At Jackson Hole, Powell explained
Inflation goals have been attained
But joblessness still
Is high, so they will
Go slow ere their bond buying’s waned
The market heard slow and they thought
The stock market had to be bought
So, prices keep rising
And it’s not surprising
The hawks are severely distraught
In my absence, clearly the biggest story has been Chairman Powell’s Jackson Hole speech, where he promised at some point that the Fed would begin to taper their bond purchases, but that it was still a bit too early to do so. He admitted that inflation had achieved their target but was still quite concerned over the employment portion of the Fed’s mandate, hence the ongoing delay in the tapering. And perhaps he was prescient as after Jackson Hole the NFP number was a massively disappointing miss, just 235K vs 733K median forecast. And to be clear, that number was well below the lowest forecast of 70 estimates. The point is, the evolution of the economy is clearly not adhering to the views expressed by many, if not most, FOMC members. We have begun to see significant reductions in GDP growth forecasts for the second half of the year, with major investment banks all cutting their forecasts and the Atlanta Fed’s GDPNow number falling to a remarkably precise 3.661% for Q3.
With this as a backdrop, it can be no surprise that the dollar has fallen dramatically during the past two weeks. For instance, in the G10, NOK (+4.2%) and NZD (+4.2%) both led the way higher as commodity prices rebounded, oil especially, and the US interest rates fell. In fact, the only currency to underperform the dollar since my last note has been the Japanese yen (-0.15%), which is essentially unchanged. The story is the same in the EMG space with virtually every currency rising led by ZAR (+6.9%) and BRL (+4.1%). In fact, only Argentina’s peso (-0.65%) managed to decline over the previous two weeks. The point is, the belief in a stronger dollar, based on the idea of the Fed tapering QE and then eventually raising interest rates, has come a cropper. The question is, where do we go from here?
With Jay in the mirror, rearview
It’s Christine’s time, now, to come through
On Thursday we’ll hear
If she’s set to steer
The ECB toward Waterloo
As the market walks in after the Labor Day holiday in the US, we are seeing the beginnings of a correction of the past two week’s price action, at least in the FX markets. Surveying the overnight data shows a minor dichotomy in Germany, where IP (+1.0%) rose a bit more than expected although the ZEW Surveys were both softer than expected. Meanwhile, Eurozone GDP grew at a slightly better than previously reported 2.2% quarterly rate in Q2, although that does not include the most recent wave of delta variant imposed lockdowns. In other words, we are no longer observing either uniform strength or weakness in the data, with different parts of each national economy being impacted very differently by Covid-19. One other thing to note here is the decline in support for the ruling CDU party in Germany where elections will be held in less than two weeks. It seems that despite 16 years of relative prosperity there, under the leadership of Chancellor Angela Merkel, the populace is looking for a change. This matters to the FX markets as a change in German economic policy priorities is going to have a major impact on the Eurozone, and by extension the euro. Of course, at this point, it is too early to tell just what that impact may be.
Of more immediate interest to the market will be Thursday’s ECB meeting, where, while policy settings will not be altered, all eyes and ears will be on Madame Lagarde to understand if the ECB, too, is now beginning to consider a tapering of its QE purchases. Last week, CPI data from the Eurozone printed at 3.0%, its highest level since September 2008, and well above the ECB’s 2.0% target (albeit not quite as far above as in the US). This has some of the punditry starting to expect that the ECB, too, is ready to begin to taper QE. However, the Eurozone growth impulse remains significantly slower than that in the US, and with the area unemployment rate still running at an uncomfortably high 7.6%, (much higher in the PIGS), it remains difficult to see why they would be so keen to begin removing accommodation. Given the ECB storyline, similar to the Fed, is that inflation is transitory, there is no reason to believe the ECB is getting set to move soon. Rather, I expect that although the PEPP may well end next March on schedule, it will simply be replaced with either an extension or expansion of the original APP, and likely both. The reality is that the bulk of the Eurozone would see a collapse in growth without the ongoing support of the ECB.
Turning away from that happy news, a quick survey of markets shows that equities in Asia have continued their recent strong performance (Nikkei +0.9%, Hang Seng +0.7%, Shanghai +1.5%), all of which have rallied sharply in the past two weeks. Europe, however, has not embraced today’s data, or is nervous about potential ECB action, as markets there are a bit softer (DAX -0.3%, CAC -0.1%, FTSE 100 -0.4%). US futures markets are essentially unchanged at this hour, continuing their recent very slow grind higher.
Of more interest today is the bond market, where Treasury yields have rallied 4.1 basis points and we are seeing higher yields throughout Europe as well (Bunds +3.9bps, OATs +4.3bps, Gilts +3.2bps). During my break, yields have managed to rally 10bps (including today) which really tells you that the market is still completely in thrall to the transitory story. Either that, or the Fed continues to absorb any excess paper around. However, higher yields seem to be helping the dollar more than other currencies despite similar size movements.
While the movement has not been significant, especially compared to the dollar weakness seen during the past two weeks, we are seeing strength in the dollar vs G10 currencies (AUD -0.5%, CAD -0.4%); EMG currencies (ZAR -0.6%, TRY -0.6%); and commodities (WTI -0.6%, Au -0.7%, Cu -1.1%). Looking at today’s price action, it appears that US rate movement has been the dominant driver.
On the data front, it is a remarkably quiet week with just a handful of numbers:
|Wednesday||JOLTs Job Openings||10.0M|
|Fed’s Beige Book|
|PPI||0.6% (8.2% Y/Y)|
|-ex food & energy||0.5% (6.6% Y/Y)|
We also hear from six Fed speakers, with NY President Williams the most important voice. But thus far, the Fed’s messaging has been quite effective as they continue to assuage fixed income investors with the transitory tale and thus interest rates remain near their longer-term lows. While at some point I expect this narrative to lose its hold on the investment community, it does not appear to be an imminent threat.
While I was out, the market flipped its views from concern over tapering leading to higher interest rates, to when tapering comes, it will be “like watching paint dry”*. FX investors and traders determined there was no cause for a much stronger dollar, and so the buck gave back previous gains and now sits back in the middle of its trading range. As such, we need to search for the next potential catalyst to change big picture views. While my money is on the collapse of the transitory narrative, and ensuing dollar weakness, you can be certain the Fed will fight hard to keep that story going. In other words, I expect that the trading range will remain intact for the foreseeable future. Trade accordingly.
Good luck and stay safe
*June 15, 2017 comments from then Fed Chair Janet Yellen regarding the normalization of Fed policy and the balance sheet, where she described the process as similar to watching paint dry. It turns out, that policy process was a bit more exciting, especially in Q4 2018 when equity markets fell 20% and Chair Powell was forced to abandon that policy.