Investors seem somewhat concerned
That risk, in all forms, has returned
Thus, stocks are backsliding
While Jay is deciding
If QE should soon be adjourned

With the FOMC beginning its two-day meeting this morning, and PPI data due at 8:30am, it is clear that investors are taking a more precautionary view of the world today.  Certainly, yesterday’s US equity market price action, where the major indices all closed on their session lows, has not helped sentiment, nor has the current market narrative of imminently tighter policy from the Fed.  As such, it should be no great surprise that risk assets across the board are under pressure while more traditional havens have found some support.

But let us ask ourselves, is this current market (not Fed) narrative realistic?  Again, I would contend the market expectations for tomorrow are that the Fed will double the pace of its QE tapering come January, which will have them finish QE by the end of March.  And it is easy to see the merits of the argument given the persistence and magnitude of price gains seen over the past twelve to fifteen months.  This is especially so given there is no obvious reason to believe prices will decline other than the economists’ mantra that supply will be created to fill the demand.  (While this is certainly true in the long run, as Keynes pointed out back in 1923, in the long run we are all dead, so timing matters here.)

However, there are counterarguments also being made that will carry weight, especially with the political bent of the current administration.  Specifically, the maximum employment piece of the Fed mandate, which Mr Powell highlighted last year when announcing the Fed’s new policy initiatives, remains an open question.  It appears that the current Fed view is that NAIRU (full employment) is reached when the Unemployment Rate reaches 3.8%.  The November NFP report showed Unemployment has declined to 4.2%, as measured, and recall that pre-pandemic, the Unemployment Rate had fallen to 3.5%, its lowest point in half a century.  Thus, the new view is that full employment will only be reached at near historic lows.  Yet, is that maximum employment in the current vernacular?

The Fed’s policy review used the terms “broad-based and inclusive” to describe maximum employment, by which they were considering not merely the statistical headline, but the makeup of the data when broken down by various subcategories, notably race.  That November report indicated that the Unemployment rate for minorities was 6.7%, considerably higher than for the white cohort which saw Unemployment of just 3.7%.  That disparity is at the heart of the question as to whether the Fed believes its employment mandate has been fulfilled.

You will not be surprised to know that there is vocal advocacy by some that the ratio that currently exists reflects bias and the Fed must do more to alleviate the problem, even at the expense of higher inflation.  Nor would you be surprised that others make the case that rising inflation is a greater burden on the lower and middle classes, so seeking those last few jobs results in a significantly worse outcome for all, especially those for whom the policies are intended to help.

The point is it is not a slam-dunk that the Fed is going to be as aggressively hawkish as the current market narrative claims.  While Chairman Powell clearly indicated that the pace of tapering would increase, do not be surprised if it rises from $15B/month to $20B or $25B/month rather than the baseline market assumption of $30B/month.  If that is the case, then another repricing in markets will be coming, with risk assets getting a reprieve while the dollar is likely to suffer.  While this is not my base case, I would ascribe at least a 30% probability to the idea that tomorrow’s FOMC is less hawkish than currently priced.  Stay on your toes.

In the meantime, here is what has been happening since you all went home last evening.  As mentioned, risk is under pressure with Asian equity markets (Nikkei -0.7%, Hang Seng -1.3%, Shanghai -0.5%) all following the US markets lower while European markets opened in a similar vein.  However, it appears that recent omicron news regarding the efficacy of current vaccinations with respect to moderating illness has begun to turn sentiment around and we now see both the DAX and CAC flat on the day while the FTSE 100 (+0.4%) has risen, embracing the new omicron news along with better than expected employment data from the UK (Unemployment fell to 4.2% with Weekly Earnings rising 4.9%).  Alas, US futures remain lower despite that Covid news, led by the NASDAQ (-0.6%).

Bond markets, which had earlier been modestly firmer (yields lower) have reversed course on the omicron news and we now see Treasury yields (+1.9bps) rising alongside the European sovereign market (Bunds +1.5bps, OATs +1.2bps, Gilts +2.3bps).  It seems market participants continue to be whipsawed between concerns over tighter policy and positive omicron news.

Commodity prices, too, have begun to reverse course as early session declines have now been erased with oil (0.0%) back to flat on the day from a nearly 1% decline a few hours ago.  While NatGas (-2.6%) in the US remains stable and under $4/mmBTU, the situation in Europe remains dire with prices rising another 3.6% as ongoing concerns over Nordstream 2 pressure the situation.  In the metals’ markets, there is mostly red with precious (Au -0.1%) softer and base (Cu -0.1%, Al -0.7%) also under pressure.  Agricultural products are falling as well today.

The dollar is on its back foot this morning as positivity permeates the markets with only NOK (-0.15%) softer in the G10, still feeling the lingering pain of oil while we see CHF (+0.35%) and EUR (+0.3%) lead the way higher.  Much of this movement, I believe, is position related as there has been little data or commentary to drive things, and the broader dollar gains that we have seen over the past months are seeing some profit-taking ahead of the FOMC and ECB meetings in the event that my case above for a more dovish outcome occurs.  Remember, too, given the market’s long dollar positioning, even a hawkish Fed could see a ‘sell the news’ result.

EMG currencies are showing similar trends with TRY (-3.3%) the true outlier as the lira quickly melts on ongoing policy concerns.  But elsewhere, HUF (+0.8%) has gained as the central bank reduced its QE purchases and expectations of further rate hikes are rampant.  CZK (+0.5%) is also benefitting from hawkish central bank news as the head there explained he saw rates closer to 4.0% than 3.0% next year (current 2.75%).  After those stories, there is much less movement overall.

Data this morning showed the NFIB Small Business Optimism Index edge slightly higher to 98.4 while PPI (exp 9.2%, 7.2% ex food & energy) is due at 8:30.  If the market takes hold of the latest omicron news, I would expect the equity market to turn around, but also the dollar as less Covid worries allows the Fed to be more hawkish.  But really, all eyes are on tomorrow afternoon, so don’t look for too much movement in either direction today.

Good luck and stay safe
Adf