Author Archives: fxpoet

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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Somewhat Misleading

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The latest inflation’ry reading
Showed price rises kept on proceeding
But bond markets jumped
While dollars were dumped
This movement seems somewhat misleading

The two market drivers yesterday were exactly as expected, the CPI report and the FOMC Minutes.  The funny thing is it appears the market’s response to the information was contrary to what would have been expected heading into the session.

Starting with CPI, by now you are all aware that it continues to run at a much hotter pace than the Fed’s average 2.0% target.  Yesterday’s results showed the M/M headline number was a tick higher than forecast at 0.4%, as was the 5.4% Y/Y number.  Ex food & energy, the results were right on expectations at 4.0%, but that is cold comfort.  Here’s a bit of bad news though, going forward for the next 5 months, the monthly comps are extremely low, so the base effects (you remember those from last year, right?) are telling us that CPI is going to go up from here.  Headline CPI is almost certain to remain above 5.0% through at least Q1 22 and I fear beyond, especially if energy prices continue to rise.  The Social Security Administration announced that benefits would be increased by 5.9% next year, the largest increase in 20 years, but so too will FICA taxes increase accordingly.

The initial market movement on the release was perfectly logical with the dollar bouncing off its lows while Treasury yields backed up.  Given the current correlation between those two, things made sense.  However, that price action was relatively short-lived and as the morning progressed into the afternoon, the dollar started to slip along with yields.  Thus, leading up to the Minutes’ release, the situation had already turned in an unusual direction.

The Minutes explained, come November,
Or possibly late as December
The time will have come
Where QE’s full sum
Ought fade like a lingering ember

The Minutes then confirmed what many in the market had expected which was that the taper is on, and that starting in either mid-November or mid-December the Fed would be reducing its monthly asset purchases by $15 billion ($10 billion less Treasuries, $5 billion less mortgages).  This timeline will end their QE program in the middle of next year and would then open the way for the Fed to begin to raise rates if they deemed it necessary.

Oddly enough, the bond rally really took on legs after the Minutes and the dollar extended its losses.  So, while the correlation remains intact, the direction is confusing, at least to this author.  Losing the only price insensitive bond buyer while the government has so much debt to issue did not seem a recipe for higher bond prices and lower yields.  Yet here we are.  The best explanation I can offer is that investors have assessed that less QE will result in slowing growth and reduced inflationary pressures, so much so that there is the beginning of talk about a recession in the US early next year.  Alas, while I definitely understand the case for slowing growth, and have been highlighting the Atlanta Fed’s GDPNow trajectory lower, there is nothing about the situation that I believe will result in lower inflation, at least not for quite a while yet.  Thus, a bond market rally continues to seem at odds with the likely future outcome.

Of course, there is one other possible explanation for this behavior.  What if, and humor me here for a moment, the Fed doesn’t actually follow through with a full tapering because equity prices start to fall sharply?  After all, I am not the only one to have noticed that the Fed’s reaction function seems to be entirely based on the level of the S&P 500.  Simply look back to the last time the Fed was trying to remove policy accommodation in 2018.  You may recall the gradual reduction in the size of their balance sheet as they allowed bonds to mature without replacing them while simultaneously, they were gradually raising the Fed funds rate.  However, by Christmas 2018, when the equity market had fallen 20% from its highs, Chairman Powell pivoted from tightening to easing policy thus driving a reversal higher in stocks.  Do you honestly believe that a man with a >$100 million portfolio is going to implement and maintain a policy that will make him poorer?  I don’t!  Hence, I remain of the belief that if they actually do start to taper, still not a given in my mind, it won’t last very long.  But for now, the bond market approves.

Thus, with visions of inflation dancing in our heads, let’s look at this morning’s market activity.  Equity markets are clearly of the opinion that everything is under control, except perhaps in China, as we saw the Nikkei (+1.5%) put in a strong performance and strength throughout most of Asia.  However, the Hang Seng (-1.4%) and Shanghai (-0.1%) were a bit less frothy.  Europe, though, is all in on good news with the DAX (+0.8%), CAC (+0.9%) and FTSE 100 (+0.7%) having very positive sessions.  This has carried over into the US futures market where all three major indices are higher by at least 0.6% this morning.

