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