Author Archives: fxpoet

It’s Still Transitory

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Said Jay, I’m not worried ‘bout wages
Creating inflation in stages
I’ll stick to my story
It’s still transitory
And will be for many more ages

So now it’s the Old Lady’s turn
To help explain if her concern
‘Bout rising inflation
Will be the causation
Of rate hikes and trader heartburn

Like a child having a temper tantrum, the Fed continues to hold its breath and stamp its feet and tell us, “[i]nflation is elevated, largely reflecting factors that are expected to be transitory. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to a sizable price increase in some sectors.” [my emphasis.]  In other words, it’s not the fault of their policies that inflation is elevated, it’s the darn pandemic and supply chain issues.  (This is remarkably similar to how the German Reichsbank president, Rudy Havenstein, behaved as that bank printed trillions of marks fanning the flames of the Weimar hyperinflation.  At every bank meeting the discussion centered on rising prices and not once did it occur to them that they were at fault by continuing to print money.)

Nonetheless, Chairman Powell must be extremely pleased this morning as he was able to announce the tapering of QE purchases, beginning this month, and equity and bond markets responded by rallying.  There was, however, another quieter announcement which may well have helped the cause, this one by the Treasury.  Given the rally in asset prices, collection of tax receipts by the government has grown dramatically and so the Treasury General Account (the government’s ‘checking’ account at the Fed) is now amply funded with over $210 billion available to spend.  This has allowed the Treasury to reduce their quarterly refunding amounts by…$15 billion, the exact amount by which the Fed is reducing its QE purchases.  Hmmmm.

So, to recap the Fed story, the tapering has begun, inflation is still transitory, although they continue to bastardize the meaning of that word, and they remain focused on the employment situation which, if things go well, could achieve maximum employment sometime next year.  Rate hikes will not be considered until they finish tapering QE to zero, and they will taper at the pace they deem correct based on conditions, so the $15 billion/month is subject to change.  One more thing; when asked at the press conference about inflation rising faster than anticipated, Powell responded, “We think we can be patient.  If a response is called for, we will not hesitate.”  Them’s pretty big words for a guy who can look at the economy’s behavior over the past twelve months and decide that inflation remains only a potential problem.

Enough about Jay, he’s not going to change, and in my view, he only has two meetings left anyway.  Consider this; President Biden needs to get the progressives onboard to have any chance of passing any part of the current spending bills and in order for them to compromise on that subject, they will want something in return.  They also hate Powell, as repeatedly vocalized by Senator Warren, so it is easy to foresee the President sacrificing Powell for the sake of his spending bill.  Especially given the results of the Virginia elections, which moved heavily against the Democrats, the administration will want to get this done before the mid-term elections next year.  I think Powell is toast.

On to the rest of the central bank world where this morning the BOE will announce their latest decision.  The market continues to be about 50/50 on a rate hike today, but have fully priced one in by December, so either today or next month.  Interestingly, the UK Gilt market is rallying this morning ahead of the announcement, with yields lower by 3.1 basis points.  What makes that so interesting is that the futures market is pricing in 100 basis points of rate hikes by the BOE within the next 12 months, which would take the base rate up to 1.0%.  Right now, 10-year Gilt yields are 1.03%.  If the futures market is right, then either Gilts are going to sell off sharply as the yield curve maintains its current shape or the market is beginning to price in much slower growth in the UK.  My money is on the latter as the UK has proven itself to be willing to fight inflation far more strenuously than the Fed in the past.  If slowing growth is a consequence, they will accept that more readily I believe.

Still on the central bank trail, it is worth highlighting that Poland’s central bank raised rates by 0.75% yesterday in a huge market surprise as they respond to quickly rising inflation.  Concerns are that CPI will reach 8.0% this year, so despite the rate hike, there is still much work to do as the current base rate there, after the hike, is 1.25%.  This morning the Norgesbank left rates on hold but essentially promised to raise them by 25bps next month to 0.50%. While they are the first G10 country to have raised interest rates, even at 0.50%, their deposit rate remains far, far below CPI of 4.1%.

So, to recap, central banks everywhere are finally starting to move in response to rapidly rising inflation.  While some countries are moving faster than others, the big picture is rates are set to go higher…for now.  However, when economic growth begins to slow more dramatically, and it is already started doing so, it remains to be seen how aggressive any central bank will be, especially the Fed.

Ok, let’s look at today’s markets.  As I said earlier, equities are rocking.  After yesterday’s US performance, where all 3 major indices reached new all-time highs, we saw strength in Asia (Nikkei +0.9%, Hang Seng +0.8%, Shanghai +0.8%) and Europe (DAX +0.5%, CAC +0.5%, FTSE 100 +0.2%).  US futures, on the other hand, are mixed with NASDAQ (+0.5%) firmer while the other two indices are little changed.

Bond prices have rallied everywhere in the world, which given the idea of tighter policy seems incongruent.  However, it has become abundantly clear that bond prices no longer reflect market expectations of inflation, but rather market expectations of QE.  At any rate, Treasuries (-3.5bps) are leading the way but Gilts (-3.1bps), Bunds (-1.7bps) and OATs (-1.8bps) are all seeing demand this morning.

After yesterday’s confusion, commodity prices are tending higher this morning with oil (+1.7%) leading the way, but gains, too, in NatGas (+0.75%), gold (+0.5%) and copper (+0.6%).  Agricultural products are mixed, as are the rest of the industrial metals, but generally, this space has seen strength today.

As to the dollar, it is king today, firmer vs. virtually every other currency in both the G10 and EMG blocs.  The euro (-0.6%) is the laggard in the G10 as the market is clearly voting the ECB will be even more dovish than the Fed going forward.  But the pound (-0.4%) is soft ahead of the BOE and surprisingly, NOK (-0.4%) is soft despite both rising oil prices and a relatively hawkish Norgesbank.  The best performer is the yen, which is essentially unchanged today.

In the EMG space, PLN (-1.0%) and HUF (-1.0%) are the laggards as both countries grapple with much faster inflation and lagging monetary policy.  But CZK (-0.7%) and TRY (-0.65%) are also under relative pressure as their monetary policies, too, are lagging the inflation situation.  Throughout Asia, most currencies slid as well, just not as much as we are seeing in EEMEA.

On the data front, Initial Claims (exp 275K) headlines this morning along with Continuing Claims (2150K), Nonfarm Productivity (-3.1%), Unit Labor Costs (7.0%) and the Trade Balance (-$80.2B).  It is hard to look at the productivity and ULC data and not be concerned about the future economic situation here.  Rapidly rising labor costs and shrinking productivity is not a pretty mix.  As to the Fed, mercifully there are no additional speakers today, so we need look only at data and market response.

