Reason to Fear

In Europe, the price of Nat Gas
Has risen to new highs, alas
As winter comes near
There’s reason to fear
A rebound will not come to pass

As well the impact on inflation
Is likely to add to frustration
Of Madame Lagarde
As she tries so hard
To hide the debt monetization

Some days are simply less interesting than others, and thus far, today falls into the fairly dull category.  There has been limited new news in financial markets overall.  While the ongoing concerns over the imminent failure of China Evergrande continue to weigh on Asian stocks (Nikkei -0.6%, Hang Seng -1.5%, Shanghai -1.3%), the story that is beginning to see some light in Europe is focused on the extraordinary rise in Natural Gas prices.  As a point of reference, in the US, Nat Gas closed yesterday at $5.34/MMBtu, itself a significant rise in price over the past six months, nearly doubling in that time.  Europeans, however, would give their eye teeth for such a low price as the price in the Netherlands for TTF (a contract standard) is $22.61/MMBtu!  This price has risen nearly fourfold during the past six months and now stands more thar four times as costly as in the US.  Whatever concerns you may have had about your personal energy costs rising in the US, they are dwarfed by the situation in Europe.

This matters for a number of reasons beyond the economic (for instance, how will people in Europe afford to heat their homes in the fast approaching winter and continue to feed their families as well?)  but our focus here is on markets and economics.  Thus, consider the following:  Europe remains a manufacturing and exporting powerhouse and is reliant on stable supply and pricing of natural gas to power their factories.  Obviously, recent price action has been anything but stable, and given the European dependence on Russian gas supplies, there is a geopolitical element overhanging the market as well.  LNG can be a substitute, but Asian buyers have been paying up to purchase most of those cargoes, so Europe is finding itself with reduced supply and correspondingly rising prices.

The first big industrial impact came yesterday when a major manufacturer of fertilizer shut down two UK plants because the cost of Nat Gas had risen too far to allow them to be competitive.  Consider the chain of events here: first, closure of the plant means reduced overall output, as well as furloughed, if not fired, workers. Second, reduction in the supply of fertilizer means that the price for farmers will almost certainly rise higher, thus forcing farmers to either raise their prices or reduce production (or go out of business).  Higher food prices, which have already risen dramatically, will result in reduced non-food consumption and strain family budgets as it feeds into inflation.  Net, slower growth and higher prices are the exact wrong combination for any economy and one to be avoided at all costs.  Alas, this is very likely the type of future that awaits many, if not most, European countries, the dreaded stagflation.  The ECB has its work cut out to combat this issue effectively while the Eurozone economy sits on more than €11.3 trillion in debt.  I don’t envy Madame Lagarde’s current position.

Beyond the macroeconomic issues, what are the potential market impacts?  Here things, as always, are less clear, but thus far, we have seen one impact, and that is a declining euro (-0.4%).  In fact, all European currencies are falling today as it becomes clearer that economic activity across the pond is going to be further impaired by this situation.  It has been sufficient to offset perceived benefits of European economies reopening in the wake of the spread of the delta variant of Covid.  However, the upshot of this currency weakness has been equity market strength.  It seems that any concerns of the ECB considering tighter policy have been pushed even further into the future thus encouraging investors to continue to add risk to their portfolios.  Hence, this morning, in the wake of the ongoing rise in Nat Gas prices, we see European equities all in the green (DAX +0.5%, CAC +1.0%, FTSE 100 +0.45%).  Under the guise of TINA, weaker growth leads to continued low rates and higher stock prices.  What could possibly go wrong?

US markets are biding their time at this hour, with futures essentially unchanged and really, so are bond markets.  Of the major sovereigns, only Gilts (+1.8bps) have moved more than a fraction of a basis point this morning.  While risk may be on, it is not aggressively so.  Either that, or European banks are back to buying more and more of their national bonds tightening the doom loop that ultimately led to the Eurozone crisis in 2012.

Commodities?  Well, as it happens, after a multi-day rally, oil prices are consolidating with WTI (-0.25%) basically holding the bulk of the $10 in gains it has made in the past month.  Nat Gas, too, is consolidating this morning, down $0.16/MMBtu, although that represents 3% (Natty is very, very volatile!)  With the dollar rocking, we are also seeing weakness across the metals’ markets, both precious (gold -0.75%) and industrial (Cu -2.0%, Al -0.6%, Pb -1.6%).  In fact, the only commodity that is performing well today is Uranium, which is higher by a further 8.1%.

Finally, the dollar is king today, rising against 9 of its G10 counterparts with CHF (-0.5%) the laggard and only NZD (+0.1%) able to show any strength today.  The Kiwi story has been a much better than expected GDP print (2.8% vs 1.1% expected) leading to growing expectations of a 0.50% rate hike next month.  Meanwhile, the rest of the bloc is suffering from the aforementioned cracks in the rebound theory as well as broad-based dollar strength.  This strength has been universal in EMG markets, with every currency sliding against the greenback.  Thus far, the worst performer has been PLN (-0.6%) followed by THB (-0.5%) and HUF (-0.5%).  Beyond that, most currencies are down in the 0.2% range.  Interestingly, for both PLN and HUF, the market discussion is about raising interest rates with Hungary looking at 50bps while Poland has called for a “gentle” rise, assumed to be 0.25%.  As to THB, it seems the market has been reacting to a rise in the number of Covid cases which is perpetuating the Asian risk-off theme.

We have a full slate of data today at 8:30 with Initial (exp 323K) and Continuing (2740K) Claims; Philly Fed (19.0) and the biggest of the day, Retail Sales (-0.7%, 0.0% ex autos).  Tuesday’s Empire Manufacturing data was MUCH stronger than expected, so there will be some hope for Philly to beat.  But the Retail Sales data is the key.  Remember, this number started to slide once the stimulus checks stopped, and last month we saw a much worse than expected -1.1% outcome.  Given the uncertainty over the near-term trajectory of the economy, this will be seen as an important number.

Well, the dollar managed to strengthen despite lacking support from yields, certainly a blow to the dollar bears out there.  The thing is, against the G10, I continue to see the dollar in a range (1.17/1.19) and will need to see a break of either side to change views.  If forced to opine, I would say the medium-term trend for the dollar is gradually higher, but would need to see the euro below 1.17, or the DXY above 93.50 before getting too excited.

I will be out of the office tomorrow so no poetry until Monday.

Good luck, good weekend and stay safe
Adf

Dissatisfaction

The Chinese would have us believe
Their growth targets, they will achieve
Alas, recent data
When looked at pro rata
Shows trust in their words is naïve

Meanwhile, in the UK, inflation
Is rising across that great nation
The market’s reaction
Is dissatisfaction
Thus, Gilts have seen depreciation

Just how fast is China’s GDP growing?  That is the question to be answered after last night’s data dump was distinctly worse than expected.  The big outlier was Retail Sales, which grew only 2.5% Y/Y in August, down from 8.5% in July and far below the expected 7.0% forecast.  But it was not just the Chinese consumer who slowed down their activity, IP rose only 5.3% Y/Y, again well below the July print of 6.4% and far below the forecast of 5.8%.  Even property investment was weaker than forecast, rising 10.9%, down from 12.7% in July and below the 11.3% forecast.  So, what gives?

Well, there seem to be several issues ongoing there, some of which may be temporary, like lockdowns due to the spreading delta variant of Covid, while others are likely to be with us for a longer time, notably the fallout from the bankruptcy of China Evergrande on the property market there.  The Chinese government is walking a very fine line of trying to support the economy without overstimulating those areas that tend toward speculation, notably real estate.  This is, however, extraordinarily difficult to achieve, even for a government that controls almost every lever of power domestically.  The problem is that the Chinese economy remains hugely reliant on exports (i.e. growth elsewhere in the world) in order to prosper.  So, as growth globally seems to be abating, the impact on China is profound and very likely will continue to detract from its GDP results.

