Could Be Dead

The tapering talk at the Fed
Continues as they look ahead
Though growth’s clearly slowing
Inflation is growing
So, QE, next year, could be dead

In Europe, though, it’s not the same
As price rises largely are tame
But plenty of squawks
From ECB hawks
Have feathered the doves with great shame

Central bank meetings continue to be key highlights on the calendar and this week is no different.  Thus far we have already heard from the RBA, who left policy unchanged, as despite inflation running at 3.8% Q/Q, are unwilling to tighten policy amid a massive nationwide lockdown.  After all, how can they justify tighter policy as growth continues to sag?

This morning the BOC meets, and the universal view is that the Overnight Lending rate will be left unchanged at 0.25%.  However, you may recall that the BOC has actually begun to taper its QE purchases, reducing the weekly amount of purchases to C$2 billion from its peak setting of C$4 billion.  Most of the punditry believe that there will be no change in the rate of QE at this meeting as the bank will want to evaluate the impact of the delta variant on the Canadian economy more fully, but most also believe that the next step lower will occur in October.  In either event, though, it seems the currency markets remain far more focused on the US half of the equation than on what the other central bank is doing.  After all, since the BOC began to taper policy in April, the Loonie has weakened by more than 1%, although it did show initial strength in the wake of the surprise announcement.

Turning to tomorrow’s ECB meeting, there has also been a clear delineation between the hawks and doves as to the proper steps going forward.  Given the macroeconomic situation in Europe, where growth is slowing from relatively modest levels and inflation remains far below levels seen in either the US or Canada (or Australia or the UK), it would seem that the doves should retain the upper hand in the discussion.

But one of the key, inherent, flaws in the Eurozone is that different countries tend to have very different economies as well as very different fiscal policies, and so the individual economic outcomes vary greatly.  Thus, while Spain remains mired with excessively high unemployment and lackluster growth prospects, as does Italy, Germany has seen rising prices in a much more sustained fashion, with CPI there running a full percentage point above the Eurozone as a whole.  Given that German DNA is vehemently anti-inflation (a result of the suffering of the Weimar Hyperinflation of the 1920’s), this situation has resulted in Bundesbank President Jens Weidmann and some of his closest colleagues (Austria’s Holtzmann and the Netherlands’ Knot) vociferously calling for a reduction in the rate of purchases in the PEPP.  However, most of the rest of the committee sees no need to slow things down.  The question tomorrow is whether or not Madame Lagarde will be able to tether the hawks.  While there is market talk that tapering will occur, my money is on no change in the pace of purchases.  The direct impact of this should be further modest weakness in the euro and a rebound in European sovereign bond market prices.

As to the Fed, they meet in two weeks’ time and after Powell’s Jackson Hole performance, I think there are vanishingly few players who believe they are going to even announce the tapering schedule then.  However, that does not mean that the segment of the FOMC who are adamantly pro-taper will be quiet, and so expect to hear a steady stream of tapering talk until the quiet period begins on Saturday.  In fact, just last night St Louis President Bullard was interviewed by the FT and reiterated his vocal stance that tapering needs to begin right away.  As well, we will hear from Dallas’ Kaplan later today with his message guaranteed to be the same.  Of more interest will be NY’s Williams, who speaks this afternoon at 1:10pm, and who has yet to voice his tapering opinion.  If he does say tapering is necessary, that would be an important signal, so we must pay close attention.

With all that in mind, markets overnight have started to take a somewhat dimmer view of risk, especially in Europe.  In fact, looking around, only the Nikkei (+0.9%) has been able to see any positivity as the rest of Asia (Hang Seng -0.1%, Shanghai -0.1%) edged lower while Europe (DAX -0.7%, CAC -0.4%, FTSE 100 -0.5%) are seeing much greater selling.  That said, the situation on the Continent was worse earlier in the session with losses everywhere greater than 1.0%.  US futures, meanwhile, are essentially unchanged on the morning, although leaning slightly lower.

In the bond market, buyers have returned with Treasury yields falling 2.4bps, reversing half of yesterday’s climb.  But Europe, too, is seeing demand for havens with Bunds (-1.2bps), OATs (-1.5bps) and Gilts (-1.0bps) all decently bid this morning.  Certainly, if the ECB does reduce its PEPP purchases you can expect yields across the board in Europe to rise.  And, in fact, that is why I don’t expect that to occur!

In a bit of a conundrum, commodity prices are generally higher, alongside the dollar.  Looking at WTI (+1.4%), it seems that energy is on the rise everywhere.  (Pay attention to Uranium, which has rallied 32% in the past month and is structurally bullish as current demand is significantly greater than the run rate of production.)  But weirdly, other than copper (-0.8%) every other key commodity is higher this morning with Au (+0.3%), Al (+0.5%) and Soybeans (+0.7%) leading the way.

This is strange because the dollar is broadly, albeit generally modestly, higher this morning.  In the G10, EUR, CAD and DKK are all softer by 0.2% while only NZD (+0.1%) has managed any gains on the back of the strength in commodity prices.  In the emerging markets, the situation is far more pronounced with TRY (-1.0%) leading the way lower after the central bank indicated rate cuts were coming, although we also saw weakness overnight in KRW (-0.75%), THB (-0.5%) and TWD (-0.4%).  All of these Asian currencies suffered on a pure risk-off viewpoint as equity markets in these nations fell as well.  But it’s not just APAC currencies as we are seeing weakness in EMEA with HUF (-0.5%) and PLN (-0.3%) also under pressure.

On the data front, today brings the JOLTS Job Openings report (exp 10.049M) which continues to indicate the labor market is quite tight despite the payroll data last week.  And after that we get the Fed’s Beige Book at 2:00.  To my mind, Williams’ speech at 1:10pm is the most important story of the day, so we will need to pay close attention when he starts speaking.

Overall, it appears that the dollar bulls have regained the upper hand and are slowly pushing the greenback higher versus most counterparts.  If Williams does agree tapering is needed, I expect the dollar to take another leg higher.  But if he is clear that there is no rush, especially with the delta variant impact, look for the dollar to cede some of its recent gains and equity markets to regain a little spring in their step.

Good luck and stay safe
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