Clearly market euphoria remains high at this time, and so further equity gains seem likely.  Alas, the underlying structure of things does not feel that stable to me.  I expect that we are getting much closer to a more substantial risk-off period which will result in a much stronger dollar (and yen), and likely weaker asset prices.  For hedgers, be careful.

Good luck and stay safe
Adf

Feathered and Tarred

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Extinct

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Qui Vive!

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“Inflation, inflation, inflation”
Lagarde explained might have duration
That’s somewhat extended
Before it has ended
But truly tis an aberration

Yet traders have come to believe
That Madame Lagarde is naïve
Though she’s been dogmatic
That rates will stay static
Investors are shouting qui vive!

It appears that, if anything, the gathering storm of interest rate hikes has done nothing but strengthen in my absence.  Inflation continues to be THE hot topic in markets, and central banks are finding themselves in uncomfortable positions accordingly.  Some, like the RBA, BOC and BOE, have either given up the ghost on the transitory idea and are moving or preparing to do so in order to address what has clearly become a much bigger problem.  Others, notably the ECB, remain ostrich-like and refuse to accept the idea that their policy responses to the pandemic induced government shutdowns and fiscal policy boosts have actually been quite inflationary.  In the face of the ever-increasing inflation numbers around the world, investors are flattening yield curves aggressively, with 2-year yields skyrocketing while 10-year and beyond yields drift lower.  At this point, yield curve inversion remains only a distant possibility, but one that is far more likely than had been the case just two weeks ago.  Ultimately, the market’s collective concern is that despite a slowing growth impulse, central banks will be forced to respond to the inflation data thus crimping future growth.  The major risk is they will ultimately slow growth with only a limited impact on prices thus exacerbating the situation.  Right now, it is not that much fun to be a central banker.

A quick recap shows that last week, Madame Lagarde pooh-poohed the idea that the market knew what it was doing by driving rates higher.  She whined that traders were not listening to the ECB’s forward guidance, which she claims shows rates are in no danger of being raised anytime soon.  However, futures traders in Europe are pricing in a 10bp rate hike by next summer, shortly after the PEPP expires.  Meanwhile, 10-year Bund yields, which have been negative since May 2019, have rallied to -0.10% and seem on the verge of returning to positive territory.  Of course, 2-year Bund yields have risen 30bps in the past 3 months as that curve flattens as well.  (As an aside, the FX market had a little hiccup here as well, with the euro rallying sharply after the Lagarde comments, only to give all that back and then some on Friday in the wake of higher than forecast PCE data from the US which has traders betting on more than 50bps of Fed Funds hikes in 2022 and another 100 basis points in 2023.

With that as backdrop, we have two major and one lesser central bank meetings this week, the RBA tonight, the FOMC on Wednesday and the BOE on Thursday.  While we will discuss the latter two at further length over the next several days, the current thinking is that the Fed will announce the timing of the tapering of QE while the market has the BOE as a 50-50 proposition to actually raise the base rate by 0.15%, returning it to 0.25%.

Beyond the central bank drama, we continue to see troubling economic statistics with US GDP growth slowing to 2.0% in Q3, a far cry from its 6.7% Q2 rate, while Chinese Manufacturing PMI fell to 49.2 and German Retail Sales fell -2.5% in September.  On the whole, the stagflation story continues to be the hottest ticket around both anecdotally and based on Google Trends.

As you can see, there is much to be discussed as the week progresses, but for now, let’s take a look at today’s markets.  Despite all the concerns over stagflation, which should theoretically be awful for equities, the US stock market knows no top and that continues to pull most other markets along for the ride.  In fact, last night, the only real issues were in China where the Hang Seng (-0.9%) and Shanghai (-0.1%) suffered as yet another Chinese real estate development company (Yango Group) is on the verge of defaulting on its debts.  However, the Nikkei (+2.6%) rallied strongly on the back of the LDP’s surprising retention of a majority (albeit reduced) of the Diet in weekend elections.  In Europe, though, there is nothing holding back equity investors with all markets in the green (DAX +0.85%, CAC +1.0%, FTSE 100 +0.5%) as bad data is ignored.  While Q3 earnings have been solid, it does seem that prospects going forward are more limited, however investors seem unconcerned for now.  And don’t worry, US futures are all firmly in the green, higher by around 0.4% at this point in the morning.

Given the risk on attitude that we have seen this morning, it is no surprise that bonds are selling off with yields backing up a bit.  Treasury yields (+2.3bps) are a bit higher but still well off the highs seen two weeks’ ago.  Across Europe, sovereign yields (Bunds +1.4bps, OATs +1.7bps and Gilts (+3.0bps) are also firmer in sync with the risk attitude as we see the entire continent’s bonds come under pressure.  One other noteworthy mover were Australian bonds (-18.3bps) which retraced 2/3 of the yield spike from last week as the market prepares for the RBA meeting tonight. You may recall that the RBA had been implementing YCC in the 3yr, seeking to hold that yield at 0.10%.  However, as inflation rose, so did that yield, finally spiking last week as market participants decided the RBA would change tactics, and the RBA did not push back.  Governor Lowe has his work cut out for him this tonight in explaining what the RBA will be doing next.

Turning to commodities, oil prices (+0.5%) are rising this morning and seem to be getting set to break the recent highs and start a new leg toward, dare I say it, $100/bbl.  Overall, however, the commodity complex is directionless today with NatGas (-1.4%) lower, gold (+0.2%) higher, copper (-0.1%) lower, the ags mixed as well as the other non-ferrous metals.  In other words, today seems to be far more noise than signal.

Finally, the dollar, too, seems confused today, with both gainers and losers abounding in both the G10 and EMG spaces.  In the G10, NOK (+0.25%) is the leader as it responds to oil’s rally, while JPY (-0.3%) is the laggard, I assume responding to the election results and the broader positive risk sentiment.  The rest of the bloc is well within those bounds and other than the data mentioned, doesn’t seem to have much short-term direction.

EMG currencies have shown a bit more movement, with TRY (+0.7%) the leader followed by CZK (+0.45%).  The Turkish story seems confused as the two data points showed PMI falling compared to last month and Inflation rising, neither of which would seem to benefit the lira, but there you go!  Meanwhile, the Czech budget deficit is expected to shrink somewhat as traders push the currency higher.  On the downside, there are a few more from which to choose as THB (-0.8%) is the worst performer followed by KRW (-0.7%) and ZAR (-0.6%).  The baht suffered as international investors sold stocks and bonds locally and repatriated currency.  Korea’s won seemed to suffer on broader based dollar strength despite decent export data, but talk is the future looks dimmer as growth around the world slows.  Meanwhile, the rand fell over ongoing concerns that the SARB, when it meets later this month, will disappoint on the rate rise front.