Adding to the Chinese government’s difficulties is that the largest property company there, Evergrande, is bankrupt and will need to begin liquidating at least a portion of its property portfolio.  Remember, it has more than $300 billion in USD debt and the government has already said that interest and principal payments due next week will not be made.  A key concern is the prospect of contagion for other property companies in China, as well as for dollar bonds issued by other Chinese and non-US entities.  History has shown that contagion from a significant bankruptcy has the ability to spread far and wide, especially given the globalized nature of financial markets.  While we will certainly hear from Chinese officials that everything is under control, recall that the Fed assured us that the subprime crisis was under control, right before they let Lehman Brothers go under and explode the GFC on the world.  The point is, there is a very real risk that investors become wary of certain asset classes and risk overall which could easily lead to a more severe asset price correction.  This is not a prediction, merely an observation of the fact that the probability of something occurring has clearly risen.

Speaking of things rising, the other key story of the morning is inflation in the UK, which printed at 3.2%, its highest level since March 2012, and continues to trend higher.  This cannot be surprising given that inflation is rising rapidly everywhere in the world, but the difference is the BOE may have a greater ability to respond than some of its central bank counterparts, notably the Fed.  For instance, the UK debt/GDP ratio, while having risen recently to 98.8%, remains well below that of the rest of the G7, notably the Fed as the US number has risen to around 130%.  As such, markets have begun to price in actual base rate hikes by the BOE, looking for the base rate to rise to 0.50% (from 0.10% today) by the end of next year with the first hike expected in May.  While that may not seem like much overall (it is not really), it is far more than anticipated here in the US.  And remember, our CPI is running above 5.0% vs. 3.2% in the UK.

The upshot of the key stories overnight is that taking risk is becoming harder to justify for investors all over the world.  While there has certainly not yet been a defining break from the current ‘buy the dip’ mentality, fingers of instability* seem to be developing throughout financial markets globally.  The implication is that the probability of a severe correction seems to be growing, although the timing and catalyst remain completely opaque.

So, how has the most recent news impacted markets?  Based on this morning’s price action, there is clearly at least some concern growing.  For example, equity markets in Asia were all in the red (Nikkei -0.5%, Hang Seng -1.8%, Shanghai -0.2%) as the fallout of slowing Chinese growth and the China Evergrande story continue to weigh on sentiment there.  In Europe, the continent is under some pressure (DAX -0.1%, CAC -0.5%) although the UK (FTSE 100 +0.1%) seems to be shaking off the higher than expected CPI readings.  As to US futures, as I type, they are currently marginally higher, about 0.2% each, but this follows on yesterday’s afternoon sell-off resulting in lower closes.  Nothing about this performance screams risk-on, although it is not entirely bad news.

The bond market seems a bit more cautious as Treasury yields have fallen further and are down 1.3bps this morning after a 4bp decline yesterday.  This is hardly the sign of speculative fever.  In Europe at this hour, yields are essentially unchanged except in Italy, where BTP yields have risen 1.6bps as concerns grow over the amount of leeway the Italian government has to continue supporting its economy.

Commodity markets show oil prices continuing to rise (WTI +1.35%) after inventory numbers continue to show drawdowns and Gulf of Mexico production remains reduced due to the recent hurricane Nicholas.  While gold prices are little changed on the day, both copper (+0.6%) and aluminum (+1.6%) are firmer on supply questions.  Certainly nothing has changed my view that the price of “stuff” is going to continue higher in step with the ongoing central bank additions of liquidity to markets and economies.

Finally, the dollar is under pressure this morning, which given the risk-off sentiment, is a bit unusual.  But against its G10 brethren, the greenback is lower across the board with NOK (+0.85%) the clear leader on the strength of oil’s rally, although we are seeing haven assets CHF (+0.4%) and JPY (+0.4%) as the next best performers.  The rest of the bloc has seen much lesser gains, but dollar weakness is clear.

The same situation obtains in the EMG markets, where the dollar is weaker against all its counterparts, although the mix of gainers is somewhat unusual.  ZAR (+0.5%) is the top performer on the back of strengthening commodity prices and it is no surprise to see RUB (+0.4%) doing well either.  But both HUF (+0.45%) and CZK (+0.4%) are near the top of the list as both have seen higher than forecast inflation readings recently and both central banks are tipped to raise rates in the next two weeks.  As such, traders are trying to get ahead of the curve there.  The rest of the bloc is also firmer, but the movement has been much less pronounced with no particular stories to note.

On the data front this morning, Empire Manufacturing (exp 17.9), IP (0.5%) and Capacity Utilization (76.4%) are on the docket, none of which are likely to change many opinions.  The Fed remains in their quiet period until the FOMC meeting next week, so we will continue to need to take our FX cues from other markets.  Right now, it appears that 10-year yields are leading the way, so if they continue to slide, look for the dollar to follow suit.

Good luck and stay safe
Adf

*see “Ubiquity” by Mark Buchanan, a book I cannot recommend highly enough

Flames of Concern

While Fed commentary is banned
Inflation has certainly fanned
The flames of concern
And soon we’ll all learn
If prices are acting as planned

Meanwhile transitory’s the word
Jay’s used to describe what’s occurred
But most people feel
Inflation is real
And denial is naught but absurd

It is CPI day in the US today and recently the results have gained nearly as much attention as the monthly payroll data.  This seems reasonable given that pretty much every other story in the press touches on the subject, although as is constantly highlighted, the Fed pays attention to PCE, not CPI.  Nonetheless, CPI is the data that is designed to try to capture the average rate of increases in price for the ordinary consumer.  As well, virtually all contracts linked to inflation are linked to CPI.  So Social Security, union wage contracts and TIPS all use CPI as their benchmark.

Of course, the reason inflation is the hot topic is because it has been so hot over the past nine months.  Consider that since Paul Volcker was Fed Chair and CPI peaked at 14.8%, in 1980, there has been a secular decline for 40 years.  Now, for the first time since 1990, we are likely to have four consecutive Y/Y CPI prints in excess of 5.0%.  Although Powell and the FOMC have been very careful to avoid defining ‘transitory’, every month that CPI (and PCE) prints at levels like this serves to strain their credibility.

This is evidenced by a survey conducted by the New York Fed itself, which yesterday showed that the median expectation for inflation in one year’s time has risen to 5.2% and in three years’ time to 4.0%.  Both of these readings are the highest in the survey’s relatively short history dating back to 2013.  But the point is, people are becoming ever more certain that prices will continue rising.  And remember, while inflation may be a monetary phenomenon, it is also very much a psychological one.  If people believe that prices will rise in the future, they are far more likely to increase their demand for things currently in order to avoid paying those future high prices.  In other words, hoarding will become far more normal and expectations for higher prices will become embedded in the collective psyche.

In fact, it is this exact situation that the Fed is desperately trying to prevent, hence the constant reminders that inflation is transitory and so behavioral changes are unnecessary.  This is what also leads to absurdities like the White House trying to explain that except for the prices of beef, pork and poultry, food prices are in line with what would be expected.  Let’s unpack that for a minute.  Beef, pork and poultry are the three main protein sources consumed in this country, if not around the world, so the fact that those have risen in price makes it hard to avoid the idea that prices are rising.  But the second half of the statement is also disingenuous, “in line with what would be expected” does not indicate prices haven’t risen, only that they haven’t risen as much as beef etc.  I’m sure that when each of you heads to the supermarket to stock up for the week, you have observed the price of almost every item is higher than it was, not only pre-Covid, but also at the beginning of the year.  Alas, at this point, there is no reason to expect inflation to slow down.

Median expectations according to Bloomberg’s survey of economists show that CPI is forecast to have risen 0.4% in August with the Y/Y increase declining to 5.3% from last month’s 5.4% reading.  Ex food and energy, the forecasts are +0.3% and 4.2% respectively.  Now, those annual numbers are 0.1% lower than the July readings, which have many economists claiming that the peak is in, and a slow reversion to the lowflation environment we experienced for the past twenty years is going to return.  Counter to that argument, though, is the idea that the economy is cyclical and that includes inflation.  As such, even if there is an ebb for now, the next cycle will likely return us to these levels once again, if not higher.  PS, if the forecasts are accurate, as I mentioned before, this will still be the fourth consecutive month of 5+% CPI, a fact which makes it much easier for the masses to believe inflation has returned.  You can see why Powell and the entire FOMC continue to harp on the transitory concept, they are desperate to prevent expectations from changing because, as we’ve discussed before, they cannot afford to raise interest rates given the amount of leverage in the system.

