Monthly Archives: November 2021

Ill-Starred

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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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Opening Move

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Forty trillion yen
Kishida’s opening move?
Or his legacy?

While it has been quite a week in the FX markets, and in truth, markets in general, it appears that both traders and investors are now tired and price volatility has ebbed.  While inflation remains topic #1 in most discussions, that poor horse has been beaten into submission at this point.  We already know that it is running hotter than most forecasts and that its composition is broadening.  This means the idea that Covid related issues, like used car prices or lumber prices, which have spiked (and in the case of lumber receded somewhat) due to supply chain issues is clearly no longer the only factor.  In fact, wages are beginning to rise substantially and with higher commodity prices, input costs continue to climb (see PPI) which is rapidly feeding into retail costs.  And it doesn’t appear this is set to slow anytime soon, despite the wishful comments by every central banker and finance minister around.  So, what’s a country to do?

Well, if you’re Japan, this is the perfect time to…spend more money!  And so, last night it was reported that new PM, Fumio Kishida, will be proposing a ¥40 trillion stimulus package in order to help support growth.  The rationale is that GDP is forecast to have contracted in Q3, rather than following in the footsteps of other major nations which all saw varying levels of growth.  Meanwhile, this being Japan, the home of the permanent deflationary impulse, one ought not be surprised at the fact that the BOJ and the government completely dismiss the recent PPI data (8.0% in October, a full point above expectations) as transitory given the decision that this will shore up the government’s approval rating.  And anyway, all the forecasts point to a still subdued 0.1% Y/Y CPI reading next week so there should be nothing to worry about.  After all, economic forecasts for inflation have been spot on around the world lately!

Since the last week of September, when USDJPY broke out of a six-month long trading range, the yen has fallen nearly 5%.  I believe that the BOJ is extremely encouraging of this movement as it has been a tacit policy goal since the initiation of Abenomimcs in 2012, when the BOJ really went all-in on its QE initiative in an effort to defeat deflation.  One thing for the Japanese to consider, though, is that history shows getting a little inflation is a very hard thing to do.  Once that genie is out of the bottle, it tends to be far more unruly than anticipated.  For Japan’s sake, I certainly hope that the PPI data is the outlier, but the risk of a policy mistake seems to be growing.  And after all, central bank policy mistakes are all the rage now (see Federal Reserve), so perhaps Kuroda-san just wants to feel like a member of the club.  At any rate, this morning the yen appears to be readying for the next leg lower and I would not be surprised at a move toward 116.75 before it’s all over.

But truthfully, there is not much to tell beyond that.  As mentioned, there is still a lot of discussion regarding inflation and its various causes and effects.  One thing to keep in mind is that history has shown the currencies of nations with high inflation tend to fall over time.  And this does not have to be hyperinflation, merely inflation running hotter than its peers.  Consider Italy, pre euro, where inflation averaged 5.4% and the currency regularly depreciated to offset the growth in prices.  In fact, the entire economic model was based on a depreciating currency to maintain the country’s industrial competitiveness.  The same can be seen in Turkey today, where each higher than expected CPI print leads to further lira weakness.

The point is, while Japan may not be able to create inflation, it is abundantly clear that we have done so in the US.  And when push comes to shove, if/when the Fed has to implement policy to support financial stability, they will be faced with the “impossible trinity” where of the three markets in question, stocks, bonds and the dollar, they will support the first two and allow the dollar as the outlet valve.  This means that eventually, a much weaker dollar is likely on the cards, not in the next several months, but very possibly within the next 2 years.  For payables hedgers, especially with the dollar showing short term strength, it may be an excellent time to consider longer term protection.  USD puts are very cheap these days.  Let’s talk.

Ok, so what do I mean by dull markets?  Well, equities are mostly higher, but generally not by very much.  In Asia, the Nikkei (+1.1%) was the big winner on the stimulus news, but both the Hang Seng (+0.3%) and Shanghai (+0.2%) were only modestly better on the night.  In Europe too, the movement has been relatively modest with the UK (FTSE 100 -0.4%) even falling on the day although the other major markets (DAX +0.1%, CAC +0.4%) are a bit firmer.  US futures are also pointing higher, with gains on the order of 0.2% across the board.

Bond markets are mixed as Treasuries (+2.2bps) are softer after yesterday’s holiday, but European sovereigns are all seeing modest yield declines (Bunds -0.9bps, OATs -0.6bps, Gilts -0.9bps).  That said, the peripheral markets also selling off a bit with Italian BTPs (+2.8bps) and Greek GGBs (+3.1bps) leading the way lower.

Commodities are actually the one market where there is still some real volatility as oil (-2.1%) leads the way lower alongside NatGas (-2.8%), although there is weakness in gold (-0.6%) and copper (-0.4%), all of which have had strong weeks.  Frankly, this feels like some position closing after a positive outcome rather than the beginning of a new trend.  In fact, if anything, what we have seen this week is commodity prices breaking out of consolidations and starting higher again.  Agriculturals are little changed and the other industrial metals like Al (+1.1
%) and Sn (+0.6%) are actually a bit better bid.  In other words, there doesn’t appear to be a cogent theme today.