It is, of course, a big data week between the Fed and Friday’s NFP report:

Today ISM Manufacturing 60.5
IS Prices Paid 82.0
Wednesday ADP Employment 400K
ISM Services 62.0
Factory Orders 0.0%
FOMC Rate decision 0.00%-0.25%
Thursday Initial Claims 275K
Continuing Claims 2136K
Nonfarm Productivity -3.2%
Unit Labor Costs 6.9%
Trade Balance -$79.9B
Friday Nonfarm Payrolls 450K
Private Payrolls 400K
Manufacturing Payrolls 28K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.8%

Source: Bloomberg

Obviously, the FOMC on Wednesday is the primary focus closely followed by Friday’s payroll report.  Before then, tonight’s RBA meeting will have the market’s attention and we cannot forget the BOE on Thursday.  All in all, it could be quite an eventful week.  As to the dollar, for now, especially against the euro, it feels like there is further room for appreciation as the market continues to see the Fed as far more hawkish than the ECB.  Quite frankly, I think both sides of that discussion will be comfortable with the outcome as a stronger dollar should help check inflation while a weaker euro can help rekindle the export engine.  Look for it to continue.

Good luck and stay safe
Adf

Costs are Aflame

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The central banks of the G10
Are starting to realize the ‘when’
Of interest rate rises
To forestall a crisis
Is sooner than they thought back then

Inflation breakevens keep rising
While companies are proselytizing
That they’re not to blame
As costs are aflame
Thus CB’s, their plans, are revising

It is difficult to scan a news source these days without seeing a story of how some company or another is raising their prices by X% due to increased shipping/raw material costs/labor costs.  And the reporter doesn’t really have to look that hard for the typical anecdotes that accompany this type of story since the situation has become increasingly prevalent.  Just this morning I read about Unilever, WD-40 and P&G all explaining that prices have not only already risen but would be rising further in the months ahead.  Obviously, this does not bode well for the transitory narrative, which is in its death throes.  That being said, it is still not the universal opinion of all Fed members.  For instance, yesterday NY Fed president John Williams exclaimed that long-term inflation expectations have risen to levels “consistent with the 2% goal.”  Now, I’m not sure what long-term expectations he is looking at, but yesterday, the 5-year/5-year inflation rate in the US Treasury market closed at 2.915%, its highest level since the series began in 2002.  The 19-year history of this measure shows an average of 1.85%, which seems more in line with Williams’ comments.  But one must be willfully blind to look at the chart of this series and claim inflation expectations remain sedate.

The risk for the central banks that maintain inflation is not a growing issue is loss of whatever credibility they have remaining.  And the upshot is, markets are not listening to them anymore and have begun to price in more aggressive rate hikes around the world.  In the US, the first rate hike is priced for next July, right about the time the Fed previously expected to finish tapering.  And there is a second hike priced in before the end of 2022.  In the UK, the first hike is priced for this December with three more expected by next September.  Even in the Eurozone, a full hike is priced in by the end of next year, something that not a single ECB banker has expressed, and in fact, several have categorically denied.

At the same time, longer term yields are rising as well, with 10-year Treasuries up to 1.68% even after having fallen 2.1 bps in the overnight session.  German bunds, while still negative (-0.09%) are at their highest level since May 2019, which was the last time their yield was at 0.0%.  And we are seeing similar price action across Gilts, OATs and Australian GBs.  (The latter despite the fact that the RBA remains adamant that they will not be raising interest rates until 2024.  Methinks they will have some crow to eat on that subject.)

The problem for central banks, and their respective governments, is that given the extraordinary amount of debt outstanding, higher yields can quickly become a problem.  So, ask yourself how can a central bank prevent rising yields without raising front end rates or expanding their balance sheets further?  You will not like this answer but here is a taste of what could be coming our way; regulatory changes that force institutions to buy government bonds.  Consider the ease with which central banks could require commercial banks to expand the ratio of government bonds in their asset portfolio, or insurance companies or pension funds or all three.  Financial repression can take form in many ways, and this would likely be the first step.  After all, for the average person, this is a relatively esoteric process and would not likely be widely understood hence would not cause an uproar.  Of course, all those insurance company and pension fund portfolios that needed to replace stock holdings with bonds would result in some pretty big selling pressure in the equity market, which would get a little more press.  But central banks wouldn’t get the blame as they are one step removed from the process.  In their eyes, this would be a win-win.

The implication is not that this is imminent, just that it is a possible pathway in the future, and one that seems more and more likely as inflation drives yields higher.  However, for now, the market is still of the belief that central banks will be forced to raise rates and are pricing accordingly.  Given the widespread nature of this belief set, the relative impact on currencies remains muted.  However, if US rates continue to lead the way higher, I think the dollar will continue to see the most support.

Ok, a quick look at today shows that despite the gathering inflation clouds, risk is in vogue with equities generally higher and bonds generally softer.  Last night saw modest gains in the Nikkei (+0.35%) and Hang Seng (+0.4%) although Shanghai (-0.35%) continues to feel the pain of the property situation in China. (As an aside, Evergrande made a surprise partial payment on the USD bond coupon that had been overdue and was about to trigger a default. So, it lives to default another day.)  Europe, too, is having a generally positive session with the CAC (+1.1%) leading the way higher but strong gains in the DAX (+0.7%) and FTSE 100 (+0.55%).  Here, the data released was the preliminary PMI data, which was best described as mixed compared to forecasts, but broadly softer compared to last month, and continues to trend lower.  The outlier here was the UK, which had stronger PMI data, but much weaker than expected Retail Sales data, so perhaps offsetting news.  As to US futures markets, the are either side of unchanged at this hour after this week’s rally.

Bond markets throughout the continent are seeing selling pressure with yields rising (Bunds +1.7bps, OATs +1.6bps) but Gilts (-0.8bps) have a bid along with Treasuries (-2.1bps).  The trend, though remains for higher yields as investors respond to rising inflationary forecasts.  Central banks have their work cut out for them if they want to maintain control of these markets.

In the commodity markets, oil (+0.4%) and NatGas (+0.8%) are back in the green as are copper (+0.75%) and gold (+0.55%).  In fact, pretty much the entire complex including industrial metals and agricultural products are all firmer this morning.

Finally, the dollar is softer across the board in the G10, with AUD (+0.45%) the leading gainer on the back of the commodity picture, followed by SEK (+0.35%) and NOK (+0.35%) which are similarly well situated.  The pound (+0.05%) is the laggard as the Retail Sales data seems to have undermined some bullish views.  In the emerging markets, there are two outliers, one in each direction.  The only loser of the day is TRY (-1.0%) which continues to suffer from yesterday’s surprising 200bps rate cut.  Meanwhile, RUB (+1.4%) has been the leading gainer after the Bank of Russia surprised the market with a 75bp rate hike, much larger than the 25bp-50bp that had been forecast.  Adding that to the price of oil has been an unalloyed positive.  Away from those two, however, gains are modest with ZAR (+0.35%) the next best performer following commodity prices higher.

