QE Galore

With Kaplan and Rosengren out
The hawks have lost much of their clout
This opens the door
For QE galore
With tapering now more in doubt

As well, has Jay’s rep now been stained
So much that he won’t be retained
As Chair of the Fed
With Brainerd, instead
The one that progressives ordained?

All the action is in the bond market these days as investors and traders focus on the idea that the Fed is going to begin tapering its asset purchases in November.  Not surprisingly, demand for Treasuries has diminished on these prospects with the yield curve bear steepening as 10-year and 30-year yields climb more rapidly than the front end of the curve.  In fact, this morning, 10-year Treasury yields have risen a further 3.5 basis points, which makes 22bps since the FOMC meeting, and is now trading at 1.52%, its highest level since June.  Yields are rising elsewhere in the world as well, just not quite as rapidly as in the US.  For instance, Bunds (+3.2bps today, +13bps since Wednesday), OATs (+3.1bps today, 15bps since Wednesday) and Gilts (+4.8bps today, +20bps since Wednesday) are also under severe pressure.  While the BOE has absolutely discussed the idea of tapering, the same is not true with the ECB, which instead is discussing how it is going to replace PEPP when it expires in March 2022.

By the way, there is another victim to these rate rises, the NASDAQ, (futures -1.6%) where the tech sector lives and whose valuations have moved to extraordinary heights based on their long duration characteristics.

But let us consider how recent, sudden, changes in the makeup of the Fed may impact the current narrative.  It seems that two of the more hawkish Regional Fed presidents, Boston’s Rosengren and Dallas’ Kaplan, were actively trading their personal accounts at the same time they were privy to the inside discussions at the FOMC.  I can’t imagine more useful information short of knowledge of an acquisition, with respect to how to position my personal portfolio.  When this news broke last week, there was an initial uproar and then a slow boil rose such that both clearly felt pressured to step down.  (Of course, they had already sold out their positions ahead of the tapering discussion, so don’t worry, they kept their gains!)

There are a couple of things here which I have not yet seen widely discussed, but which must be considered when looking ahead.  First, the two of them were amongst the more hawkish FOMC members, with Kaplan the first to talk about tapering and Rosengren climbing on that bandwagon several months ago with vocal support.  So, will their replacements be quite as hawkish?  It would not surprise if Dallas goes for another hawk but given the progressivity of the bulk of New England, the new Boston Fed president seems far more likely to lean dovish in my view.  So, the tone of the FOMC seems likely to change.

Perhaps of more importance, though, is that this went on under Chairman Powell’s nose with no issues raised until it became public.  That is hardly a sign of strong leadership, and the very idea that two FOMC members were trading their personal accounts on the back of inside information is a huge black mark on his chairmanship.  You can be certain that when he sits down before the Senate Banking Panel today, Senator Warren is going to be tenacious in her attacks.  The point is, the idea that Powell will be reappointed may just have been squashed.  This means that Lael Brainerd, currently a Fed governor, may well get the (poison) chalice.  Governor Brainerd, just yesterday, explained that she was not nearly ready to taper, rather that the labor market was still “a bit short of the mark” of the “substantial further progress” threshold.  In fact, she is convinced that the economy will revert to its pre-pandemic characteristics soon after the delta variant dissipates.

If you consider the implications of this new information, we could well wind up with a more dovish FOMC generally with a much more dovish Fed chair.  Ask yourself if that scenario is likely to produce a consensus to taper asset purchases?  While Jay may get the process started, assuming economic activity holds up through November, they will never end QE with that type of FOMC bias.  In fact, it would not be surprising if the Biden administration nominated someone like Professor Stephanie Kelton, the queen of MMT, for one of the open governorships.

Summing up, recent surprising actions have now opened the door for a much more dovish Fed going forward.  This means that the fight against inflation, which even Powell has begun to admit could last a bit longer than initially anticipated, is of secondary, if not tertiary, importance.  For now, the dollar is following US rates higher as spreads widen in the dollar’s favor, but if the Fed gets reconstructed in a more dovish manner, which seems far more likely this morning than last week, I would expect the dollar to find a top sooner rather than later.

However, that is all prognostication of what may happen.  What is happening right now is that yields are rising on the taper talk and risk is being jettisoned as a result.  So, equity markets are generally under pressure.  Last night saw the Nikkei (-0.2%) slip a bit while the bulk of the rest of the region suffered more acutely (Australia -1.5%), although Shanghai (+0.5%) and the Hang Seng (+1.2%) were the positive outliers.  However, that seemed more like dip buying than fundamentally led activity.  Europe is really under the gun (DAX -1.15%, CAC -1.75%, FTSE 100 -0.5%) as yields, as discussed above, rise everywhere.

Commodity prices continue to show mixed behavior as oil (WTI +0.95%) and Nat Gas (+7.5%), rise sharply on supply concerns while metals (Au -0.9%, Cu -1.3%) all suffer on the back of concerns over economic growth and the dollar’s strength.

Speaking of the dollar, it is universally higher this morning against both G10 and EMG counterparts.  NZD (-0.8%) and GBP (-0.7%) are the downside leaders this morning, with kiwi feeling pressure from falling iron ore prices while the pound turned tail recently on position adjustments as traders await a dovish BOE speaker’s comments later in the session.  But, AUD (-0.6%) is also feeling the pressure from declining metals prices and in a more surprising outcome, NOK (-0.5%) is floundering despite rising oil prices and the fact that the Norgesbank was the First G10 central bank to actually raise rates!  As well, don’t forget JPY (-0.4%) which is now pushing to its highest levels of the year and not far from multi-year highs.  Remember, high energy prices are a distinct yen negative.

EMG currencies are being led lower by ZAR (-1.0%) on weaker metals prices and THB (-0.75%) which is continuing to feel pressure from its fiscal accounts.  But here too, the weakness is widespread (KRW -0.65%, MXN -0.6%, PLN -0.6%) as the dollar is simply in substantial demand on the back of the yield benefit.

On the data front, yesterday’s Durable Goods numbers were much stronger than expected, clearly helping the rate/dollar story.  This morning brings Case Shiller House Prices (exp 20.0%) as well as Consumer Confidence (115.0) and the Advanced Goods Trade Balance (-$87.3B).  But the feature event will be the 10:00am sit down by Powell and Yellen at the Senate.  We do hear from four other FOMC members, but none will garner the same attention.  It will be interesting to hear how he parries what are almost certain to be questions about the insider trading scandal as well as more persistent inflation.  Stay tuned!

The correlation of the dollar to the 10-year yield has risen sharply in the past several sessions and is now above 60%.  I see no reason for that to change, nor any reason for yields to stop climbing right now.  While I doubt we even get back to the March highs of 1.75%, that doesn’t mean we won’t see some more fireworks in the meantime.

Good luck and stay safe