As to the dollar, mixed is the best adjective today.  In the G10, we have several gainers led by the pound (+0.2%) as well as several laggards led by SEK (-0.4%).  The thing is, there is very little to hang your hat on with respect to stories driving the activity.  Neither nation published any data and there haven’t been any comments of note either.  In the EMG space, PHP (+0.6%) is the leading gainer on the strength of equity market inflows as well as central bank comments indicating they will seek to allow the market to determine the exchange rate.  On the downside, RUB (-1.0%) is falling sharply on the back of oil’s sell-off and rising geopolitical tensions with Russia complaining about NATO activity near its borders.  Between those two extremes, however, the movement is limited and pretty equal on both sides in terms of the number of currencies rising or falling.  Last night, Banxico raised rates by 25bps, as widely expected and the peso is weaker this morning by -0.25% alongside oil’s decline.

Data-wise, JOLTS Jobs (exp 10.3M) and Michigan Sentiment (72.5) are both 10:00 numbers, but neither seems likely to move markets.  NY Fed president Williams speaks at noon, so perhaps there will be something there, but I doubt that too.

For now, the dollar’s trend is clearly higher in the short term, especially if we continue to see Treasury yields climb.  However, as mentioned above, I think the medium-term story can be far more negative for the greenback, so consider that as you plan your hedging for 2022 and beyond.

Good luck, good weekend and stay safe
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Shocked

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The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked

Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?

I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory.  Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles.  However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass.  In fact, back in the day, the Fed was still concerned about deflation.

Well Jay, how about now?  Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows.  And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years.  One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship.  The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.

And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond.  Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.

As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September.  While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement.  In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.

The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions.  While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act.  Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10.  Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.

So, how are markets digesting this news?  Not terribly well.  At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared.  However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit.  US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices.  Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.

Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps.  Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day.  But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out.  This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour.  But the rest of Europe is not so lucky, especially with the PIGS still under pressure.  I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.

Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs.  This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates.  NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October.  It seems that some of those fears have abated.  Gold, however, continues to rally, up another 0.4% today and about 4% in the past week.  Perhaps it has not entirely lost its inflationary magic.

And finally, the dollar continues to perform very well after a remarkable performance yesterday.  For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%.  ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse.  But don’t discount the euro having taken out every level of technical support around and falling 1%.  This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun.  In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements.  The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age.  The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.

With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly.  There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk.  In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term.  Later on?  Perhaps a very different story.

Good luck and stay safe
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Prices Rise in a Trice#CPI, #inflationexpectations

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There once was a world where the price
Of stuff stayed the same…paradise
But then central banks
Were born, and now thanks
To them prices rise in a trice

Now, worldwide the story’s the same
As these banks, inflation, can’t tame
They’re all terrified
That stocks might just slide
And they would come in for the blame

“I’d expect price increases to level off, and we’ll go back to inflation that’s closer to the 2% that we consider normal.  In the 70’s and 80’s inflation expectations became embedded in the American psyche.  That isn’t happening now.”  So said Treasury Secretary Yellen yesterday in an interview on NPR.  One has to wonder on what she bases these expectations.  Certainly not on any of the evidence as per the most recent data releases.

For instance, the NY Fed’s latest Inflation expectation survey was released yesterday with 1-year (5.7%) and 3-year (4.2%) both at the highest level in the series’ history since it began in 2013.  She cannot be looking at yesterday’s PPI data (8.6%, 6.8% core) as an indicator given both of these are at their highest level on a final demand basis since PPI started being measured in this manner in 2011.  However, a look a little deeper at the intermediate levels, earlier in the supply chain, show inflation running at levels between 11.8% and 27.8% Y/Y.  While all of these costs are not likely to flow into the price of finished goods, you can be sure that the pressure to raise prices throughout the chain for both goods and services remains great.  And of course, later this morning we will see the CPI data (exp 5.9% Y/Y, 4.3% ex food & energy) with both indicators forecast to show substantial increases from last month.  Secretary Yellen continues to try to sell the transitory story and twelve months of increasing prices later, it is wearing thin.

The US, though, is not the only place with this problem, it is a global issue.  Last night China released its inflation readings with PPI (13.5%) rising far more than expected and touching levels not seen since 1995.  CPI there rose to 1.5%, a tick higher than expected which indicates that either there is a serious lack of final demand in the country or they are simply manipulating the data to demonstrate that the government is in control.  (In fact, it is always remarkable to me when a Chinese data point is released that is not exactly as expected given the control the government exerts on every aspect of the process.)  Regardless, the fact is that price pressures continue to rise in China on the back of rising energy costs and shortages of available energy, and ultimately, given China’s status as the world’s largest exporter, those costs are going to feed into other nations’ import prices.

How about Europe?  Well, German CPI rose 4.5% Y/Y in October, the highest level since September 1993 in the wake of the German reunification which dramatically shook up the economy there.  Remember, too, the German’s have a severe phobia over inflation given the history of the Weimar Hyperinflation, so discontent with the ECB’s performance is growing apace in the country.