Bonds, meanwhile, are having a good day as well, with Treasury yields sliding 0.7bps after a nearly 5bp decline yesterday.  In Europe, given those markets were closed during much of the US bond rally, we are seeing a catch-up of sorts with Bunds (-3.7bps), OATs (-3.1bps) and Gilts (-1.6bps) all trading well as are the rest of Europe’s sovereign markets.

On the commodity front, pretty much everything is higher as oil (+1.25%), NatGas (+2.1%) and Uranium (+21.7%!) lead the energy space higher.  Metals, too, are climbing with gold (+0.4%), copper (+0.7%) and aluminum (+3.4%) all quite firm this morning.  Not to worry, your food is going up in price as well as all the major agricultural products are seeing price rises.

As to the dollar, it is almost universally lower this morning with only two currencies down on the day, TRY (-0.9%) and JPY (-0.15%).  The former is suffering as President Erdogan fired three more central bankers who refuse to cut interest rates as inflation soars in the country and the market concern grows that Turkey will soon be Argentina.  The yen, on the other hand, seems to be feeling the pressure from ongoing sales by Japanese investors as they seek to buy Treasury bonds with much higher yields than JGBs.  However, away from those two, the dollar is under solid pressure against G10 (SEK +0.9%, NOK +0.8%, CAD +0.55%) and EMG (THB +0.7%, IDR +0.7%, KRW +0.6%).  Broadly speaking, the story is much more about the dollar than about any of these particular currencies although commodity strength is obviously driving some of the movement as is positive news in Asia on the Covid front where some nations (Thailand, Indonesia) are easing restrictions on travel.

On the data front, this morning brings the weekly Initial (exp 320K) and Continuing (2.67M) Claims numbers as well as PPI (8.7%, 7.1% ex food & energy).  PPI tends to have less impact when it is released after CPI, so it seems unlikely, unless it is a big miss, to matter that much.  However, it is worth noting that Chinese PPI (10.7%) printed at its highest level since records began in 1995 while Korean import and export prices both rose to levels not seen since the Asian financial crisis in 1998.  The point is there is upward price pressure everywhere in the world and more of it is coming to a store near you.

We hear from six more Fed speakers today, but it would be quite surprising to have any change in message at this point.  To recap the message, inflation is proving a bit stickier than they originally thought but will still fade next year, they will never allow stock prices to fall, inflation expectations remain anchored and tapering will begin shortly.

While I still see more reasons for the dollar to rally than decline, I believe it will remain linked to Treasury yields, so if those decline, look for the dollar to follow and vice versa.

Good luck and stay safe
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Prices Will Grow

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As markets await CPI
It’s funny to watch the Fed try
Explaining inflation
Will lack the duration
To send expectations sky-high

But even their own surveys show
That most people already know
Inflation is here
And well past next year
The level of prices will grow

Each month the Federal Reserve Bank of New York publishes the results of a survey of consumer expectations on inflation.  Yesterday, they published the September results and, lo and behold, the data showed that 1-year inflation expectations rose to 5.31%, by far the highest point since the survey began in 2013.  The 3-year data rose to its highest ever level of 4.19%, also well above the Fed’s 2.0% target.  And yet somehow, the authors of the report explained that inflation expectations remain well anchored.  Their claim is that if you look at the 5-year expectations, they remain near the levels seen before the pandemic, indicating that there should be no concern.  I don’t know about you, but 3 years of inflation running above 4.0% seems a lot longer than transitory.

Of course, it’s not just the analysts at the NY Fed who are unwilling to admit to the increasingly obvious situation, we continue to hear the same from other officials.  For instance, Treasury Secretary Janet Yellen, in a televised interview yesterday remarked, “I believe it’s [inflation] transitory, but I don’t mean to suggest these pressures will disappear in the next month or two.”  She then raised the specter of shortages by commenting, “There’s no reason for consumers to panic over the absence of goods they’re going to want to acquire at Christmas.”  Now, don’t you feel better?

