In Germany, Covid’s widespread
And lockdowns seem likely ahead
But that hasn’t stopped
Inflation which popped
To levels the people there dread

The upshot is risk’s in retreat
As equities, traders, excrete
But bonds and the buck
Are showing their pluck
And havens now look mighty sweet

While Covid has obviously not disappeared, for a time it seemed much less important to investors and traders and so, had a lesser impact on price action.  But that was then.  During the past few weeks, Covid has once again become a much bigger problem despite the inoculation of large portions of the population in most developed countries.  Exhibit A is Austria, where they have imposed a full-scale vaccine mandate and have the police checking papers randomly to insure that anyone outside their home is vaccinated.  If you are found without papers, the penalty is prison.  However, Germany seems determined to catch up to Austria on this count, as the infection rate there climbs rapidly, and the healthcare system is getting overwhelmed.  There is talk that a nationwide lockdown is coming there as well, and soon.

Of course, what we learned during the first months of Covid’s spread was that when lockdowns are imposed, economic activity declines dramatically.  After all, in-person services all but end, and without government financial support, many people are unable to maintain their levels of consumption.  As such, the prospect of the largest economy in Europe going into a total lockdown is a pretty negative signal for future economic activity.  Alas for the authorities, the one thing that does not seem to be in retreat is inflation.  While Germany is contemplating a national lockdown, this morning it released its latest PPI data and in October, Producer Prices rose 3.8%, which takes their year-on-year rise to…18.4%!  This is the highest level since 1951 and obviously greatly concerning.  While some portion of these increased costs will be absorbed by companies, you can be sure that a substantial portion will be passed on to customers.  CPI is already at 4.6% and there is no indication that it is about to retreat.

And folks, this is Germany, the nation that is arguably the most phobic regarding inflation of any in the developed world.  Sure, Turkey and Argentina and Venezuela have bigger inflation problems right now.  So does Brazil, for that matter.  And many of these latter nations have long histories of inflation ruling the roost.  But ever since 1924, when the newly established Rentenbank helped break the Weimar hyperinflation, sound money and low inflation have been the hallmarks of German policy and politics.  So, the idea that any price index is printing in double digits, let alone nearly at 20% per annum, is extraordinary.  In fact, this is what makes yesterday’s comments from Isabel Schnabel, a German PhD economist and member of the ECB’s Executive Board, so remarkable.  For any German with sway over monetary policy to pooh-pooh the current inflation levels is unprecedented.  Even more remarkably, with Jens Weidmann leaving the role of Bundesbank President, Schnabel is on the short list to replace him.

This drama in Germany matters because if the Bundesbank, traditionally one of the most hawkish central banks, and the biggest counterweight to the ECB as a whole, is turning dovish, then the implications for the euro, as well as Eurozone assets, are huge.  If the Bundesbank will not be holding back Madame Lagarde’s push to do more, we can expect an expansion in QE from here and overall higher inflation going forward.  Both bonds and stocks will rally, as will the price of commodities in euros, while the euro itself will fall sharply.  In fact, this may be enough to offset any incipient dovishness from the Fed should Lael Brainerd wind up as Fed Chair.  It would certainly change medium and long-term views on the EURUSD exchange rate.  And you thought that the week before Thanksgiving would be quiet.

And so, it is a risk-off type day today.  While Asian equity markets managed more winners than losers (Nikkei +0.5%, Hang Seng -1.1%, Shanghai +1.1%), Europe is completely in the red (DAX -0.2%, CAC -0.3%, FTSE 100 -0.5%) and US futures are pointing down as well, with DJIA futures (-0.6%) leading the way.

Bond markets are behaving exactly as would be expected on a risk-off day, with Treasury yields falling 4.6bps while European Sovereigns (Bunds -5.5bps, OATs -5.4bps, Gilts -5.8bps) have rallied even further.  In fact, German 30-year bunds have fallen into negative territory again for the first time since August.

If you want to see risk being shed, look no further than oil (-3.1%) which is lower yet again and seems to have found a short-term top.  It seems the news of SPR releases as well as slowing growth prospects has been enough to halt the inexorable rally seen since April 2020.  Interestingly, a number of other commodities are performing quite well with NatGas (+1.1%), copper (+0.9%) and aluminum (+0.7%) all nicely higher.  Gold (+0.2%) continues to edge up as well, with more and more inflows given its haven status.  Somewhat surprisingly, Bitcoin (-4.7%, -10.5% in the past week) is not similarly benefitting, although the narrative of it being digital gold remains strong.  Perhaps it was simply massively overbought!

Finally, the dollar is clearly king this morning, rallying strongly vs all its G10 peers except the yen (+0.35%), with NOK (-1.1%) the biggest laggard on the back of oil’s decline, although the SEK (-0.9%) and EUR (-0.7%) are no slouches either.  The funny thing about the euro was it spent all day yesterday climbing slowly after touching new lows for the move.  However, this morning, it is below 1.13 and pressing those lows from Wednesday with no end in sight.

EMG currencies are also under pressure across the board with HUF (-1.6%) the worst performer as it has unwound the gains seen from yesterday’s surprising large rate hike, and is now suffering as Covid spreads rapidly and it may soon be a restricted zone for travel from Europe.  CZK (-1.1%) is next in line, as it too, is in the crosshairs of authorities to prevent travel there due to Covid.  In fact, the entire CE4 is the worst bloc, but we are also seeing further weakness in TRY (-0.6%) after yesterday’s rate cut, and RUB (-0.5%) with oil’s slide as the cause.

There is no data to be released today and only two Fed speakers, Waller and Clarida, with the latter losing his clout as he will soon be exiting the FOMC.  There continues to be a wide rift between the hawks and doves on the Fed, but as long as Powell, Brainerd and Williams remain dovish, and they have, the very modest steps toward tapering are all we are likely to see.  The problem is that while we are all acutely aware of inflation and the problems it brings, the FOMC is lost in its models and sees a very different reality.  Not only that, inflation diminishes the real value of the US’s outstanding debt and so serves an important purpose for the government.  While there continues to be lip service paid to inflation as a problem, policy actions show a willingness to tolerate higher inflation for a much longer time.  Alas, it will be topic number one with respect to markets for a long time to come.

For now, the dollar is performing well against all the major currencies, but there are many potential twists in our future.  As I have said before, payables hedgers should be picking levels to add to their hedges.

Good luck, good weekend and stay safe
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