Essentially, it is abundantly clear that rising prices have become the norm, and that any idea that we are going to ease back to moderate inflation in the near-term are fantasy.  Naturally, with inflationary pressures abundant, one might expect that central banks would be out to address them by tightening policy.  And yet, while peripheral nations have already done so, the biggest countries remain extremely reluctant to tighten as concern over economic output and employment growth continue to dominate their thoughts.

Historically, central bank decision making always required balancing the two competing goals of pumping up supporting the economy while preventing prices from running away.  Between the GFC and the pandemic, though, there was no need to worry as measured inflation never reared its ugly head, so easy money supported growth with no inflationary consequences.  But post-pandemic fiscal largess has changed the equation and now central banks have to make a decision, with significant political blowback to either choice.  Yet the biggest risk is the lack of a decisiveness may well lead to the worst of all worlds, rising prices and slowing growth, i.e. stagflation.  I promise you a stagflationary environment will be devastating to financial assets all over.

Now, as we await the CPI data, let’s take a look around the markets to see how traders and investors are responding to all the latest news and data.

Equity markets are mostly following the US lead from yesterday with declines throughout most of Asia (Nikkei -0.6%, Hang Seng +0.7%, Shanghai -0.4%) and most of Europe (DAX -0.2%, CAC -0.3%, FTSE 100 +0.4%).  US futures are all pointing lower at this hour as well (DOW -0.3%, SPX -0.3%, NASDAQ -0.5%) so there is little in the way of joy at the current moment.  Risk is definitely under pressure.

What’s interesting is that bonds are not seen as a viable replacement despite declining stock prices as yields in Treasuries (+2.7bps) and throughout Europe (Bunds +0.8bps, OATs +2.1bps, Gilts +3.4bps) are higher.  So, stocks are lower and bonds are lower.  Did I mention that stagflation would be negative for financial assets?

On this very negative day, commodity prices, too, are under pressure with oil (-0.6%), NatGas (-1.8%), gold (-0.35%), copper (-0.3%) and tin (-1.1%) all suffering.  In fact, throughout the entire commodity complex, only aluminum (+2.0%) and corn (+0.5%) are showing gains.  At this point, oil remains in a strong uptrend, so any pullback is likely technical in nature.  NatGas continues to respond to the glorious weather in the northeast and Midwest with reduced near-term demand.  Even in Europe, Gazprom has finally started to let some more gas flow hence reducing price pressures there although it remains multiples of the US price.

Turning to the dollar, it is today’s clear winner, gaining against 9 of its G10 brethren, with CAD (flat) the only currency holding its own.  SEK (-0.6%) and NOK (-0.5%) lead the way lower with the latter tracking oil’s declines while the former is simply showing off its high beta characteristics with respect to dollar movement.  In the EMG bloc, TRY (-1.1%) is the laggard as traders anticipate another interest rate cut, despite high inflation, and there is concern over the fiscal situation given significant foreign debt payments are due next week.  ZAR (-0.9%) is slumping on the commodity story as well as concerns that the budget policy may sacrifice the currency on the altar of domestic needs.  But the weakness extends throughout the space with APAC currencies under pressure as well as LATAM currencies.  This is a dollar story today, with very little holding up to the perceived stability of the buck.

As well as the CPI data, given tomorrow’s holiday, we see Initial (exp 260K) and Continuing (2050K) Claims at 8:30.  There are actually no further Fed speakers today with Bullard yesterday remarking that two rate hikes were likely in 2022.  We shall see.

With the inflation narrative so strong, this morning’s data will be key to determining the short-term direction of markets.  A higher than expected print is likely to see further declines in both stocks and bonds with the dollar benefitting.  A weaker outcome seems likely to unleash yet another bout of risk acquisition with the opposite effects.

Good luck and stay safe
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Damnified

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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
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Growing Disdain

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There is now a silver haired queen
Whose role since she came on the scene
Has been to explain,
With growing disdain,
Inflation is still unforeseen
 
Her minions, as well, all campaign
To make sure the message is plain
Though prices are rising
They won’t be revising
Their plans, or so said Philip Lane
 
There is a growing disconnect between the ECB and the rest of the world’s central banks.  While the transitory narrative has been increasingly taken out back and shot, the ECB will not let that story die.  Just today, ECB Chief Economist Philip Lane defended the ECB stance, explaining, “If we look at the situation over the medium term, the inflation rate is still too low, below our 2% target.  This period of inflation is very unusual and temporary, and not a sign of a chronic situation.  The situation we are in now is very different from the 1970’s and 1980’s.”  [author’s emphasis]  In other words, in case Madame Lagarde’s comments from last week that the ECB is “very unlikely” to raise rates next year, were not clear, the ECB is telling us that their mind is made up and there will be no policy tightening in the foreseeable future.
 
