Existing Home Sales (5.90M).  Fed speakers remain incommunicado due to the quiet period so as long as the ECB meets expectations the dollar should continue to follow its risk theme, which today is risk-on => dollar lower.

Good luck and stay safe
Adf

On Command

As Covid infections expand
Worldwide, and more meetings get banned
The worry is that
Growth’s surge will fall flat
And stocks will not rise on command

But Monday’s price action was fleeting
As dip buyers now are competing
To add to their stash
Of low value trash
Before the Fed’s next monthly meeting

Come with me on a journey to the past.  A time when investors considered risks as well as rewards and if those risks seemed elevated, those very same investors would consider actually selling stocks and running to the (relative) safety of the government bond market.  Risks could include slower growth, higher inflation or even the recurrence of a global pandemic.  Naturally, under circumstances of that nature, investors displayed caution.  Now, fortunately, situations like that don’t seem to happen very often anymore, although if you think back to…Monday, that seemed to be the developing narrative.   Ahh, but as Dinah Washington crooned so fantastically in 1959, What a Difference a Day Makes.

Monday’s price action and narrative might as well have occurred in 2008 during the GFC given how long ago it seems and how short memories have become over time.  So, all of the angst regarding the spread of the delta variant and additional lockdowns around the world, as well as the impact that would have on the global growth scenario has essentially been expunged from the record and it’s now all sunshine, lollipops and rainbows going forward.  At least, that’s the way it seems this morning.

Yesterday saw a significant rebound in the equity market and a sharp sell-off in Treasury and other government bond markets as the bargain hunters were out in force taking advantage of the 2% dip seen Monday.  After all, it’s not as though there was any new news released to encourage a change in view.  The only data release was Housing Starts which were marginally better than expected, but then everybody knows the housing market is en fuego.  With both the Fed and ECB in their quiet periods ahead of upcoming meetings, there were no central bank statements to help ameliorate concerns that had become manifest on Monday.  Which leads to the conclusion that nothing in the zeitgeist has changed; buy the dip because there is no alternative remains the single most powerful underlying force in markets today.

Which brings us to this morning’s situation, where the rally continues in equity markets, bond markets continue to retreat from their recent highs and commodity markets are getting their feet under themselves again.  What about inflation you may ask?  Bah, old news.  Clearly it is transitory as there hasn’t been a higher than expected print in more than a week!  (Well, that’s not strictly true as this morning South African CPI was released at a higher than expected 4.9% which has pushed back on the growing narrative that the SARB might be able to back off its mooted tightening.)  But South Africa is insignificant in the broad scheme of things, so the combination of increasing infections there along with rioting over the imprisonment of former president Jacob Zuma has just not been enough to concern investors in other markets.

One has to give props to the central banking community for their ability to convince economists, politicians and investors that the worsening inflation situation is really a very short-term blip, and that the big problem remains deflation.  Of course, it is not hard to convince politicians once they understand this stance allows for more spending.  Economists tend to be lost in their models so aren’t that important anyway.  Investors, however, have historically taken these things with a bit more skepticism, and the fact that the market is responding in exactly the manner central banks want is the truly surprising outcome.  Nothing has changed my view that this entire house-of-cards-like market will come tumbling down at some point, but it is very clear that as John Maynard Keynes explained in 1924, “the market can stay irrational longer than you can stay solvent.”  In other words, calling the timing of any significant pullback is a fool’s errand, and I will endeavor not to be foolish today.

As to markets today, it is very clear by now that risk is back on.  Equities in Asia were generally higher (Nikkei +0.6%, Hang Seng -0.1%, Shanghai +0.7%) and are quite strong in Europe (DAX +0.9%, CAC +1.4%, FTSE 100 +1.7%).  US futures you ask?  Generally higher as well, with DOW +0.4%, although NASDAQ futures are actually -0.1% at this hour.  The rotation into value seems to be this morning’s view.

The bond market is behaving as expected with investors quickly getting out of their recently added long positions.  Treasury yields are higher by 2.2bps, while Bunds, OATs and Gilts are all about 1.5bps higher this morning.  There is certainly no reason to own bonds when stocks are on the move!

