It’s not clear why there’s a concern
Inflation could cause a downturn
Cause stocks keep on rising
Though Jay’s emphasizing
The Fed, QE’s, set to adjourn
But still there is something awry
In how traders, every dip, buy
With growth clearly slowing
Though wages are growing
The value of stocks seems too high
One has to be remarkably impressed with the price action of risk assets these days and their ability to completely ignore growing signs that long-delayed problems are fast approaching. The first of these problems is clearly inflation, something that has been ignored for decades by investors as long-term factors like globalization and demographics, as well as technological innovation, have served to suppress any significant inflationary impulse throughout the developed world. Certainly, there were some EMG nations (Argentina, Venezuela, Zimbabwe) that managed to buck that trend and impose policies so horrendous as to negate the long-term benefits of stable prices, but generally speaking, inflation has not been a problem.
Then, Covid came along and the policy response was truly
draconian dramatic, essentially shutting down much of the global economy for a number of months. In hindsight, it cannot be surprising that the disruption to finely tuned supply chains that was imposed has been difficult to repair. After all, it took years to achieve the true just-in-time nature of manufacturing and distribution across almost every industry. While there are currently herculean efforts to get things back to the way they were, I suspect we will never again return to the previous situation. A combination of policy decisions and population adaptations has altered the underlying framework thus there is no going back.
Consider the current energy situation (crisis?) as an example. What is very clear now is that the price of energy is rising rapidly with both oil (+69% YTD, 0.85% today) and NatGas (+127% YTD, 1.0% today) continuing to climb with no end in sight. Arguably, there have been a number of deliberate policy choices as well as some investing fashions which have dramatically reduced the investment in the production of these two key energy sources thus not merely reducing current supply but prospects for future supply as well. Pressure from environmentalists to prevent this investment has done wonders for driving up prices, alas the mooted renewable replacements have yet to demonstrate their long-term effectiveness as uninterrupted power sources. And this situation is manifest not only in the West, but in China as well, where they are currently suffering from major power shortages amid rapidly rising prices for LNG and coal as well as oil. This morning’s WSJ has a lead article on how the rising price of NatGas is going to drive up winter heating bills substantially and the negative consequences for lower- and middle-income folks.
And yet…risk appetite remains robust. You can tell because regardless of the news, equity prices consistently rise. I grant it is not actually every day, but the trend remains quite clearly higher. In traditional analysis, it would be difficult to rationalize this price movement as while the current situation may be working fine for companies, the fact is there are numerous issues that are coming, notably rising wages and a shrinking labor force, that are going to pressure margins, and arguably profits, going forward. Clearly, however, that tradition is dead. In its stead is the investor view that as long as the Fed keeps supplying liquidity to the
markets economy, it will prevent any significant price dislocation. Trickle Down theory remains alive and well on Wall Street. This is evident today, where equity markets worldwide are higher, and has been evident in the fact that the recent Evergrande induced scare that resulted in a 5% correction was the first correction of that magnitude in more than a year. The current investment zeitgeist remains; stocks only go up so buy more. While I recognize I sound curmudgeonly on this topic, remember, reality is a b*tch and it will win out in the end. Until then, though, it is unclear what type of catalyst is needed to change views, so risk assets are likely to remain in favor regardless of everything else.
And of course, today is a perfect example where equity markets are all green (Nikkei +1.8%, Hang Seng +1.5%, Shanghai +0.4%) in Asia and Europe (DAX +0.3%, CAC +0.4%, FTSE 100 +0.3%) as well. Don’t worry, US futures are all pointing higher by 0.25%-0.35% at this hour, so all our 401K’s still look good.
Meanwhile, bonds are not required in a risk-on scenario so it should be no surprise that yields are rallying today with Treasuries (+3.3bps) leading the way but higher yields throughout Europe as well (Bunds +2.0bps, OATs +2.3bps, Gilts +3.7bps). These price movements have been seen throughout the rest of the continent and in Asia last night with yields rising universally.
Commodity prices are broadly firmer, although with risk appetite robust, precious metals (Au -0.85, Ag -1.2%) are unwanted. We discussed oil prices and we are seeing strength in the industrial metals (Cu +2.4%, Al +2.4%) as well as the Ags (corn +1.2%, wheat +1.4%, soybeans +0.7%). In other words, risky assets are the place to be.
You should not be surprised that the dollar (and yen) are suffering on this movement given haven assets serve no purpose today! In the G10 space, GBP (+0.6%) is leading the way higher followed by NOK (+0.55%) and then everything else is just modestly higher except JPY (-0.6%). The sterling story seems to revolve around continued belief in BOE rate hikes coming early next year while NOK is simply following oil for now.
Of more interest, I believe, is the yen, which admittedly has been falling quite rapidly, down nearly 5% in the past three weeks, and quite frankly, shows no signs of stopping. At this point, it doesn’t seem so much like Japanese investment outflows as it does like a speculative move that has discerned there is limited real demand for the currency. Amazingly, last night, the new FinMin, Shunichi Suzuki, felt compelled to explain that, “stability in currencies is very important.” He further indicated that there was concern a weaker yen could cause prices to rise, especially energy prices. Now, call me crazy but, BOJ policy for the past decade explicitly and the past three decades with less verve, has been to drive inflation higher. Abenomics was all about achieving 2.0% inflation, something that had not been seen since before the Japanese bubble collapsed in 1989. Now, suddenly, with inflation running at 0.2%, they are starting to get concerned that higher energy prices are going to be a problem? Are they going to raise rates? Are they going to intervene? Absolutely not in either case. Sometimes you have to wonder what animates policy maker comments.
As to EMG currencies, ZAR (+0.6%) and KRW (+0.4%) are the leaders this morning with the former benefitting from higher metals prices while the latter is responding to comments from the BOK governor that a rate hike could be coming at the November meeting. On the downside here, TRY (-0.4%) continues to suffer from Erdogan’s capriciousness with respect to his central bankers, while THB (-0.3%) appears to be consolidating after a strong rally over the past week.
We have a bunch more data this morning led by Retail Sales (exp -0.2%, +0.5% ex autos) as well as Empire Manufacturing (25.0) and Michigan Sentiment (73.1). There are two more Fed speakers, Bullard and Williams, but it seems unlikely that either will change the current narrative of a taper coming soon.
The reality is you can’t fight the tape. As long as risk appetite remains buoyant, the dollar and yen are likely to remain on their back foot. For the dollar, I see no long-term danger as I believe it will consolidate further before making its next move higher. the yen, on the other hand, could be a bit more concerning. If fear has gone missing, and with yields rising elsewhere in the world, a much weaker yen remains a real possibility.
Good luck, good weekend and stay safe