In Europe, though prices keep rising
The central bank is emphasizing
No rate hikes are near
In this or next year
So, traders, their views, are revising
Meanwhile in the States the reverse
Is true with inflation much worse
Now traders believe
The Fed’s on the eve
Of trying to tighten their purse
It cannot be surprising that inflation remains topic number one in the markets as its existence is driving virtually every narrative. For instance, the choice for next Fed Chair is seen as having a direct impact on inflation based on the relative dovishness of Lael Brainerd vs. Jay Powell. Too, as oil prices have risen so sharply over the past year, driving up the price of gas at the pump and inflation in general, the Biden Administration is now exhorting all nations to release oil from their strategic reserves in order to damp down those price pressures. And what about wages, you may ask? As per the WSJ this morning, here is the latest on the just agreed wage deal at Deere & Co, whose workers had been on strike for the past 5 weeks,
“Deere workers returning to assembly plants and warehouses will get an immediate 10% raise, and each worker will receive an $8,500 bonus. Additional 5% pay raises will be provided in 2023 and 2025, and lump-sum bonuses amounting to 3% of workers’ annual pay will be awarded in the three other years.
The deal approved Wednesday also will increase the base pay level for Deere’s continuous-improvement program by about 4%, giving workers more weekly pay from the program if their productivity meets the company’s goals. About two-thirds of UAW-represented Deere workers receive production-based compensation on top of their regular wages, according to the company.”
Apparently, the cost of the settlement is on the order of $3.5 billion, a very substantial portion of their forecast 2021 earnings estimates of $5.8 billion. It strikes that either Deere is going to be raising prices (likely) to offset that margin compression, or its earnings numbers are going to diminish (also likely) thus putting pressure on its stock over time. Recall, Chairman Powell has been adamant, and we have heard from numerous other Fed speakers as well, that wage inflation is not imminent and thus recent price rises are likely to be temporary. This appears to be one more data point that makes the Fed story less plausible.
In Europe, however, there is a full-court press by ECB members to convince the investment and trading communities that they are not going to raise rates anytime soon as inflation there, too, is still transitory. While it should be no surprise that Mario Centeno, the Portuguese central bank head and ECB member is all-in for never raising rates again, it is a huge surprise that Germany’s Isabel Schnabel is talking about the need to avoid premature tightening as deflation risks still haunt the Eurozone. Her comments come despite CPI in Germany running at 4.5%, the highest since the reunification in the early 90’s and causing significant domestic strife. If one was looking for a sign that the ECB doves have coopted the hawks to their side, there is no better indication than this! As such, traders, who had been pricing for a 10bp rise in the deposit rate by the end of 2022 have pushed that view back nearly 12 months.
In sum, the battle between the central bank narratives and reality continues apace with the central banks, remarkably, holding their own in the face of growing evidence to dispute their claims. And it is this battle that will continue to drive markets and help maintain volatility as each data point or comment has the ability to alter things at the margin.
So, as we look at markets this morning, remember the backdrop remains, Inflation, friend or foe?
Ok, how has risk appetite been affected by the latest news? Well, US equities all moved lower yesterday and that carried over into Asia with the Nikkei (-0.3%), Hang Seng (-1.3%) and Shanghai (-0.5%) all in the red. Part of that is because the Chinese property sector continues to weigh on sentiment there with the latest news that several large property companies, including Evergrande, are set to unload stakes in other companies to raise cash. While these sales will be at great losses, the imperative for the cash is obvious. Not surprisingly, selling large stakes of publicly held companies tends to weigh on their stock price and thus the market as a whole.
In Europe, the picture is more mixed (DAX +0.1%, CAC +0.2%, FTSE 100 -0.2%) with the UK seeming to suffer from growing concerns the Johnson government may invoke Article 16 from the Brexit deal which would suspend part of the Northern Ireland solution and could quickly evoke retaliation by the EU. As to US futures, given it appears to be illegal for two consecutive down days in the equity markets, it should not be surprising that futures are pointing higher by between 0.2% and 0.5% at this hour.
Bond market price action is a very clear result of the central bank narrative as European sovereigns have all seen rallies (lower yields) while Treasuries remain under pressure as investors anticipate higher rates in the States. This morning the 10-year Treasury yield is higher by 1 basis point while in Europe (Bunds -0.9bps, OATs -1.3bps, Gilts -2.7bps) the entire continent has seen demand pick up and yields decline. Clearly, if the ECB remains full-bore on QE, it will support these prices for a long time.
Turning to the commodity markets, pretty much the entire space is softer today led by oil (-0.5%), gold (-0.2%) and copper (-0.7%). But there is weakness across the rest of the industrial and precious metal space as well. In fact, the only gainers on the day are NatGas (+1.8%) which looks very much like a rebound from its recent sharp sell-off, and the agricultural space, where the big 3 products are all firmer by a bit.
Turning to the FX markets, the dollar is under a bit of pressure this morning, which mostly seems like a pull-back from its recent strength. Technically, it does seem overbought. In the G10, NZD (+0.7%) is far and away the leading gainer after the RBNZ published their inflation expectations survey at the highest level in a decade and traders began to price in another 25 basis point rate hike at their meeting next week. However, after that, the rest of the bloc has seen much more modest strength except for NOK (-0.1%) which is suffering from oil’s recent travails, and JPY (-0.1%) which may be reacting to news that the Kishida government is discussing yet more fiscal stimulus, this time to the tune of ¥78.9 trillion.
Emerging market currencies have a more mixed tone with the outlier continuing to be TRY (-2.1%) as the central bank remained true to form and cut its base rate to 15.0% despite runaway inflation. Next worst is CLP (-0.7%) which has fallen as the finance ministry has stopped its regular dollar sales to maintain cash balances, but pulling support from the currency, and then we see both MXN (-0.55%) and ZAR (-0.5%) suffering on the back of commodity weakness. On the plus side, HUF (+0.7%) is the big winner after the central bank raised rates by a more than expected 0.70% in their efforts to fight inflation.
On the data front this morning comes weekly Initial (exp 260K) and Continuing (2120K) Claims as well as the Philly Fed (24.0) and Leading Indicators (0.8%). The Fed speaker onslaught slows a bit today with only four speakers, although despite yesterday’s plethora of speakers, it doesn’t appear we learned anything new.
For now, the broad narrative remains the Fed is going to be the first large central bank to tighten and that is driving the dollar higher. While today we seem to be pausing for a bit, this story does not yet appear to have run its course. Hence, I reiterate for payables hedgers, pick your levels and take advantage of the dollar’s strength for now. orders are an excellent way to manage this risk.
Good luck and stay safe