Monthly Archives: August 2021

Starting to Wane

Posted on by

The rebound is starting to wane
In England, in France and in Spain
But prices keep rising
With German’s realizing
They’ve not yet transcended their pain

First, some housekeeping, I will be on my mandatory two-week leave starting Monday, so there will be no poetry after today until September 7.

Meanwhile, this morning’s market activity is bereft of interesting goings-on, with very few stories of note as the summer holiday season is clearly in full swing.  Perhaps the three most notable events were UK Retail Sales, German PPI and new Chinese legislation.  Frankly, none of them paint a very positive picture regarding either the economy or markets going forward.

Starting at the top, UK Retail Sales (-2.4% in July) fell short of expectations, with the Y/Y reading back down to +1.8% from a revised +6.8% and the universal description of the situation as the reopening rebound is over.  The spread of the delta variant continues to add pressure as closures are dotted throughout the country, and sentiment seems to be turning lower.  It ought be no surprise that the pound (-0.15%) has fallen further, taking its month-to-date losses to 2.5%.  Too, the FTSE 100 (-0.2%) is under pressure, although it does remain in a broader uptrend, unlike the pound.  However, the first indication here is that risk is being sold off, which seems a pretty good description of the day.

Next, we turn to Germany’s PPI reading (10.4% Y/Y, 1.9% M/M) which is actually the largest annual rise since January 1975, where prices were impacted by the oil crisis!  While we have all been constantly reassured that inflation is a fleeting event and there is absolutely no indication that the ECB will see this number and consider tightening policy in any way, shape or form, I suspect that the good people of Germany may see things a bit differently.  The chatter from Germany is a growing concern over rapidly rising prices with a real chance of political fallout coming.  Remember, Germany goes to the polls next month in an effort to replace Chancellor Merkel, who has been running the country for the past 16 years.  Currently no candidate looks particularly strong, so a weak coalition seems a very possible outcome.  It is not clear that a weakened Germany will be a positive for the euro, which while unchanged on the day has been trending steadily lower for the past two months and yesterday broke below, what I believe is, a key support level at 1.1704.  Look for further declines here.

And finally, the Chinese passed a stricter personal data protection law prohibiting private companies from collecting and keeping data on their customers without explicit permission, a practice that had heretofore been commonplace. This appears to be yet another attack on the tech sector in China as President Xi ensures that the Chinese tech behemoths are disempowered.  After all, similarly to the US, the value of the big platforms comes from these companies’ abilities to compile and monetize the meta-data they collect by using it for targeted advertising.  Of course, the law says nothing about the Chinese government collecting that data and maintaining it, as that is part and parcel of the new normal in China.  One cannot be surprised that Chinese equity markets continue to decline on the back of these ongoing attacks against formerly unsullied companies, with the Hang Seng (-1.85%) now lower by 21% from its peak in February, and showing no signs of stopping as international funds flow out of the country.  Shanghai (-1.1%) also fell sharply, but given this index has more SOE’s and less tech, its decline from its February peak is only 9%.  As to the renminbi, it softened a bit further and is pushing slowly back above 6.50 at this time, its weakest level since April.

Otherwise, nada.  Equity markets are in the red everywhere, with the Nikkei (-1.0%) also slipping and we are seeing losses throughout Europe (DAX -0.4%, CAC -0.3%, FTSE 100 -0.2%) as well.  US futures, too, are pointing lower, with all three indices looking at 0.4% declines.  Of course, yesterday, things looked awful at this hour and both the NASDAQ and S&P 500 managed to close higher on the day, albeit only slightly.

Bonds are definitely in the ascendancy with yields continuing to slide.  Treasury yields are lower by 1.5 bps, Bunds and OATs by 0.5bps and Gilts by 2.0bps.  The question to be asked here, though, is, does this represent confidence that inflation is truly transitory?, or is this a commentary on future economic activity?, or perhaps, is this simply the recognition that central banks have distorted these markets so much they no longer give useful signals?  Whatever the underlying driver, the reality of bonds’ haven appeal remains and given the signals from the equity market, falling bond yields are not a big surprise.

Commodity prices remain under pressure generally, with oil (-0.8%) continuing its recent decline.  After a massive rally from last November through its peak in early July, crude has fallen 17% as of this morning.  In this case, while I understand the story regarding weakening economic growth, it seems to me the long term picture here remains quite positive as the Biden administration’s efforts to end oil production in the US, or at the very least starve it of future growth, means that supply is going to lag demand for years to come.  That implies higher prices are on the way.  As to the rest of the space, gold (+0.25%) continues to trade in its 1775-1805 range since mid-June with the exception of the two-day blip lower that was quickly erased.  Copper’s recent downtrend remains intact although it has bounce 0.3% this morning, and the rest of the industrial metals are either side of unchanged.

The dollar is broadly stronger this morning, with CAD (-0.7%) the weakest of the G10 currencies, clearly suffering from oil’s decline but also, seemingly, from self-inflicted wounds regarding its draconian Covid policies.  The Loonie has now fallen 4.25% this month with half of that coming in just the last two sessions.  But we are seeing continued weakness throughout the commodity bloc here with NOK (-0.45%) and AUD and NZD (both -0.3%) continuing their recent declines.  On the plus side, only CHF (+0.2%) has shown any strength of note.

Emerging market currencies are also under pressure this morning led by ZAR (-0.6%) and MXN (-0.4%) as softer commodity prices weigh heavily here.  We also continue to see weakness in some APAC currencies, with IDR (-0.35%) and KRW (-0.3%) suffering from concerns over the ongoing spread of the delta variant and the corresponding investor funds outflow from those nations.  On the flipside, PHP (+0.35%) was the only gainer of note in the region after the government loosened some Covid restrictions.

There is no economic data today and only one Fed speaker, Dallas Fed President Kaplan.  Of course, Kaplan has been the most vocal calling for tapering, so we already know his view, and after the Minutes from Wednesday, it seems he has persuaded many of his colleagues.  But once again I ask, if the economy is slowing, which I believe to be the case, will the Fed really start to remove accommodation?  I don’t believe that will be the case.  However, for now, the market is likely to bide its time until next week’s Jackson Hole speech by Powell.  Beware summer choppiness due to lack of liquidity and look for the current dollar uptrend to continue while I’m away.

Good luck, good weekend and stay safe
Adf

To Taper’s Ordained

Posted on by

The Minutes on Wednesday explained
That QE would still be sustained
But ere this year ends
Some felt that the trends
Implied that, to taper’s, ordained

But ask yourself this, my good friends
What happens if tapering sends
The stock market down
Will they turn around
And restart QE as amends?

Remember all the times the Fed tried to tell the world that their current policy stance, notably the massive amount of QE purchases, were not the driving force in the equity market?  Stock market bulls played along with this as well, explaining that historically high valuation measures were all appropriate given the huge corporate profit margins, and had nothing to do with the Fed’s suppression of interest rates along the entire yield curve.  The bulls would point to 30-year interest rates below 2.00% and explain that when you discounted future cash flows at such low levels, it was only natural that stock valuations were high.  The fact that it was the Fed that was simultaneously buying up all the net Treasury issuance, and then some, thus driving rates artificially lower, as well as promising to do so for the foreseeable future was seen as a minor detail.

Perhaps that detail was not as minor as the bulls would have you believe!  Yesterday, the FOMC Minutes were released and the part that garnered all the attention was the discussion on the current asset purchase framework and how it might change in the future.

“Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met. At the same time, most participants remarked that this standard had been achieved with respect to the price- stability goal. (my emphasis) A few participants noted, however, that the transitory nature of this year’s rise in inflation, as well as the recent declines in longer-term yields and in market-based measures of inflation compensation, cast doubt on the degree of progress that had been made toward the price-stability goal since December.”

