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