Keeping all this in mind, it is easy to understand why the CPI data release has gained so much in importance, even to the Fed, who ostensibly focuses on PCE.  We shall see what the data brings.

In the meantime, the markets overnight have been mostly quiet with a few outlying events.  China Evergrande, the massively indebted Chinese property company has hired two law firms with expertise in bankruptcy.  This is shaking the Chinese markets as given the massive amount of debt involved (>$300 billion of USD debt) there is grave concern a bankruptcy could have significant knock-on repercussions across all sub-prime markets.  It should be no surprise that Chinese equity markets fell last night with Shanghai (-1.4%) and the Hang Seng (-1.2%) both under continued pressure.  However, the Nikkei (+0.7%) rose to its highest level since 1990, although still well below the peak levels from the Japanese bubble of the late ‘80s.  Europe is also mixed with the DAX (+0.1%) managing to eke out some gains while the rest of the continent slides into the red (CAC -0.4%, FTSE 100 -0.3%). US futures are basically unchanged this morning as we all await the CPI data.

Interestingly, despite a lot of equity uncertainty and weakness, bonds are also under pressure with yields rising across the board.  Treasuries (+1.2bps), Bunds (+1.9bps), OATs (+1.6bps) and Gilts (+3.8bps) have all sold off, with only Gilts making some sense as UK employment data was generally better than expected and indicative of a rebound in growth.

In the commodity markets, oil (WTI + 0.6%) continues to rebound as another hurricane hits the Gulf Coast and is shutting in more production.  But metals prices are under pressure led by copper (-1.25%) and aluminum (-1.0%).

As to the dollar, mixed is the best description I can give this morning.  In the G10, AUD (-0.5%) is the laggard after RBA Governor Lowe questioned why market participants thought the RBA would be raising rates anytime soon despite potential tapering in the US and Europe.  Australia is in a very different position and unlikely to raise rates before 2024.  On the plus side, NOK (+0.4%) continues to benefit from oil’s rebound and the rest of the bloc has seen much more modest movement, less than 0.2%, in either direction.

EMG markets are a bit weaker this morning, seemingly responding to the growing risk off sentiment as we see ZAR (-0.65%) and RUB (-0.5%) both under a fair amount of pressure with a long list of currencies declining by lesser amounts.  While declining metals prices may make sense as a driver of the rand, the ruble seems to be ignoring the oil price rally, as traders await the CPI data.  On the plus side, KRW (+0.45%) was the best performer as positions locally were adjusted ahead of the upcoming holiday there.

And that’s really the story as we await the CPI release.  The dollar, while softening slightly from its best levels recently, continues to feel better rather than worse, so I suspect we could see modest further strength if CPI is on target.  However, a miss in the print can have more significant repercussions, with a high print likely to see the dollar benefit  initially.

Good luck and stay safe
Adf

Outmoded

In Germany prices exploded
While confidence there has eroded
Now all eyes will turn
Back home where we’ll learn
On Tuesday if QE’s outmoded

The most disturbing aspect of the inflation argument (you know, is it transitory or not) is the fact that those in the transitory camp are willing to completely ignore the damage inflation does to household budgets.  Their attitude was recently articulated by the chief European economist at TS Lombard, Dario Perkins, thusly, “There is nothing inherently dangerous about inflation settling in, say, a 3-5% range instead of the 1-2% that’s been normal for the past decade.”  He continued, “the bigger risk is that hitherto dovish central bankers lose their nerve and raise interest rates until it causes a recession, like they’ve done in the past.”

Let’s consider that for a moment.  The simple math shows that at a 2% inflation rate, the price of something rises about 22% over the course of a decade.  So, that Toyota Camry that cost $25,000 in 2011 would cost $30,475 today.  However, at a 5% inflation rate over that time, it would cost $40,725, a 63% increase.  That’s a pretty big difference.  Add in the fact that wage gains have certainly not been averaging 5% per year and it is easy to see how inflation can be extremely damaging to anybody, let alone to the average wage earner.  The point is, while to an economist, inflation appears to be an abstract concept that is simply a number input into their models, to the rest of us, it is the cost of living.  And there is nothing that indicates the cost of living will stop rising sharply anytime soon.

This was reinforced overnight when Germany released its wholesale price index, which rose 12.3% in the past twelve months.  That is the highest rate of increase since 1974 in the wake of the OPEC oil embargo.  Now fortunately, the ECB is on the case.  Isabel Schnabel, the ECB’s head of markets explained, “The prospect of persistently excessive inflation, as feared by some, remains highly unlikely.  But should inflation sustainably reach our target of 2% unexpectedly soon, we will act equally quickly and resolutely.”  You know, they have tools!

On the subject of Wholesale, or Producer, Prices, while Germany’s were the highest print we’ve seen from a major economy, recall last week that Chinese PPI printed at 9.5%, in the US it was 8.3% and even in Japan, a nation that has not seen inflation in two decades, PPI rose 5.6% last month.  It appears that the cost of making “stuff” is rising pretty rapidly.  And even if the pace of these increases does slow down, the probability of prices declining is essentially nil.  Remember, the current central bank mantra is deflation is the worst possible outcome and they will do all they can to prevent it.  All I can say is, I sure hope everyone’s wages can keep pace with inflation, because otherwise, we are all at a permanent disadvantage compared to where things had been just a year or two ago.

Well, I guess there is one beneficiary of higher inflation…governments issuing debt.  As long as inflation grows faster than the size of their debt, a government’s real obligations decline.  And you wonder why the Fed insists inflation is transitory.  Oh yeah, for all of you who think that higher inflation will lead to higher interest rates, I wouldn’t count on that outcome either.  Whether or not the Fed actually tapers, they have exactly zero incentive to raise rates anytime soon.  And as to bonds, they have shown before (post WWII) that they are willing to cap yields at a rate well below inflation if it suits their needs.  And I assure you, it suits their needs right now.

So, what will all this do to the currency markets?  As always, FX is a relative game so what matters is the degree of change from one currency to the next.  The medium-term bearish case for the dollar is that inflation in the US will run hotter than in Europe, Japan or elsewhere, while the Fed caps yields in some manner.  The resultant expansion of negative real yields will have a significant negative impact on the dollar.  This argument will fail if one of two things occurs; either other central banks shoot for even greater negative yields, or, more likely, the Fed allows the back end of the curve to rise thus moderating the impact of negative real yields.  In either case, the dollar should benefit.  In fact, this is why the taper discussion is of such importance to the FX market, tapering implies higher yields in the back end of the US yield curve and therefore an opportunity for a stronger dollar.  Remember, though, there are many moving pieces, so even if the Fed does taper, that is not necessarily going to support the dollar all that much.

Ok, let’s look at this morning’s markets, where risk is largely being acquired, although there is no obvious reason why that is the case.  Equity markets in Asia were mixed with both gainers (Nikkei +0.2%, Shanghai +0.3%) and Losers (Hang Seng (-1.5%) as the ongoing Chinese crackdown on internet companies received new news.  It seems that the Chinese government is going to split up Ant Financial such that its lending business is a separate company under stricter government control.  Ali Baba, which is listed in HK, not Shanghai, fell sharply, as did other tech companies in China, hence the dichotomy between the Hang Seng and Shanghai indices.  But excluding Chinese tech, stocks were in demand.  The same is true in Europe where the screen is entirely green (DAX +1.1%, CAC +0.8%, FTSE 100 +0.8%) as it seems there is little concern about a passthrough of inflation, but great hope that reopening economies will perform well.  US futures are also looking robust this morning, with all three major indices higher by at least 0.5% as I type.

Funnily enough, despite the risk appetite in equities, bond prices are rallying as well, with 10-year Treasury yields lower by 1.7bps, and European sovereigns also seeing modest yield declines of between 0.5 and 1.0 bps. Apparently, as concerns grow over the possibility of a technical US default due to a debt ceiling issue, the safety trade is to buy Treasuries.  At least that is the explanation being offered today.