So, it seems they are in sync on the fact that the employment situation has room to run, and they don’t want to act too early because of that.  But what I find more interesting is that they can use the term ‘price stability’ when discussing inflation running in the 4.0%-5.0% range.  As well, it is apparent that many of the committee members are drinking their own Kool-Aid on the transitory story.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year because they saw the Committee’s “substantial further progress” criterion as satisfied with respect to the price-stability goal and as close to being satisfied with respect to the maximum employment goal. Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year because they saw prevailing conditions in the labor market as not being close to meeting the Committee’s “substantial further progress” standard or because of uncertainty about the degree of progress toward the price-stability goal.” (my emphasis)

But this was the money line, the clear talk that most of the committee expected tapering to begin before the end of the year.  While we have not yet heard any of the three key leaders (Powell, Williams and Brainerd) say they were ready to taper, it seems that most of the rest of the committee is on board.  Jackson Hole suddenly became much more interesting, because if Powell discusses tapering as likely to occur soon, it will be a done deal.  But if he doesn’t explain that tapering is coming soon, it is possible that we see four dissents, at the next meeting.  And how about this for a thought, what if those three are the only votes to stand pat, and the other six voting members want to start the taper?  That would truly be unprecedented and, I think, have major negative market ramifications.  I don’t expect that to occur, but after everything that has occurred over the past 18 months, I wouldn’t rule out anything anymore.

At any rate, the tapering talk remains topic number one in every market, and one cannot be surprised that the market’s reaction has been a clear risk-off response.  Equity markets around the world are lower, substantially so in Europe; bond markets are rallying as risk is jettisoned; commodity prices are falling, and the dollar is king!

So, let’s take a tour and see where things are.  Starting in Asia, we saw equities decline throughout the region with the Nikkei (-1.1%), Hang Seng (-2.1%) and Shanghai (-0.6%) all under pressure.  But the real pressure was felt in Korea (KOSPI -1.9%) and Taiwan (TAIEX -2.7%).  In fact, the only markets in the region to hold their own were in New Zealand.  Turning to Europe, it is a uniform decline with the DAX (-1.6%), CAC (-2.5%), and FTSE 100 (-2.0%) all falling sharply, with the lesser known indices also completely in the red.  I guess the prospect of less Fed largesse is not seen as a positive after all.  Meanwhile, ahead of this morning’s opening, US equity futures are all sharply lower, on the order of 0.75%.

Turning to the bond market, the prospect of less Fed buying is having an interesting outcome, bonds are rallying.  Of course, this is because Treasuries remain the ultimate financial safe-haven trade and as investors flee risky assets, bonds are the natural response.  So, 10-year Treasury yields have fallen 3.5bps, and we are seeing yields decline in the European market as well, at least those countries that are deemed solvent.  So, Bunds (-1.4bps), OATs (-1.1bps) and Gilts (-3.4bps) are all seeing demand.  Yields for the PIGS, however, are unchanged to higher on the day.

Commodity prices are uniformly lower, except for gold, which is essentially unchanged on the day.  Oil (-3.7%) leads the way down, but we are seeing weakness in base metals (Cu -3.3%) as well as the Agricultural space (Wheat -1.5%, Soybeans -1.2%).

Finally, the dollar is on top of the world this morning, as investors are buying dollars to buy bonds, or so it seems.  In classic risk-off fashion, only the yen (+0.1%) has managed to hold its own vs. the dollar as the rest of the G10 bloc is weaker led by NOK (-0.95%) and AUD (-0.95%).  NZD (-0.7%) and CAD (-0.7%) are also suffering greatly given the commodity weakness story.  But do not ignore the euro (-0.15%) which while it hasn’t moved very far, has managed to finally trade below the key 1.1704 support level, and is set, in my view, to head much lower.

In the EMG space, ZAR (-1.3%) is the leading decliner, falling alongside the commodity complex.  KRW (-0.7%) has given back all of yesterday’s gains as equity outflows continue to dominate the market there, but we are seeing weakness across the board with most currencies falling between 0.3%-0.6% purely on the dollar’s overall strength.

On the data front, this morning brings the weekly Initial Claims (exp 364K) and Continuing Claims (2.8M) as well as Philly Fed (23.1) and Leading Indicators (+0.7%).  There’s no scheduled Fedspeak, but what else can they say after yesterday’s Minutes anyway?  If you recall, Monday’s Empire Mfg was quite weak, so I would not be surprised to see Philly follow suit.  In fact, I think the biggest problem the Fed is going to have is that the data is rolling over and looking like a slowing economy, despite high inflation.  If they keep seeing economic weakness, are they really going to taper into a weakening economy?  They may start, but I doubt they get two months in before they stop, especially if equities continue to revalue (fall).  As to the dollar, for now, I like its prospects and suspect that we are going to trade to levels not seen since June of last year.

Good luck and stay safe
Adf

Beyond His Control

Posted on by

Next week look for Jay to extol
His record, when in Jackson Hole,
He offers the view
Equality’s skew
Is mostly beyond his control

Now keep that in mind when you hear
That China has also made clear
Division of wealth
Is better for health
Thus, taxes will soon be severe

In a market with muted price action across all asset classes overnight, two stories this morning seem to encapsulate the current zeitgeist.  First is the fact that, in what can only be described as extraordinarily ironic, when Chairman Powell regales us next week regarding the evils of inequality and all the things the Fed is heroically doing to right those wrongs, he will be doing so from the seat of the richest county in the United States.  That’s right, Teton County has the nation’s highest per capita income from wealth.  Apparently, irony is second only to hypocrisy when considering political commentary.  And make no mistake, the Fed is completely political.

The other story of note, and one that follows directly from the recent Chinese attacks on their own successful tech companies, is that China has now made clear that wealth in the country needs to be more evenly divided.  Given the fact that China is ostensibly a communist country, or at the very least clearly run by a communist party, it also seems a bit ironic that there is so much concern over wealth inequality.  One would have thought the Gini coefficient would have been far lower there.  But I guess, equality is the new freedom, a valuable political slogan if not an actual goal.  The reason this matters, however, is that it implies the recent Chinese efforts to rein in certain highly successful companies, and especially their high profile bosses, has no end in sight.  From an investment point of view, it appears the Chinese equity markets are going to have any gains severely impeded.  Look, too, for new taxes on estates and wealth there, all of which will have a decided impact on international investing.

Remarkably, beyond those stories, it is difficult to come up with anything that is truly meaningful regarding markets today.  The RBNZ did wind up leaving interest rates on hold, backing away from the expected 0.25% increase, as the fact that the nation has reverted to a complete and total lockdown due to the single case of Covid that was detected last week, has given them pause on their views of future growth.  NZD (-0.4%) is the worst G10 currency performer today on the back of that policy activity (or lack thereof), but given the tiny size of the nation, it has not had any other significant impact.

Inflation data was released in both Europe (2.2%, 0.7% core) as expected and the UK (CPI 2.0%, 1.9% core) with both of those readings 0.2% lower than forecast.  So, while inflation is seemingly running quite hot in the US, it appears to have potentially plateaued across the pond.  While we can be certain that the ECB is not going to change its current policy stance anytime soon, there has been a great deal more discussion regarding the BOE.  Hawkish vibes were emanating from Threadneedle Street recently, but if inflation is not going to rise further, then those views may soon be called into question.  However, there is a case to be made that this is a temporary lull in the CPI data and that looking ahead, readings will push up toward 4.0%, at least, as previously announced price increases start to be felt throughout the economy.  Thus far, the FX impact from this data has been essentially nil, but equity markets in Europe and the UK are all under modest pressure this morning (DAX -0.1%, CAC -0.35%, FTSE 100 -0.35%).

As to markets elsewhere, Asia saw some rebounding from its recent travails, with the Nikkei (+0.6%), Hang Seng (+0.5%) and Shanghai (+1.1%) all having their first positive day in five sessions.  We also saw a reversal in some currency activity there as KRW (+0.7%) was the best performer after comments from the central bank describing the recent weakness as an overshoot and that the Finance Ministry is monitoring things closely.