Commodity markets are mixed this morning, although the most important of the bunch, oil, is higher by 1.5% and continuing to rebound from Monday’s substantial declines.  That price action on Monday was clearly technical in nature and shook out a great many weak hands.  The case for higher oil prices remains strong in my view, as the lack of capex in the sector as well as the ESG efforts to starve the industry of capital will result in a supply demand mismatch over time that will only resolve itself with higher prices.  As to the rest of the commodity space, precious metals are mixed (Au -0.5%, Ag 0.7%), as are base metals (Cu -0.2%, al +0.2%) and Ags (Soybeans -0.4%, Wheat +0.4%).  In other words, there is no directional bias here.

Finally, in the currency markets, movement has been a bit more muted overall, and mixed just like elsewhere.  In the G10 bloc, NOK (+0.35%) is following oil higher and JPY (-0.25%) is seeing its haven status work against it as it reverts to form, with the rest of the bloc +/- 0.1% meaning there is nothing to discuss.  In the emerging markets, there is a bit more weakness with ZAR (-0.4%) still suffering from the increased spread of Covid as are KRW (-0.3%) and the CE4 (HUF -0.3%, CZK -0.3%, PLN -0.25%).  On the plus side there is only CNY (+0.2%) which was supported by comments from the central bank claiming they will keep the yuan “basically stable”.

There is no data and no speakers today which means that the FX market is left to watch other markets for its cues.  With risk back in vogue, I expect that the dollar could cede some ground against the majors, but the ongoing issues throughout different emerging markets are likely to continue to weigh on currencies in that sector.

Good luck and stay safe
Adf

Far From Benign

Was yesterday’s market decline
A flash or a longer-term sign
Of things gone astray
That might well give way
To outcomes quite far from benign

Is this the end?  Have we seen the top in the equity markets?  That seems to be the question being asked this morning as both traders and investors try to determine if the first risk-off session in a number of months is the beginning of a trend, or merely a symptom of some short-term position excesses.  While Asian markets (Nikkei -1.0%, Hang Seng -0.85%, Shanghai -0.1%) continued along the theme of greater problems to come, Europe is not quite as worried, at least not in the equity space.  Interestingly, despite the rebound in Europe (DAX +0.1%, CAC +0.4%, FTSE 100 +0.3%) European sovereign debt has continued its rally with yields there lower by a pretty consistent 3 basis points across the board.

Meanwhile, after a tremendous rally in the Treasury market yesterday, where 10-year yields fell 10 basis points and the 2yr-10-yr spread flattened to below 100bps, buyers are still at large with the 10-year declining a further 1.2bps as I write.

It seems the narrative that is beginning to take hold is that the economic rebound from the Covid recession has reached its peak and that going forward, growth will quickly revert to trend.  This newer narrative has been reinforced by the spread of the delta variant of Covid throughout Asia and Europe (and the US, although lockdowns don’t seem to be on the agenda here) and the renewed closures being imposed around the world.  For instance, half of Australia has been put back under lockdown, as has New Zealand and growing parts of Southeast Asia including Singapore and Indonesia.  Europe, too, is feeling the pressure with rising caseloads n the UK, Spain and France resulting in calls for further restrictions.   The upshot of this is that earnings will struggle to rise as much as previously expected and that inflation pressures will quickly abate, and the concept of transitory inflation may be proven correct.

Chair Powell and friends are quite sure
Inflation, we won’t long endure
But pundits abound
Who’ll gladly expound
On why it’s the problem du jour

This brings us back to the big question hanging over markets, is inflation transitory or persistent?  Certainly, the recent trend in the data might argue for persistence as we continue to see higher prints than both the previous period as well as than forecasted.  As long as that is the case, it will be more and more difficult for the central banks to declare victory.  While commodity futures markets are well off their highs, a broad index of basic materials prices, things where there are no futures markets, is at all-time highs and rising.  Wages continue to rise as well, as the disconnect between the number of unemployed people and the number of job openings is forcing business to increase pay to get workers to come on board.  All of these things point to continued higher prices going forward, as do surveys of both consumers and businesses who virtually all agree higher prices are in our future.

However, the evidence from the bond market, the market that is historically seen as the most attuned to inflationary pressures, would argue that the inflation scare has passed.  With yields tumbling, US 10-year yields are more than 60 basis points off their late March highs, and the yield curve flattening.  All indications are that bond investors are sanguine over the inflation threat and are actually more worried about deflation.