On the commodity front, oil (WTI +0.8%) is leading the way higher although we are seeing gains in many of the industrial metals as well, notably aluminum (+1.6%), which seems to be feeling some supply shortages.  Copper (-0.45%), surprisingly, is softer on the day, but the rest of that space is firmer.  I mentioned Uranium last week, and as an FYI, it is higher by 5% this morning as more and more people begin to understand the combination of a structural shortage of the metal and the increasing likelihood that any carbonless future will require nuclear power to be far more prevalent.

Finally, the dollar is broadly, although not universally, stronger this morning.  In the G10, only NOK (+0.2%) and CAD (+0.1%) have managed to hold their own this morning on the strength of oil’s rally.  Meanwhile, CHF (-0.7%) is under the most pressure as havens lose their luster, although the rest of the bloc has only seen declines of between -0.1% and -0.3%.  In the EMG bloc, THB (-0.75%) and KRW (-0.6%) lead the way lower as both nations saw equity market outflows on weakness in Asian tech stocks.  But generally, almost all currencies here are softer by between -0.2% and -0.4%.  the exceptions are TRY (+0.3%) and RUB (+0.25%) with the latter supported by oil while the former is benefitting from hope that the central bank will maintain tight policy to fight inflation.

On the data front, we have both CPI and Retail Sales leading a busy week:

Today Monthly Budget Statement -$175B
Tuesday NFIB Small Biz Optimism 99.0
CPI 0.4% (5.3% Y/Y)
-ex food & energy 0.3% (4.2% Y/Y)
Wednesday Empire Manufacturing 18.0
IP 0.4%
Capacity Utilization 76.4%
Thursday Initial Claims 320K
Continuing Claims 2740K
Retail Sales -0.8%
-ex auto -0.1%
Philly Fed 19.0
Friday Michigan Sentiment 72.0

Source: Bloomberg

With no recent stimulus checks, Retail Sales are forecast to suffer greatly.  Meanwhile, the CPI readings are forecast to be a tick lower than last month, but still above 5.0% for the third consecutive month.  Certainly, my personal experience is that prices continue to rise quite rapidly, and I would not be surprised to see a higher print.  Mercifully, the Fed is in its quiet period ahead of next week’s FOMC meeting, so we no longer need to hear about when anybody thinks tapering should occur.  The next information will be the real deal from Chairman Powell.

The tapering argument seems to be the driver right now, with a growing belief the Fed will reduce its QE purchases and US rates will rise, at least in the back end.  That seems to be the genesis of the dollar’s support.  As long as that attitude exists, the dollar should do well.  But if the data this week points to further slowing in the US economy, I would expect the taper story to fade along with the dollar.

Good luck and stay safe
Adf

Recalibrate

Christine said she’d recalibrate
The PEPP, but she clearly did state
No taper’s occurring
Because we’re still spurring
Inflation to reach our mandate

I felt it was important for all of us to be reminded of what tapering means, hence this definition from the Merriam-Webster dictionary:

taper   verb

1               : to become progressively smaller toward one end
2               : to diminish gradually (emphasis added)

But perhaps there is a better source to explain Madame Lagarde’s dissembling comments yesterday; Lewis Carrol.

“I don’t know what you mean by ‘glory,’ ” Alice said.
Humpty Dumpty smiled contemptuously. “Of course, you don’t—till I tell you. I meant ‘there’s a nice knock-down argument for you!'”
“But ‘glory’ doesn’t mean ‘a nice knock-down argument’,” Alice objected.
“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”

Apparently, Madame Lagarde was channeling Humpty Dumpty in her press conference yesterday when she said that while the ECB would be gradually reducing the rate of purchases in the PEPP program in the coming quarter, it was definitely not tapering.  One of the problems this author has with centralbankspeak is that my education taught me based on the plain meaning of the words used.  Hence, claiming that a reduced rate of purchases is not tapering is simply dishonest.  However, central bankers everywhere, led by the Fed and ECB, have come to rely on redefining terms in order to placate both of their masters, markets and governments, who frequently require opposing policies to achieve their goals.

Remember, too, what happened to Humpty Dumpty, a lesson I daresay has been lost on Powell, Lagarde and their comrades-in-arms:

Humpty Dumpty sat on a wall
Humpty Dumpty had a great fall
All the King’s horses and all the King’s men
Couldn’t put Humpty together again.

As economist Herbert Stein explained in 1986, “if something cannot go on forever, it will stop.”  Central bank balance sheets cannot grow indefinitely, at least not without other repercussions.  The most likely relief valve will be the currency, but do not be surprised if there is significant damage to all financial assets at the time investors and markets cease to accept centralbankspeak as a valid guide to the future.

Ever since the GFC, central banks around the world have been aggressively adding liquidity to economies at a far faster pace than those economies create goods and services.  For the first decade of this process, that liquidity mostly found its way into financial markets resulting in the longest bull market in history.  But lately, that liquidity has begun to seep into the real economy on the back of a massive uptick in fiscal stimulus.  The result, you may have noticed, is that financial markets have stopped rising at their previous rate, but the price of stuff you buy every day/week, has started to rise much more rapidly. It is this fact that was the genesis of the ‘transitory’ inflation story, as central banks, notably the Fed, recognize they cannot afford to be blamed for rising consumer inflation, but also cannot afford to fight inflation in the traditional manner of raising interest rates as they are terrified adjusting their current policy will result in a massive market decline.  Hence, I fear the Humpty Dumpty metaphor will wind up being very accurate.  However, he hasn’t fallen yet.

And so, Madame Lagarde did exactly what she set out to do; she was able to explain the ECB would be slowing their PEPP purchases without the market responding in a knee-jerk sell-off.  She placated the hawks on the ECB Council, and watched as Italian BTPs outperformed German bunds thus reducing pressure on the biggest potential problem in Europe.  In the end, kudos are due, at least for now.  I sure hope it lasts, but fear there is much turmoil in our future.

In the meantime, the overall market response to Lagarde has been…buy risk!  Equity markets everywhere are in the green with Asia (Nikkei +1.25%, Hang Seng +1.9%, Shanghai +0.3%) charging ahead and Europe (DAX +0.3%, CAC +0.3%, FTSE 100 +0.3%) following, albeit at a bit slower rate.  US futures, after two lackluster sessions in NY, are pointing higher by 0.4% to start the day.

Of course, with risk appetites whetted, there is no need to hold havens like bonds and so prices there have fallen everywhere with corresponding rises in yields.  Treasuries (+2.9bps) are leading the way but we are seeing Europe (Bunds +1.8bps, OATs +1.9bps, Gilts +1.1bps) all under some pressure as well.  As long as risk is in the ascendancy, I expect that bond yields will continue to edge higher.

Commodity prices are also firmer this morning led by oil (+1.7%) and the entire energy complex.  But metals, too, are up, at least industrial metals with copper (+1.9%), aluminum (+1.6%) and tin (+1.2%) all much stronger and with the latter two pushing to multi-year highs.  While gold is flat on the day, and has been doing very little lately, broadly speaking, the commodity complex continues to perform well.

Finally, the dollar, not surprisingly, is under significant pressure this morning, down versus most of its G10 counterparts, notably the commodity bloc.  NZD (+0.6%), NOK (+0.45%) and AUD and CAD (+0.4%) are all looking strong today bolstered by broad dollar weakness and strong commodity price action.  On the flip side, JPY (-0.2%) is the only real decliner as haven assets are sold, although CHF is also modestly softer.  In the emerging markets, the screen is entirely green led by ZAR (+0.75%), CZK (+0.5%) and IDR (+0.35%).  Rand is clearly in thrall to commodity prices while the koruna is rallying on the back of a much higher than expected CPI print of 4.1%, which has traders looking for a central bank rate increase at the next meeting at the end of the month.  As to the rupiah, it seems this is entirely a result of the risk-on attitude in markets this morning.

On the data front, early this morning the UK released its monthly GDP print at a worse than expected 0.1%, blamed now on the increase of the delta variant.  German CPI was confirmed at 3.9% in August, and Italian IP managed to rise 0.8% in July, a bit better than expected.  Here at home we will see PPI (exp 8.2%, 6.6% ex food & energy) which will continue to challenge the transitory narrative but will not have nearly the impact of next Tuesday’s CPI release.  As well, we hear from the Cleveland Fed’s Loretta Mester this morning, but she has already explained she is ready to taper QE purchases, so unless that story changes, I don’t foresee any impact.