In fairness, raising interest rates will not convince Russia to pump more natural gas through the pipelines to help mitigate the dramatic rise in prices there.  Nor will it help build new semiconductor fabs to alleviate that shortage.  However, what it might do is reduce demand for many things thus easing supply constraints and perhaps encouraging prices to fall.  After all, that is exactly what tighter monetary policy is supposed to do.  The problem with that logic, though, is that there isn’t a central banker on the continent that is willing to risk slowing down growth in order to address rapidly rising prices.  The politics of that move would likely bring more rioters into the streets.  Once again, central banks’ vaunted independence is shown to be a sham.  They are completely political and beholden to the government in charge at any given time.
 
And so, we are left with a situation where prices continue to rise throughout the world while the two largest economic areas, the US and Eurozone, maintain the easiest monetary policy in history.  Yes, I know the Fed said it would begin to reduce its QE purchases, but even if they do reduce purchases by $15 billion / month, they are still going to expand their balance sheet by a further $420 billion and interest rates are still at zero.  There remains virtually zero chance that inflation is going to fade as long as the current incentive structure remains in place. 
 
Speaking of the Fed, Friday’s NFP data was substantially better than expected with job growth rising 531K and revisions higher for the previous two months of an additional 235K.  The Unemployment Rate fell to 4.6% and wages continue to climb smartly, +4.9% Y/Y.  (Of course, on a real basis, that is still negative given the current 5.4% CPI with expectations that on Wednesday, the latest release will jump to 5.9%.)  However, Chairman Powell has indicated that the Fed believes there is still a great deal of slack in the labor market, based on the Participation Rate remaining well below pre-pandemic levels, and so raising rates prematurely would be a mistake.  Summing it all up, there is no reason to believe that either US or ECB monetary policy is going to be changing anytime soon, regardless of the data.
 
The question at hand, then, is what will this mean for markets in general and the dollar in particular?  As long as new, excess liquidity continues to flood the markets, there is little reason to believe that the ongoing bull market in equities, commodities, real estate, and bonds is going to end.  While history has shown that rising inflation will eventually hurt both bonds and stocks, we are not yet at that point, and quite frankly don’t appear to be approaching it that rapidly.  Though there remains a small cadre of old-timers (present company included) who have a difficult time accepting current valuations as normal and who have actually lived through inflationary times, the bulk of the market participants do not carry that baggage and so are unencumbered by negative thoughts of that nature.  But, as an example of how inflation can degrade equity markets, from Q4 1968 through Q1 1980, the S&P 500 fell 1% in nominal terms while inflation averaged 7.1% per year with a high print of 14.8%.  The point is that the last time we had an inflation situation of the current magnitude, holding equities did not solve the problem.  As George Santayana famously told us back in 1905, “Those who cannot remember the past are condemned to repeat it.”
 
With this in mind, let us take a look at markets and the week ahead.  Aside from the ECB comments this morning, arguably the most impactful news from the weekend was the story that Elon Musk is planning to sell $20 billion worth of stock in order to pay his upcoming tax bill.  Not surprisingly Tesla’s stock is lower by nearly 6% on the news and it seems to have put a damper on all equity activity.  After all, if Tesla isn’t going higher, certainly nothing else can have value!
 
Looking at equity markets, Asia (Nikkei -0.35%, Hang Seng -0.4%, Shanghai +0.2%) were mixed but leaning weaker.  That is an apt description of Europe as well (DAX -0.2%, CAC +0.2%, FTSE 100 -0.1%) although overall, the movement has not been that significant.  US futures, meanwhile, are little changed although NASDAQ futures are slightly lower while the other two major indices are edging higher.
 
Bonds, on the other hand, are all under pressure with Treasuries (+2.8bps) leading the way although this was after a major rally on Friday that saw the 10-year yield fall 7bps and a total of 15bps since the FOMC last Wednesday.  But European sovereigns, too, are all lower with yields rising (Bunds +2.0bps, OATs +2.1bps, Gilts +2.9bps).  Perhaps bond investors are beginning to register their concern over the inflation story.
 
On that front, commodity prices are rebounding off the lows seen last week led by energy with oil (+1.25% and back over $82/bbl) and NatGas (+1.1%) both having good days.  The rest of the space, though, is more mixed with copper (+0.2%) and tin (+0.4%) both firmer this morning, while aluminum (-0.2%) and iron ore (-3.25%) are both suffering.  Precious metals are little changed although Friday saw a sharp rally in the barbarous relic.  And yes, the cryptocurrency space is rocking today as well.
 
As to the dollar, it has had a mixed performance this morning with both gainers and losers across the G10 and EMG spaces.  In the G10, NZD (+0.6%) is the clear leader as the government is talking of ending the draconian lockdown measures by the end of the month.  In fact, we saw similar behavior in the EMG currencies as THB (+0.8%) and IDR (+0.5%) rallied on similar news.  On the flip side, BRL (-0.8%) continues to decline despite the central bank being one of the most aggressive in its rate hike path having raised the SELIC rate from 2% in March to 7.75% last month with expectations growing for yet another hike in December.  Of course, inflation is running at 10.25% there, so real yields remain firmly negative.
 
On the data front, this is inflation week with both the PPI and CPI on the docket.
 