Preliminary PMI data is the only thing on the docket data wise this morning, but Chairman Powell speaks at 11:00 as the final speaker before the quiet period begins.  Given the differences we heard from Williams and Waller, it will be very interesting to see if Powell is more concerned about inflation or employment.

As such, I expect a muted morning ahead of Powell’s comments and then the opportunity for some activity if he substantially changes the narrative.  My sense is that any change would be hawkish and therefore a dollar positive.

Good luck, good weekend and stay safe
Adf

PS, I will be out of the office next week so no poetry again until November 1st.

A Touch of Despair

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The Beige Book detected the fact
That bottom lines all have been whacked
As wages explode
While growth, somewhat, slowed
Inflation, it seems, ain’t abstract

Meanwhile we heard from a vice-Chair
Whose words had a touch of despair
It seems he now thinks
There just might be links
Twixt QE and price everywhere

Chairman Powell’s comments due tomorrow are taking on much greater importance than just a few days ago as the Fed narrative is seemingly in the middle of a change.  While many have been willing to dismiss the fact that the regional Fed presidents have been more hawkish lately, leading the charge for the beginning of tapering, the Fed governors had been far more sanguine on the subject, at least until very recently.  Tuesday, we heard from Governor Waller about his concerns that inflation could be more persistent, especially if one looked at the headline measures as he dismissed the other measures as efforts at manipulation.  Yesterday it was vice-Chair Quarles’ turn to put the market on notice that inflation’s persistence has begun to become troublesome and while he still felt price pressures would abate next year, his level of confidence in that forecast was clearly declining.  Both of them hinted at the possible need for rate hikes sooner than previously expected.

Yesterday, too, the release of the Fed’s Beige Book presented a clear picture of two issues: wages were rising rapidly, and growth was slowing.  The problem stems from the fact that despite wage increases of 20% or more, companies are still having a problem staffing up to desired levels and that has led to reduced output.  It has also led to business after business explaining that they would be raising prices to offset increased costs for not just wages, but raw materials and shipping.  In your Economics 101 textbook (likely Samuelson’s) this was the very definition of a wage-price spiral.

It is this recent hawkish turn by several Fed governors that brings even greater attention to Chairman Powell’s comments tomorrow.  The market is already assuming that tapering will begin next month, but the question remains, will the Fed be able to continue along that line if economic activity continues to slide?  I raise this issue because after Tuesday’s weaker than expected housing data, the Atlanta Fed’s GDPNow indicator has fallen to 0.533% for Q3.  And that’s an annual rate, down from Q2’s 6.8% GDP growth.  It appears the Fed may have a difficult decision to make in the near future; fight rapidly rising inflation or fight rapidly slowing growth. As I’ve written before, stagflation is a b*tch.

Adding to the economic problems is the continued slowing of growth in China where ongoing power shortages combined with a resurgence of Covid related shutdowns and the implosion of China Evergrande have resulted in the slowest, non-Covid, growth in decades.  At the same time, the PBOC continues to drain liquidity from the economy in an effort to reduce leverage which has the effect of further slowing activity there.  Given China has been the global growth engine for at least the past decade, a slowdown there means we are going to see slower activity everywhere else.  Alas, for the central banking community, it is not clear that will help price pressures abate, not as long as energy and raw material prices continue to rise.

Summing it all up shows that growth worldwide is falling from Q2’s peak while price pressures are flowing from commodities to shipping and now wages.  All this is occurring with interest rates broadly at their lowest levels in history. (I know some countries have raised rates a bit, but the reality is there is far less room to ease policy than tighten overall.)  Given this backdrop, it remains amazing to me that equity markets worldwide have been able to continue to perform well.  And yet, they continue to do so broadly, albeit not last night.  However, I believe that interest rate markets are beginning to recognize that the future may not be so rosy as we are seeing yields continue to climb and inflation breakevens rise to levels not seen in nearly a decade.  Remember, there is no perpetual motion machine and no free lunch.  Central banks have spent the entire post GFC period continually supporting markets while allowing significant imbalances to develop across all segments of the economy and, ironically, markets.  I have often said the Fed’s biggest problem will arrive when they announce a policy change and the market ignores the announcement.  I fear that time is growing much nearer.

With those cheery thoughts to support us, let’s take a look at the overnight session.  It seems that risk is having a bit of a struggle today with most of Asia (Nikkei -1.9%, Hang Seng -0.5%, Shanghai +0.2%) under pressure and Europe (DAX -0.1%, CAC -0.4%, FTSE 100 -0.6%), too, having difficulty this morning.  US futures are also pointing lower, -0.3% or so across the major ones, which implies pressure at the opening at the very least.  China continues to be a drag on the global markets as other Chinese real estate companies are starting to fall and the word is Evergrande’s sales have fallen 97%.  I guess buying from a bankrupt company is not that attractive a proposition.

In a bit of a surprise, European sovereign bond yields are rising this morning (Bunds +1.6bps, OATs +1.2bps, Gilts +3.7bps) as ordinarily one would expect a rush into safe havens when risk is on the run.  However, as the EU begins another summit, it is likely to simply highlight the ongoing problems across the continent, notably in energy, and that seems to be sapping confidence from investors.  Treasury yields are very marginally softer on the day, so far, but with more and more Fed members talking up inflation worries, I expect they are likely to continue to rise for a while yet.

Commodity markets are under pressure today as well with oil (WTI -0.8%) and NatGas (-1.7%) leading the way, but weakness, too, in copper (-2.9%), aluminum (-0.3%) and all the main agriculturals (soy -0.7%, wheat -0.7%, corn -0.5%).  By contrast, gold’s unchanged price is looking good!

As to the dollar, it is broadly, though not universally, stronger this morning.  In the G10, AUD (-0.3%) and NZD (-0.3%) lead the way down with the rest of the commodity bloc also suffering a bit.  On the plus side, JPY (+0.25%) is the only gainer, which given equity price action seems pretty standard.  In the emerging markets, TRY (-2.4%) is the outlier after the central bank cut interest rates by 2.0%, double the expected outcome, to 16.0%, despite inflation running at 19.6% in September.  You may recall that President Erdogan fired several central bankers last week as they were clearly not willing to do his bidding.  There is nothing promising about the lira these days.  Aside from that, the rest of the space is softer led by ZAR (-0.7%) on weaker commodity prices, and PLN (-0.4%) as investors’ concerns grow that the EU is going to try to punish Poland for its recent court ruling that said EU law does not reign supreme in Poland.  Other movers have been less significant but are spread across all three geographies.