The argument on this side remains that temporary bottlenecks have resulted in price pressures during the reopening of economies from the Covid lockdowns.  Economists’ models point to those very price pressures as the impetus for increased supply and, thus, lower prices in the future.  The problem is that the timeline for increasing supply is very different across different products.  Perhaps the most widely known shortage is semiconductors which has led to reductions in the production of cars, washing machines and consumer electronics.  But it takes at least 2 years to build a semiconductor factory, so it is quite possible the shortage will not be alleviated anytime soon.  Similarly, with mined raw materials, it takes multiple years to open up new mines, so shortages in copper or tin may not be alleviated for a number of years yet.  Of course, if growth is slowing, demand for these items will diminish and price pressures are likely to fade as well.

Let’s consider a few things about which we are certain.  First, securities prices do not travel in a straight line, and in fact, there are many short-term reversals involved in long-term trends.  Thus, if inflation is indeed persistent, the recent bond rally may well be the result of short-term factors and position reductions.  Recall, higher yields were the consensus Wall Street forecast three months ago, with expectations for the 10-year to be yielding between 2.0% and 2.5% in December.  Large fund managers were on board with that idea and built large positions, which take time to unwind.  It is entirely possible we are seeing the last throes of those position adjustments right now.

Another thing about which we are (pretty) certain is that during the Fed’s quiet period, we will not hear from any Fed speakers.  This means that in the event the market really does continue yesterday’s declines and starts to accelerate, the Fed will be hamstrung in their ability to try to jawbone things back to a smoother path.  Would Powell break the quiet period if markets fell 5% or 8% in a day?  My sense is he might, but that is exactly the type of thing that markets like to test.

Finally, let’s not forget that markets are hugely imperfect forecasters of the future.  After all, it was only 3 months ago when markets were forecasting much greater inflation while anticipating no change in Fed policy until 2024.  So, just because the current market view points to a potential slowing of economic growth and reduced inflation pressures, the economy behaves independently of the markets, and may well show us that the views from March were, in fact, correct.

Having already touched on equity and bond markets, a quick look at the FX markets shows that the dollar continues to power ahead vs. its G10 counterparts with NOK (-0.7%) and NZD (-0.65%) the laggards this morning.  NOK continues to suffer from oil’s remarkable 7.5% decline yesterday, while New Zealand is suffering on renewed lockdown fervor, and this after the RBNZ just last week explained they were about to tighten policy!  But we are seeing weakness in the pound (-0.45%) and AUD (-0.35%) both of which seem to be Covid shutdown related, while JPY (0.0%) is the only currency holding up in the bloc today despite further negative news regarding the Olympics and athletes contracting Covid as well as sponsors pulling out.

Emerging markets have been more varied with losers in Asia (SGD -0.35%, KRW -0.25%) on the back of Covid lockdowns, while gainers have included TRY (+0.4%), INR (+0.35%) and RUB (+0.3%).  The ruble seems to be reacting to the end of oil’s decline, unlike NOK, while INR saw equity market inflows driving the currency higher.  TRY, which is on holiday today, is benefitting from a higher inflation reading than expected and expectations of further policy tightening by the central bank there.

On the data front today we see Housing Starts (exp 1590K) and Building Permits (1696K).  We all know the housing market remains hot, so these data points are unlikely to move markets.  Rather, watch carefully for a continuation of yesterday’s risk off session and a stronger dollar.  I have a feeling that this morning’s price action is more pause than trend.

Good luck and stay safe
Adf

Bears’ Great Delight

As Covid renews its broad spread
Investors have started to shed
Their risk appetite,
To bears’ great delight,
And snap up more havens instead

Risk is off this morning on a global basis.  Equity markets worldwide have fallen, many quite sharply, while haven assets, like bonds, the yen and the dollar, are performing quite well.  It seems that the ongoing increase in Covid infections, not only throughout emerging markets, but in many developed ones as well, has investors rethinking the strength of the economic recovery.

The latest mutation of Covid, referred to as the delta variant, is apparently significantly more virulent than the original.  This has led to a quickening of the pace of infections around the world.  Governments are responding in exactly the manner we have come to expect, imposing lockdowns and curfews and restricting mobility.  Depending on the nation, this has taken various forms, but in the end, it is clearly an impediment to near-term growth.  Recent examples of government edicts include France, where they are now imposing fines on anyone who goes to a restaurant without a vaccine ‘passport’ as well as on the restaurants that allow those people in.  Japan has had calls to cancel the Olympics, as not only will there be no spectators, but an increasing number of athletes are testing positive for the virus and being ruled out of competition.