Tuesday

NFIB Small Biz Optimism

99.5

 

PPI

0.6% (8.6% Y/Y)

 

-ex food & energy

0.5 (6.8% Y/Y)

Wednesday

Initial Claims

263K

 

Continuing Claims

2050K

 

CPI

0.6% (5.9% Y/Y)

 

-ex food & energy

0.4% (4.3% Y/Y)

Friday

JOLTS Job Openings

10.4M

 

Michigan Sentiment

72.5

Source: Bloomberg
 
Of course, the Fed doesn’t care about CPI as its models work better with core PCE, which also happens to be designed to be permanently lower.  The rest of us, however, know better and recognize the pain.  We have a number of Fed speakers on the calendar this week as well, with Chairman Powell headlining 9 planned appearances.  My sense is that there will be a strenuous effort to press the storyline that inflation may take a little longer to fall back, but don’t worry, it will fall again.
 
If pressed, I would say the dollar is far more likely to continue to grind higher, but that any movement will be slow.  While Treasury yields are not supportive right now, the reality is that amid major currency bonds, Treasuries continue to offer the best combination of yield and liquidity so remain in demand.  I think that along with the need for other economies to buy dollars to buy energy will maintain the bid in the buck.
 
Good luck and stay safe
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Their Latest Excuse

Posted on by

While prices worldwide keep on rising
Most central banks are still devising
Their latest excuse
For why money, loose,
Is still the least unappetizing

On Wednesday Chair Powell explained
That QE would slowly be drained
Then Thursday the Bank
Of England helped sank
Gilt yields, leaving traders bloodstained

Now Friday’s arrived and we’re all
Concerned that a Payrolls curveball
Could quickly defuse
The new dovish views
With hawks back for their curtain call

If you sell stuff in the UK, or hold assets there, I sure hope you’ve hedged your currency exposure.  In what can only be described as shocking, the Bank of England left policy on hold yesterday after numerous hints from members, including several explicitly from Governor Andrew Bailey, that something needed to be done about rising inflation. The combination of rising inflation prints, rising inflation forecasts and comments from BOE members had the market highly convinced that a 0.15% base rate hike was coming yesterday, with the idea it would then allow the central bank to hike further in 25 basis point increments with futures pointing to the base rate at 1.00% come next December.  But it was not to be.  Instead, in a 7-2 vote, the BOE left policy rates unchanged and will continue its current QE program which has £20 billion left to buy to reach their target.

The result was a massive repricing of markets as interest rates tumbled across the entire curve and the pound tumbled along side them.  In what is perhaps the most brazen lie audacious statement from a major central banker lately, Bailey explained in a Bloomberg TV interview that it was “not our job to steer markets.”  Seriously?  That is all every central banker ever tries to do.  If financial stability is one of the goals enumerated for central banks, the BOE failed dismally yesterday.  Tallying up the impact shows that 10-year Gilt yields fell 13 basis points (and another 4.1 this morning), OIS markets saw the 1-year interest rate decline 20 basis points and the pound fell 1.4% yesterday and a further 0.5% this morning.  It was ugly.

Perhaps the lesson to learn here is that as central banks around the world try to adjust monetary policy going forward, there are going to be a lot more bumps along the way, with market expectations being left unfulfilled and severe market reactions accordingly.  Forward guidance, which has become a critical tool for central banks over the past decade plus is no longer going to be as effective.  When Ben Bernanke highlighted the idea in 2009, it was thought to be a great addition to the central bank toolkit, the ability to adjust markets without adjusting policy.  And while that may have been true when monetary policy was being eased for years, it turns out that forward guidance is a bit more difficult to handle in the other direction.  Market volatility, across all markets, is likely to increase over the next couple of years as the coordinated central bank activities we have become used to seeing disappear.  Consider that while the Fed, ECB, BOJ and BOE have all pushed back on raising rates soon, the Norgesbank, BOC, RBNZ, RBA and a host of emerging market central banks are starting the process or already well along the way.

Turning to this morning’s data, if you recall, the last two NFP numbers were quite disappointing, with both coming in well below expectations.  The only thing we know about the labor market is that we don’t really know what is going on there anymore.  Clearly, based simply on the JOLTS data we know there are more than 10 million job openings in the country.  (That is also made obvious whenever you leave your home and see all the help wanted signs in store windows.)  But despite clearly rising wages, it has thus far not been enough to entice many people back into the labor force.  So, the Unemployment Rate remains far higher than it was pre-pandemic, but there are plenty of jobs available.  In this situation I feel for the Fed, as there is no clarity available with conflicting data rampant.  At any rate, here are the forecasts heading into the release:

Nonfarm Payrolls 450K
Private Payrolls 420K
Manuacturing Payrolls 30K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%

Source: Bloomberg

One interesting thing is that excluding the pandemic stimulus checks, the current Y/Y Earnings data is the highest since the series began in 2006.  And worse still, it is lagging CPI by at least a half-point.  My sense is that we are likely to see another weaker than expected number as the kinks in the labor market have not yet been worked out.