While the dollar is softer this morning, there is no indication it is going to decline substantially at any point in the near future.  Rather, we remain in the middle of the 1.17/1.20 trading range that has capped movement since June.  I see no reason for anything to change here and expect the week to finish in a quiet manner.

Good luck, good weekend and stay safe
Adf

Anything But Preordained

Some pundits think Madame Lagarde
Is ready, the PEPP, to retard
But others believe
She’ll never achieve
Her goals sans her bank’s credit card

Meanwhile data last night explained
That factory prices had gained
The idea inflation
Is due for cessation
Is anything but preordained

Two noteworthy stories this morning are the ECB meeting, where shortly we will learn if the much-mooted reduction in PEPP purchases is, in fact, on the way and Chinese inflation data.  Similar to the Fed, despite a more lackluster economic performance across the Eurozone as a whole, the hawkish contingent of the ECB (Germany, Austria, Finland and the Netherlands) have been extremely vocal in their calls for tapering PEPP bond purchases.  While the Germans have been the most vocal, and are also seeing the highest inflation readings, this entire bloc has a history of fiscal prudence and the ongoing ECB asset purchase programs, which essentially fund fiscal policy in the PIGS, remains a significant concern.  However, the majority of nations in the Eurozone appear quite comfortable with the ongoing purchase programs.  At times like this, one cannot think along the lines of the economic logic of tapering; instead one must consider the political logic.  Remember, Lagarde is a politician, not a true central banker steeped in policy and economics.  To the extent that enough of her constituents believe the current purchase rate of €80 billion to €85 billion per month is appropriate, that is the rate she will maintain.

Markets are generally, I believe, looking for a modest reduction in PEPP purchases, so if the ECB does not adjust purchases lower, I would expect European sovereign bonds (currently slightly firmer with yields lower by about 1 basis point) to rally and the euro (+0.15% this morning) to decline.  European bourses, currently all lower by between 0.25% and 0.75%, are also likely to perform well on the news.

On a different note, China reported its inflation data last night and while CPI there remains muted (0.8% Y/Y), PPI (9.5% Y/Y) is absolutely soaring.  This is the highest reading since August 2008, right before the GFC began, and is the product of rising commodity prices as well as increases in shipping costs and shortages of labor.  The reason this matters so much to the rest of the world is that China continues to be the source of a significant portion of “stuff” consumed by most nations.  Whether that is tee-shirts or iPhones, rising prices at the Chinese factory gate imply further price pressures elsewhere in the world, notably here in the US.  Several studies have shown a strong relationship between Chinese PPI and US CPI, and the logic behind the relationship seems impeccable.  Perhaps a key question is whether or not Chinese PPI increases are also transitory, as that would offer some hope for the Fed.  Alas, history has shown that the moderation of Chinese PPI is measured in years, not months.

Before we turn to today’s markets, I believe it is worthwhile to mention the latest Fedspeak.  Yesterday we heard from NY Fed president John Williams who stayed on message, explaining that substantial further progress had been made on the Fed’s inflation goal, but not yet on the employment goal.  He followed that up by telling us that if things go according to his forecasts, tapering could well begin before the end of the year.  The theme of tapering before the end of 2021, assuming the economy grows according to plan, has been reiterated by numerous Fed speakers at this point, with both Kaplan and Bostic adding to Williams’ comments yesterday.  But what happens if growth does not achieve those lofty goals?  After all, the Atlanta Fed’s own GDPNow data is now forecasting 1.943% growth in Q3.  That seems quite a bit lower than FOMC forecasts.  And yesterday’s JOLTS data showed nearly 11 million job openings are extant, as the supply of willing workers continues to shrink.  A cynic might believe that the current Fedspeak regarding the potential for tapering shortly, assuming data adheres to forecasts, is just a ruse as there is limited expectation, within the Fed, that the data will perform.  This will allow the Fed to maintain their easy money with a strong rationale while sounding more responsible.  But that would be too cynical by half. Do remember, however, Fed forecasts are notoriously inaccurate.

OK, markets overnight are continuing down a very modest risk-off path.  Equities in Asia were generally lower (Nikkei -0.6%, Hang Seng -2.3%) with Shanghai (+0.5%) a major exception.  Ongoing crackdowns on on-line gaming continue to undermine the value of some of China’s biggest (HK listed) companies, while the debt problems at China Evergrande continue to explode.  (China Evergrande is the second largest real estate company in China with a massive debt load of >$350 billion and has been dramatically impacted by China’s attempts to deflate its real estate bubble.  It has been downgraded multiple times and its stock price has now fallen well below its IPO price.  There are grave concerns about its ability to remain an ongoing company, but given the size of its debt load, a failure would have a major impact on the Chinese banking sector as well as, potentially, markets worldwide.  Think Lehman Brothers.)  Alongside the previously mentioned weakness in Europe, US futures are all currently lower by about 0.25%.

Treasury prices are continuing their modest rally, with yields falling another 1.2bps as risk appetite generally wanes.  Given the FOMC meeting is still two weeks away, investors remain comfortable that Treasuries are still a better buy than other securities.  Interestingly, the debt ceiling question does not seem to have reached the market’s collective consciousness yet, although it does offer the opportunity for some serious concern.  However, history shows that despite all the huffing and puffing, Congress will never allow a default, so this is probably the correct behavior.

Commodity prices are rebounding with oil (+0.8%), gold (+0.45%) and copper (+1.3%) leading the way.  The rest of the industrial space is generally firmer although foodstuffs are all softer this morning in anticipation of upcoming crop reports (“sell Mortimer!”)

As to the dollar, it is on its heels this morning, down versus all its G10 counterparts led by NOK (+0.35%) and GBP (+0.3%).  Clearly the former is benefitting from oil’s rise while the pound seems to be benefitting from BOE comments indicating a greater concern with inflation and the fact the Old Lady may need to address that sooner than previously anticipated.  In the EMG bloc, there are far more winners than losers, but the gains have been muted.  For instance, PHP (+0.4%) has been the biggest winner, followed by ZAR (+0.3%) and RUB (+0.25%).  While the latter two are clear beneficiaries of firmer oil and commodity prices, PHP seems to have gained on the back of a potential reversal of Covid lockdown policy by the government, with less restrictions coming.  On the downside, only KRW (-0.25%) was really under pressure as the Asian risk-off environment continues to see local equity market sales and outflows by international investors.

On the data front, this morning brings only Initial (exp 335K) and Continuing (2.73M) Claims.  However, we do hear from four more Fed speakers, with only Chicago’s Evans having yet to say tapering could be a 2021 event.  In truth, at this point, given how consistent the message has been, I feel like data is more likely to drive markets than comments.  Given today’s calendar is so light, I expect we will see another day of modest movement.  The one caveat is if the ECB surprises in some manner, with a greater risk of a more dovish stance than the market assumes.

Good luck and stay safe
Adf

Could Be Dead

The tapering talk at the Fed
Continues as they look ahead
Though growth’s clearly slowing
Inflation is growing
So, QE, next year, could be dead

In Europe, though, it’s not the same
As price rises largely are tame
But plenty of squawks
From ECB hawks
Have feathered the doves with great shame

Central bank meetings continue to be key highlights on the calendar and this week is no different.  Thus far we have already heard from the RBA, who left policy unchanged, as despite inflation running at 3.8% Q/Q, are unwilling to tighten policy amid a massive nationwide lockdown.  After all, how can they justify tighter policy as growth continues to sag?

This morning the BOC meets, and the universal view is that the Overnight Lending rate will be left unchanged at 0.25%.  However, you may recall that the BOC has actually begun to taper its QE purchases, reducing the weekly amount of purchases to C$2 billion from its peak setting of C$4 billion.  Most of the punditry believe that there will be no change in the rate of QE at this meeting as the bank will want to evaluate the impact of the delta variant on the Canadian economy more fully, but most also believe that the next step lower will occur in October.  In either event, though, it seems the currency markets remain far more focused on the US half of the equation than on what the other central bank is doing.  After all, since the BOC began to taper policy in April, the Loonie has weakened by more than 1%, although it did show initial strength in the wake of the surprise announcement.

