The market has turned its attention
To Brainerd’s potential ascension
As Chair of the Fed
Thus, bond bulls imbed
The view QE gets an extension
This adds to the growing divide
Twixt nations who’ve identified
Inflation as bad
From those who are mad
Their laxness have been damnified
The dollar is under some pressure this morning as bonds rally (yields decline) and commodity prices pick up further. If equity markets were higher this would be a classic risk-on session, alas, that picture is mixed, and anyway, whatever movement there is has been modest at best. (It’s almost as if equity bulls are getting tired at all-time highs with record valuations.)
What, then, you may ask, is driving today’s price action? I give you Lael Brainerd PhD, current Fed governor, former Under Secretary of International Affairs at the US Treasury, and the woman most likely to be our next Federal Reserve Chair. The news broke that President Biden interviewed her for the role and there is a growing belief that in the current political zeitgeist, a Democratic woman favored by the progressive wing of the party will be much more palatable than a Republican man with a mixed track record on issues like FOMC membership trading improprieties. It doesn’t hurt that she has been an unrequited dove since her appointment by President Obama in 2014, nor that she has been vocal on the need for more stringent regulatory control over the big banks.
As markets are discounting instruments, ostensibly looking forward a number of months to where things will be rather than where they currently sit, there is a growing belief that a Chairwoman Brainerd will be loath to continue tapering asset purchases and far more comfortable allowing inflation to run even hotter in her desire to achieve an even lower unemployment rate. Hence, the idea that fed funds rate hikes will be coming sooner has been pushed back further. In the wake of last week’s very surprising BOE meeting, where the widely anticipate rate hike was delayed, and the Fed’s own extremely dovish tapering message, the idea that a change at the Fed will lean even more dovish than now is music to bond bulls’ ears. And so, as we survey the largest economies, the US seems to be turning more dovish, the Eurozone continues to burnish its dovish bona fides and the BOJ…well the BOJ is unlikely to ever tighten policy again.
However, as we look elsewhere in the world, the story is very different. Central banks all over, from smaller G10 nations to large EMG group members have clearly articulated that inflation is a major concern with no clear end in sight and that tighter monetary policy is in order. In the G10, Canada appears on the cusp of tightening, Norway has done so already and promised another hike next month. New Zealand has ended QE and raised rates, Australia has given up on YCC and Sweden is hinting at a rate rise coming soon. The noteworthy link is these are all small, relatively open economies with trade a key part of the mix and rising prices are very evident.
But do not forget the EMG space where we have seen far more dramatic moves already and are almost certain to see more of the same going forward. The Czech Republic hiked rates 125bps last week, far more than expected, while Russia has already raised rates 2.50% in the past 9 months with no signs of slowing down. Meanwhile, Polish central bankers are previewing more rapid rate hikes despite a larger than expected 75 basis point move last week. In LATAM, Brazil has already raised rates 5.25% and is in no mood to stop with inflation running above 10% there. Mexico, too, is up 0.75% from its lows while Chile (+2.25%), Colombia (+0.75%) and Peru (+1.75%) have all reacted strongly to rising inflation.
The point is this dichotomy between the G3 and the rest of the world seems unlikely to continue forever. There seem to be two likely scenarios to close this interest rate gap, neither of them to be hoped for; either the G3 will finally blink, recognize inflation is real and raise rates far more rapidly than currently expected, or the transitory story will be correct as the economic imbalances will drive a massive crash with economic growth slowing dramatically into a severe recession and no reason to raise interest rates. In the first case, financial assets will almost certainly suffer greatly while commodities should perform well. In the second case, everything will suffer greatly with cash regaining its title as king.
Like I said, neither is a pleasant outcome, but neither is about to happen yet either. So, looking at today’s activity, the growing assumption of a more dovish Fed (remember that vice-chairs Clarida and Quarles will be out within months as well) has led to lower yields and a somewhat softer dollar along with ongoing higher commodity prices.
Equities, however, remain mixed overall, albeit starting to edge higher in the session. In Asia, the picture was mixed with the Nikkei (-0.75%) falling on the back of yen strength, while the Hang Seng (+0.2%) and Shanghai (+0.2%) both managed to edge higher. Europe, which had been mixed to lower earlier in the session has started to turn green with the DAX (+0.2%), CAC (+0.3%) and FTSE 100 (+0.1%) all in positive territory. US futures are generally little changed ahead of this morning’s PPI data, (exp 8.6%, 6.8% ex food & energy) but really with the market focusing on tomorrow’s CPI data.
As mentioned, bonds are having a good day, with Treasuries (-3.1bps) falling back to Friday’s low yields, while European sovereigns (Bunds -3.5bps, OATs -3.7bps, Gilts -1.3bps) all rally as well. In Europe, the curves are flattening pretty aggressively, hardly a vote of confidence in future activity.
Oil prices (+0.45%) are once again firmer although NatGas (-1.6%) has slipped as warm weather in the mid-Atlantic and Midwest states reduces near term heating demand. Precious metals, which have been rallying nicely of late are little changed on the day but industrial metals (Cu +0.5%, Al +0.1%, Sn +0.3%) are all a bit firmer. Agricultural products continue to rise as food inflation worldwide continues to grow.
Finally, the dollar, which had been broadly softer earlier in the session on the dovish discussion, has rebounded slightly, although is hardly rocking. In the G10, the largest moves have been 0.25% in either direction (AUD -0.25%, JPY +0.25%) however, there have been limited stories to drive perceptions. Given the yen’s recent bout of significant weakness, this appears to be a corrective move rather than a new direction. As to Aussie, it too seems more technical than fundamental in nature.
Emerging markets, however, have seen more movement led by THB (+0.8%) and KRW (+0.5%) on the news that both economies are reopening amid a decline in Covid infections and the allowance of more inbound tourist traffic. RUB (+0.45%) seems to be benefitting from oil’s rise as well. On the downside, ZAR (-0.6%) fell after a report that foreign holdings of South African sovereign debt fell to its lowest level in 10 years.
On the data front, aside from the PPI, we have already received the NFIB Small Business Optimism number at a disappointing 98.2 (exp 99.5) indicating that the growth impulse in the US is still under pressure. In addition, there are 4 more Fed speakers today after yesterday’s warnings from Vice-chair Clarida that inflation may be a problem going forward.
For now, the dollar seems to be under modest pressure as it consolidates the latest leg of a slow move higher. If the Fed tapering is going to diminish, the dollar bulls are going to have a harder road to hoe going forward. As such, much will depend on who is our next Fed chair.
Good luck and stay safe