Ok, a quick look at markets shows that Asia had a rough go of it last night (Nikkei -0.6%, Hang Seng -1.4%, Shanghai -1.0%) as continued concerns over the Chinese property market weigh on the economy there while Japan looks more like position adjustment ahead of the weekend.  Europe, on the other hand, is doing much better (DAX +0.15%, CAC +0.6%, FTSE 100 +0.55%) despite much weaker than expected IP data from both Germany (-1.1%) and France (-1.3%) in September.  Too, Eurozone Retail Sales (-0.3%) badly missed expectations in September, but revisions helped ameliorate some of those losses.  Regardless, I would argue that the weak data has encouraged investors and traders to believe that all the talk of tightening to address inflation is ebbing.  Meanwhile, US futures, which had spent the bulk of the evening essentially unchanged are now higher by about 0.25%.

Bond yields are generally lower again this morning with most European sovereigns seeing declines of around 1 basis point except for Gilts, pushing 4bps.  Treasuries, which had seen softer yields earlier in the session have now turned around and edged lower (higher yields) but are still less than a basis point different from yesterday’s close.

Commodity prices also had a wild session yesterday with oil initially rallying $2/bbl before abruptly reversing and falling $5/bbl to close back below $80 for the first time in a month.  Given that backdrop, this morning’s 0.6% rise seems less interesting and it is still below $80.  NatGas (-0.5%) has slipped this morning, while the rest of the commodity complex is showing no trends whatsoever, with both gainers and losers.  Like every other market, traders are trying to come to grips with the new central bank situation.

The one consistency has been the dollar, which rallied yesterday and is continuing today.  In the G10, the pound (-0.5%) is the worst performer but we are seeing weakness in AUD (-0.4%), CHF (-0.4%) and NOK (-0.35%) as well with the entire bloc under pressure.  NOK is clearly still being impacted by yesterday’s oil moves while the others seem to be feeling the heat from suddenly more dovish thoughts regarding policy.  In the EMG space, PHP (+0.55%) is the outlier, rallying on comments from the central bank that it will continue to support the economy and news that the Covid infection rate has been falling.  Otherwise, the bulk of the bloc is in the red led by ZAR (-0.45%), PLN (-0.4%) and MXN (-0.35%).  Of these, the most noteworthy is PLN, where the central bank, which had just been touting its hawkish bona fides, has completely reversed and indicated that further rate hikes may not be necessary.  This seems odd given inflation is running at 6.8%, and forecast to top 8.0% next year, while the base rate was just raised to 1.25%.  It feels to me like PLN could fall further.

So, for now, we all await the payroll data and then get to reevaluate our views and expectations of Fed actions.  Nothing has changed my view that inflation will continue higher and nothing has changed my view that growth is going to slow.  So, while the Fed may begin to taper, I still believe they will stop before the end.  However, for now, the Fed is the most hawkish dove out there, so the dollar can continue to rally.

Good luck, good weekend and stay safe
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It’s Still Transitory

Posted on by

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
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Feathered and Tarred

Posted on by

The talk of the town is that Jay
Will outline the taper today
Inflation’s been mulish
And he has been foolish
-ly saying t’would soon go away

This outcome means Madame Lagarde
Remains as the final blowhard
Who claims that inflation
Is our ‘magination
Which might get her feathered and tarred

It’s Fed day today and the market discussion continues apace as to just what Chairman Powell and his FOMC acolytes are going to do this afternoon.  The overwhelming majority view amongst the economics set is the Fed will outline its plans to taper QE purchases starting immediately.  Expectations are for a reduction in purchases by $10 billion/month of Treasuries and $5 billion/month of Mortgage Backed Securities.  Many analysts also believe the statement will leave wiggle room for the FOMC to adjust the pace as necessary depending on the unfolding economic conditions.  Powell has been taking great pains in trying to separate the timing of reducing QE with the timing of raising interest rates, and I expect that will continue to be part of the discussion.  Of course, the market is currently pricing in two 25bp rate hikes in 2022, essentially saying the Fed will finish the taper next June and hike rates immediately.  This is clearly not Powell’s desired path, but the wisdom of crowds may just have it right.  We shall see.

In addition to that part of the announcement, we are going to hear the Fed’s view on how inflation will evolve going forward, although at this point, I think even they have realized they cannot use the word transitory in their communications.  Talk about devaluing the meaning of a word!  What remains remarkable to me is the unwavering belief, at least the expressed unwavering belief, that while inflation may print high for a little while longer, it is due to settle back down to the 2% level going forward.  I continue to ask myself, why is that the central bank view?  And not just in the US, but in almost every developed nation.  For instance, just moments ago Madame Lagarde was quoted as saying, “Medium-term inflation outlook remains subdued,” and “conditions for rate hike unlikely to be met next year.”

To date, there has certainly been no indication that global supply chains are working more smoothly than they were during the summer, and every indication things will get worse before they get better.  The number of ships anchored off major ports continues to grow, the number of truck drivers continues to shrink and demand, courtesy of literally countless trillions of dollars of fiscal stimulus shows no sign of abating.  Add to that the current environmental zeitgeist, which demonizes fossil fuels and seeks to prevent any investment in their production thus reducing supply into accelerating demand and it is easy to make the case that prices are likely to rise going forward, not fall.