Turning to tomorrow’s ECB meeting, there has also been a clear delineation between the hawks and doves as to the proper steps going forward.  Given the macroeconomic situation in Europe, where growth is slowing from relatively modest levels and inflation remains far below levels seen in either the US or Canada (or Australia or the UK), it would seem that the doves should retain the upper hand in the discussion.

But one of the key, inherent, flaws in the Eurozone is that different countries tend to have very different economies as well as very different fiscal policies, and so the individual economic outcomes vary greatly.  Thus, while Spain remains mired with excessively high unemployment and lackluster growth prospects, as does Italy, Germany has seen rising prices in a much more sustained fashion, with CPI there running a full percentage point above the Eurozone as a whole.  Given that German DNA is vehemently anti-inflation (a result of the suffering of the Weimar Hyperinflation of the 1920’s), this situation has resulted in Bundesbank President Jens Weidmann and some of his closest colleagues (Austria’s Holtzmann and the Netherlands’ Knot) vociferously calling for a reduction in the rate of purchases in the PEPP.  However, most of the rest of the committee sees no need to slow things down.  The question tomorrow is whether or not Madame Lagarde will be able to tether the hawks.  While there is market talk that tapering will occur, my money is on no change in the pace of purchases.  The direct impact of this should be further modest weakness in the euro and a rebound in European sovereign bond market prices.

As to the Fed, they meet in two weeks’ time and after Powell’s Jackson Hole performance, I think there are vanishingly few players who believe they are going to even announce the tapering schedule then.  However, that does not mean that the segment of the FOMC who are adamantly pro-taper will be quiet, and so expect to hear a steady stream of tapering talk until the quiet period begins on Saturday.  In fact, just last night St Louis President Bullard was interviewed by the FT and reiterated his vocal stance that tapering needs to begin right away.  As well, we will hear from Dallas’ Kaplan later today with his message guaranteed to be the same.  Of more interest will be NY’s Williams, who speaks this afternoon at 1:10pm, and who has yet to voice his tapering opinion.  If he does say tapering is necessary, that would be an important signal, so we must pay close attention.

With all that in mind, markets overnight have started to take a somewhat dimmer view of risk, especially in Europe.  In fact, looking around, only the Nikkei (+0.9%) has been able to see any positivity as the rest of Asia (Hang Seng -0.1%, Shanghai -0.1%) edged lower while Europe (DAX -0.7%, CAC -0.4%, FTSE 100 -0.5%) are seeing much greater selling.  That said, the situation on the Continent was worse earlier in the session with losses everywhere greater than 1.0%.  US futures, meanwhile, are essentially unchanged on the morning, although leaning slightly lower.

In the bond market, buyers have returned with Treasury yields falling 2.4bps, reversing half of yesterday’s climb.  But Europe, too, is seeing demand for havens with Bunds (-1.2bps), OATs (-1.5bps) and Gilts (-1.0bps) all decently bid this morning.  Certainly, if the ECB does reduce its PEPP purchases you can expect yields across the board in Europe to rise.  And, in fact, that is why I don’t expect that to occur!

In a bit of a conundrum, commodity prices are generally higher, alongside the dollar.  Looking at WTI (+1.4%), it seems that energy is on the rise everywhere.  (Pay attention to Uranium, which has rallied 32% in the past month and is structurally bullish as current demand is significantly greater than the run rate of production.)  But weirdly, other than copper (-0.8%) every other key commodity is higher this morning with Au (+0.3%), Al (+0.5%) and Soybeans (+0.7%) leading the way.

This is strange because the dollar is broadly, albeit generally modestly, higher this morning.  In the G10, EUR, CAD and DKK are all softer by 0.2% while only NZD (+0.1%) has managed any gains on the back of the strength in commodity prices.  In the emerging markets, the situation is far more pronounced with TRY (-1.0%) leading the way lower after the central bank indicated rate cuts were coming, although we also saw weakness overnight in KRW (-0.75%), THB (-0.5%) and TWD (-0.4%).  All of these Asian currencies suffered on a pure risk-off viewpoint as equity markets in these nations fell as well.  But it’s not just APAC currencies as we are seeing weakness in EMEA with HUF (-0.5%) and PLN (-0.3%) also under pressure.

On the data front, today brings the JOLTS Job Openings report (exp 10.049M) which continues to indicate the labor market is quite tight despite the payroll data last week.  And after that we get the Fed’s Beige Book at 2:00.  To my mind, Williams’ speech at 1:10pm is the most important story of the day, so we will need to pay close attention when he starts speaking.

Overall, it appears that the dollar bulls have regained the upper hand and are slowly pushing the greenback higher versus most counterparts.  If Williams does agree tapering is needed, I expect the dollar to take another leg higher.  But if he is clear that there is no rush, especially with the delta variant impact, look for the dollar to cede some of its recent gains and equity markets to regain a little spring in their step.

Good luck and stay safe
Adf

Severely Distraught

At Jackson Hole, Powell explained
Inflation goals have been attained
But joblessness still
Is high, so they will
Go slow ere their bond buying’s waned

The market heard slow and they thought
The stock market had to be bought
So, prices keep rising
And it’s not surprising
The hawks are severely distraught

In my absence, clearly the biggest story has been Chairman Powell’s Jackson Hole speech, where he promised at some point that the Fed would begin to taper their bond purchases, but that it was still a bit too early to do so.  He admitted that inflation had achieved their target but was still quite concerned over the employment portion of the Fed’s mandate, hence the ongoing delay in the tapering.  And perhaps he was prescient as after Jackson Hole the NFP number was a massively disappointing miss, just 235K vs 733K median forecast.  And to be clear, that number was well below the lowest forecast of 70 estimates.  The point is, the evolution of the economy is clearly not adhering to the views expressed by many, if not most, FOMC members.  We have begun to see significant reductions in GDP growth forecasts for the second half of the year, with major investment banks all cutting their forecasts and the Atlanta Fed’s GDPNow number falling to a remarkably precise 3.661% for Q3.

With this as a backdrop, it can be no surprise that the dollar has fallen dramatically during the past two weeks.  For instance, in the G10, NOK (+4.2%) and NZD (+4.2%) both led the way higher as commodity prices rebounded, oil especially, and the US interest rates fell.  In fact, the only currency to underperform the dollar since my last note has been the Japanese yen (-0.15%), which is essentially unchanged.  The story is the same in the EMG space with virtually every currency rising led by ZAR (+6.9%) and BRL (+4.1%).  In fact, only Argentina’s peso (-0.65%) managed to decline over the previous two weeks.  The point is, the belief in a stronger dollar, based on the idea of the Fed tapering QE and then eventually raising interest rates, has come a cropper.  The question is, where do we go from here?

With Jay in the mirror, rearview
It’s Christine’s time, now, to come through
On Thursday we’ll hear
If she’s set to steer
The ECB toward Waterloo

As the market walks in after the Labor Day holiday in the US, we are seeing the beginnings of a correction of the past two week’s price action, at least in the FX markets.  Surveying the overnight data shows a minor dichotomy in Germany, where IP (+1.0%) rose a bit more than expected although the ZEW Surveys were both softer than expected.  Meanwhile, Eurozone GDP grew at a slightly better than previously reported 2.2% quarterly rate in Q2, although that does not include the most recent wave of delta variant imposed lockdowns.  In other words, we are no longer observing either uniform strength or weakness in the data, with different parts of each national economy being impacted very differently by Covid-19.  One other thing to note here is the decline in support for the ruling CDU party in Germany where elections will be held in less than two weeks.  It seems that despite 16 years of relative prosperity there, under the leadership of Chancellor Angela Merkel, the populace is looking for a change.  This matters to the FX markets as a change in German economic policy priorities is going to have a major impact on the Eurozone, and by extension the euro.  Of course, at this point, it is too early to tell just what that impact may be.