A look at bonds shows that Treasury yields have backed up 1.2bps this morning after having fallen by about 10bps in the prior three sessions.  European sovereigns, though, continue to find support as the ECB continues to hoover up virtually all the paper issued.  As such, Bunds, OATs and Gilts have all seen yields slip about 1 basis point.

Finally, the dollar can only be described as mixed this morning, with movement in the G10, aside from kiwi’s decline, pretty minimal, <0.2%, although with an equal number slightly lower and higher.  EMG currencies show the same pattern, with most movement quite limited and only one notable laggard (TRY -0.7%) which also seems to be a trading response to its recent strong rally (+3.3% in the past 5 sessions).  In other words, there is very little to discuss at all today.

On the data front, after yesterday’s disappointing Retail Sales number (-1.1%, exp -0.3%), this morning brings Housing Starts (exp 1600K) and Building Permits (1610K) and then this afternoon, we get the potentially most interesting news, the FOMC Minutes.

On the Fedspeak front, thus far, the only three FOMC members who have not advocated for tapering are Powell, Williams and Brainerd, as even Kashkari, yesterday, said he could see the case for tapering by early next year.  But Powell gave no indication he is ready to go down that road, so barring an insurrection at the Fed, one has to believe any tighter policy is still some ways away.  Today, we hear from Bullard, but he has already made his tapering bona fides known.

And that is really all there is today.  It truly has all the hallmarks of a summer doldrums day, with limited price action and limited news, unless something shocking comes from the Minutes.  My money is on nothing, and a range trading day ahead of us.

Good luck and stay safe
Adf

They’re Still Exposed

Posted on by

Though merely a few angstroms wide
The pressure that Covid’s applied
To all politicians
Has led to conditions
That many find unjustified

For instance, New Zealand has closed
Its borders, and rights they’ve bulldozed
To help in prevention
Of viral retention
Unfortunately, they’re still exposed

While the major headlines around the world continue to focus on the ongoing events in Afghanistan, at this point, they have had limited, if any, impact on markets in general.  And let’s face it, if for some reason there was a negative market impact traced to the Afgahi government collapse, it is pretty clear that the global central bank response would simply be to print more money thus supporting markets more completely.  But so far, that has not been the case (I just hope you weren’t long Afghani, interestingly the name of their currency as well, as it has fallen about 4.5% in the past 72 hours.)

This means we must turn our attention elsewhere for market moving information.  Asia continues to be the region with the most interesting issues, although Oceania is making a run for the money there in the following way; PM Ardern of New Zealand has imposed a level 4 lockdown for the next three days because a single case of the delta variant of Covid-19 has been found in the entire country!  This has resulted in a significant reevaluation of the RBNZ’s next move.  Prior to this devastating outbreak, the punditry had largely concluded that the RBNZ would be the first developed country to raise rates at their meeting tonight.  But now, second thoughts have crept in and a number of economists have changed their view and are calling for no change.  You would have thought that Covid was the most powerful force in the universe based on the (over)reaction of policymakers.  A single case!  At any rate, this change in view has resulted in NZD (-1.4%) falling sharply along with the local equity market, while NZ government bonds rallied almost a full point with yields declining by 9.7bps to 1.70%.  A single case! 

Meanwhile, in Australia, the government is proposing rounding up 24,000 unvaccinated children in a stadium to insure they are vaccinated as half that nation remains under lockdown.  The economic data Down Under has clearly rolled over with Consumer confidence the latest number to fall, while the RBA minutes, released last night, indicated that they were “prepared to act” in the event a further outbreak had a significant impact on the economy.  Not surprisingly, the market understood that to be a more dovish stance than the comments immediately following their meeting two weeks ago when they promised to start taper asset purchases next month.  AUD (-0.7%) is correspondingly under pressure as well today.

As to Asia, the big news continues to come from China where the government continues its relentless attack on its tech behemoths as President Xi has become more focused on removing any sources of power that do not emanate from his office.  Chinese equity markets sold off once again (Shanghai -2.0%, Hang Seng -1.7%) as investors read about the newest competition rules that were to come into force there and would break down the walls between financial networks run by Alibaba and Tencent.  It appears that capitalism with Chinese characteristics actually means, government-controlled businesses…full stop.

And so, before Europe even walked in, risk was under severe pressure and continues that way as I type.  Markets remain amazingly resilient with respect to business failures, but when it comes to potential policy failures, investors have less confidence that everything will work out well.  Remember, too, that it has been many months since we have even seen a 5% drawdown in the S&P 500, so do not be surprised if this is the catalyst for some further risk mitigation.

Thus far, today is definitely in the risk-off column with not just the Chinese markets declining, but the Nikkei (-0.4%) also sliding, albeit not nearly as drastically.  European markets are generally weak (Dax -0.24%, CAC -0.55%, FTSE MIB -1.0%, IBEX -0.95%) although the UK (FTSE 100 +0.1%) is holding its own after much better than expected employment data was released earlier.  It seems the combination of a highly vaccinated population and massive fiscal and monetary stimulus is helping the UK economy recover quite nicely.

It can be no surprise that bond markets are rallying sharply on this risk-off day, with Treasuries seeing yields fall by 3.7 basis points while all of Europe (Bunds -2.1bps, OATs -2.1bps, Gilts -3.8bps) are also seeing demand for haven assets.  This is even true for the PIGS where yields have fallen between 1 and 2 basis points.

On the commodity front, oil (-0.8%) continues to respond to concerns over slowing economic growth worldwide amid the spread of the delta variant, as does copper (-0.9%).  Both of these commodities are seen as the most sensitive to economic expectations.  Gold (+0.4% today, +6.2% from last week’s low) is performing the way many believe it should in times of stress.  As to the rest of the bloc, there are gainers and losers amid both base metals and agricultural products.

Finally, the dollar is on top of the world this morning, rallying against 9 of its G10 counterparts with only CHF (+0.1%) maintaining its status as a world haven.  Granted, the commodity currencies are the worst off, with CAD (-0.35%) also under pressure.  Interestingly, despite the positive UK data, the pound (-0.45%) is feeling the weight of the dollar today.

Emerging market currencies continue to struggle in general, although there are a couple of positive stories.  First up is PHP (+0.45%) which saw equity inflows as bargain hunters were seen following several days of equity market declines, and the central bank indicated no policy change was upcoming, an upgrade from concerns over further easing.  THB (+0.45%) was also stronger on the back of comments from the central bank governor as well as the fact that it had fallen so far lately, more than 6% in the past two months and back to 3-year lows, that there was a bout of profit taking.  On the downside, KRW (-0.65%) continues to be the region’s laggard as ongoing concern over chip stocks has encouraged more equity market selling (KOSPI -0.9%) and seen funds flow out of the country.  Adding to this pressure is the continued increase in Covid infections and that has been enough for the won to fall 3.4% in the past two weeks.

On the data front, this morning brings Retail Sales (exp -0.3%, +0.2% ex autos) as well as IP (0.5%) and Capacity Utilization (75.7%).  The Retail Sales data has been quite volatile lately, as each wave of Federal stimulus money has quickly found uses, but when that money has not been forthcoming, sales decline sharply.  I have seen estimates that we could see a MUCH worse than expected outcome here, something on the order of -2.5%, which would be of a piece with the weaker Michigan and Philly Fed data that we have seen lately.

This afternoon, Chairman Powell hosts a town hall meeting with educators, which does not seem like a venue for new information.  We also hear from the uber dove, Neel Kashkari.

While I understand tapering talk remains all the rage, I cannot help but look at what clearly appears to be a weakening economic impulse and wonder if by the time the Fed says they want to start tapering, the data are pointing in the wrong direction and it never comes to pass.  In that event, I feel the dollar, which has greatly benefitted from tapering talk, is likely to fall back, maybe quite a bit.  But that is still a few months away.  For now, it feels like the dollar remains numero uno.