A quick look at hugely imperfect data from Worldometer shows that 8 of the 10 nations with the most reported new cases yesterday are emerging markets, led by Indonesia and India.  But perhaps of more interest is that the largest number of new cases reported was from the UK.  Today is ‘Freedom Day’ in the UK, where the lockdowns have ended, and people were to be able to resume their pre-Covid lives.  However, one has to wonder if the number of infections continues to rise at this pace, how long it will be before further restrictions are imposed.  Clearly, market participants are concerned as evidenced by the >2.0% decline in the FTSE 100 as well as the 0.45% decline in the pound.

While this story is not the only driver of markets, it is clearly having the most impact.  It has dwarfed the impact of the OPEC+ agreement to raise output thus easing supply concerns for the time being.  Oil (WTI – 2.75%) is reacting as would be expected given the large amount of marginal supply that will be entering the market, but arguably, lower oil prices should be a positive for risk appetite.  As I indicated, today is a Covid day.  The other strong theme is in agricultural products where prices are rising in all the major grains (Soybeans +0.6%, Wheat +1.4%, Corn +1.7%) as the weather is having a detrimental impact on projected crop sizes.  The ongoing drought and extreme heat in the Western US have served to reduce estimates of plantings and heavy rains have impacted crops toward the middle of the country.

With all that ‘good’ news in mind, it cannot be surprising that risk assets have suffered substantially, and havens are in demand.  For instance, Asian equity markets were almost universally in the red (Nikkei -1.25%, Hang Seng -1.85%, Shanghai 0.0%), while European markets are performing far worse (DAX -2.0%, CAC -2.0%, FTSE MIB (Italy) -2.9%).  US futures are all pointing lower with the Dow (-1.0%) leading the way but the others down sharply as well.

Bonds, on the other hand, are swimming in it this morning, with demand strong almost everywhere.  Treasuries are leading the way, with yields down 4.7bps to 1.244%, their lowest level since February, and despite all the inflation indications around, sure look like they are headed lower.  But we are seeing demand throughout Europe as well with Bunds (-2.4bps, OATs -2.0bps and Gilts -3.6bps) all well bid.  The laggards here are the PIGS, which are essentially unchanged at this hour, but had actually seen higher yields earlier in the session.  After all, who would consider Greek bonds, where debt/GDP is 179% amid a failing economy, as a haven asset.

We’ve already discussed commodities except for the metals markets which are all lower.  Gold (-0.35%) is not performing its haven function, and the base metals (Cu -1.7%, Al -0.1%, sn -0.7%) are all responding to slowing growth concerns.

Ahh, but to find a market where something is higher, one need only look at the dollar, which is firmer against every currency except the yen, the other great haven.  CAD (-1.2%) is the laggard today, falling on the back of the sharp decline in oil and metals prices.  NOK (-0.9%) is next in line, for obvious reasons, and then AUD (-0.7%, and NZD (-0.7%) as commodity weakness drags them lower.  The euro (-0.25%) is performing relatively well despite the uptick in reported infections, as market participants start to look ahead to the ECB meeting on Thursday and wonder if anything of note will appear beyond what has already been said about their new framework.  In addition, consider that weakness in commodities actually helps the Eurozone, a large net importer.

In the EMG space, it is entirely red, with RUB (-0.75%) leading the way lower, but weakness in all regions.  TRY (-0.7%), KRW (-0.7%), CZK (-0.55%) and MXN (-0.5%) are all suffering on the same story, weaker growth, increased Covid infections and a run to safety and away from high yielding EMG currencies.

Data this week is quite sparse, with housing the main theme

Tuesday Housing Starts 1590K
Building Permits 1700K
Thursday Initial Claims 350K
Continuing Claims 3.05M
Leading Indicators 0.8%
Existing Home Sales 5.90M
Friday Flash PMI Mfg 62.0
Flash PMI Services 64.5

Source: Bloomberg

The Fed is now in their quiet period, so no speakers until the meeting on the 28th.  Thursday, we hear from the ECB, where no policy changes are expected, although further discussion of PEPP and the original QE, APP, are anticipated.  So, until Thursday, it appears that the FX markets will be beholden to both exogenous risks, like more Covid stories, and risk sentiment.  If the equity market remains under pressure, you can expect the dollar to maintain its bid tone.  If something happens to turn equities around (and right now, that is hard to see) then the dollar will likely retreat in a hurry.

