Said Jay, I’m not worried ‘bout wages
Creating inflation in stages
I’ll stick to my story
It’s still transitory
And will be for many more ages
So now it’s the Old Lady’s turn
To help explain if her concern
‘Bout rising inflation
Will be the causation
Of rate hikes and trader heartburn
Like a child having a temper tantrum, the Fed continues to hold its breath and stamp its feet and tell us, “[i]nflation is elevated, largely reflecting factors that are expected to be transitory. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to a sizable price increase in some sectors.” [my emphasis.] In other words, it’s not the fault of their policies that inflation is elevated, it’s the darn pandemic and supply chain issues. (This is remarkably similar to how the German Reichsbank president, Rudy Havenstein, behaved as that bank printed trillions of marks fanning the flames of the Weimar hyperinflation. At every bank meeting the discussion centered on rising prices and not once did it occur to them that they were at fault by continuing to print money.)
Nonetheless, Chairman Powell must be extremely pleased this morning as he was able to announce the tapering of QE purchases, beginning this month, and equity and bond markets responded by rallying. There was, however, another quieter announcement which may well have helped the cause, this one by the Treasury. Given the rally in asset prices, collection of tax receipts by the government has grown dramatically and so the Treasury General Account (the government’s ‘checking’ account at the Fed) is now amply funded with over $210 billion available to spend. This has allowed the Treasury to reduce their quarterly refunding amounts by…$15 billion, the exact amount by which the Fed is reducing its QE purchases. Hmmmm.
So, to recap the Fed story, the tapering has begun, inflation is still transitory, although they continue to bastardize the meaning of that word, and they remain focused on the employment situation which, if things go well, could achieve maximum employment sometime next year. Rate hikes will not be considered until they finish tapering QE to zero, and they will taper at the pace they deem correct based on conditions, so the $15 billion/month is subject to change. One more thing; when asked at the press conference about inflation rising faster than anticipated, Powell responded, “We think we can be patient. If a response is called for, we will not hesitate.” Them’s pretty big words for a guy who can look at the economy’s behavior over the past twelve months and decide that inflation remains only a potential problem.
Enough about Jay, he’s not going to change, and in my view, he only has two meetings left anyway. Consider this; President Biden needs to get the progressives onboard to have any chance of passing any part of the current spending bills and in order for them to compromise on that subject, they will want something in return. They also hate Powell, as repeatedly vocalized by Senator Warren, so it is easy to foresee the President sacrificing Powell for the sake of his spending bill. Especially given the results of the Virginia elections, which moved heavily against the Democrats, the administration will want to get this done before the mid-term elections next year. I think Powell is toast.
On to the rest of the central bank world where this morning the BOE will announce their latest decision. The market continues to be about 50/50 on a rate hike today, but have fully priced one in by December, so either today or next month. Interestingly, the UK Gilt market is rallying this morning ahead of the announcement, with yields lower by 3.1 basis points. What makes that so interesting is that the futures market is pricing in 100 basis points of rate hikes by the BOE within the next 12 months, which would take the base rate up to 1.0%. Right now, 10-year Gilt yields are 1.03%. If the futures market is right, then either Gilts are going to sell off sharply as the yield curve maintains its current shape or the market is beginning to price in much slower growth in the UK. My money is on the latter as the UK has proven itself to be willing to fight inflation far more strenuously than the Fed in the past. If slowing growth is a consequence, they will accept that more readily I believe.
Still on the central bank trail, it is worth highlighting that Poland’s central bank raised rates by 0.75% yesterday in a huge market surprise as they respond to quickly rising inflation. Concerns are that CPI will reach 8.0% this year, so despite the rate hike, there is still much work to do as the current base rate there, after the hike, is 1.25%. This morning the Norgesbank left rates on hold but essentially promised to raise them by 25bps next month to 0.50%. While they are the first G10 country to have raised interest rates, even at 0.50%, their deposit rate remains far, far below CPI of 4.1%.