In fairness, however, there are several Fed members who have finally admitted that the transitory emperor has no clothes.  Atlanta Fed President Raphael Bostic explained yesterday, “It is becoming increasingly clear that the feature of this episode that has animated price pressures – mainly the intense and widespread supply-chain disruptions – will not be brief.  By this definition, then, the forces are not transitory.”  As well, we heard from St Louis Fed President James Bullard, “I have to put some probability on a scenario where inflation stays high or even goes higher.”

At this point, it’s fair to ask, which is it?  Clearly there is a split at the Fed with some regional presidents recognizing that inflation has risen sharply and has all the appearances of being persistent, while Fed governors seem more likely to lean toward the transitory fable.  Perhaps what explains this split is the regional presidents have a far different constituency than do the Fed governors.  The Fed presidents are trying to address the issues extant in their respective geographies, so rising inflation matters to them.  Meanwhile, the governors, despite the claim that the Fed is apolitical, serve their masters in Congress and the White House, who believe they need to continue QE and ZIRP forever to continue spending money in unconscionable sums while not suffering from the slings and arrows of the bond market vigilantes.  But remember this too, every Fed governor votes at every meeting while only a handful of regional presidents vote (granted, Bostic is one of those right now.)  I fear we will continue to hear transitory for a while yet.

All this is a prelude to two key pieces of information today, this morning’s CPI release (exp 5.3% headline, 4.0% core) and the FOMC Minutes from the September meeting to be released at 2:00pm.  The one thing that has been very clear lately is that interest rate markets are beginning to buy into the persistence of inflation.  While Treasury yields have edged lower by 1.6bps this morning, in the past 3 weeks, those yields have risen 26 basis points.  And this is a global phenomenon with Bund yields, for instance, having risen 20 basis points over the same period despite a 4.1bp decline today.  Investors are starting to pressure the central bank community with respect to interest rates, driving them higher as fears of rising inflation abound worldwide.  While some, central banks have recognized the reality on the ground (Norway, New Zealand, numerous EMG nations) and others have paid lip service to the idea of raising rates (the UK, Canada), the two biggest players, the Fed and ECB, will not even discuss raising rates, although the Fed continues to tease us with talk of tapering.

However, I will ask again, do you believe the Fed will taper (tighten) policy if GDP growth is more clearly abating?  My view remains that they may actually start to taper, but that it will be a short-lived process as weak GDP growth will dissuade them from doing anything to worsen that side of the ledger.  While eventually, weaker GDP growth will result in demand destruction and reduced price pressures, that is likely to take a very long time.  Hence, the idea of stagflation remains very viable going forward.

Now it’s time to look at markets.  Equities have had a mixed session thus far with Asia (Nikkei -0.3%, Hang Seng -1.4%, Shanghai +0.4%) seeing both gainers and losers and Europe (DAX +0.7%, CAC +0.25%, FTSE 100 -0.1%) seeing similar mixed price action.  UK data showed August GDP was a tick lower than forecast and is clearly slowing from its previous pace, arguably weighing on the FTSE.  As to US futures, they are edging higher ahead of the data with gains in the 0.1%-0.3% range after yesterday’s modest declines.

We’ve already discussed bonds so a look at commodities shows that oil (-0.6%) is retreating for the moment as is NatGas (-1.5%), while we are seeing strength in gold (+0.7%) and copper (+1.7%).  In fact, the entire metals complex is stronger today as apparently, weaker energy prices are good for industrial activities.