Good luck and stay safe
Adf

Havoc Our Way

Posted on by

It’s been fifty years to the day
Since Nixon brought havoc our way
He slammed down the sash
Where gold swapped for cash
That’s led to today’s disarray

Given the importance of this event, although it is often overlooked, I felt I had to mention the anniversary.  In truth, it was yesterday, August 15, 1971, when President Nixon closed the gold window, ending the Bretton Woods agreement that insured (allowed?) every nation to convert their dollars to gold and ushered in the current framework of fiat currencies.  Prior to his action, the global monetary system was based on the value of gold, which was exchangeable into US dollars (or perhaps the other way around) at $35.00/oz.  Each nation’s gold sat in cages in the vault at the Federal Reserve Bank of NY and would literally be physically moved from cage to cage in order to satisfy national debts amongst the countries. The problem for the US was that most of the movement was out of the US cage into other countries’, which represented the massive trade and current account deficits the US was running.  So, Nixon essentially told the world, holding dollars was the only choice.

Of course, the fiat currency regime has evolved into the current situation where the ability to print money is endless, and every government is happy for it to never end.  The strictures of a gold-backed currency are far too confining for the social programs deemed essential by virtually every government in the world today, which is why we will never go back.  The real question is, what lies ahead?

The ructions in China persist
As data last night, forecasts, missed
And President Xi
Continues to see
More targets that he can blacklist

As to the markets today, the single biggest story has been the release of Chinese data at significantly worse than expected levels.  The key figures showed Retail Sales (8.5%, exp 10.9%), IP (6.4%, exp 7.9%) and Fixed Asset Investment (10.3%, exp 11.3%).  The disappointing outcome has been attributed to the spread of the delta variant of Covid which has not only resulted in the closure of some key infrastructure points, notably two busy ports, but also weighed on many peoples’ willingness to travel during the typically busy summer vacation season.  Given the Chinese propensity for draconian measures in their effort to stop the spread of the virus, people are concerned they will get stuck some place with no ability to return home if there is a sudden lockdown.

The Wall Street response was immediate, with a number of economic forecasts for China taken lower by between 0.5%-0.7% for 2021 as a whole.  In addition, greater attention has been paid to the Chinese credit impulse (the amount of credit that is flowing into the economy from the banking system) which has been slowing rapidly since a peak in October.  This statistic tends to lead the Chinese economy’s performance by between 6 and 12 months, so it should be no surprise we are starting to see reduced output there.

Interestingly, despite the slowing growth story, the Xi government continues to attack its bellwether tech firms, the ones that have been growing the fastest.  It is becoming increasingly evident that President Xi is perfectly willing to sacrifice economic growth in an effort to consolidate his power even further.  Last night we again saw key government editorials about the evils of online gaming and how it should be curtailed even further.  Alibaba, one of the largest and most successful Chinese internet companies, remains squarely in Xi’s sights as he brings every potential threat to heel.  In the end, this is unlikely to help the Chinese economy writ large which from this poet’s perspective means we are likely to see a very gradual depreciation in the yuan as the currency market becomes a relief valve for domestic economic pressures.

The only other headline news has been the fall of Kabul to the Taliban in a remarkably swift 72 hours, with numerous stories about the evacuation as well as the political failures that led to this outcome.  Perhaps this is the impetus for today’s risk reduction, or perhaps it is the China story, or simply the ongoing spread of the delta variant; but whatever the reason, we are definitely seeing a bit of risk-off attitude across markets.

For instance, equity screens are all red with Asia ((Nikkei -1.6%, Hang Seng -0.8%, Shanghai 0.0%) and Europe (DAX -0.6%, CAC -1.0%, FTSE 100 -1.1%) clearly under pressure.  I’m sure Friday’s very weak Michigan Sentiment number (70.2, weakest since 2011) did not help anyone’s mood, and despite the fact that all three major US indices crept higher on the day Friday, by 0.1% or less, to new record highs, this morning all three are pointing lower by about -0.3%.

Bonds though are a bit more circumspect here, as while Treasury yields have edged lower by 0.3bps, all of Europe’s sovereign markets are selling off with yields rising.  Perhaps, investors have decided that the situation is so dire they don’t want any European paper at all!  So, bunds (+1.0bps), OATs (+1.4bps) and Gilts (+1.2bps) are all lower along side their respective equity markets.

Commodities, too, are softer this morning led by oil (-1.35%) and gold (-0.2%) with base metals (Cu -1.6%, Al -0.2%, Sn -0.3%) falling as well.  In fact, the only part of this bloc holding up is foodstuff, where the big three, corn, wheat and soybeans are all firmer.

Where, you may ask, is everybody putting their money if they are selling both stocks and bonds?  It seems the dollar is finding support against most currencies, except for the havens of JPY (+0.25%) and CHF (+0.2%).  Otherwise, the rest of the G10 is softer vs. the dollar, notably the commodity bloc where AUD (-0.5%), NOK (-0.45%) and CAD (-0.3%) are the laggards.  Similarly, in the EMG bloc, it is the commodity currencies that are under the most pressure with RUB (-0.3%), ZAR (-0.2%) and PHP (-0.35%).  In fact, the only currency with gains is TRY (+0.6%) which continues to benefit from the highest real yields on the planet.

The data story this week brings Retail Sales and Housing data as well as the FOMC Minutes on Wednesday.

Today Empire Manufacturing 28.5
Tuesday Retail Sales -0.2%
-ex autos 0.2%
IP 0.5%
Capacity Utilization 75.7%
Wednesday Housing Starts 1600K
Building Permits 1610K
FOMC Minutes
Thursday Initial Claims 365K
Continuing Claims 2800K
Philly Fed 24.0
Leading Indicators 0.7%

Source: Bloomberg

Retail Sales and the FOMC Minutes are likely to get the most attention, although any really big miss, like Friday’s Michigan data, could lead to further movements, so beware.  As well we hear from a few Fed speakers, with Chairman Powell talking tomorrow, but the subject does not appear to be the economy, then uber-dove Kashkari and his counterpart, the hawkish Kaplan later in the week.

At this point, risk remains under pressure and I sense that it has some room to run lower.  It has been more than 9 months since there has been a 5% drawdown in the equity market, an inordinately long period of time for pressures to build up.  This is not to say that a drawdown is coming, just that there is real instability underlying the market, so one is very possible.  And I sense that this risk-off event would be classic with the dollar gaining real ground against virtually everything.

Good luck and stay safe
Adf

They Cannot Wait

Posted on by

While Jay and the FOMC
Are certain it’s transitory
Inflation elsewhere
Has forced some to pare
Their policy stance by degree

Thus none of us ought be amazed
That yesterday Banxico raised
Its overnight rate
As they cannot wait
Til prices (and people) get crazed

Last week the central bank of Brazil raised its overnight rate by 1.0%, taking it back to 5.25%, and promised to continue raising rates until they get inflation back under control.  This seems pretty reasonable since the latest inflation reading there was 8.99%.  Currently, the market is pricing in a 1.25% rate hike next month.  Yesterday afternoon, Mexico’s central bank raised the overnight rate by 25 basis points for the second consecutive meeting, taking it up to 4.50%.  Given that the latest reading on inflation there is 5.81%, it seems they, too, have further to raise rates in order to tame rising prices.

In fact, this is a scenario we are witnessing around the world in emerging markets, where inflation has been rising quite rapidly and the monetary authorities, recognizing that they don’t have infinite capacity to borrow in either their local currency or in dollars, find themselves in a very uncomfortable position.  Either attack inflation now by raising rates and earning the wrath of their government, or let it rip and watch the country descend into more dire straits, akin to Argentina, Turkey, or worst of all, Venezuela.

