Two central banks managed to shock
The market by walking the walk
The Old Lady jacked
By fifteen, in fact
Banxico then doubled the talk
So, now that it’s all said and done
C bankers, a new tale have spun
The virus no longer
Is such a fearmonger
Inflation’s now job number one
Talk, as we all know, is cheap, but from the two largest central banks, that’s mostly what we got. While Chairman Powell got a positive market response from his erstwhile hawkish comments initially, yesterday investors started to rethink the benefits of tighter monetary policy and decided equity markets might not be the best place to hold their assets. This is especially true of those invested in the mega-cap tech companies as those are the ones that most closely approximate an extremely long-duration bond. So, the NASDAQ’s -2.5% performance has been followed by weakness around the globe and NASDAQ futures pointing down -0.9% this morning. As many have said (present company included) the idea that the Fed will be aggressively tightening monetary policy in the face of a sharp sell-off in the stock market is pure fantasy. The only question is exactly how far stocks need to fall before they blink. My money is on somewhere between 10% and 20%.
Meanwhile, Madame Lagarde continues to pitch her view that inflation remains transitory and that while it is higher than the target right now, by next year, it will be back below target and the ECB’s concerns will focus on deflation again. So, while the PEPP will indeed be wound down, it will not disappear as it is always available for a reappearance should they deem it necessary. And in the meantime, they will increase the APP by €40 billion/month while still accepting Greek junk paper as part of the mix. Even though inflation is running at 4.9% (2.6% core) as confirmed this morning, they espouse no concern that it is a problem. Perhaps the most confusing part of this tale is that the EURUSD exchange rate rallied on the back of a more hawkish Fed / more dovish ECB combination. One has to believe that is a pure sell the news result and the euro will slowly return to recent lows and make new ones to boot.
One final word about the major central banks as the BOJ concluded its meeting last night and…left policy unchanged as universally expected. There is no indication they are going to do anything different for a long time to come.
However, when you step away from the Big 3 central banks, there was far more action in the mix, some of it quite surprising. First, the BOE did raise the base rate by 15 basis points to 0.25% and indicated that it will be rising all throughout next year, with expectations that by September it will be 1.00%. The MPC’s evaluation that omicron would not derail the economy and price pressures, especially from the labor market, were reaching dangerous levels led to the move and the surprise helped the pound rally as much as 0.7% at one point. Earlier yesterday, the Norges Bank raised rates 25bps, up to 0.50%, and essentially promised another 25bp rise by March. Then, in the afternoon, Banco de Mexico stepped in and raised their overnight rate by 0.50%, twice the expected hike and the largest move since they began this tightening cycle back in June. It seems they are concerned about “the magnitude and diversity” of price pressures and do not want to allow inflation expectations to get unanchored, as central bankers are wont to say.
Summing up central bank week, the adjustment has been significant from the last round of meetings with inflation clearly now the main focus for every one of them, perhaps except for Turkey, where they cut the one-week repo rate by 100 basis points to 14.0% and continue to watch the TRY (-7.0%) collapse. It is almost as if President Erdogan is trying to recreate the Weimar hyperinflation of the 1920’s without the war reparations.
Will they be able to maintain this inflation fighting stance if global equity markets decline? That, of course, is the big question, and one which history does not show favorably. At least not the current crop of central bankers. Barring the resurrection of Paul Volcker, I think we know the path this will take.
This poet is seeking his muse
To help him define next year’s views
Thus, til New Year’s passed
Do not be aghast
My note, you’ll not have, to peruse
Ok, for my final note of the year, let’s recap what has happened overnight. As mentioned above, risk is under pressure after a poor performance by equity markets in the US. So, the Nikkei (-1.8%), Hang Seng (-1.2%) and Shanghai (-1.2%) all fell pretty sharply overnight. This morning, Europe has also been generally weak, but not quite as badly off as Asia with the DAX (-0.65%) and CAC (-0.7%) both lower although the FTSE 100 (+0.3%) is bucking the trend after stronger than expected Retail Sales data (+1.4%). Meanwhile, Germany has been dealing with soaring inflation (PPI 19.2%, a new historic high) and weakening growth expectations as the IFO (92.6) fell to its lowest level since January and is trending sharply lower. US futures are also pointing lower at this hour.
Bond markets, meanwhile, are generally firmer although Treasury yields are unchanged at this time. Europe, though, has seen declining yields across the board led by French OATs (-2.6bps) and Bunds (-1.8bps) with the peripherals also doing well. Gilts are bucking this trend as well, with yields unchanged this morning.
In the commodity space, oil (-1.75%) is leading the energy sector lower along with NatGas (-1.9%), but metals markets are going the other way. Gold (+0.5%, and back above $1800/oz) and silver (+0.7%) feel more like inflation hedges this morning, and we are seeing strength in the industrial space with copper (+0.45%), aluminum (+2.1%) and tin (+1.8%) all rallying.
Lastly, looking at the dollar, on this broad risk-off day, it is generally stronger vs. its G10 counterparts with only the yen (+0.2%) showing its haven status. Otherwise, NZD (-0.5%) and AUD (-0.4%) are leading the way lower with the entire commodity bloc under pressure. As to the single currency, it is currently slightly softer (-0.1%) but I believe it has much further to run by year end.
In the EMG bloc, excluding TRY’s collapse, the biggest mover has actually been ZAR (+0.6%) after it reported that the hospitalization rate during the omicron outbreak has collapsed to just 1.7% of cases being admitted. This speaks to the variant’s less pernicious symptoms despite its rapid spread. Other than that, on the plus side KRW (+0.25%) benefitted from central bank comments that they would continue to support the economy but raise rates if necessary. On the downside, CLP (-0.4%) is opening poorly as traders brace for this weekend’s runoff presidential election between a hard left and hard right candidate with no middle ground to be found. However, beyond those moves, there has been much less activity.
There is no economic data today and only one Fed speaker, Governor Waller at 1:00pm. So, the FX market will once again be seeking its catalysts from other markets or the tape. At this point, if risk continues to be shed, I expect the dollar to continue to recoup its recent losses and eventually make new highs.
As I mention above, this will be the last daily note for 2021 but the FX Poet will return with his forecasts on January 3rd, 2022, and the daily will follow afterwards. To everyone who continues to read, thank you for your support and I hope everyone has a happy and healthy holiday season.
Good luck, good weekend and stay safe