Some pundits think Madame Lagarde
Is ready, the PEPP, to retard
But others believe
She’ll never achieve
Her goals sans her bank’s credit card
Meanwhile data last night explained
That factory prices had gained
The idea inflation
Is due for cessation
Is anything but preordained
Two noteworthy stories this morning are the ECB meeting, where shortly we will learn if the much-mooted reduction in PEPP purchases is, in fact, on the way and Chinese inflation data. Similar to the Fed, despite a more lackluster economic performance across the Eurozone as a whole, the hawkish contingent of the ECB (Germany, Austria, Finland and the Netherlands) have been extremely vocal in their calls for tapering PEPP bond purchases. While the Germans have been the most vocal, and are also seeing the highest inflation readings, this entire bloc has a history of fiscal prudence and the ongoing ECB asset purchase programs, which essentially fund fiscal policy in the PIGS, remains a significant concern. However, the majority of nations in the Eurozone appear quite comfortable with the ongoing purchase programs. At times like this, one cannot think along the lines of the economic logic of tapering; instead one must consider the political logic. Remember, Lagarde is a politician, not a true central banker steeped in policy and economics. To the extent that enough of her constituents believe the current purchase rate of €80 billion to €85 billion per month is appropriate, that is the rate she will maintain.
Markets are generally, I believe, looking for a modest reduction in PEPP purchases, so if the ECB does not adjust purchases lower, I would expect European sovereign bonds (currently slightly firmer with yields lower by about 1 basis point) to rally and the euro (+0.15% this morning) to decline. European bourses, currently all lower by between 0.25% and 0.75%, are also likely to perform well on the news.
On a different note, China reported its inflation data last night and while CPI there remains muted (0.8% Y/Y), PPI (9.5% Y/Y) is absolutely soaring. This is the highest reading since August 2008, right before the GFC began, and is the product of rising commodity prices as well as increases in shipping costs and shortages of labor. The reason this matters so much to the rest of the world is that China continues to be the source of a significant portion of “stuff” consumed by most nations. Whether that is tee-shirts or iPhones, rising prices at the Chinese factory gate imply further price pressures elsewhere in the world, notably here in the US. Several studies have shown a strong relationship between Chinese PPI and US CPI, and the logic behind the relationship seems impeccable. Perhaps a key question is whether or not Chinese PPI increases are also transitory, as that would offer some hope for the Fed. Alas, history has shown that the moderation of Chinese PPI is measured in years, not months.
Before we turn to today’s markets, I believe it is worthwhile to mention the latest Fedspeak. Yesterday we heard from NY Fed president John Williams who stayed on message, explaining that substantial further progress had been made on the Fed’s inflation goal, but not yet on the employment goal. He followed that up by telling us that if things go according to his forecasts, tapering could well begin before the end of the year. The theme of tapering before the end of 2021, assuming the economy grows according to plan, has been reiterated by numerous Fed speakers at this point, with both Kaplan and Bostic adding to Williams’ comments yesterday. But what happens if growth does not achieve those lofty goals? After all, the Atlanta Fed’s own GDPNow data is now forecasting 1.943% growth in Q3. That seems quite a bit lower than FOMC forecasts. And yesterday’s JOLTS data showed nearly 11 million job openings are extant, as the supply of willing workers continues to shrink. A cynic might believe that the current Fedspeak regarding the potential for tapering shortly, assuming data adheres to forecasts, is just a ruse as there is limited expectation, within the Fed, that the data will perform. This will allow the Fed to maintain their easy money with a strong rationale while sounding more responsible. But that would be too cynical by half. Do remember, however, Fed forecasts are notoriously inaccurate.
OK, markets overnight are continuing down a very modest risk-off path. Equities in Asia were generally lower (Nikkei -0.6%, Hang Seng -2.3%) with Shanghai (+0.5%) a major exception. Ongoing crackdowns on on-line gaming continue to undermine the value of some of China’s biggest (HK listed) companies, while the debt problems at China Evergrande continue to explode. (China Evergrande is the second largest real estate company in China with a massive debt load of >$350 billion and has been dramatically impacted by China’s attempts to deflate its real estate bubble. It has been downgraded multiple times and its stock price has now fallen well below its IPO price. There are grave concerns about its ability to remain an ongoing company, but given the size of its debt load, a failure would have a major impact on the Chinese banking sector as well as, potentially, markets worldwide. Think Lehman Brothers.) Alongside the previously mentioned weakness in Europe, US futures are all currently lower by about 0.25%.
Treasury prices are continuing their modest rally, with yields falling another 1.2bps as risk appetite generally wanes. Given the FOMC meeting is still two weeks away, investors remain comfortable that Treasuries are still a better buy than other securities. Interestingly, the debt ceiling question does not seem to have reached the market’s collective consciousness yet, although it does offer the opportunity for some serious concern. However, history shows that despite all the huffing and puffing, Congress will never allow a default, so this is probably the correct behavior.
Commodity prices are rebounding with oil (+0.8%), gold (+0.45%) and copper (+1.3%) leading the way. The rest of the industrial space is generally firmer although foodstuffs are all softer this morning in anticipation of upcoming crop reports (“sell Mortimer!”)
As to the dollar, it is on its heels this morning, down versus all its G10 counterparts led by NOK (+0.35%) and GBP (+0.3%). Clearly the former is benefitting from oil’s rise while the pound seems to be benefitting from BOE comments indicating a greater concern with inflation and the fact the Old Lady may need to address that sooner than previously anticipated. In the EMG bloc, there are far more winners than losers, but the gains have been muted. For instance, PHP (+0.4%) has been the biggest winner, followed by ZAR (+0.3%) and RUB (+0.25%). While the latter two are clear beneficiaries of firmer oil and commodity prices, PHP seems to have gained on the back of a potential reversal of Covid lockdown policy by the government, with less restrictions coming. On the downside, only KRW (-0.25%) was really under pressure as the Asian risk-off environment continues to see local equity market sales and outflows by international investors.
On the data front, this morning brings only Initial (exp 335K) and Continuing (2.73M) Claims. However, we do hear from four more Fed speakers, with only Chicago’s Evans having yet to say tapering could be a 2021 event. In truth, at this point, given how consistent the message has been, I feel like data is more likely to drive markets than comments. Given today’s calendar is so light, I expect we will see another day of modest movement. The one caveat is if the ECB surprises in some manner, with a greater risk of a more dovish stance than the market assumes.
Good luck and stay safe