As to the dollar, it is under some modest pressure today across the board.  In the G10, SEK (+0.35%) and CHF (+0.35%) lead the way with JPY (0.0%) the laggard.  However, there are no specific stories that seem to be driving things, rather this is a broad-based dollar correction from recent strength.  The same situation holds in the EMG bloc with ZAR (+0.75%) the leader followed by much lesser movement of KRW (+0.4%), CZK (+0.35%) and PLN (+0.35%).  The won has responded to comments from the central bank that it is closely watching the exchange rate and will not be afraid to step in if it becomes destabilized.  That is a euphemism for much weaker, as the currency had fallen nearly 9% in the previous four months.  As to the others, recent weakness seems to merely being consolidated with nothing new driving price action.

While the Fed may not care much about CPI, the rest of us do care.  And really, so do they, but it doesn’t tell their story very well.  At any rate, while it is entirely reasonable that we see a continued flatlining of price rises, the risks remain to the upside as at some point, housing inflation is going to show up in the data.  And that, my friends, is going to be significant and persistent!  Ahead of the number, don’t look for much.  If we see a high print, expect the dollar to regain this morning’s losses, though, as the market will become that much surer the taper is on its way.

Good luck and stay safe
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Hikes Are Impending

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In London on Threadneedle Street
The Old Lady’s not been discrete
Some hikes are impending
With rates soon ascending
Before they shrink their balance sheet

The BOE has made it quite clear that they are itching to raise interest rates pretty soon in order to address rising inflation.  Today’s employment data, which saw the Unemployment Rate fall to 4.5% while employment grew by 235K on a 3M/3M basis, has helped to cement the idea that the economy is continuing to rebound sharply and price pressures are likely to continue to grow.  With CPI at 3.2%, already well above the 2.0% target, and tipped to rise much further by the end of the year given the rapid rise in energy and commodity prices, the BOE has come to believe they need to do something to prevent inflation from getting out of control.  Unlike the Fed, the BOE has also indicated they are quite comfortable raising interest rates before shrinking their balance sheet back to pre-pandemic levels.

The risk they face, which has become the talk of the market today, is that by raising rates so soon, especially before the Fed acts, they will simultaneously destroy the nascent growth impulse while failing to address the cause of the inflation.  And in truth, that could well happen.  Alas, that is a result of trying to address a stagflationary environment with the limited tools available to a central bank.  For the time being, the biggest decision a central bank has is to determine which affliction is a bigger problem, rising prices or slowing economic activity.  Since this seems to be the situation in almost every developed nation, we are going to witness a lot of variations on this theme going forward.

The interesting thing about the pound is that its behavior amid pending rate hikes, as well as the market narrative about the pound, seems to be quite negative.  For some reason, there has been a connection made between an early rate hike in the UK and a falling pound.  This is opposite what we have seen in most other countries, where those rate hikes have been supportive of the currency as would normally be expected.  But there is now talk that the UK is going to make a policy error by tightening ahead of the Fed.  This argument seems specious, however, as economic growth has rarely been a short-term driver of exchange rates, while interest rate changes are critical.  The idea that suddenly traders and investors are critiquing the long-term ramifications of the BOE is preposterous.  Instead, I would offer that any pound weakness, although an early decline after the data release has already been reversed, is far more likely due to the dollar’s continuing broad strength.  So, as I type, the pound is essentially unchanged on the day.

Of course, this begs the question, is the Fed going to start to tighten policy with their potential tapering decision next month.  My answer is leaning towards no.  The reasoning here is that we will have already seen the first estimate of Q3 GDP by the time the Fed meets, and the early indications are that GDP growth has really declined sharply with the Atlanta Fed’s GDPNow forecast declining to 1.306% after the payroll data on Friday.  Tightening policy into a clearly slowing economy seems highly improbable for this Fed regardless of the inflation situation.  It seems far more likely that a weak GDP print will result in the Fed walking back their tapering language by describing the slowing growth as an impediment from achieving that vaunted “substantial further progress” on their employment goals and thus tapering is not yet appropriate.  Remember, after nearly a decade of worrying about deflation, not inflation, concern over rising prices is not their normal response.  Despite talk of the tools they have available to fight inflation, there is no indication the Fed has the gumption to use them if the result would be a recession, or more frighteningly for them, a stock market decline.