But that the Fed would respond to inflation in the same manner.  Instead, we continue to get high inflation readings (yesterday’s PPI jumped to 7.8%, 6.2% ex food & energy) and a steady stream of pablum about the transitory nature of inflation in the US.  While only time will actually tell if higher inflation is truly here to stay, there certainly seems to be a lot of evidence that is the case.  One cannot open a newspaper (or perhaps scroll a newsfeed) without immediately seeing a story about how fast food restaurants, or food manufacturers or…fill in the blank, are raising prices because of a combination of higher input and shipping costs.  Perhaps, what is more surprising is that these companies have gained confidence that higher prices will not scare off their customers, meaning these price rises will stick.

On the wage front, this morning’s story of how newly minted college graduates taking (getting?) a job at Evercore Securities will now be paid a starting salary of $120,000 per year seems a pretty good indication that wages are rising.  Given the JOLTS data showing there are over 10 million open positions in the country, it is not surprising that ‘finding qualified people to hire’ remains the top problem of small businesses according to the NFIB survey.  The implication is wages are going to continue to rise and prices alongside them.

Speaking of shipping costs, we continue to see record rises in shipping rates as well as huge delays in timing.  China closed one-quarter of its Ningbo port, the third largest in China, because of concerns over the spread of the delta variant of Covid.  While US ports have not yet closed because of this, the backlog of ships waiting to unload continues to run near record high levels, and now delays from China will result in even bigger logistical and supply chain problems.  All in all, it remains difficult for this author to see a future, at least a near future, where prices do anything but go much higher.

Into that environment we continue to see the key Fed leadership remain sanguine over the prospects of inflation, maintaining the narrative that any price rises are transitory.  Apparently, this has come to mean prices will stop going up so rapidly but are unlikely to come back down.  While there is a growing chorus of FOMC members, mostly regional presidents, that believe it is coming time to taper QE purchases, until we hear that from Powell or Williams or Brainerd, I think it remains a 50:50 proposition at best.    But even if they do start to taper, given their history of responding to asset valuations, any stock market decline, which would seem likely given the current valuations are entirely built on the ‘lower forever’ interest rate scenario, would almost certainly see them stop quickly.  Painting a picture where real yields do anything but fall deeper into negative territory continues to be a difficult thing.  And that, ultimately, is going to be a negative for the dollar.

But when is ultimately?  It is still a little ways off.  Until then, it appears that the market is set up for the dollar to strengthen somewhat further.  The dollar’s relationship with 10-year yields, which had been strong in Q1 and broke in Q2, seems to be back on track.  All the taper talk has bond traders looking for a further backup in yields, and correspondingly, a further rise in the dollar.  While today it is drifting lower vs. most of its counterparts, this can easily be explained by the fact that it is a summer Friday and traders are paring positions going into the weekend.  But the medium-term view needs to be that higher US yields will support the dollar.

As to the rest of the markets, Asian equity markets continue to struggle as the spread of the delta variant accelerates and more countries in the region consider more drastic responses.  Last night saw losses in all the major markets (Nikkei -0.15%, Hang Seng -0.5%, Shanghai -0.25%) and as long as these nations have difficulty managing the resurgence of infections, investors seem to believe that the growth story will be negatively impacted.  Europe, on the other hand, is all green this morning (DAX +0.4%, CAC +0.35%, FTSE 100 +0.35%) as there is a greater belief that Covid issues are under better control.  Vaccination rates have risen quite rapidly and so while infection rates may be rising, hospitalizations are not, just like in the US.  Many analysts continue to believe European equity markets, writ large, are undervalued vs. their US counterparts, and while there is tapering talk here, there is absolutely no indication whatsoever that the ECB is going to do anything but continue to print money.

Treasury yields have drifted lower by 1.3bps this morning, which helps explain the dollar’s modest decline, but they remain right at 1.35% and show no signs of retracing last week’s sharp move higher.  European sovereigns, on the other hand, are a bit softer this morning, classic risk-on behavior, with Bunds (+0.9bps) and OATs (+1.4bps) slipping into the weekend.  Gilts are essentially unchanged, as it happens.

The commodity market is showing no clear directional bias of late, with both oil (-0.35%) and gold (+0.4%) having retraced a portion of major price declines over the past two weeks, but neither showing signs of either a break higher or the next leg down.  Rather, they are both a bit choppy right now.

Finally, the dollar is mostly softer against its G10 counterparts, with NOK (+0.3%) the leader and the euro pushing up 0.25%.  Frankly, both of these appear to be trading moves, as both had shown weakness all week, so positions are likely being pared into the weekend.

In the emerging market space, KRW (-0.65%) continues to be the bloc’s biggest laggard, falling for the fifth consecutive day as the combination of the record level of Covid infections, and concerns over the semiconductor space in the KOSPI have seen sellers come out of the woodwork for both stocks and the currency.  Away from the won, weakness was evident throughout the APAC currencies, albeit to a much lesser extent, as the Covid spread story is regionwide.  On the plus side, both CE4 and LATAM currencies are performing well, with MXN (+0.4%) the leader on the back of Banxico’s rate hike, and RUB (+0.4%) seeing position unwinding after a particularly weak trading period this week.

Data this morning brings Michigan Sentiment (exp 81.2) as well as some further secondary price indices, Import and Export prices, which have been running well above 10% each.  The point is there is inflationary pressure everywhere.

It is not surprising that after a week where the dollar was broadly stronger, it softens on Friday, but nothing has changed the short-term view that modestly higher US yields will lead to further dollar strength.  Keep an eye on the 1.1704 level in EURUSD, which I believe can be a catalyst for a much larger move higher in the dollar if it breaks.

Good luck, good weekend and stay safe
Adf

Nothing Will Thwart

Posted on by

Inflation continues to be
The problem the Fed will not see
The latest report
Shows nothing will thwart
Their views that it’s transitory

Perspective is a funny thing; it has the ability to allow different people to see the same events in very different ways.  For example, yesterday’s CPI report, which printed at 5.4% headline and 4.3% ex food & energy, was fodder for both those with an inflationary bias and those who are in the transitory camp.  As predicted here yesterday morning, any number that was not higher than the June report would be touted as proof inflation is transitory.  And so it has been.  The highlighted facts are the month on month reading was ‘only’ 0.5%, much lower than the previous three months’ readings of 0.9%.  Of course, that is true, but it ignores the fact that a monthly rate of 0.5% annualizes to 6.16%, still dramatically higher than the target.  As well, there was much ink spilled on the fact that used car prices, which had admittedly been rising remarkably quickly due to the unusual circumstances of the semiconductor shortage impeding new car production, fell back to a more normal pace of growth.  The problem with that story is despite one of the ostensible key reasons inflation had been misleadingly higher, used car prices, ceasing to be an issue, inflation still printed at 5.4%!  Clearly there are other things at work here.

Another aspect of perspective comes in the form of the averaging concept, which is the Fed’s latest ruse in rationalizing higher inflation.  For instance, those in the transitory camp, which seems to include the entire FOMC, but also much of the punditry, remain hostile to the idea of inflation settling in at a rate of 1.8%, slightly below the Fed’s target, but are entirely sanguine about that same statistic running at 2.8% for a while to help make up for lost time.  It is this distorted lens that seems to drive the description of inflation as ‘too-low’.  From up here in the cheap seats, inflation cannot be too low.  The idea that we are all better off with prices rising is wrong on its face.

And the idea that wage increases drive inflation also needs to be reconsidered.  After all, if that were the case, we would all be rooting for inflation as that means our wages would be rising quickly.  However, as we know simply by living our lives, and as has been demonstrated by the data, wage increases are broadly lagging inflation.  In fact, yesterday, as part of the Bureau of Labor Statistics data dump, Real Average Hourly and Weekly Earnings showed Y/Y declines of -1.2% and -0.7% in July.  It is no secret that inflation destroys the real value of your earnings, and yet the Fed continues to target a higher level of inflation than had been seen during the past decade and remains comfortable that the current sharply higher numbers are inconsequential in the long run.