So, to recap, central banks everywhere are finally starting to move in response to rapidly rising inflation. While some countries are moving faster than others, the big picture is rates are set to go higher…for now. However, when economic growth begins to slow more dramatically, and it is already started doing so, it remains to be seen how aggressive any central bank will be, especially the Fed.
Ok, let’s look at today’s markets. As I said earlier, equities are rocking. After yesterday’s US performance, where all 3 major indices reached new all-time highs, we saw strength in Asia (Nikkei +0.9%, Hang Seng +0.8%, Shanghai +0.8%) and Europe (DAX +0.5%, CAC +0.5%, FTSE 100 +0.2%). US futures, on the other hand, are mixed with NASDAQ (+0.5%) firmer while the other two indices are little changed.
Bond prices have rallied everywhere in the world, which given the idea of tighter policy seems incongruent. However, it has become abundantly clear that bond prices no longer reflect market expectations of inflation, but rather market expectations of QE. At any rate, Treasuries (-3.5bps) are leading the way but Gilts (-3.1bps), Bunds (-1.7bps) and OATs (-1.8bps) are all seeing demand this morning.
After yesterday’s confusion, commodity prices are tending higher this morning with oil (+1.7%) leading the way, but gains, too, in NatGas (+0.75%), gold (+0.5%) and copper (+0.6%). Agricultural products are mixed, as are the rest of the industrial metals, but generally, this space has seen strength today.
As to the dollar, it is king today, firmer vs. virtually every other currency in both the G10 and EMG blocs. The euro (-0.6%) is the laggard in the G10 as the market is clearly voting the ECB will be even more dovish than the Fed going forward. But the pound (-0.4%) is soft ahead of the BOE and surprisingly, NOK (-0.4%) is soft despite both rising oil prices and a relatively hawkish Norgesbank. The best performer is the yen, which is essentially unchanged today.
In the EMG space, PLN (-1.0%) and HUF (-1.0%) are the laggards as both countries grapple with much faster inflation and lagging monetary policy. But CZK (-0.7%) and TRY (-0.65%) are also under relative pressure as their monetary policies, too, are lagging the inflation situation. Throughout Asia, most currencies slid as well, just not as much as we are seeing in EEMEA.
On the data front, Initial Claims (exp 275K) headlines this morning along with Continuing Claims (2150K), Nonfarm Productivity (-3.1%), Unit Labor Costs (7.0%) and the Trade Balance (-$80.2B). It is hard to look at the productivity and ULC data and not be concerned about the future economic situation here. Rapidly rising labor costs and shrinking productivity is not a pretty mix. As to the Fed, mercifully there are no additional speakers today, so we need look only at data and market response.
Clearly market euphoria remains high at this time, and so further equity gains seem likely. Alas, the underlying structure of things does not feel that stable to me. I expect that we are getting much closer to a more substantial risk-off period which will result in a much stronger dollar (and yen), and likely weaker asset prices. For hedgers, be careful.
Good luck and stay safe
I have not seen the Haverstein’s name referenced in many years, I recall an anecdote in Yeager;s The International Monetary Mechanism” (I think? the gray cells aren’t what they used to be. ). As the German hyperinflation surged in full force, Haverstein observed that prices were advancing at a much faster rate than the Reichsbank could print money. Having eschewed the quantity theory of money, Haverstein concluded that there was a shortage of paper money!! Why else would prices increase faster than the quantity of money, So he had the Reichsbank order new high speed printing presses. Fortunately for the Reich, Haverstein passed away before the new presses arrived and a currency reform could be implemented. Separately I enjoy your daily blog as I did our interaction when I worked at Cat. Let me know if you are coming to Reno. All the best Dan kanyr
Dan, so good to hear from you. Glad you still like the note. Sometimes I’m amazed I still write it every day. If we are heading out there will definitely reach out but that has not been on the travelogue yet. Hope all else is well there. Take care