Thus, the question that remains is, how will the market respond to a Fed that decides not to taper with inflation still rising?  Much of the current discussion regarding the Treasury market is around the idea that tapering is the driver of the steeper yield curve, although there is a strong case to be made it is simply consistently higher inflation readings doing the work.  For our purposes in the FX markets, it’s not clear the underlying driver matters that much.  The key is where do rates and yields go from here.  If they continue to rise, I expect the dollar has further room to rise as well.

Ok, with markets back to full strength today, a look around sees a pretty negative risk sentiment.  Equities in Asia (Nikkei -0.95%, Hang Seng -1.4%, Shanghai -1.25%) were all under pressure with the latter two dealing with yet another property company that is defaulting on a USD bond.  The China story appears to be getting a bit less comfortable as we watch what seems to be a slow motion implosion of the real estate bubble there.  As to Europe, its all red there as well (DAX -0.4%, CAC -0.5%, FTSE 100 -0.4%) as London is suffering despite the strong data and Germany seems to be feeling the weight of stagflation after PPI (+13.2% Y/Y in Sept) rose to its highest level since 1974 while the ZEW Surveys all fell even further than expected.  At this hour, US futures are either side of unchanged.

On this risk off day, bond markets are seeing a bit of a bid, but in truth, it is not that impressive, especially given how far they have fallen recently.  So, Treasury yields (-1.6bps) have edged just below 1.60% for now while European sovereigns (Bunds -0.6bps, OATs -0.8bps, Gilts -1.4bps) have also seen very modest demand.

Oil prices (+0.4%) continue to lead the way higher for most commodities, although today’s movement has been less consistent.  The trend, however, remains firmly upward in this space.  So, while NatGas (-1.6%) is lower on the session, we are seeing gains in gold (+0.5%) and aluminum (+0.7%) although copper (-0.25%) is consolidating today.  Many less visible commodity prices are rising though, things like lumber (+5.5%) and cotton (+2.3%) which are all part of the same trend.

Finally, the FX markets have seen a very slight amount of dollar weakness net, although there are quite a number of currencies that have fallen vs. the greenback as well.  In the G10, NOK (+0.7%) is the leader on oil price rises while AUD (+0.4%) and NZD (+0.4%) are following on the broader commodity price trend.  Interestingly, JPY (0.0%) is not seeing any bid despite a declining risk appetite.  This seems to be a situation where the spread between Treasuries and JGB’s has widened sufficiently to interest Japanese investors who are selling yen/buying dollars to buy bonds.  As long as Treasury yields continue to rise, look for USDJPY to follow.  After all, it has risen 1.7% in the past week alone.

In the emerging markets, THB (+1.3%) has been the big winner after the government eased restrictions for travelers entering the country thus opening the way for more tourism, a key part of the economy there.  ZAR (+0.85%) and MXN (+0.5%) are the next best performers on the strength of the commodity story.  On the downside, many APAC currencies (TWD (-0.35%, KRW -0.3%, INR -0.2%) saw declines on a combination of continued concerns over the potential implications of the Chinese real estate issue as well as rising commodity prices as all these nations are commodity importers.

Data-wise, NFIB Small Business Optimism was just released at a slightly weaker than expected 99.1, hardly a harbinger of strong future growth, while the JOLTS Jobs report (exp 10.954M) is due at 10:00 this morning.  There are three Fed speakers on the slate with vice-Chair Clarida at the World Bank/IMF meetings and Bostic and Barkin also due.  It will be interesting to see the evolution of the narrative as it becomes clearer that GDP growth is slowing rapidly.  But given that has not yet happened, I expect more taper talk for now.

There is no reason to think that the dollar’s recent strength has reached its peak.  If anything, my take is we are consolidating before the next leg higher so hedge accordingly.