However, in the end, whether we agree or disagree with the Fed’s current policy stance and its impacts, the reality is we are not going to have any say in the matter.  All we can do is strive to understand their reaction functions and manage our risks accordingly.  Ultimately, I continue to see the biggest risk as a significantly higher rate of inflation in the US, which will eventually drive nominal yields somewhat higher and real yields still lower than current levels.  That cannot be good for the dollar but will likely help the prices of ‘stuff’.  In the end, be long anything on the periodic table, as that will maintain its value.

The summer doldrums continue as market movement remains fairly limited across equities, bonds, commodities and currencies.  This is not to say there aren’t individual things that move or are trending, just that the broader picture is one of a decided lack of activity.

Last night, for instance, Asian equity markets (Nikkei -0.2%, Hang Seng -0.5%, Shanghai -0.2%) were all lower, but only just.  European markets are more mixed, with both gainers (DAX +0.4%, CAC +0.2%) and losers (FTSE 100 -0.1%) but as can be seen, the movements are not terribly exciting.  This morning saw the release of a plethora of UK data led by Q/Q GDP (+4.8%) and then many of its details showing Consumption by both the government and the population at large grew dramatically, while businesses slowed down somewhat, with IP and Construction both lagging estimates.  I guess investors were generally unimpressed as both the stock market and the pound (-0.1%) have edged somewhat lower after the reports.  Finally, US futures are either side of unchanged again, with the NASDAQ continuing to lag in the wake of the recent rise in US 10-year yields.

Speaking of yields, after the very sharp rise seen in the previous five sessions, yesterday’s Treasury price action was far less exciting and this morning we see the 10-year yield higher by just 1.0 basis point after a decline of similar magnitude Wednesday.  European sovereigns show Bunds (+0.8bps) and OATs (+0.7bps) modestly softer while Gilts (+2.5bps) seem to believe that the UK data was actually better than other market impressions.

Commodity prices are mixed this morning as oil (-0.2%) has given up early gains, along with gold (-0.1%) and the agricultural space.  Copper, however, is bucking the trend and higher by 0.8%.

Lastly, the dollar can only be characterized as mixed this morning, with some weakness in AUD and NZD (-0.25% each) and some strength in NOK (+0.2%) and otherwise a lot of nothing in between.  It is hard to make a case that there is much market moving news in any of these currencies as the UK was the only country with significant new information.

Emerging market currencies are also split, with KRW (-0.4%) continuing to lag the rest of the space as concern grows over the semiconductor manufacturing sector leading to continued equity market outflows and currency sales.  I would imagine that the recent rantings by Kim Jong-Un’s little sister about increased nuclear activity cannot be helping the situation there, but it is not getting headline press in financial discussions.  Otherwise, PLN (-0.3%) is the next weakest currency in the bloc today which seems to be a reaction to some legislation passed that would ostensibly restrict media and speech in the country.  On the plus side, TRY (+1.0%) is today’s champion as traders and investors respond to the central bank’s moderately more hawkish than expected statement after leaving interest rates unchanged (at 19.0%!) as widely expected.  Otherwise, there is nothing noteworthy in the space.

Data today brings the weekly Initial Claims (exp 375K) and Continuing Claims (2.9M) data as well as PPI (7.2%, 5.6% ex food & energy).  However, with CPI already having been released, this data seems relatively insignificant.  There are no scheduled Fed speakers as most FOMC members seem to be going on vacation ahead of the Jackson Hole conference in two weeks’ time.

For now, the dollar seems to be tracking yields pretty well, so if we see movement in the bond market, look for the dollar to follow.  Otherwise, we are likely to remain rangebound for the time being.

Good luck and stay safe
Adf

Nowhere Near

Posted on by

Charles Evans, on Tuesday, explained
Inflation can well be contained
In fact, his concern
Is prices could turn
Back lower ere targets are gained

“I’m going to be very regretful if we sort of claim victory on averaging 2% and then we find ourselves in 2023 with about a 1.8% inflation rate, sustainable, going forward. That would be a challenge for our long-run framework,” he [Evans] said. “We ought to be willing to average inflation above 2%—frankly, well above 2%. [author’s emphasis]”

One cannot overstate the hubris associated with the above quote from Chicago Fed President Charles Evans.  The fact that he legitimately believes the Fed’s powers are such that they can fine-tune a $24 trillion economy to the point that measured estimates of particular features of that economy are able to be managed to a decimal place of an annualized percentage outcome is extraordinary.  It is the perfect illustration of the fact that the Fed is completely out of touch with the economy in which you and I live and completely ensconced in a model driven framework where data represents reality.  But it is exactly this hubris that has resulted in the policy decisions that have brought the world negative interest rates and a defense of debt monetization.  As long as central bankers, notably the Fed, continue to believe that their models are the economy, rather than a simplified representation of the economy, they are likely to continue to make decisions with significant unintended consequences from which we all will suffer.

This morning the market awaits
The latest inflation updates
What’s patently clear
Is they’re nowhere near
An outcome to end the debates

Speaking of inflation, this morning brings the latest CPI data with expectations running as follows: Headline (0.5%, 5.3% Y/Y) and ex food & energy (0.4%, 4.3% Y/Y).  Both of those forecasts are slightly lower than the prints seen in July, and if realized, you can be sure that we will hear a chorus of FOMC members highlighting the transitory nature of inflation.  Of course, if the outcomes are higher than forecast, something we have seen in each of the past twelve reports, we will also hear a chorus of FOMC members explaining that this remains a temporary phenomenon and that inflation is transitory.  [Perhaps when Ralph Waldo Emerson wrote in 1841, “a foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines,” he was anticipating the Fed.]  However, financial markets may not be quite as sanguine over the results, especially if they continue their year-long streak of outperforming the median estimate.

Markets, of late, have been starting to discern between those products that will benefit from altered policy and those products that will suffer.  Nowhere is this clearer than in the US equity markets where we have seen the NASDAQ underperform its brethren indices.  Recall, given the NASDAQ’s strong bias toward high growth (and low profit) companies that benefit greatly from extremely low interest rates, the index behaves very much like a very long-duration bond.  So, in a scenario where inflation is rising and market expectations are for tapering of asset purchases to begin soon(ish), it should be no surprise that the NASDAQ falls alongside the price of bonds.  At the same time, if the implication is that rising inflation is being caused by rebounding growth, rather than supply-chain blockages, there is an opportunity for more mundane, value-type companies to outperform.  Hence, the differing performance of the DOW vs. the NASDAQ.
Of course, the place where inflation is likely to have the most direct effect is the bond market, where long-term yields are theoretically supposed to reflect inflation expectations.  And while we have certainly seen yields rise over the past week, there is no way they currently reflect those expectations.  They cannot do so as long the Fed continues to buy all the new issuance, and then some, thus artificially driving up prices and driving down yields.  Ask yourself this, does it make sense that US 10-year yields are at 1.36% if inflation is at 5.4%?  Of course, the answer to that is a resounding ‘No!’  Yet, that is the current situation.  To observe the bond market and believe it is not artificially inflated (everywhere in the world, mind you) is akin to believing that the moon is made of green cheese.  It just ain’t so!

At any rate, ahead of this morning’s CPI release, investors have generally been biding their time as they wait to determine if they need to adjust their world view.  Equity markets are generally a bit firmer as Asia mostly eked out some gains (Nikkei +0.6%, Hang Seng +0.2%, Shanghai 0.0%) with Europe following suit (DAX 0.0%, CAC +0.3%, FTSE 100 +0.5%).  US futures are split with the NASDAQ (-0.2%) slipping following yesterday’s losses, while the other two main indices are essentially unchanged.  All in all, it appears that there is some hope that CPI prints on the low side to allow the Fed narrative to continue apace, and therefore to allow rates to remain lower for longer.