On the data front, this morning brings the weekly Initial (exp 297K) and Continuing (2548K) Claims numbers as well as Philly Fed (25.0), Leading Indicators (+0.4%) and Existing Home Sales (6.09M).  Of this group, I expect the Philly number will give the most information, but in truth, I believe traders and investors are more interested in hearing from Chris Waller again as well as NY Fed president Williams this morning to try to get any more information about the evolving Fed story.

Broadly speaking, I believe the US interest rate story continues to underpin the dollar and I see nothing to change that view.  The dollar has been trending higher since summer and while the last week has seen marginal dollar softness, I believe it is merely a good time to take advantage and buy dollars for receivables hedgers.

Good luck and stay safe
Adf

More Duration

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A governor, Fed, name of Waller
Who previously had been a scholar
Remarked that inflation
Might have more duration
Which could cause a weakening dollar

As well, he explained that his view
Was rate hikes just might soon ensue
Were that to transpire
Then yields would move higher
While equity losses accrue

In what can only be termed a bit surprising, Fed governor Chris Waller, the FOMC member with the shortest tenure, explained yesterday that he is “greatly concerned abut the upside risk that elevated inflation will not prove temporary.”  While refreshing, that is certainly a far cry from the narrative that the Fed has been pushing for many months.  Of course, if one simply looks at the inflation data, which has been trending sharply higher, it seems apparent that transitory is not an apt description.  As well, he is the first Fed member to be honest in the discussion about bottlenecks and supply chain issues as he commented, “bottlenecks have been worse and are lasting longer than I and most forecasters expected, and an important question that no one knows the answer to is how long these supply problems will persist.” [emphasis added].

During the entire ‘transitory inflation’ debate, the issue with which I most disagreed was the working assumption that these transportation bottlenecks and supply chain disruptions would quickly work themselves out.  It was as though the central bank community believed that because economic models explain that higher prices lead to increased production of those goods or services, the result was a magical appearance of additional supply to push prices back down.  Meanwhile, in the real world filled with regulations, restrictions and skill and resource mismatches and misallocations, these things can take a long time to correct themselves.  There is no little irony that government regulations regarding truck drivers have significantly reduced the supply of available truckers which has led to those very bottlenecks that are now bedeviling the economy (and government).  Alas, in the great Rube Goldberg tradition, rather than simplify processes to open up supply chains, it appears that government will be adding new regulations designed to offset the current ones which will almost certainly have other negative consequences down the road.

Finally, Governor Waller was refreshingly honest in his view of things like core inflation and trimmed-mean CPI or PCE calling them, “a way of manipulating data.”  Of course, that is exactly what they are.  Central banks have relied on these lower numbers as a rationale for continuing extraordinarily easy monetary policy despite the very clear rise in inflation.   And despite Mr Waller’s comments, the Powell/Yellen narrative remains inflation is not that high and anyway it’s transitory.

As it happens, though, the bond market seems to have been listening to Waller’s comments as it sold off pretty aggressively yesterday with yields backing up 4 basis points to their highest level since May.  While this morning Treasury yields are unchanged, it is becoming clear that a trend higher in yields is manifesting itself with the market clearly targeting the highs seen in March at 1.75%.

A fair question would be to ask if this price action is occurring elsewhere in the world and the answer would be a resounding yes.  For instance, UK Gilts, which today have actually fallen 3.1bps, are trending sharply higher over the past two months and are at their highest levels since early 2019.  Today’s UK CPI report showed inflation at 3.1%, which was a tick lower than forecast, but still well above their 2.0% target.  In addition, virtually the entire MPC has acknowledged that CPI is likely to rise above 4.0% by December with a very uncertain timeline to fall back.  Governor Bailey has made it clear that they will be raising interest rates at their next meeting in early November and there has been no pushback regarding the market pricing in 3 more rate hikes in 2022.

The upshot of all this is the carefully curated narrative by the Fed and its brethren is being destroyed by events on the ground and in addition to damage control, they are trying very hard to establish the new narrative.  However, it is not clear the market is going to be so willing to go along this time.  Too, all this price pressure is occurring with a backdrop of softening economic data, with yesterday’s Housing data the latest numbers to fall both from the previous month and below forecasts.  As I’ve written before, were I Chairman Powell, I wouldn’t accept renomination even if it is offered.  The Fed chair, when things hit the fan, will not have a very good time.

On the flip side of all this distress there is the equity market, which continues blithely along the trail of rallying on every piece of news, whether good or bad.  Now that we have entered earnings season, with expectations for a strong Q2 (after all, GDP grew at 6.8%), algorithms investors remain ready to buy more of whatever is hot.  Yesterday saw solid gains across all three US indices and we continue to see more strength than weakness overseas.  In Asia, for instance, the Nikkei (+0.15%) edged higher while the Hang Seng (+1.35%) had quite a good day although Shanghai (-0.2%) continues to suffer under the ongoing pressure from the Chinese real estate market.  Today another Chinese real estate developer, Sinic, defaulted on a bond and by the end of the week the 30-day grace period for Evergrande will end and we will see if there are more ramifications there.

As to the rest of the world, both Europe (DAX +0.1%, CAC -0.1%, FTSE 100 +0.1%) and US futures are essentially flat this morning.  The investor question is, can strong earnings offset tighter monetary policy?  While we shall see over the course of the next few weeks, I suspect that a more hawkish Fed, if that is what shows up, will be very difficult to offset for the broad indices.

Commodities have taken a breather today with oil (-1.2%) and NatGas (-1.3%) slipping and dragging most other things down with them.  So, copper (-1.3%) and aluminum (-1.1%) are feeling that pain although gold (+0.7%) and silver (+1.25%) are both benefitting from either the inflation narrative or the fact that the dollar is arguably somewhat softer.

Speaking of the dollar, it is best described as mixed today, with a range of gainers and losers versus the greenback.  In the G10, NOK (-0.45%) is the worst performer, clearly suffering on the back of oil’s decline, with the pound (-0.3%) next in line after CPI printed a tick lower than expected and some thought that might dissuade the BOE from raising rates (it won’t).  But other than those two, everything else is +/- 0.15% which is indicative of nothing happening.

EMG currencies are also mixed with the biggest winners INR (+0.6%) and KRW (+0.4%) both benefitting from equity market inflows amid hopes for stronger growth.  After that, the gainers have been modest at best with nothing really standing out.  On the downside, RUB (-0.2%) following oil and CNY (-0.2%) have been the worst performers.  China is interesting as the PBOC set the fix for a much weaker than expected renminbi as it is clearly becoming a bit uncomfortable with the currency’s recent appreciation (+1.9% in past two months before last night).  Remember, for a mercantilist economy like China, excessive currency strength is an economic problem.  Look for the PBOC to continue to push against further strength.

