Though Jay and the FOMC
Refuse to accept it can be
Most prices worldwide
Can be certified
As rising like tides in the sea
Back in 2011, wedged between the GFC and the European debt crisis, the world witnessed the Arab Spring. This was a series of populist protests throughout the Middle East and North Africa that were triggered by a confluence of events including a desire for more freedom and democracy by a group of populations that had been oppressed by kleptocratic and authoritarian rulers. But one of the key issues that was apparent in each of the nations involved was the fact that inflation, specifically food prices, were rising rapidly and the impoverished citizenry of many of these nations could no longer afford to feed themselves or their families. Ultimately, while there was much angst at the time about changes in ruling regimes and much hope that the siren song of freedom would be heard in heretofore brutal dictatorships, very little changed except the name of the authoritarian and kleptocratic leader.
From our perspective in the markets, the importance of this lesson is the potential impact that sharply rising food prices can have on both financial markets and political outcomes. This appears topical given the rioting that has begun in two very different countries, Cuba and South Africa. In Cuba, the list of complaints could have been written in Tunisia in 2011, as the people there are growing tired of the conditions under which they are forced to live by Raul Castro and Miguel Diaz-Canel, the heirs to the Fidel Castro regime. The economy is in tatters and food shortages are rampant with little hope of change as long as the government remains in place. South Africa, meanwhile, has had a different catalyst, the imprisonment of former president Jacob Zuma, but the conditions on the ground, where inflation is rising sharply, and growth has been lagging are not dissimilar to what precedes this behavior anywhere.
While two countries don’t yet make a trend, it will be important to pay close attention to other EMG nations who are experiencing the same types of pressures. Remember, just because the Fed, ECB and BOJ are not ready to raise rates as they studiously ignore rising inflation, the same has not been true in a number of emerging markets like Brazil, Hungary and Mexico, whose central banks are responding to the obvious rise in price pressures by raising their policy rates. Inflation is insidious as it impacts all that we do and eventually weighs on how we approach our everyday tasks. Yesterday, the NY Fed released its monthly survey of inflation expectations and it jumped to 4.8% in the one-year category, the highest level since the survey began. While inflation is frequently described as a monetary phenomenon, it is also a psychological one. When you expect prices to rise, you tend to err on the side of buying things sooner rather than waiting. And that behavior drives prices as well. As the evidence of more persistent price rises continues to increase, there will come a denouement between the Fed and reality. It is at that point that we could see some cracks in the current narrative of “stonks to the moon!” Remember, being hedged ahead of a significant policy change makes a great deal of sense, so don’t wait until it’s too late.
Meanwhile, the market story today is one of a modest continuation of recent trends with no substantial outliers. It appears investors are waiting for more information from the ECB on their new policy framework next week, as well as this morning’s testimony by Chairman Powell at the House of Representatives.
After yesterday’s late day rally in the US, Asian equity markets were all in the green (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.3%) with the big data release Chinese trade numbers showing their exports climbed more than forecasts, clearly a positive sign for both China and global growth. Europe has been a bit more mixed with extremely modest movement either side of unchanged and no story or data to discuss while US futures show the NASDAQ (+0.35%) continuing to power ahead although the other two main indices have done nothing.
Bond markets are rallying ever so slightly with Treasury yields lower by 0.8bps and similar declines throughout Europe (Bunds -0.7bps, OATs -1.5bps, Gilts -1.1bps). As to commodity markets, they are mixed this morning with oil (+0.1%) marginally higher along with gold (+0.1%), while copper (-1.1%) is lagging. The long-term trend for most commodities remains higher, although we continue to see short-term consolidation.
In the FX market, the most notable mover has been ZAR (-1.35%) which is continuing to suffer on the back of the rioting in the country and the likely negative impact it will have on the economy. Other laggards in the EMG bloc are HUF (-0.5%), PLN (-0.5%) and MXN (-0.4%), as traders respond to differing issues in each nation. Poland’s central bank has hinted that they will extend QE at a moment’s notice in the event the delta variant of Covid becomes a bigger problem, while Hungary seems to be suffering for its unwillingness to agree to a global corporate tax rate. As to Mexico, the nominee for central bank governor, Arturo Herrera, explained he would not expect Banxico to begin a tightening cycle, despite the fact they have already raised rates once. On the plus side, RUB (+0.4%) leads the way as traders anticipate future gains in the oil price.
In the G10 space, while the dollar is broadly firmer, the biggest movers have been GBP (-0.3%) and NOK (-0.3%), hardly the stuff of excitement. Arguably, what we continue to see is short USD covering as positions remain overly short, albeit somewhat reduced from where things stood at the beginning of the quarter.
This morning, in addition to the Powell testimony, we see CPI (exp 4.9%, 4.0% ex food & energy), which ought to be quite interesting. If the forecast is correct, it would be the first time that the Y/Y data fell since last November. As well, if this is the case, Chair Powell will almost certainly point to the outcome in his comments today as a strong sign the Fed’s transitory inflation story playing out exactly as they anticipate. Of course, a higher than expected print will require a bit more tap dancing on Powell’s part.
The FX market continues to consolidate with no large trend driving things currently. Now that the relationship between the dollar and Treasuries has seemingly broken, traders are looking for new short-term drivers and waiting for clarification as to how the next trend will derive. In other words, we are likely to continue to see somewhat choppy and directionless trading for the next several weeks unless we get something of real note. So, paraphrasing Samuel Beckett, it appears we are ‘Waiting for Powell.”
Good luck and stay safe