Good luck and stay safe
Adf

How They Debase

The world’s central banks, as a whole
Have signaled they need to control
Not only the pace
Of how they debase
Their cash, but of digging for coal

Thus, now the Big 3 have explained
The policies they have ordained
Will fund, efforts, green
But not what is seen
Endorsing ‘brown’ growth unrestrained

Last night’s BOJ meeting resulted in exactly zero monetary policy surprises but did serve to confirm that the central banking community has decided to take on a task well outside their traditional purview; climate change.  While they left policy unchanged, as universally expected, they announced that they would be introducing a new funding measure targeting both green and sustainability-linked loans and bonds.  In other words, as well as purchasing JGB’s, equities and ETF’s, they are going to expand their portfolio into ESG bonds.  The interesting thing is that the universe of ESG bonds in Japan is not that large, so the BOJ is going to wind up buying non-JPY denominated assets.  In other words, they are going to be selling a bunch of newly printed yen and converting it into other currencies to achieve their new goals.  This sounds suspiciously like FX intervention, but dressed in more politically correct clothing.  The impact, however, is likely to be a bias for a somewhat weaker yen over time.  For those of you with yen assets, keep that in mind.

Meanwhile, we have already heard from both the Fed and ECB that they, too, are going to increase their focus on climate.  Here, too, one might question whether this is an appropriate use of central bank resources.  After all, it’s not as though the economy in either place is humming along with solid growth, low inflation and excellent future prospects based on strong productivity.  But hey, combatting climate change is far trendier than the boring aspects of monetary policy, like trying to address rapidly rising inflation without tightening policy and risking a crash in equity markets.

In the end, the only thing this shift in policy focus will achieve is longer-lasting inflation.  The effort to develop new and cleaner energy by starving current energy production of capital will result in higher prices for the stuff we actually use.  Over a long enough time horizon, this strategy can make sense; alas we live our lives in the here and now and need energy every day to do so.  Germany is the perfect example of what can happen when politics overrides economics. Electricity prices in Germany average $0.383 (€0.324) per kWh.  In the US, that number is $0.104 per kWh.  Ever since the Fukushima earthquake led to Germany scrapping their nuclear fleet of power reactors, the price of electricity there has more than tripled.  I fear this is in our future if monetary policymakers turn their attention away from their primary role.

Of course, higher inflation is in our future even if they don’t do this, and there is no evidence yet, at least from the Fed or ECB, that they are about to change the current monetary policy stance that is exacerbating that inflation.  However, almost daily we are seeing markets respond to data and comments from other countries that are far more concerned with the inflationary outlook.  Last week the RBNZ ended QE abruptly and indicated they may start raising rates soon.  Last night, CPI there jumped to 3.3%, the highest level since 2011 and above their target band.  It should be no surprise that NZD (+0.45%) rose after the print as did local yields as expectations for a rate hike accelerated.  In fact, I believe this is what the immediate future will look like; smaller countries with rising inflation will tighten monetary policy and their currencies will appreciate accordingly.

Turning to today’s markets, risk was under pressure overnight after a generally weak US session.  Led by the Nikkei (-1.0%), most of Asia was softer, but not all (Hang Seng 0.0%, Shanghai -0.7%, Australia +0.2%).  Europe, which had been higher on the opening has since drifted down and is now mixed with the DAX (0.0%) unchanged while the CAC (-0.5%) lags the rest of the continent and the FTSE 100 (+0.2%) has managed to hold its early gains.  US futures have also held onto small gains with all three indices up about 0.2%.

Bond markets are somewhat mixed as Treasuries (+2.5bps) sell off after yesterdays rally where yields fell 5bps.  However, European sovereigns are all in demand this morning with yield declines ranging from 1.0 to 1.8 basis points.  Commodity markets show crude slightly higher (+0.15%), gold under pressure (-0.7%) and base metals mixed (Cu -0.3%, Al +0.3%, Sn +0.7%).