Of more immediate interest to the market will be Thursday’s ECB meeting, where, while policy settings will not be altered, all eyes and ears will be on Madame Lagarde to understand if the ECB, too, is now beginning to consider a tapering of its QE purchases.  Last week, CPI data from the Eurozone printed at 3.0%, its highest level since September 2008, and well above the ECB’s 2.0% target (albeit not quite as far above as in the US).  This has some of the punditry starting to expect that the ECB, too, is ready to begin to taper QE.  However, the Eurozone growth impulse remains significantly slower than that in the US, and with the area unemployment rate still running at an uncomfortably high 7.6%, (much higher in the PIGS), it remains difficult to see why they would be so keen to begin removing accommodation.  Given the ECB storyline, similar to the Fed, is that inflation is transitory, there is no reason to believe the ECB is getting set to move soon.  Rather, I expect that although the PEPP may well end next March on schedule, it will simply be replaced with either an extension or expansion of the original APP, and likely both.  The reality is that the bulk of the Eurozone would see a collapse in growth without the ongoing support of the ECB.

Turning away from that happy news, a quick survey of markets shows that equities in Asia have continued their recent strong performance (Nikkei +0.9%, Hang Seng +0.7%, Shanghai +1.5%), all of which have rallied sharply in the past two weeks.  Europe, however, has not embraced today’s data, or is nervous about potential ECB action, as markets there are a bit softer (DAX -0.3%, CAC -0.1%, FTSE 100 -0.4%).  US futures markets are essentially unchanged at this hour, continuing their recent very slow grind higher.

Of more interest today is the bond market, where Treasury yields have rallied 4.1 basis points and we are seeing higher yields throughout Europe as well (Bunds +3.9bps, OATs +4.3bps, Gilts +3.2bps).  During my break, yields have managed to rally 10bps (including today) which really tells you that the market is still completely in thrall to the transitory story.  Either that, or the Fed continues to absorb any excess paper around.  However, higher yields seem to be helping the dollar more than other currencies despite similar size movements.

While the movement has not been significant, especially compared to the dollar weakness seen during the past two weeks, we are seeing strength in the dollar vs G10 currencies (AUD -0.5%, CAD -0.4%); EMG currencies (ZAR -0.6%, TRY -0.6%); and commodities (WTI -0.6%, Au -0.7%, Cu -1.1%).  Looking at today’s price action, it appears that US rate movement has been the dominant driver.

On the data front, it is a remarkably quiet week with just a handful of numbers:

Wednesday JOLTs Job Openings 10.0M
Fed’s Beige Book
Thursday Initial Claims 335K
Continuing Claims 2744K
PPI 0.6% (8.2% Y/Y)
-ex food & energy 0.5% (6.6% Y/Y)

Source: Bloomberg

We also hear from six Fed speakers, with NY President Williams the most important voice.  But thus far, the Fed’s messaging has been quite effective as they continue to assuage fixed income investors with the transitory tale and thus interest rates remain near their longer-term lows.  While at some point I expect this narrative to lose its hold on the investment community, it does not appear to be an imminent threat.

While I was out, the market flipped its views from concern over tapering leading to higher interest rates, to when tapering comes, it will be “like watching paint dry”*.  FX investors and traders determined there was no cause for a much stronger dollar, and so the buck gave back previous gains and now sits back in the middle of its trading range.  As such, we need to search for the next potential catalyst to change big picture views.  While my money is on the collapse of the transitory narrative, and ensuing dollar weakness, you can be certain the Fed will fight hard to keep that story going.  In other words, I expect that the trading range will remain intact for the foreseeable future.  Trade accordingly.

Good luck and stay safe
Adf

*June 15, 2017 comments from then Fed Chair Janet Yellen regarding the normalization of Fed policy and the balance sheet, where she described the process as similar to watching paint dry.  It turns out, that policy process was a bit more exciting, especially in Q4 2018 when equity markets fell 20% and Chair Powell was forced to abandon that policy.

Starting to Wane

The rebound is starting to wane
In England, in France and in Spain
But prices keep rising
With German’s realizing
They’ve not yet transcended their pain

First, some housekeeping, I will be on my mandatory two-week leave starting Monday, so there will be no poetry after today until September 7.

Meanwhile, this morning’s market activity is bereft of interesting goings-on, with very few stories of note as the summer holiday season is clearly in full swing.  Perhaps the three most notable events were UK Retail Sales, German PPI and new Chinese legislation.  Frankly, none of them paint a very positive picture regarding either the economy or markets going forward.

Starting at the top, UK Retail Sales (-2.4% in July) fell short of expectations, with the Y/Y reading back down to +1.8% from a revised +6.8% and the universal description of the situation as the reopening rebound is over.  The spread of the delta variant continues to add pressure as closures are dotted throughout the country, and sentiment seems to be turning lower.  It ought be no surprise that the pound (-0.15%) has fallen further, taking its month-to-date losses to 2.5%.  Too, the FTSE 100 (-0.2%) is under pressure, although it does remain in a broader uptrend, unlike the pound.  However, the first indication here is that risk is being sold off, which seems a pretty good description of the day.

Next, we turn to Germany’s PPI reading (10.4% Y/Y, 1.9% M/M) which is actually the largest annual rise since January 1975, where prices were impacted by the oil crisis!  While we have all been constantly reassured that inflation is a fleeting event and there is absolutely no indication that the ECB will see this number and consider tightening policy in any way, shape or form, I suspect that the good people of Germany may see things a bit differently.  The chatter from Germany is a growing concern over rapidly rising prices with a real chance of political fallout coming.  Remember, Germany goes to the polls next month in an effort to replace Chancellor Merkel, who has been running the country for the past 16 years.  Currently no candidate looks particularly strong, so a weak coalition seems a very possible outcome.  It is not clear that a weakened Germany will be a positive for the euro, which while unchanged on the day has been trending steadily lower for the past two months and yesterday broke below, what I believe is, a key support level at 1.1704.  Look for further declines here.

And finally, the Chinese passed a stricter personal data protection law prohibiting private companies from collecting and keeping data on their customers without explicit permission, a practice that had heretofore been commonplace. This appears to be yet another attack on the tech sector in China as President Xi ensures that the Chinese tech behemoths are disempowered.  After all, similarly to the US, the value of the big platforms comes from these companies’ abilities to compile and monetize the meta-data they collect by using it for targeted advertising.  Of course, the law says nothing about the Chinese government collecting that data and maintaining it, as that is part and parcel of the new normal in China.  One cannot be surprised that Chinese equity markets continue to decline on the back of these ongoing attacks against formerly unsullied companies, with the Hang Seng (-1.85%) now lower by 21% from its peak in February, and showing no signs of stopping as international funds flow out of the country.  Shanghai (-1.1%) also fell sharply, but given this index has more SOE’s and less tech, its decline from its February peak is only 9%.  As to the renminbi, it softened a bit further and is pushing slowly back above 6.50 at this time, its weakest level since April.

Otherwise, nada.  Equity markets are in the red everywhere, with the Nikkei (-1.0%) also slipping and we are seeing losses throughout Europe (DAX -0.4%, CAC -0.3%, FTSE 100 -0.2%) as well.  US futures, too, are pointing lower, with all three indices looking at 0.4% declines.  Of course, yesterday, things looked awful at this hour and both the NASDAQ and S&P 500 managed to close higher on the day, albeit only slightly.

Bonds are definitely in the ascendancy with yields continuing to slide.  Treasury yields are lower by 1.5 bps, Bunds and OATs by 0.5bps and Gilts by 2.0bps.  The question to be asked here, though, is, does this represent confidence that inflation is truly transitory?, or is this a commentary on future economic activity?, or perhaps, is this simply the recognition that central banks have distorted these markets so much they no longer give useful signals?  Whatever the underlying driver, the reality of bonds’ haven appeal remains and given the signals from the equity market, falling bond yields are not a big surprise.

Commodity prices remain under pressure generally, with oil (-0.8%) continuing its recent decline.  After a massive rally from last November through its peak in early July, crude has fallen 17% as of this morning.  In this case, while I understand the story regarding weakening economic growth, it seems to me the long term picture here remains quite positive as the Biden administration’s efforts to end oil production in the US, or at the very least starve it of future growth, means that supply is going to lag demand for years to come.  That implies higher prices are on the way.  As to the rest of the space, gold (+0.25%) continues to trade in its 1775-1805 range since mid-June with the exception of the two-day blip lower that was quickly erased.  Copper’s recent downtrend remains intact although it has bounce 0.3% this morning, and the rest of the industrial metals are either side of unchanged.

