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