In the FX markets, aside from kiwi, NOK (+0.25%) has rallied on oil’s rebound from its lows earlier this week, but the rest of the G10 is softer.  It should be no surprise JPY (-0.35%) is the worst performer, while the other currencies are simply drifting slightly lower, down in the 0.1% – 0.2% range.  In the EMG bloc, ZAR (+1.5%) is the big winner as it regains some of the ground it lost earlier in the week on the back of the rioting there.  The government has sent in the army to key hot spots to quell the unrest and so far, it seems to be working thus international investors are returning.  Otherwise, we see gains in RUB (+0.3%) and MXN (+0.3%), both of which benefit from oil and tighter monetary policy from their respective central banks.  On the downside, TWD (-0.4%) has been the worst performer in the bloc as dividend repatriation from foreign equity holders pressured the currency.  This is not a long-term issue.   Away from that, some of the CE4 are drifting lower alongside the euro but there has not been much other news of note.

On the data front this morning we see Retail Sales (exp -0.3%, +0.4% ex autos) as well as Michigan Sentiment (86.5).  After two days of Powell testimony, where he continued to maintain there would be no policy tightening and that inflation is transitory, today we hear from NY’s Williams, one of the key members of the FOMC, and someone who has remains steadfastly dovish.

The dollar’s recent strength seems to have reached its limit so I expect that we could see a bit of a pullback if for no other reason than traders who got long during the week will want to square up ahead of the weekend.

Good luck, good weekend and stay safe
Adf

Progress, Substantial

To everyone who thought the Fed
Was ready to taper, Jay said
‘Til progress, substantial,
Is made, no financial
Adjustments are reckoned ahead

If, prior to yesterday, you were worried that the Fed was getting prepared to taper its asset purchases, stop worrying.  It doesn’t matter what Dallas Fed President Kaplan, or even SF Fed President Daly says about the timing of tapering.  The only ones who matter are Powell, Clarida, Williams and Brainerd, and as the Chairman made clear once again yesterday, they ain’t going to taper anytime soon.

In testimony to the House Financial Services Committee Chairman Jay sent a clear message; nothing is changing until the Fed (read the above-mentioned four) sees “substantial further progress” on their twin goals of maximum employment and an average inflation rate of 2.0%.  Obviously, they have moved a lot closer on the inflation front, with many pundits (present company included) saying that they have clearly exceeded their goal and need to address that issue.  But for as much vitriol as is reserved for our previous president, both the Fed and Congress are clearly all-in on the idea that the 3.5% Unemployment Rate achieved during his term just before the pandemic emerged, which was the lowest in 50 years, is actually the appropriate level of NAIRU.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment and is the economic acronym for the unemployment rate deemed to be the lowest possible without causing increased wage pressures leading to rising inflation.  For the longest time, this rate was thought to be somewhere in the 4.5%-5.5% area, but in the decade following the GFC, as policymakers pushed to run the economy as hot as possible, the lack of measured consumerinflation, despite record low unemployment, forced economists to rethink their models.  Arguably, it is this change in view that has led to the fascination with MMT and the willingness of the current Fed to continue QE despite the evident froth in the asset markets.  Of course, now those asset markets are not just paper ones like stocks and bonds, but also housing and commodities.

But that is the situation today, despite what appears to be very clear evidence that inflationary pressures are not just high, but longer lasting as well, the Fed has their story and they are sticking to it.  They made this clear to everyone last year with the new policy framework that specifically explains they will remain behind the curve on inflation because they will not adjust policy until they see real data, not surveys, that demonstrate growth is overheating.  Yet, given the Fed’s history, where they have often tightened policy in anticipation of higher inflation and thereby reduced growth, or even caused recessions, the market has learned to expect that type of response.  While I personally believe prudent policy would be to tighten at this time, I take Mr Powell at his word, they are not going to change anytime soon.  I assure you that of the dots in the last dot plot, Jay Powell’s was not one of the ones expecting interest rates to be 0.50% by the end of 2023.

One of the things that makes this so interesting is the difference of this policy with that of an increasing number of other central banks, where recognition of rising inflation is forcing them to rethink their commitment to ZIRP.  Earlier this week, the RBNZ abruptly ended QE and explained rates may rise before the summer is over.  Yesterday, the Bank of Canada reduced its QE purchases by another C$1 billion/week, furthering the progress they started in June, and Governor Macklem made clear that if inflation did persist, they would react appropriately.  Last night it was the Bank of Korea’s turn to explain that economic activity was picking up quickly and inflationary pressures alongside that which would make them consider raising the base rate at their next meeting.  Finally, all eyes are turning toward the BOE as this morning’s employment report showed that the recovery is still picking up pace and that wage growth, at a 7.3% Q/Q rise, is really starting to take off.  Market talk is now focused on whether the Old Lady will be the next to start to tighten.