Bond markets, though, are starting to get a bit antsy these days with Treasury yields edging higher again (+1.7bps) with similar type gains seen throughout Europe (Gilts +1.4bps, OATs +1.8bps, Bunds +0.8bps).  At this point, 10-year Treasury yields have risen 0.25% in the space of a week, which is a very substantial move, especially when considering that the base at the beginning was just 1.12%.  One has to believe the Fed is watching extremely closely as they do not want to see the market run too far ahead of their mooted tapering and create Taper tantrum #2 inadvertently.  It is here where a higher than forecast CPI print could have quite an impact and which may force the Fed to reconsider the idea of tapering.  After all, they cannot afford for 10-year yields to rise to 2.0% while they are still purchasing $120 billion per month of paper.

Commodity prices are mixed today with oil (-1.1%) feeling the pressure of higher yields while gold (+0.5%) seems to be ignoring that same pressure.  Of course, gold was just subject to a significant sell-off, so this could easily be a simple trading bounce.  As it happens, both agricultural and base metal prices are showing a mixture of gainers and losers and no real underlying theme.

Finally, the dollar is definitely stronger again this morning.  While the movement vs. its G10 brethren has not been large, it is unanimous, with all currencies in the red today.  A particular shout-out goes to the euro, which is trading just pips from the key support level of 1.1704.  Watch that carefully as a break there is likely to open up much lower levels.  In the emerging markets, KRW (-0.6%) has been the laggard, followed by TRY (-0.5%) and HUF (-0.4%).  The won has been suffering from a combination of rising covid cases, with a record high 2200 reported yesterday, which has been encouraging the liquidation by foreign investors of Korean equities.  Meanwhile, TRY is under pressure as traders are concerned the President Erdogan will once again interfere in the central bank’s business and prevent them from raising rates at tomorrow’s meeting.  Finally, the forint seems to be suffering for the sins of its neighbors as concerns over German growth, a key market, and Polish politics, a close neighbor, have encouraged selling.

And that’s really it for today.  All eyes will be on the CPI at 8:30. More than just watching the tape, I always pay attention to @inflation_guy on Twitter as he does an excellent job breaking down the drivers of the number and offering insight into how things may evolve.  I highly recommend following him.

As to the dollar, the slow grind higher continues and as long as US rates are rising, I think so will the dollar.  If we break the 1.1704 level in the euro, look for a bit of an acceleration.  But don’t be surprised if we reject the move given it is the first test of the support level since it was established back in March.

Good luck and stay safe
Adf

The Chorus has Grown

Posted on by

T’was only a few months ago
When Kaplan from Dallas said, whoa
The time has arrived
Where growth has revived
And bond buying needs to go slow

Since then, though, the chorus has grown
As seven more members have shown
That they all agree
It’s time for QE
To end and leave markets alone

We continue to hear from more FOMC members that it is time to taper the Fed’s purchases of both Treasuries and mortgage-backed securities.  Last Wednesday, of course, the big news was that Vice-Chairman Richard Clarida came out so hawkishly in his comments, not only calling for tapering bond purchases but also raising rates sooner than the median forecast had anticipated.  Yesterday, three Fed speakers were all on the same page, with Boston’s Eric Rosengren the newest name added to the tapering crew (Bostic and Barkin were already known taperers.)  That takes the count to at least eight (Clarida, Bostic, Barkin, Rosengren, Bullard, Daly, Waller and Kaplan) with the two most hawkish FOMC members, Loretta Mester and Esther George, on the docket for today and tomorrow respectively.  It is not unreasonable, based on their respective histories, to expect both of them to call for tapering as well.  That would make ten of the seventeen members as confirmed supporters of the process.

The question is, will that be enough?  The Fed’s power core for the last several years has been concentrated in four members, Powell, Clarida, Williams and Brainerd.  Of this group, only Clarida has publicly proclaimed it has come time to taper.  And potentially, his importance is diminishing as his term ends within months and he is seen as highly unlikely to be reappointed.  Rather, the talk of the town is that Chairman Powell is also losing fans in the Senate with respect to his reappointment, and that Governor Lael Brainerd is the new leading candidate to become Fed Chair.  As it happens, neither of those two have come out for tapering soon, and in fact, last week, Ms Brainerd was adamant in her belief it was far too early to do so.  The point is, the Fed has never been a democratic institution although it is an extremely political one.  Having a majority of members agree on a view only matters if it is a majority of the right members.  By my count, that is not yet the case.  Perhaps come Jackson Hole in two plus weeks, we will hear the Chairman agree, but tapering is not yet a done deal.

Traders, however, see the world very differently than pundits, and certainly very differently than the Fed itself.  And what has become very clear in the past several days is that traders are increasingly placing bets that tapering is coming…and coming soon.  The combination of all those Fed speakers talking about tapering, the very strong NFP data as well as yesterday’s JOLTs blowout (>10 million jobs are open), and the constant stream of stories about rising wages (just this morning a BBG story on JPM raising salaries to compete to hold onto staff is simply the latest) have been sufficient to logically conclude that it is time for the Fed to begin removing accommodation.  Hence, Treasury yields have backed up nearly 20 basis points from the lows seen last Wednesday morning, the dollar has risen against all its counterparts and the price of oil has fallen by more than 4%.

Looking ahead, the question becomes, is this likely to continue?  Or have we reached a peak?  It is not unreasonable to assume that both George and Mester will call for tapering this week.  It is also not unreasonable to assume that the CPI data tomorrow is going to point to a still rising price environment, whether it ticks slightly higher or lower than last month’s 5.4% headline print.  Any number in that vicinity remains far above the Fed’s average target of 2.0%.  The point is that there is nothing obvious on the horizon that should cause the tapering hawks to back off, at least not until the end of the month.  As such, hedgers need to be prepared for a continuation of the recent price action.

Meanwhile, a look at today’s markets shows that these recent trends remain intact.  While Asian equity markets continue to follow their own drummer (Nikkei +0.25%, Hang Seng +1.25%, Shanghai +1.0%), European bourses continue to struggle (DAX +0.2%, CAC +0.1%, FTSE 100 -0.1%) as do US futures with all three major indices either side of unchanged.  Asia seems to be benefitting from the view that the PBOC is preparing to ease policy further as China responds to the increased lockdowns due to the delta variant of Covid that has been spreading quite rapidly there, in addition to the fact that the Chinese authorities have not named a new target in its seemingly random crackdown of successful companies.

Bond markets, while edging higher today, have been generally losing ground.  So, while Treasury yields are lower by 0.5bps this morning, they are at 1.32%, well off the lows seen last week.  European sovereigns are generally a touch firmer as well, with yields down by between 0.5bps and 1 bp but they, too, have seen yields climb back a bit lately.

Commodity prices, which have been under severe pressure, are rebounding slightly this morning, although this has the appearance of a trading bounce more than a sea change in view.  Commodity prices are likely to be amongst the hardest hit if the Fed really does start to tighten policy.  But this morning, oil (+2.0%) has rebounded nicely although gold (0.0%) has been unable to bounce from yesterday’s massive sell-off.  Copper (+0.65%) is leading base metals modestly higher and ags have bumped up a bit as well.

As to the dollar, right now it is arguably slightly stronger overall, but only just as there are a mix of gainers and losers vs. the greenback.  In the G10 space, the euro (-0.1%) is continuing toward its test of key support at 1.1704, albeit quite slowly.  The entire space, though, is +/- 0.2% or less, which is indicative of position adjustments rather than news driven activity.

EMG currencies are also mixed with KRW (-0.5%) the weakest of the bunch on the back of concerns over the impact of the delta variant as well as equity market outflows by international investors.  PLN (-0.4%) is the next weakest as central bank comments seemed to delay the timing of a mooted rate hike.  On the flip side, TRY (+0.6%) is the leader as Unemployment data there was released at a much lower than expected 10.6%.

Data today showed that Small Business Optimism has suffered lately with the NFIB Index falling to 99.7.  At 8:30 we see Nonfarm Productivity (exp 3.2%) and Unit Labor Costs (+1.0%), although it is unlikely either will have a big market impact.  Arguably, market participants are all waiting for tomorrow’s CPI data for the next big piece of news.