The dollar is broadly stronger this morning, with CAD (-0.7%) the weakest of the G10 currencies, clearly suffering from oil’s decline but also, seemingly, from self-inflicted wounds regarding its draconian Covid policies.  The Loonie has now fallen 4.25% this month with half of that coming in just the last two sessions.  But we are seeing continued weakness throughout the commodity bloc here with NOK (-0.45%) and AUD and NZD (both -0.3%) continuing their recent declines.  On the plus side, only CHF (+0.2%) has shown any strength of note.

Emerging market currencies are also under pressure this morning led by ZAR (-0.6%) and MXN (-0.4%) as softer commodity prices weigh heavily here.  We also continue to see weakness in some APAC currencies, with IDR (-0.35%) and KRW (-0.3%) suffering from concerns over the ongoing spread of the delta variant and the corresponding investor funds outflow from those nations.  On the flipside, PHP (+0.35%) was the only gainer of note in the region after the government loosened some Covid restrictions.

There is no economic data today and only one Fed speaker, Dallas Fed President Kaplan.  Of course, Kaplan has been the most vocal calling for tapering, so we already know his view, and after the Minutes from Wednesday, it seems he has persuaded many of his colleagues.  But once again I ask, if the economy is slowing, which I believe to be the case, will the Fed really start to remove accommodation?  I don’t believe that will be the case.  However, for now, the market is likely to bide its time until next week’s Jackson Hole speech by Powell.  Beware summer choppiness due to lack of liquidity and look for the current dollar uptrend to continue while I’m away.

Good luck, good weekend and stay safe
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To Taper’s Ordained

The Minutes on Wednesday explained
That QE would still be sustained
But ere this year ends
Some felt that the trends
Implied that, to taper’s, ordained

But ask yourself this, my good friends
What happens if tapering sends
The stock market down
Will they turn around
And restart QE as amends?

Remember all the times the Fed tried to tell the world that their current policy stance, notably the massive amount of QE purchases, were not the driving force in the equity market?  Stock market bulls played along with this as well, explaining that historically high valuation measures were all appropriate given the huge corporate profit margins, and had nothing to do with the Fed’s suppression of interest rates along the entire yield curve.  The bulls would point to 30-year interest rates below 2.00% and explain that when you discounted future cash flows at such low levels, it was only natural that stock valuations were high.  The fact that it was the Fed that was simultaneously buying up all the net Treasury issuance, and then some, thus driving rates artificially lower, as well as promising to do so for the foreseeable future was seen as a minor detail.

Perhaps that detail was not as minor as the bulls would have you believe!  Yesterday, the FOMC Minutes were released and the part that garnered all the attention was the discussion on the current asset purchase framework and how it might change in the future.

“Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met. At the same time, most participants remarked that this standard had been achieved with respect to the price- stability goal. (my emphasis) A few participants noted, however, that the transitory nature of this year’s rise in inflation, as well as the recent declines in longer-term yields and in market-based measures of inflation compensation, cast doubt on the degree of progress that had been made toward the price-stability goal since December.”

So, it seems they are in sync on the fact that the employment situation has room to run, and they don’t want to act too early because of that.  But what I find more interesting is that they can use the term ‘price stability’ when discussing inflation running in the 4.0%-5.0% range.  As well, it is apparent that many of the committee members are drinking their own Kool-Aid on the transitory story.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year because they saw the Committee’s “substantial further progress” criterion as satisfied with respect to the price-stability goal and as close to being satisfied with respect to the maximum employment goal. Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year because they saw prevailing conditions in the labor market as not being close to meeting the Committee’s “substantial further progress” standard or because of uncertainty about the degree of progress toward the price-stability goal.” (my emphasis)

But this was the money line, the clear talk that most of the committee expected tapering to begin before the end of the year.  While we have not yet heard any of the three key leaders (Powell, Williams and Brainerd) say they were ready to taper, it seems that most of the rest of the committee is on board.  Jackson Hole suddenly became much more interesting, because if Powell discusses tapering as likely to occur soon, it will be a done deal.  But if he doesn’t explain that tapering is coming soon, it is possible that we see four dissents, at the next meeting.  And how about this for a thought, what if those three are the only votes to stand pat, and the other six voting members want to start the taper?  That would truly be unprecedented and, I think, have major negative market ramifications.  I don’t expect that to occur, but after everything that has occurred over the past 18 months, I wouldn’t rule out anything anymore.

At any rate, the tapering talk remains topic number one in every market, and one cannot be surprised that the market’s reaction has been a clear risk-off response.  Equity markets around the world are lower, substantially so in Europe; bond markets are rallying as risk is jettisoned; commodity prices are falling, and the dollar is king!

So, let’s take a tour and see where things are.  Starting in Asia, we saw equities decline throughout the region with the Nikkei (-1.1%), Hang Seng (-2.1%) and Shanghai (-0.6%) all under pressure.  But the real pressure was felt in Korea (KOSPI -1.9%) and Taiwan (TAIEX -2.7%).  In fact, the only markets in the region to hold their own were in New Zealand.  Turning to Europe, it is a uniform decline with the DAX (-1.6%), CAC (-2.5%), and FTSE 100 (-2.0%) all falling sharply, with the lesser known indices also completely in the red.  I guess the prospect of less Fed largesse is not seen as a positive after all.  Meanwhile, ahead of this morning’s opening, US equity futures are all sharply lower, on the order of 0.75%.

Turning to the bond market, the prospect of less Fed buying is having an interesting outcome, bonds are rallying.  Of course, this is because Treasuries remain the ultimate financial safe-haven trade and as investors flee risky assets, bonds are the natural response.  So, 10-year Treasury yields have fallen 3.5bps, and we are seeing yields decline in the European market as well, at least those countries that are deemed solvent.  So, Bunds (-1.4bps), OATs (-1.1bps) and Gilts (-3.4bps) are all seeing demand.  Yields for the PIGS, however, are unchanged to higher on the day.

Commodity prices are uniformly lower, except for gold, which is essentially unchanged on the day.  Oil (-3.7%) leads the way down, but we are seeing weakness in base metals (Cu -3.3%) as well as the Agricultural space (Wheat -1.5%, Soybeans -1.2%).

Finally, the dollar is on top of the world this morning, as investors are buying dollars to buy bonds, or so it seems.  In classic risk-off fashion, only the yen (+0.1%) has managed to hold its own vs. the dollar as the rest of the G10 bloc is weaker led by NOK (-0.95%) and AUD (-0.95%).  NZD (-0.7%) and CAD (-0.7%) are also suffering greatly given the commodity weakness story.  But do not ignore the euro (-0.15%) which while it hasn’t moved very far, has managed to finally trade below the key 1.1704 support level, and is set, in my view, to head much lower.

In the EMG space, ZAR (-1.3%) is the leading decliner, falling alongside the commodity complex.  KRW (-0.7%) has given back all of yesterday’s gains as equity outflows continue to dominate the market there, but we are seeing weakness across the board with most currencies falling between 0.3%-0.6% purely on the dollar’s overall strength.

On the data front, this morning brings the weekly Initial Claims (exp 364K) and Continuing Claims (2.8M) as well as Philly Fed (23.1) and Leading Indicators (+0.7%).  There’s no scheduled Fedspeak, but what else can they say after yesterday’s Minutes anyway?  If you recall, Monday’s Empire Mfg was quite weak, so I would not be surprised to see Philly follow suit.  In fact, I think the biggest problem the Fed is going to have is that the data is rolling over and looking like a slowing economy, despite high inflation.  If they keep seeing economic weakness, are they really going to taper into a weakening economy?  They may start, but I doubt they get two months in before they stop, especially if equities continue to revalue (fall).  As to the dollar, for now, I like its prospects and suspect that we are going to trade to levels not seen since June of last year.

Good luck and stay safe
Adf