The future is like the past
Ergo, rates unchanged
The BOJ concluded their latest policy meeting last night and the results were…nothing changed. Well, that’s not strictly true. Their economic and inflation forecasts were tweaked to arrive at a revised path to the same outcome. So, instead of faster growth this year, they decided it would be delayed a year before falling back to its long-term 1.0% trend while inflation is now forecast to jump up to… 1.1% for the next two years, from a previous expectation of 1.0%. Now that’s precision! Kuroda-san’s term expires in April 2023 and despite 12 years of extraordinarily easy money, with QE, YCC and NIRP all employed to drive inflation higher, at this time it seems likely that he will have failed dismally in his only task. (As an aside, I would wager if you surveyed the Japanese population, there would be scant few demands for higher prices in their purchases. Just sayin’.) As to the yen, it is essentially unchanged on the day and when asked about the currency, Kuroda explained it should move stably (whatever that means), but that a weaker yen would ultimately be desired. Plus ça change.
Excitement has started to build
And bond market bears are all thrilled
With One point Eight breached
The story they’ve preached
Is finally being fulfilled
Arguably, however, the biggest story today is that the US 10-year yield has finally traded above 1.80% (as I type it is +3.2bps at 1.816%) for the first time since before the pandemic in February 2020. For those market participants who have been preaching that rising inflation would lead to higher yields, this is a clear milestone. Regarding the transitory vs. persistent inflation narrative, this also indicates a growing number of investors are moving toward the persistent side of the argument. The key question, of course, is why has this happened today? Are there specific catalysts or was it simply time?
Perhaps the first place to look is the oil market, where WTI (+1.2%) has rallied more than $1.00/bbl and is trading back above $85/bbl for the first time since October 2014. We all know that higher oil prices tend to have a very clear impact on both actual prices and price expectations. Today’s oil rally seems to be the result of a few different issues. First has been the news that there was a drone attack on oil facilities in the UAE raising the specter of market disruptions from the Middle East. A background story there is that the amount of spare capacity available in OPEC+ members may also be somewhat overstated as evidenced by the fact that OPEC’s last production increase of 400K barrels per day fell short because several members simply couldn’t pump enough to meet their quotas. Meanwhile, demand seems pretty robust as 1) the omicron variant is quickly becoming seen as akin to the common cold and so not too disruptive; and 2) with NatGas prices so high in Europe and Asia, utilities are turning to both oil and coal to power their countries adding to oil demand.
Of course, the other key feature of the US interest rate market is forecasting what the Fed is going to do this year and how that will impact things. It is worth noting that while 10-year yields have jumped 3+ basis points this morning, 2-year yields are higher by more than 6 basis points and back above 1.0% for the first time since before the pandemic as well. But that means that the yield curve continues to flatten, a harbinger of slower future growth. Now, one might expect that slower future growth would help reduce inflationary fears and ordinarily that would be a good thought. However, there is nothing ordinary about the current policy settings nor their recent history and it is those features that are likely to drive market sentiment for at least a little longer.
Remember, monetary policy works with “long and variable lags” which historically has been calculated as somewhere between 24 and 30 months. This implies that whatever action the Fed takes next week will not start to impact the economy until 2024. It also means that the actions they took at the beginning of the pandemic, about 22 months ago, are likely starting to be felt in the real economy. Money supply rose >35% for many months throughout 2020 and the early part of 2021, and it is fair to expect that the impact of all that extra cash floating around has not yet completely been seen. The point is that inflation remains built up in the system and is likely to be with us for quite some time to come. With this in mind, it is easy to see why yields are rising.
And there is one more thing to add to the puzzle, QT. Remember, too, comments from a number of FOMC members hinted at an increasing desire to start reducing the size of their balance sheet. If they do follow through with that process, it seems likely that Treasury yields will move even higher across the curve as the only price insensitive buyer leaves the market. The question then becomes, at what point do yields rise enough to make the Treasury uncomfortable when it comes to refinancing the current debt? I make no claims that I know where that level lies, but I remain confident that as soon as carrying costs for debt start to climb as a percentage of GDP, QT is going to end. Summing up, there is a lot happening and it feels like we may be at the beginning of some significant trend changes.
How has all this activity impacted markets today? You will not be surprised to know that risk has been significantly reduced across the board. Looking at equity markets, red is the predominant color on screens this morning with only one exception, Shanghai (+0.8%) as traders react to easing monetary policy and support for property markets in China. Otherwise, it is not pretty (Nikkei -0.3%, Hang Seng -0.4%, DAX -1.0%, CAC -1.0%, FTSE 100 -0.6%). US futures are also under severe pressure led by the NASDAQ (-1.8%) although both the DOW and SPX are lower by -1.0% at this hour. It seems that rising yields are pretty bad for growth stocks and I believe that story has legs.
Global bond markets had all been much softer earlier in the session but have since recouped their losses so that European sovereigns are essentially unchanged at this hour. The one outlier, again, in Asia was China, where CGB’s saw yields decline 4.4bps last night as investors pile in looking for further policy ease.
On the commodity front, we have already discussed oil, which is by far the most interesting thing out there. NatGas in the US is little changed on the day and actually slightly lower in Europe. Gold (-0.3%) has fallen which should be no surprise given the rise in yields across the curve, and copper (-0.85%) is also under pressure as the flatter curve and declining stocks hint at weaker future growth.
As to the dollar, it is generally firmer this morning although not universally so. SEK (-0.5%) is the laggard in the G10 on a combination of residual belief the Riksbank will remain relatively dovish and the beginnings of concern over election outcomes when the Swedes go to the polls in September. After that, AUD (-0.4%) and NZD (-0.4%) are next in line, both suffering from weakness in metals and agricultural markets. The rest of the bloc is softer by about 0.2% or so save CAD (+0.1%) which is benefitting from oil’s rise.
In the emerging markets, TRY (-0.8%) volatility continues to dominate, but INR (-0.45%), PHP (-0.45%) and HUF (-0.45%) are all under pressure as well. The first two are feeling the effects of higher Treasury yields as well as concerns over potential CNY weakness after PBOC comments about preventing one-way trading (meaning continued strength). As to HUF, it and the rest of the CE4 look simply to be displaying their relatively high betas with respect to the euro (-0.2%).
On the data front, Empire Manufacturing (exp 25.0) is today’s only number of note and we will need a big surprise in either direction to have a market impact. Rather, today’s trend seems pretty clear, higher yields, weaker stocks and a stronger dollar. Will it continue much longer? That, of course, is the key question.
Good luck and stay safe