At this point, the dollar’s modest uptrend remains in place and I see no reason to believe that will change.  At least not until we hear differently from Powell or the data turns much worse.

Good luck and stay safe
Adf

Resolute

Posted on by

The narrative is resolute
That though prices did overshoot
They’re certain to fall
And that, above all,
The Fed’s in control, absolute

However, concern is now growing
That growth round the world’s started slowing
Though Friday’s report
On jobs was the sort
To help the bull market keep going

Clearly, my concerns over a weak payroll report were misplaced as Friday’s data was strong on every front, although perhaps too strong on some.  Nonfarm payrolls grew a robust 943K with net revisions higher of 119K for the past two months.  The Unemployment Rate crashed to 5.4%, down one-half percent, and Average Hourly Earnings rose 4.0% Y/Y.  It is the last of these that may generate some concern, at least from the perspective of the transitory inflation story.

While it is unambiguously good news for the working population that their wages are rising, something that has been absent for the past two decades, as with Newton’s first law (every action has an equal and opposite reaction) the direct result of rising wages tends to be rising prices.  So, while getting paid more is good, if the things one buys cost more, the net impact may not be as positive.  And in fact, consider that while the 4.0% annual rise is the highest (excluding the distortions immediately following the  Covid-19 lockdowns) in the series since at least the turn of the century, when compared to the most recent CPI data (you remember, 5.4%) we find that the average employee continues to fall behind on a real basis.

When discussing inflation, notice that the Fed harps on things like used car prices or hotel prices as the key drivers of the recent rise in the data.  They also tend to explain that commodity prices play a role, and that is something they cannot control.  But when was the last time Chairman Powell talked about rapidly rising wages or housing prices as an underlying cause of inflation?  In fact, when asked about whether the Fed should begin tapering mortgage-backed securities purchases sooner because of rapidly rising house prices, he claimed the Fed’s purchases have no impact on house prices, but rather it was things like the temporary jump in lumber prices that were the problem.  Oh yeah, and see, lumber prices have fallen back down so there is nothing to worry about.

Of course, wages are not part of CPI directly.  Rising wages are reflected in the rising prices of everything as companies both large and small find it necessary to raise prices to maintain their profitability.  Certainly, there are some companies that have more pricing power than others and so are quicker to raise prices, but in the end, rising wages result in one of two things, higher prices or lower margins, and oftentimes both.  In the broad scheme of things, neither of these outcomes is particularly positive for generating real economic growth, which is arguably the goal of all monetary policies.

Consider, to the extent rising wages force companies to raise the price of their product or service, the result is an upward bias in inflation that is independent of the price of oil or lumber or copper.  In fact, one of the key features of the past 40 years of disinflation has been the fact that labor’s share of the economic pie has fallen substantially compared to that of capital.  This has been the result of the globalization of the workforce as the addition of more than 1 billion new workers from developing nations was sufficient to keep downward pressure on wages.

Arguably, this has also been one of the key reasons corporate profit margins have risen and stock prices along with them.  Now consider what would happen if that very long-term trend was in the process of reversing.  There is a likelihood of rising prices of goods and services, otherwise known as inflation.  There is also a likelihood of a revaluation of equity prices if margins start to decline. And nothing helps margins decline like rising labor costs.

Consider, also, this is the sticky type of inflation, exactly the opposite of all the transitory claims.  This is the widely (and rightly) feared wage-price spiral.  I am not saying this is the current situation, at least not yet, but that things are falling into place that could easily result in this outcome.

Now put yourself in Chairman Powell’s shoes.  Prices have begun rising more rapidly as companies respond to rising wage pressures.  The employment situation has been improving more rapidly so there is less concern over the attainment of that part of your mandate.  But…the amount of leverage in the system is astronomical with government debt running at record high levels (Federal government at 127%) and all debt, including household and corporate at 400% of GDP.  Do you believe that the economy can withstand higher interest rates of any substance?  After all, in order to tackle inflation, real rates need to be positive.  What do you think would happen if the Fed raised rates to 6%?  And this is my point as to why the Fed has painted themselves into the proverbial corner.  They cannot possibly respond to inflation with their “tools” because the negative ramifications would be far too large to withstand.  It is also why I don’t’ believe the Fed will make any substantive policy changes despite all the tapering talk.  They simply can’t afford to.

Ok, on to the markets.  One of the notable things overnight was the flash crash in the price of gold, which tumbled $73 as the session began on a huge sell order in the futures market, although has since regained $54 and is currently down 1.1% from Friday’s close.  The other things was the release of Chinese CPI (1.0%) and PPI (9.0%), both of which printed a few ticks higher than expected.  Obviously, there is not nearly as much pass-through domestically from producer to consumer prices in China, but that tends to be a result of the fact that consumption is a much smaller share of the Chinese economy.  However, higher prices on the production side, despite the government’s efforts to stop commodity speculation and hoarding, does not bode well for the transitory story.  And while discussing EMG inflation readings, early this morning we saw Brazil (1.45% M/M) and Mexico (5.86% Y/Y) both print higher than forecast results.  Certainly, it is no surprise that both central banks are in tightening mode.

A quick peak at equity markets showed Asia performed reasonably well (Nikkei +0.3%, Hang Seng +0.4%, Shanghai +1.0%) although Europe has been struggling a bit (DAX -0.2%, CAC -0.1%, FTSE 100 -0.4%).  US futures, meanwhile, are either side of unchanged with very modest moves.

Treasury yields have given back 2 basis points from Friday’s post-NFP surge of 7.5bps, although there are many who continue to believe the short-term down trend has been ended.  European sovereigns are also rallying a bit, with Bunds (-1.3bps), OATs (-1.3bps) and Gilts (-3.5bps) leading a screen that has seen every European bond rally today.

Commodity prices are perhaps the most interesting as oil prices have fallen quite sharply (-4.0%) with WTI back to $65.50/bbl, its lowest level since late May.  This appears to be a recognition of the growth of the Delta variant and how more and more nations are responding with another wave of lockdowns and restrictions on movement, thus less travel and overall economic activity.  As such, it should be no surprise that copper (-1.5%) is lower or that the metals space as a whole is under pressure.

Interestingly, the dollar is not showing a clear trend at all today, with gainers and losers about evenly mixed and no particularly large moves.  In the G10, NOK (-0.3%) is the laggard, clearly impacted by oil’s decline, but away from that, the mix is basically +/- 0.1%, in other words, no real change.  In the emerging markets, ZAR (+0.3%) is the leader, although this appears more to be a response to its sharp weakness last week than to any specific news.  And that is the only EMG currency that moved more than 0.2%, again, demonstrating very little in the way of new information.

Data this week brings CPI amongst a bunch of lesser numbers:

Today JOLTS Jobs Openings 9.27M
Tuesday NFIB Small Biz Optimism 102.0
Nonfarm Productivity 3.2%
Unit Labor Costs 0.9%
Wednesday CPI 0.5% (5.3% Y/Y)
-ex food & energy 0.4% (4.3% Y/Y)
Thursday Initial Claims 375K
Continuing Claims 2.88M
PPI 0.6% (7.1% Y/Y)
-ex food & energy 0.5% (5.6% Y/Y)
Friday Michigan Sentiment 81.2

Source: Bloomberg

At this point, the response to the CPI data will be either of the following; a high number will be ignored (transitory remember), and a low number will be proof they are correct.  So, while we may all be suffering, the narrative will have no such problems!

There are a handful of Fed speakers this week as well, with the two most hawkish voices (Mester and George) on the calendar.  Right now, the narrative has evolved to tapering is part of the conversation and Jackson Hole will give us more clarity.  The market is pricing the first rate hike by December 2022 based on the recent commentary.  We shall see.  Until then, I don’t anticipate a great deal as many desks will be thinly staffed due to summer vacations.  Just be careful if you have a large amount to execute.

Good luck and stay safe
Adf