In truth, the only three central banks that have made clear they are not ready to do so are the big 3, the Fed, ECB and BOJ.  The BOJ meets tonight with no changes to policy expected as they seem to be focused on what they can do to address climate change (my sense is they can have the same success on climate change as they have had on raising inflation, i.e. none).  Next week the ECB will unveil their new framework which seems likely to include the successor to the PEPP as well as their already telegraphed new symmetrical inflation target of 2.0%.  And then the Fed meets the following week, at which point they will work very hard to play down inflation in the statement but will not alter policy regardless.

As you consider the policy changes afoot, as well as the trajectory of inflation, and combine that with your finance 101 models that show inflation undermines the value of a currency in the FX markets, it would lead you to believe that the dollar has real downside opportunity vs. many currencies, just not the euro or the yen.  But markets are fickle, so don’t put all your eggs in that basket.

Turning to today’s activities, while Chinese equity markets performed well (Hang Seng +0.75%, Shanghai +1.0%) after Chinese GDP data was released at 7.9% for Q2, just a tick lower than forecast, and the rest of the data, Retail Sales and Fixed Asset Investment all beat expectations, the rest of the world has been much less exuberant.  For instance, the Nikkei (-1.15%) stumbled along with Australian and New Zealand indices, although the rest of SE Asia actually followed China higher.  Europe has been under pressure from the start this morning led by the DAX (-0.9
%) although the CAC (-0.75%) and FTSE 100 (-0.7%) are nothing to write home about.  US futures are also under pressure (Dow -0.5%, SPX -0.3%) although the NASDAQ continues to power ahead (+0.2%).

In this broadly risk-off session, it is no surprise that bond markets are rallying.  Treasuries, after seeing yields decline 7bps after Powell’s testimony, are down another 2bps this morning.  Similarly, we are seeing strength in Bunds (-1.4bps) and OATs (-1.1bps) although Gilts (+1.4bps) seem to be concerned about potential BOE policy changes.

On the commodity front, oil fell sharply after the Powell testimony and has continued its downward move, falling 1.8% this morning.  Gold, which had been higher earlier in the session is now down 0.15%, although copper (+0.6%) remains in positive territory.  At this point, risk has come under pressure across markets although there is no obvious catalyst.

It should not be surprising that as risk is jettisoned, the dollar is rebounding.  From what had been a mixed session earlier in the day, the dollar is now firmer against 9 of the G10 with NOK (-0.5%) the laggard although the entire commodity bloc is suffering.  The only gainer is the pound (+0.1%) which seems to be on the back of the idea the BOE may begin to tighten sooner than previously expected.

EMG currencies that are currently trading are all falling, led by ZAR (-0.7%), PLN (-0.5%) and HUF (-0.5%).  The rand is very obviously suffering alongside the commodity story, while HUF and PLN are under pressure as a story about both nations losing access to some EU funds because of their stance on issues of judicial and immigration policies is seen as a negative for their fiscal balances.  Overnight we did see strength in KRW (+0.6%) and TWD (+0.4%) with the former benefitting from the BOK’s comments on tightening policy while the latter saw substantial equity market inflows driving the currency higher.

Data today includes Initial (exp 350K) and Continuing (3.3M) Claims as well as Empire Mfg (18.0), Philly Fed (28.0), IP (0.6%) and Capacity Utilization (75.6%).  Yesterday’s PPI was also much higher than forecast, but that can be no surprise given the CPI data on Tuesday.  In addition, Chairman Powell testifies before the Senate Banking Panel today, with the same prepared testimony but a whole new set of questions.  (I did reach out to my Senator, Menendez, to ask why Chairman Powell thinks forcing prices higher is helping his constituents, but I’m guessing it won’t make the cut!)

And that’s the day.  Right now, with risk under pressure, the dollar has a firm tone.  But the background of numerous other central banks starting to tighten as they recognize rising inflation and the Fed ignoring it all does not bode well for the dollar in the medium term.

Good luck and stay safe
Adf