Christine said she’d recalibrate
The PEPP, but she clearly did state
No taper’s occurring
Because we’re still spurring
Inflation to reach our mandate
I felt it was important for all of us to be reminded of what tapering means, hence this definition from the Merriam-Webster dictionary:
1 : to become progressively smaller toward one end
2 : to diminish gradually (emphasis added)
But perhaps there is a better source to explain Madame Lagarde’s dissembling comments yesterday; Lewis Carrol.
“I don’t know what you mean by ‘glory,’ ” Alice said.
Humpty Dumpty smiled contemptuously. “Of course, you don’t—till I tell you. I meant ‘there’s a nice knock-down argument for you!'”
“But ‘glory’ doesn’t mean ‘a nice knock-down argument’,” Alice objected.
“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”
Apparently, Madame Lagarde was channeling Humpty Dumpty in her press conference yesterday when she said that while the ECB would be gradually reducing the rate of purchases in the PEPP program in the coming quarter, it was definitely not tapering. One of the problems this author has with centralbankspeak is that my education taught me based on the plain meaning of the words used. Hence, claiming that a reduced rate of purchases is not tapering is simply dishonest. However, central bankers everywhere, led by the Fed and ECB, have come to rely on redefining terms in order to placate both of their masters, markets and governments, who frequently require opposing policies to achieve their goals.
Remember, too, what happened to Humpty Dumpty, a lesson I daresay has been lost on Powell, Lagarde and their comrades-in-arms:
Humpty Dumpty sat on a wall
Humpty Dumpty had a great fall
All the King’s horses and all the King’s men
Couldn’t put Humpty together again.
As economist Herbert Stein explained in 1986, “if something cannot go on forever, it will stop.” Central bank balance sheets cannot grow indefinitely, at least not without other repercussions. The most likely relief valve will be the currency, but do not be surprised if there is significant damage to all financial assets at the time investors and markets cease to accept centralbankspeak as a valid guide to the future.
Ever since the GFC, central banks around the world have been aggressively adding liquidity to economies at a far faster pace than those economies create goods and services. For the first decade of this process, that liquidity mostly found its way into financial markets resulting in the longest bull market in history. But lately, that liquidity has begun to seep into the real economy on the back of a massive uptick in fiscal stimulus. The result, you may have noticed, is that financial markets have stopped rising at their previous rate, but the price of stuff you buy every day/week, has started to rise much more rapidly. It is this fact that was the genesis of the ‘transitory’ inflation story, as central banks, notably the Fed, recognize they cannot afford to be blamed for rising consumer inflation, but also cannot afford to fight inflation in the traditional manner of raising interest rates as they are terrified adjusting their current policy will result in a massive market decline. Hence, I fear the Humpty Dumpty metaphor will wind up being very accurate. However, he hasn’t fallen yet.
And so, Madame Lagarde did exactly what she set out to do; she was able to explain the ECB would be slowing their PEPP purchases without the market responding in a knee-jerk sell-off. She placated the hawks on the ECB Council, and watched as Italian BTPs outperformed German bunds thus reducing pressure on the biggest potential problem in Europe. In the end, kudos are due, at least for now. I sure hope it lasts, but fear there is much turmoil in our future.
In the meantime, the overall market response to Lagarde has been…buy risk! Equity markets everywhere are in the green with Asia (Nikkei +1.25%, Hang Seng +1.9%, Shanghai +0.3%) charging ahead and Europe (DAX +0.3%, CAC +0.3%, FTSE 100 +0.3%) following, albeit at a bit slower rate. US futures, after two lackluster sessions in NY, are pointing higher by 0.4% to start the day.
Of course, with risk appetites whetted, there is no need to hold havens like bonds and so prices there have fallen everywhere with corresponding rises in yields. Treasuries (+2.9bps) are leading the way but we are seeing Europe (Bunds +1.8bps, OATs +1.9bps, Gilts +1.1bps) all under some pressure as well. As long as risk is in the ascendancy, I expect that bond yields will continue to edge higher.
Commodity prices are also firmer this morning led by oil (+1.7%) and the entire energy complex. But metals, too, are up, at least industrial metals with copper (+1.9%), aluminum (+1.6%) and tin (+1.2%) all much stronger and with the latter two pushing to multi-year highs. While gold is flat on the day, and has been doing very little lately, broadly speaking, the commodity complex continues to perform well.
Finally, the dollar, not surprisingly, is under significant pressure this morning, down versus most of its G10 counterparts, notably the commodity bloc. NZD (+0.6%), NOK (+0.45%) and AUD and CAD (+0.4%) are all looking strong today bolstered by broad dollar weakness and strong commodity price action. On the flip side, JPY (-0.2%) is the only real decliner as haven assets are sold, although CHF is also modestly softer. In the emerging markets, the screen is entirely green led by ZAR (+0.75%), CZK (+0.5%) and IDR (+0.35%). Rand is clearly in thrall to commodity prices while the koruna is rallying on the back of a much higher than expected CPI print of 4.1%, which has traders looking for a central bank rate increase at the next meeting at the end of the month. As to the rupiah, it seems this is entirely a result of the risk-on attitude in markets this morning.
On the data front, early this morning the UK released its monthly GDP print at a worse than expected 0.1%, blamed now on the increase of the delta variant. German CPI was confirmed at 3.9% in August, and Italian IP managed to rise 0.8% in July, a bit better than expected. Here at home we will see PPI (exp 8.2%, 6.6% ex food & energy) which will continue to challenge the transitory narrative but will not have nearly the impact of next Tuesday’s CPI release. As well, we hear from the Cleveland Fed’s Loretta Mester this morning, but she has already explained she is ready to taper QE purchases, so unless that story changes, I don’t foresee any impact.
While the dollar is softer this morning, there is no indication it is going to decline substantially at any point in the near future. Rather, we remain in the middle of the 1.17/1.20 trading range that has capped movement since June. I see no reason for anything to change here and expect the week to finish in a quiet manner.
Good luck, good weekend and stay safe