On the data front, only the Fed’s Beige Book is released this afternoon, but we do hear from 5 more FOMC members.  Remember, nobody expected Waller’s comments to be market moving, so we must keep our antenna up for something else.

In fact, my sense is that the Fed is going to try very hard to reestablish the narrative they want regarding inflation and the future of interest rates.  That implies we are going to hear more and more from Fed speakers.  The risk is that the divide at the Fed between hawks and doves will widen to a point where no consistent narrative is forthcoming.  At that point, markets are likely to pay less attention to the comments and more to the data and expectations.  If forward guidance loses its strength, the Fed will be in a much worse position and market volatility is likely to increase substantially.  However, we have not yet reached that point.  In the meantime, the dollar is searching for its next catalyst.  Until then, consolidation of recent gains continues to be the most likely outcome.

Good luck and stay safe
Adf

Stop It

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There are several central banks which
Are starting to look at a switch
From policy ease
To tight, if you please
As QE they now want to ditch

The Old Lady and RBA
Are two that seem ready to say
Inflation’s too high
And so we must try
To stop it ere it runs away

The dollar is under pressure this morning as investors and traders start to look elsewhere in the world for the next example of policy tightening.  The story of tapering in the US is, quite frankly, getting long in the tooth as it has been a topic of discussion for the past six months and every inflation reading points to the fact that, despite their protestations, FOMC members realize they need to do something.  But in essence, that is already a given in the market, so short of Chairman Powell explaining in his Friday appearance that the FOMC is likely to end QE entirely next month, this is no longer market moving activity.  The dollar has already benefitted from the relatively higher yields that are extant in the Treasury market, and expectations for a further run up are limited.

However, the same is not true elsewhere in the world as central bank plans are only recently crystalizing alongside the universally higher inflation prints.  So, the BOE, which has been more vocal than most, seems to be working hard to prepare markets for a rate hike and the market has taken the ball and run with it.  Thus, UK yields in the short end of the curve have moved rapidly higher with 3-year gilt yields higher by 53 basis points in the past 6 weeks and 15 bps in the past three sessions.  On Sunday we heard from BOE Governor Bailey that they will “have to act” soon to address rapidly rising inflation, and traders continue to push UK yields higher and take the pound along with it.  This morning, pound Sterling is higher by 0.75% and amongst the leading FX gainers on this ongoing activity.

Perhaps more interesting is the market reaction to the RBA Minutes last night, where discussion regarding rising real estate prices and the need to do something about them has encouraged the investment community to push yields much higher, challenging the RBA’s YCC in the 3-year AGB.  In fact, despite the RBA explicitly reiterating that conditions for raising rates “will not be met before 2024”, yields continue to rise sharply as fears that inflation will outpace current RBA expectations grow widespread.  Given this price action, one cannot be surprised that the Aussie dollar (+0.85%) has also risen quite sharply this morning.

The thing is, there are a number of conundrums here as well.  For instance, the euro is performing well this morning, up 0.4%, and there has been absolutely zero indication that the ECB is considering tighter monetary policy.  It is widely known that the PEPP will expire in March, but it is also very clear that the previous QE program, the APP, is going to be expanded and extended in some manner to make up for the PEPP.  The only question here is exactly what form it will take.  Similarly, there is no indication that the BOJ is even considering the end of QE or NIRP or YCC, yet the yen has managed to gain 0.3% this morning as well.

In fact, today’s price action is looking much more like broad-based dollar weakness abetted by some other idiosyncratic features rather than other stories driving the market.  This becomes clearer when viewing the commodity markets where virtually every commodity price is higher this morning led by oil (+1.25%), gold (+0.75%), copper (+1.15%) and aluminum (+1.6%).  Today is very much a classic risk-on type session with the dollar under pressure and other assets performing well in sync.

For instance, equity markets are in the green everywhere (Nikkei +0.65%, Hang Seng +1.5%, Shanghai +0.7%, DAX +0.2%, FTSE 100 +0.1%) with US futures also pointing higher by roughly 0.4% across the board.  At the same time, bond yields are creeping higher (Bunds +1.8bps, OATs +2.1bps, Gilts +1.8bps) as investors jettison their haven assets in order to jump on the risk bandwagon.  Treasury yields, though, are unchanged on the day although still trending higher from the levels seen late last week.

Adding it up; rising equity prices, rising commodity prices, falling bond prices, and a weaker dollar (with EMG currencies also firmer across the board) results in a clear risk-on framework.  This will warm the cockles of every central bankers’ heart as they will all see it as a vote of confidence in the job they are doing.  Whether that is an accurate representation is another question entirely, but you can’t fight the tape.  Risk is clearly in vogue today.

It is, however, worth asking if this positive attitude is misplaced.  After all, the recent data has hardly been the stuff of dreams.  Yesterday’s US releases were uniformly awful (IP -1.3%, Capacity Utilization 75.2%) with both significantly worse than forecast.  The upshot is that the Atlanta Fed GDPNow number fell to 1.165%, another step lower and an indication that despite (because of?) high inflation, growth is slowing more rapidly.  Meanwhile, Eurozone Construction Output fell -1.3% in August, continuing the down trend that began in March of this year.

I recognize it is earnings season and the initial releases for Q2 have been quite positive.  But I ask, is slowing growth and rising inflation really a recipe for continued earnings growth?  History tells us the answer is no, and I see no reason to believe this time is different.  Today’s price action seems anomalous to the big picture ideas, so be cognizant of that fact.  While markets can remain irrational longer than we can remain solvent, that does not mean it is sensible to go ‘all-in’ on risk because there is one very positive market day.  Tread carefully.

This morning’s US data brings Housing Starts (exp 1613K) and Building Permits (1680K) and that is all.  Though these are unlikely to get the market excited, we also hear from four Fed speakers, Daly, Barkin, Bostic and Waller, where efforts at recapturing the narrative will be primary.  It is growing increasingly clear that the Fed is annoyed that the persistent inflation narrative is gaining traction as it may force their hand in tightening policy before they would like.  Just remember, as important as the Fed is (and every central bank in their own economy), the market is much bigger.  And if the market determines that the Fed is no longer leading the way, or will soon need to change tack, it will force the issue.  On this you can depend.

While today everything is coming up roses, the lesson is that the Fed’s control over markets is beginning to wane.  Eventually that will be quite a negative for the dollar, but for now, despite today’s decline, I think the trend remains for a higher dollar.

Good luck and stay safe
Adf

Protests Are Growing

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In China the growth impulse waned
As policy makers have strained
To maintain control
While reaching the goal
Of growth that Xi has preordained

In other news protests are growing
By pundits that markets are showing
Too much in the way
Of rate hikes today
Since wags think inflation is slowing

Risk is getting battered this morning, but interestingly, so are many havens.  It seems that the combination of slowing growth and higher inflation is not all that positive for assets in general, at least not financial ones.  Who would have thunk it?