Good luck and stay safe
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A Fad that is Passing

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Said central banks, stop your harassing
Inflation’s a fad that is passing
By next year we see
(Or by ‘Twenty-three)
More bonds you will all be amassing

But lately some central bank hawks
Explained that the recent price shocks
Could well last much longer
With wage growth much stronger
And that might not be good for stocks

As we walk in on this Columbus Day holiday, where US banks and the Federal Reserve are closed, although equity markets remain open, the most notable price movement has been in oil where WTI (+2.8%) has rallied to its highest price since October 2014 and now sits well above the $80/bbl level.  Fortunately, we’ve been constantly reassured that this is a temporary transitory phenomenon by numerous central bankers around the world, most frequently by Chairman Powell and ECB President Lagarde.  The claim continues to be that the only reason prices keep rising is as a result of constricted supply chains amid a massive recovery (due to their actions) from the Covid pandemic economy-wide shutdowns.  Soon enough, they also exhort, these supply chain snafus will have been corrected and then shortages of stuff will be a distant memory as we revert to the steady growth and low inflation economies we have all come to know and love.  It’s such a nice, neat story and I’m confident that they both tell themselves constantly that it is true.

Alas, reality has a nasty way of intruding upon a good storyline and recent energy price action is pretty clearly pointing to a different story than the one being peddled by Powell and Lagarde.  In fact, some of their own colleagues, as well as brethren from other key central banks like the BOE, are singing a different tune, one much more in line with reality.  For instance, last night, Klaas Knot, the Dutch Central bank president and ECB member warned investors not to underestimate inflation risks, “This risky behavior [excessive leverage] is only sustainable at low inflation and interest rates.  From the perspective of healthy risk management, it is also important to take other scenarios into consideration.”  I wonder what other scenarios he is considering.  Refreshingly, he followed that comment with this, “There is more in the inflation process we don’t understand than we do understand,” as humble a comment as one can ever expect from a central banker!

However, given Knot’s constant hawkish rhetoric, markets did not really react to his comments, as they were not terribly new.  Of more interest were comments from two separate BOE members, Governor Andrew Bailey and Michael Saunders, the most hawkish member of the MPC.  In both cases, they commented that the market was quite right to begin pricing in higher interest rates as inflation was becoming more problematic and could be “very damaging” if policymakers don’t act.  Traders did not need much prompting beyond this to reprice interest rate futures such that a first hike of 15 basis points (to 0.25%) is now expected by December, while by the end of 2022, the market is pricing a base rate of 0.75%, so two more hikes after that.  Given that UK CPI is forecast to hit 4.0% in Q4 this year, that still seems awfully far behind the curve, but then compared to the US, where inflation is already well above 4%, even on the PCE measure, and Fed Funds remained pegged at 0.00%-0.25%, that counts as tight policy.  When the comments were first published, the pound did jump as much as 0.45%, however, that has already largely faded and as I type, the pound is only 0.1% higher on the day.

Perhaps these are the first real signs that the central bank community is recognizing inflation may not be as transitory as their models (and political needs) had indicated was likely (and necessary) respectively.  Instead, its persistence is becoming more evident, even to them, and calls for tighter monetary policy to address inflation are likely to grow.  Of course, given the extraordinary levels of leverage in the global monetary system, higher rates are going to be very difficult to achieve without an ensuing dramatic decline in asset prices.  This is the corner into which the Fed (and the ECB) have painted themselves.  (As I’ve said before, if I were Chairman Powell, I would be happy to step down allowing my successor to deal with the mess that is surely coming.)  Even if the Fed does begin to taper QE purchases, they will remain behind the curve for a very long time, and those vaunted ‘tools’, which they keep describing as available, will likely not be used to full effect.  Not only is inflation going to continue to rise, but central banks are going to continue to remain behind the curve for a long time to come.  Be prepared.

Ok, with that in mind, let’s look at markets overnight.  Equities in Asia had a pretty good session, with the Nikkei (+1.6%) and the Hang Seng (+2.0%) both performing well, although Shanghai was unchanged on the day.  Europe (DAX -0.5%, CAC -0.4%), on the other hand, is a little less optimistic.  The outlier here is the UK (FTSE 100 +0.15%) where it seems investors are happy to hear of a central bank willing to address incipient inflation.  US futures are all pointing lower, however, led by the NASDAQ (-0.7%) but -0.4% losses elsewhere.