There is a saying in economics that, ‘the cure for high prices is high prices.’  The idea is that higher prices will encourage increased supply thus driving prices back down.  And historically, this has been true, especially in commodity markets.  However, the unspoken adjunct to that saying is that policies do not exist to prevent increased supply and that the incentive of higher revenues is sufficient to encourage that new supply to be created.  Alas, the world in which we find ourselves today is rife with policies that may have political support but are not economically sound.  The current US energy policy mix preventing oil drilling in ANWR and offshore, as well as the cancellation of the Keystone Pipeline served only to reduce the potential supply of oil with no replacement strategy.  If policy prevents new production, then no price is high enough to solve that problem, and therefore the ceiling on prices is much higher.

I focus on energy because it is a built-in component of everything that is produced and consumed, and while the Fed may ignore its price movement, manufacturers and service providers do not and will raise prices to cover those increased costs.  The upshot here is that instead of high prices encouraging new supply, it appears increasingly likely that prices will have to rise high enough to destroy new, and existing, demand before markets can once again return to a semblance of balance.  Given the fact that fiscal largesse has been extraordinary and household savings has exploded to unprecedented heights during the pandemic and remains well above pre-pandemic levels, it seems that demand is not going to diminish anytime soon.  I fear that rising prices is a new feature of our lives, across all segments, and something we must learn to address going forward.  While there is no reason to believe we are heading to a Weimar-style hyperinflation, do not be surprised if the “new normal” CPI is 3.5%-4.5% going forward.  At the current time, there is simply nothing to indicate this problem will be addressed by the Fed although we are likely to see smaller, open economy central banks raise interest rates far more aggressively.  As that process plays out, the dollar will almost certainly weaken, but we are still months away from that situation.

So, ahead of the FOMC statement and Powell presser this afternoon, here’s what’s been happening in markets.  Despite record high closes in the US markets yesterday, Asia (Nikkei -0.4%, Hang Seng -0.3%, Shanghai -0.2%) did not follow through at all.  Europe, too, sees no joy although only the FTSE 100 (-0.2%) has even moved on the day with other major markets essentially unchanged.  US futures are also little changed at this time with everyone waiting for Jay.

Bond markets, on the other hand are continuing their recent rally with Treasury yields lower by 1.4bps and Europe (Bunds -1.5bps, OATs -2.0bps, Gilts -0.3bps) all rallying as well.  Peripheral markets are doing even better as it seems the European view is turning toward the idea that the ECB will be outlining their new QE program in December with no capital key involved.

Commodity prices continue to give mixed signals with oil (WTI -2.4%) falling sharply, ostensibly on comments from President Biden admonishing OPEC+ to pump more oil.  Will that really get them to do so?  NatGas (-0.7%) is also a bit softer, but the metals complex is actually firmer with copper (+1.05%, aluminum +1.45%, and tin +1.8%) all showing strong gains.  This as opposed to precious metals which are essentially unchanged on the day.

As to the dollar, it is hard to describe today.  While versus the G10, it is generally weaker (CHF +0.4%, NZD +0.4%, SEK +0.3%) it has performed far better against EMG currencies (TRY -0.8%, RUB -0.7%, KRW -0.6%) although PLN (+0.4%) is having a good day.  Unpacking all this the Swiss story seems to be premised on the idea that the market is testing the SNB to see if they can force more intervention while the kiwi story is a response to stronger jobs data overnight.  Sweden seems to be benefitting from the emerging view of tighter policy from the Riksbank as they reduce QE.  On the EMG side, Turkey’s inflation rate continues to be breathtakingly high (CPI 19.89%, PPI 46.31%!) and yet there is no indication the central bank will respond by tightening policy as that is against the view of President Erdogan.  Oil’s decline is obviously driving the ruble lower, surprisingly not NOK, and KRW saw an increase in foreign equity sales and outflows thus weakening the won.

Ahead of the FOMC we see ADP Employment (exp 400K), ISM Services (62.0) and Factory Orders (0.1%), but while ADP will enter the conversation tomorrow, once we are past the Fed, I expect the morning session to be extremely quiet ahead of 2:00pm.  From there, all bets are off, although my take is the level of hawkishness on the FOMC is edging higher.  Perhaps there is some dollar strength to be seen post-Powell.

Good luck and stay safe
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Extinct

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Down Under the RBA blinked
Regarding their policy linked
To Yield Curve Control
Which seemed, on the whole
To crumble and now is extinct

The question’s now how will the Fed
Address what’s become more widespread?
As prices keep rising
The market’s surmising
That rate hikes will soon go ahead

Here’s the thing, how is it that the Fed, and virtually every central bank in the developed world, have all been so incredibly wrong regarding inflation’s persistence while virtually every private economist (and markets) have been spot on regarding this issue?  Are the economists at the Fed and the other central banks really bad at their jobs?  Are the models they use that flawed?  Or, perhaps, have the central banks been knowingly trying to mislead both markets and citizens as they recognize they have no good options left regarding policy?

