Ill-Starred

The latest from Treasury’s Yellen
Is really not all that compellin’
The problem, she said
Is Covid’s widespread
So, prices just won’t stop their swellin’

This morning, then, Madame Lagarde
Repeated her latest canard
If we were to tighten
Too early, we’d heighten
The risk of an outcome, ill-starred

As we begin a new week the only thing that has changed is the date, at least with respect to the official narrative regarding inflation and the economy.  Once again, this weekend, Treasury Secretary Yellen complained explained that Covid-19 is the reason inflation is running so high, and that once the pandemic is under control, prices will slow their ascent.  That seems to ignore the Fed’s balance sheet expansion of $5 trillion since last year, as well as the $5 trillion in special fiscal assistance that has been enacted by the government, the last $1.9 trillion under her guidance.  And of course, she is cheerleading the next $1.75 trillion in the Administration’s plans.  Yet she continues to claim that when Covid recedes, all will be well again.

At the same time, ECB President Christine Lagarde continues along the same lines, pooh-poohing the idea that the ECB should consider tightening policy because the current bout of inflation is only temporary (wisely, she has stopped using the term transitory at this point) and were they to act now, by the time their policy change had any effect on the economy, inflation would already be slowing down on its own.  So, you can be sure that the ECB is not about to alter its policy either anytime soon.  In fact, when the PEPP expires in March next year, you can be certain that the APP, the original Asset Purchase Plan (QE) will be expanded and extended to keep the cocaine flowing into the Eurozone economy’s bloodstream.

Will this process change at any point soon?  The odds remain extremely low in either the US or Europe given the evolution of the membership of both policy boards.  In the US, it appears the odds of a Chairwoman Lael Brainerd grow each day, and with that, the odds of easier monetary policy for an even longer time.  A telling blurb about her views recounts the time when then Chair Yellen wanted to start to raise rates in 2015 and Brainerd argued forcefully against the idea.  History shows that the Fed missed a key opportunity at that time to more fully normalize policy, leading directly to the lack of effective tools they currently possess.  While Chairman Powell has certainly been no hawk, relative to Ms Brainerd, his talons look quite sharp.

At the same time, the news that Bundesbank president Jens Weidmann is stepping down has resulted in the most forceful counterbalance to the large dovish wing in the ECB leaving the governing council.  While the next Buba president is sure to be more hawkish than most ECB members, he will not have the gravitas nor sway that Weidmann holds, and therefore, will be less able to push against the doves.

While smaller economies around the world continue to respond to rapidly rising inflation (just Thursday, Banxico raised the base rate in Mexico another 0.25% to 5.00%) it is abundantly clear that neither the Fed nor ECB is anywhere near that path.  Yes, the Fed has started to marginally slow down balance sheet expansion, but that is not tightening policy under any definition.  It is unclear what type of shock will be necessary to force these two central banks to rethink their current plans, but if history is any guide, central banks tend to overstay their welcome when it comes to easing monetary policy.  You can have too much of a good thing and I fear that is what we are all going to experience at some point in the not too distant future.

In the meantime, however, nothing seems to stop the march higher in equity markets and today is no exception.  Last night in Asia, the Nikkei (+0.6%) and Hang Seng (+0.25%) both moved higher although Shanghai (-0.2%) continues to be weighed down by the property sector with Evergrande as well as several other developers barely able to continue as going concerns.  Europe is generally firmer as well led by the CAC (+0.4%) and DAX (+0.1%) although, here too, there is a laggard in the form of the FTSE 100 (-0.2%) after housing prices slipped and seemed to portend a slowing in the economy there.  US futures are currently about 0.2% higher on the day.

In the bond market, which has been remarkably volatile lately, this morning is showing a respite, with Treasury yields (-0.3bps) nearly unchanged and similar modest yield declines throughout Europe (bunds flat, OATs -0.5bps, Gilts -0.9bps).  At this stage, the bond bulls and bears are fighting to a draw and waiting the next key signal.  Certainly, inflation would have you believe that yields should rise, but between ongoing QE and concerns over a slowing economy, the bond bulls are still in the driver’s seat.

In the commodity markets, oil is continuing last week’s sell-off, down 1.5% this morning with WTI back below $80/bbl. NatGas (-0.9%), too is falling, at least in the US, but not in Europe, where Gazprom, which had increased flows for a few days, seems to have cut back yet again.  I fear it is going to be a long, cold winter on the continent.  In the metal’s markets, gold (-0.1%) has edged lower this morning although has been performing quiet well over the past two weeks having rallied more than 6%.  But all the base metals (Cu -0.3%, al -0.7%, Sn -0.8%) are under pressure, hardly a sign of robust growth on the horizon.

Overall, the dollar is under modest pressure this morning, although recall, it has been quite firm for the past several weeks.  In the G10, AUD (+0.45%) and NZD (+0.4%) are the leading gainers as investors are sensing an opportunity in recently rising bond yields there.  Interestingly, NOK (+0.35%) is also higher despite oil’s decline, although this appears to be more of a technical correction than a trend change.  In the EMG bloc, ZAR (+0.9%) and RUB (+0.7%) are the leading gainers, both on the strength of expectations for further policy tightening by their central banks.  On the downside, PHP (-0.65%) is the key laggard as importers were seen selling dollars to pay for things like oil and gas.

Data this week is led by Retail Sales and comes as follows:

Today Empire Manufacturing 22.0
Tuesday Retail Sales 1.3%
-ex Autos 1.0%
IP 0.8%
Capacity Utilization 75.9%
Wednesday Housing Starts 1580K
Building Permits 1630K
Thursday Initial Claims 260K
Continuing Claims 2123K
Philly Fed 24.0
Leading Indicators 0.8%

Source: Bloomberg

In addition, we have ten Fed speakers on the calendar across fifteen different speaking engagements.  Be prepared for at least a little movement from that cacophony.

For now, the medium-term trend remains for dollar strength, despite today’s price action, as ongoing high inflation readings continue to drive the idea that the Fed will actually tighten policy at some point.  While that remains to be seen, it is the current market view, and I would not stand in its way.

Good luck and stay safe
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