Our story starts in China where Q3 GDP was released at a slower than expected 4.9% down from 7.9% in Q2 and 18.3% in Q1.  If nothing else, the trend seems to be clear.  And, while Retail Sales there rose a more than expected 4.4%, IP (3.1%) and Fixed asset Investment (7.3%), the true drivers of the Chinese economy, both slumped sharply from last quarter and were well below estimates.  In other words, the Chinese economy is not growing as quickly as the punditry, and arguably, the market had expected.  This is made clear by the ongoing lackluster performance in Chinese equity markets which are also being accosted by President Xi’s ongoing transformation of the Chinese economy to one more of his liking.  (In this vein, the latest is the attack on the press such that all media must now be state-owned.  Clearly there is no 1st Amendment there.)  Of course, if the press is state-controlled, it is much easier for the government to prevent inconvenient stories about things like Evergrande from becoming widespread inside the country.  That being said, we know the Evergrande situation is under control because the PBOC told us so!

Ultimately, this matters to markets because China has been a significant growth engine for the global economy and if it is slowing more rapidly than expected, it doesn’t bode well for the rest of the world.  Apparently ongoing energy shortages in China continue to wreak havoc on manufacturing companies and hence supply chains around the world.  But don’t worry, factory gate inflation there is only running at 10.7%, so there seems little chance of inflationary pressures seeping into the rest of the world.  In the end, risk appetite is unlikely to increase substantially if the narrative turns to one of slower growth ahead, unable to support earnings expectations.

With this in mind, it is understandable why equity markets are under pressure this morning which has been true in almost every major market; Nikkei (-0.15%), Shanghai (-0.1%), DAX (-0.5%), CAC (-0.8%), FTSE 100 (-0.2%). US futures (-0.3%), with only the Hang Seng (+0.3%) bucking the trend.  Funnily enough, though, bond markets are also under universal pressure (Treasuries +4.4bps, Bunds +4.4bps, OATs +4.7bps, Gilts +6.7bps, Australia GBs +9.0bps, China +5.3bps, and the pièce de résistance, New Zealand +15.5bps) as it seems investors are beginning to fret more seriously over inflation and ensuing policy action by central bankers.

Yesterday, BOE Governor Andrew Bailey explained that the BOE will “have to act” to curb inflationary forces.  That is a pretty clear statement of intent and one based on the reality that inflation is well above their target and trending higher.  Interest rate markets quickly priced in rate hikes in the UK with the first expected next month and a second by February.  In fact, by next September, the market is now pricing in 4 rate hikes, expecting the base rate to be 1.00% vs. the current rate of 0.10%.  In New Zealand, meanwhile, CPI printed at 4.9% last night, well above the expected 4.2% and the market quickly adjusted its views on interest rates there as well, with a 0.375% increase now price for the late November meeting and expectations that in one year’s time, the OCR (overnight cash rate) will be up at 1.95% compared to today’s 0.50%.

Naturally, this price action doesn’t suit the central bank narrative and so there has been a concerted push back on the higher inflation story from many sectors.  My personal favorite is from the pundits who are focusing on the Fed staff economists with the claim that they are far more accurate than the Street and their current forecast of 2022 inflation of 1.7% should be the baseline.  But we have heard from others with vested interests in the low inflation narrative like Blackrock (who gets paid by the Fed to manage the purchases of assets) as well as a number of European central bankers (Villeroy and Vizco) who maintain that it is critical the ECB keep policy flexibility when PEPP ends.  This appears to be code for ignore the inflation and keep buying bonds.

The point of today’s story is that the carefully controlled narrative that has been fostered by the central banking community is under increasing pressure, if not falling apart completely.  Markets are pricing in rate hikes despite protests by central bankers, as they see rising inflation trends as becoming much more persistent than those central bankers would like you to believe.  At this point, no matter what inflation statistic you consider (CPI, PCE, trimmed-mean CPI, median CPI, sticky CPI) all are running well above the Fed’s 2.0% target and all are trending higher.  The same situation obtains in almost every major nation as the combination of 18 months of excessive money-printing and significant fiscal spending seems to have done the trick with respect to reviving both inflation and inflation expectations.  If I were the Fed, I’d be taking a victory lap as they have been fighting deflation for a decade.  Clearly, they have won!

So, if stocks and bonds are both falling, what is rising?  I’m sure you won’t be surprised that oil (+1.6%) is leading the way higher as demand continues to rise while supply doesn’t.  OPEC+ has refused to increase production any further and the US production situation remains under pressure from Biden administration policies.  While NatGas in the US is softer (-1.8%), in Europe, it is much firmer again (+16.2%) as Russia continues to restrict supply.  Precious metals remain unloved (Au -0.2%, Ag -0.2%) but industrial metals are firm (Cu +0.9%, Al +0.45%, Sn +1.2%) along with the agriculturals.

Finally, the dollar is definitely in demand rising against 9 of its G10 brethren (only NOK has managed to hold its own on the back of oil’s rally) but with the rest of the bunch falling between 0.1% and 0.5% on general dollar strength. After all, if neither NZD (-0.1%) nor GBP (-0.15%) can rally after interest rate markets have jumped like they have, what chance to other currencies have today?

EMG currencies are also under pressure this morning led by ZAR (-1.0%) and followed by MXN (-0.6%) with both falling despite rising oil and commodity prices.  Both seem to be suffering from a general malaise regarding EMG currencies as concerns grow that rising inflationary pressures are going to slow growth domestically, thus pressuring their central banks to maintain easier policy than necessary to fight rising inflation.  Stagflation is a b*tch.

Turning to the data front, this week sees much less of interest with housing being the focus:

Today IP 0.2%
Capacity Utilization 76.5%
Tuesday Housing Starts 1615K
Building Permits 16680K
Wednesday Fed Beige Book
Thursday Initial Claims 300K
Continuing Claims 2550K
Philly Fed 25.0
Leading Indicators 0.4%
Existing Home Sales 6.08M

Source: Bloomberg

On the Fed front, 10 more speakers are on the docket across a dozen different venues including Chairman Powell on Friday morning.  At this point, with inflation rising more rapidly than expected everywhere in the world and the market pricing in rate hikes far more aggressively than central banks deem appropriate, the case can be made that the central banks have lost control of the narrative.  I expect this week’s onslaught of commentary to try very hard to regain the upper hand.  However, as I have long maintained, at some point the Fed will speak and act and the market will not care.  We could well be approaching that point.  In that event, the only thing that seems certain is that volatility will rise.

As to the dollar today, I think we need to see some confirmation that this modest corrective decline is over, but for now, the medium-term trend remains for a higher dollar.  I see nothing to change that view yet.