It is a sad situation that my fervent desire is they are simply incompetent.  Alas, I fear that central bank policy has evolved from trying to prevent excessive economic outcomes to trying to drive them.  After all, how else could one describe the goal of maximum employment other than as an extreme?  At any rate, as the saying goes, these chickens are finally coming home to roost.  The latest central bank to concede that their previous forecasts were misguided and their policy settings inappropriate was the RBA which last night ended its 20-month efforts at yield curve control while explaining,

“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.”

And that is how a central bank cries ‘uncle!’

Recall, the RBA targeted the April 2024 AGB to keep it at a yield of, first 0.25%, and then after more lockdowns and concerns over the impact on the economy, they lowered that level to 0.10%.  Initially, it had success in that effort as after the announcement, the yield declined from 0.55% to 0.285% in the first days and hovered either side of 0.25% until they adjusted things lower.  In fact, just this past September, the yield was right near 0.0%.  But then, reality intervened and inflation data around the world started demonstrating its persistence.  On October 25, the yield was 0.125%, still behaving as the RBA desired.  By October 29, the end of last week, the yield had skyrocketed to 0.775%!  In truth, last night’s RBA decision was made by the market, not by the RBA.  This is key to remember, however much control you may believe central banks have, the market is still bigger and will force the central bank’s hand when necessary.

Which of course, brings us to the FOMC meeting that starts this morning and whose results will be announced tomorrow afternoon at 2:00pm.  Has the market done enough to force the Fed’s hand into adjusting (read tightening) policy even faster than they have expressed?  Will the Fed find themselves forced to raise rates immediately upon completing the taper or will they be able to wait an extended length of time before acting?  The latter has been their claim all along.  Thus far, bond traders and investors have driven yields in the front end higher by 25bps in the 2-year and 35bps in the 3-year over the past 6 weeks.  Clearly, the belief is the Fed will be raising rates much sooner than had previously been considered.

The problem for the Fed is that the economic data is not showing the robust growth that they so fervently desire in order to raise interest rates.  While inflation is burning, growth seems to be slowing.  Raising rates into that environment could easily lead to even slower growth while having only a minimal impact on prices, the worst of all worlds for the Fed.  If this is the outcome, it also seems likely that risk assets may suffer, especially given their extremely extended valuations.  One must be very careful in managing portfolio risk into this situation as things could easily get out of hand quickly.  As the RBA demonstrated last night, their control over interest rates was illusory and the Fed’s may well be the same.

With those cheery thoughts in our heads, a look at markets this morning shows that risk is generally being shed, which cannot be that surprising.  In Asia, equity markets were all in the red (Nikkei -0.4%, Hang Seng -0.2%, Shanghai -1.1%) as the euphoria over the LDP election in Japan was short-lived and the market took fright at the closure of 18 schools in China over the increased spread of Covid.  In Europe, equity markets are mixed with the DAX (+0.5%) and CAC (+0.4%) both firmer on confirmation of solid PMI Manufacturing data, but the FTSE 100 (-0.5%) is suffering a bit as investors grow concerned the BOE will actually raise the base rate tomorrow.

Speaking of interest rates, given the risk-off tendencies seen today, it should be no surprise that bond yields are lower.  While Treasury yields are unchanged as traders await the FOMC, in Europe, yields are tumbling.  Bunds (-3.5bps) and OATs (-5.6bps) may be the largest markets but Italian BTPs (-10.7bps) are the biggest mover as investors seem to believe that the ECB will remain as dovish as possible after last week’s ECB confab.  Only Gilts (-0.4bps) are not joining the party, but then the BOE seems set to crash it with a rate hike, so there is no surprise there.

Once again, commodity prices are mixed this morning, with strong gains in the agricultural space (wheat >$8.00/bushel for the first time since 2008) and NatGas also firmer (+3.0%), but oil (-0.35%). Gold (-0.1%), copper (-0.5%) and the rest of the base metals softer.  In other words, there is no theme here.

Finally, the dollar is having a pretty good day, at least in the G10 as risk-off is the attitude.  AUD (-0.85%) is the worst performing currency as positions get unwound after the RBA’s actions last night.  This has dragged kiwi (-0.7%) down with it.  But NOK (-0.6%) on lower oil prices and CAD (-0.3%) on the same are also under pressure.  In fact, only JPY (+0.35%) has managed to rally as a traditional haven asset.  In emerging markets, the outlier was THB (+0.6%) which has rallied on a sharp decline in Covid cases leading to equity inflows, while the other currency gainers have all seen only marginal strength.  On the downside, RUB (-0.5%) is feeling the oil heat while ZAR (-0.2%) and MXN (-0.2%) both suffer from the metals’ markets malaise.

There is absolutely no data today, nor Fed speakers as all eyes now turn toward ADP Employment tomorrow morning and the FOMC statement and following press conference tomorrow afternoon.  At this point, my sense remains that the market perception is the Fed will be the most hawkish of all central banks in the transition from QE infinity to the end of QE.  That should generally help support the dollar for now.  however, over time, the evolution of inflation and policy remains less clear, and if, as I suspect, the Fed decides that higher inflation is better than weakening growth, the dollar could well come under much greater pressure.  I just don’t think that is on the cards for at least another six months.

Good luck and stay safe
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