Good luck and stay safe
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Something Awry

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It’s not clear why there’s a concern
Inflation could cause a downturn
Cause stocks keep on rising
Though Jay’s emphasizing
The Fed, QE’s, set to adjourn

But still there is something awry
In how traders, every dip, buy
With growth clearly slowing
Though wages are growing
The value of stocks seems too high

One has to be remarkably impressed with the price action of risk assets these days and their ability to completely ignore growing signs that long-delayed problems are fast approaching.  The first of these problems is clearly inflation, something that has been ignored for decades by investors as long-term factors like globalization and demographics, as well as technological innovation, have served to suppress any significant inflationary impulse throughout the developed world.  Certainly, there were some EMG nations (Argentina, Venezuela, Zimbabwe) that managed to buck that trend and impose policies so horrendous as to negate the long-term benefits of stable prices, but generally speaking, inflation has not been a problem.

Then, Covid came along and the policy response was truly draconian dramatic, essentially shutting down much of the global economy for a number of months.  In hindsight, it cannot be surprising that the disruption to finely tuned supply chains that was imposed has been difficult to repair.  After all, it took years to achieve the true just-in-time nature of manufacturing and distribution across almost every industry.  While there are currently herculean efforts to get things back to the way they were, I suspect we will never again return to the previous situation.  A combination of policy decisions and population adaptations has altered the underlying framework thus there is no going back.

Consider the current energy situation (crisis?) as an example.  What is very clear now is that the price of energy is rising rapidly with both oil (+69% YTD, 0.85% today) and NatGas (+127% YTD, 1.0% today) continuing to climb with no end in sight.  Arguably, there have been a number of deliberate policy choices as well as some investing fashions which have dramatically reduced the investment in the production of these two key energy sources thus not merely reducing current supply but prospects for future supply as well.  Pressure from environmentalists to prevent this investment has done wonders for driving up prices, alas the mooted renewable replacements have yet to demonstrate their long-term effectiveness as uninterrupted power sources.  And this situation is manifest not only in the West, but in China as well, where they are currently suffering from major power shortages amid rapidly rising prices for LNG and coal as well as oil.  This morning’s WSJ has a lead article on how the rising price of NatGas is going to drive up winter heating bills substantially and the negative consequences for lower- and middle-income folks.

And yet…risk appetite remains robust.  You can tell because regardless of the news, equity prices consistently rise.  I grant it is not actually every day, but the trend remains quite clearly higher.  In traditional analysis, it would be difficult to rationalize this price movement as while the current situation may be working fine for companies, the fact is there are numerous issues that are coming, notably rising wages and a shrinking labor force, that are going to pressure margins, and arguably profits, going forward.  Clearly, however, that tradition is dead.  In its stead is the investor view that as long as the Fed keeps supplying liquidity to the markets economy, it will prevent any significant price dislocation.  Trickle Down theory remains alive and well on Wall Street.  This is evident today, where equity markets worldwide are higher, and has been evident in the fact that the recent Evergrande induced scare that resulted in a 5% correction was the first correction of that magnitude in more than a year.  The current investment zeitgeist remains; stocks only go up so buy more.  While I recognize I sound curmudgeonly on this topic, remember, reality is a b*tch and it will win out in the end.  Until then, though, it is unclear what type of catalyst is needed to change views, so risk assets are likely to remain in favor regardless of everything else.

And of course, today is a perfect example where equity markets are all green (Nikkei +1.8%, Hang Seng +1.5%, Shanghai +0.4%) in Asia and Europe (DAX +0.3%, CAC +0.4%, FTSE 100 +0.3%) as well.  Don’t worry, US futures are all pointing higher by 0.25%-0.35% at this hour, so all our 401K’s still look good.

Meanwhile, bonds are not required in a risk-on scenario so it should be no surprise that yields are rallying today with Treasuries (+3.3bps) leading the way but higher yields throughout Europe as well (Bunds +2.0bps, OATs +2.3bps, Gilts +3.7bps).  These price movements have been seen throughout the rest of the continent and in Asia last night with yields rising universally.

Commodity prices are broadly firmer, although with risk appetite robust, precious metals (Au -0.85, Ag -1.2%) are unwanted.  We discussed oil prices and we are seeing strength in the industrial metals (Cu +2.4%, Al +2.4%) as well as the Ags (corn +1.2%, wheat +1.4%, soybeans +0.7%).  In other words, risky assets are the place to be.

You should not be surprised that the dollar (and yen) are suffering on this movement given haven assets serve no purpose today!  In the G10 space, GBP (+0.6%) is leading the way higher followed by NOK (+0.55%) and then everything else is just modestly higher except JPY (-0.6%).  The sterling story seems to revolve around continued belief in BOE rate hikes coming early next year while NOK is simply following oil for now.

Of more interest, I believe, is the yen, which admittedly has been falling quite rapidly, down nearly 5% in the past three weeks, and quite frankly, shows no signs of stopping.  At this point, it doesn’t seem so much like Japanese investment outflows as it does like a speculative move that has discerned there is limited real demand for the currency.  Amazingly, last night, the new FinMin, Shunichi Suzuki, felt compelled to explain that, “stability in currencies is very important.” He further indicated that there was concern a weaker yen could cause prices to rise, especially energy prices.  Now, call me crazy but, BOJ policy for the past decade explicitly and the past three decades with less verve, has been to drive inflation higher.  Abenomics was all about achieving 2.0% inflation, something that had not been seen since before the Japanese bubble collapsed in 1989.  Now, suddenly, with inflation running at 0.2%, they are starting to get concerned that higher energy prices are going to be a problem?  Are they going to raise rates?  Are they going to intervene?  Absolutely not in either case.  Sometimes you have to wonder what animates policy maker comments.

As to EMG currencies, ZAR (+0.6%) and KRW (+0.4%) are the leaders this morning with the former benefitting from higher metals prices while the latter is responding to comments from the BOK governor that a rate hike could be coming at the November meeting.  On the downside here, TRY (-0.4%) continues to suffer from Erdogan’s capriciousness with respect to his central bankers, while THB (-0.3%) appears to be consolidating after a strong rally over the past week.

We have a bunch more data this morning led by Retail Sales (exp -0.2%, +0.5% ex autos) as well as Empire Manufacturing (25.0) and Michigan Sentiment (73.1).  There are two more Fed speakers, Bullard and Williams, but it seems unlikely that either will change the current narrative of a taper coming soon.

The reality is you can’t fight the tape.  As long as risk appetite remains buoyant, the dollar and yen are likely to remain on their back foot.  For the dollar, I see no long-term danger as I believe it will consolidate further before making its next move higher.  the yen, on the other hand, could be a bit more concerning.  If fear has gone missing, and with yields rising elsewhere in the world, a much weaker yen remains a real possibility.

Good luck, good weekend and stay safe
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