The Treasury bond market is closed in the US today, but in Europe, the trend is clear, higher yields across the board, which is exactly what we saw in Asia as well.  So, Bunds (+3.5bps), OATs (+3.0bps) and Gilts (+5.0bps) are all selling off sharply with similar movement seen across the continent.  Asia, too saw sharp declines in bond prices with Australia (+8.0bps) leading the way but even China (+6.0bps) falling sharply despite ordinary efforts to prevent volatility in that market.

In the commodity space, while oil is leading the way, pretty much everything except gold is higher with NatGas (+3.8%), copper (+1.4%) aluminum (+2.3%) and the agricultural products all firmer on the day.  Remember this, the longer food and energy prices continue to climb, the more likely those price rises bleed into “core” inflation and drive that higher as well.

Turning to the dollar, the biggest loser today is JPY (-0.6%) as the widening yield differential in favor of the dollar has reached a point where Japanese investors have started to move money more actively into USD investments on an unhedged basis.  At this point, there doesn’t seem to be much reason for JPY to rally, so a test of 115 seems to be far more likely in the near term.  After that, we shall see.  On the plus side, AUD (+0.5%) has been the biggest beneficiary of the commodity rally while surprisingly, neither NOK nor CAD, both unchanged on the day, have seen a boost from the much higher oil prices.

In the EMG bloc, INR (-0.5%) and PHP (-0.4%) are the laggards of note with RUB (+0.3%) the only notable gainer.  Oil is obviously supporting the ruble while the rupee and peso both suffer on the same story, as both India and the Philippines are major oil importers.

On the data front, nothing is released today due to the holiday, but we get some important things this week:

Tuesday NFIB Small Biz Optimism 99.5
JOLTS Job Openings 10.934M
Wednesday CPI 0.3% (5.3% Y/Y)
-ex food & energy 0.2% (4.1% Y/Y)
FOMC Minutes
Thursday Initial Claims 320K
Continuing Claims 2686K
PPI 0.6% (8.7% Y/Y)
-ex food & energy 0.5% (7.1% Y/Y)
Friday Empire Manufacturing 25.0
Retail Sales -0.2%
-ex autos 0.5%
Business Inventories 0.6%
Michigan Sentiment 73.5

Source: Bloomberg

Aside from critical CPI and Retail Sales data, we hear from ten different Fed speakers across more than a dozen events this week, including Governor Brainerd on Wednesday, someone we should be listening to very closely given the rising probability she is named the new Chair.

Right now, the dollar is consolidating its recent gains, but showing no signs of giving any of them back.  I expect that we will see another leg higher in the near future as there is no evidence that either inflation or US yields are going to decline soon.  And right now, I think those are the drivers.  At some point, inflation may become detrimental to the dollar, but for now, buy dollars on dips.

Good luck and stay safe
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A Gordian knot

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Now, what if inflation is not
As transit’ry as Powell thought?
And what if there’s slowing
Instead of more growing?
Would that be a Gordian knot?

Well, lately the bond market’s view
Appears to be, in ‘Twenty-two
Inflation will soar
Much higher before
The Fed figures out what to do

The Fed has been pushing the transitory inflation narrative for quite a while now, but lately, they have been struggling to get people to accept it at face value.  You can tell this is the case because pretty much every third story in any newsfeed is about rising prices in some product or service.  Commodities are particularly well represented in these stories, especially energy, as oil, NatGas and coal have all seen dramatic price rises in the past month or so.  It is also important to understand that despite the durm und strang regarding the continued use of coal as an energy source, it remains the largest source of electricity worldwide.  I bring this up because the situation in China is one where the country is restricting energy use due to a lack of coal available to burn.  (Perhaps one of the reasons for this is the Chinese, in a snit over Australia calling them out as to the origins of Covid-19, banned Australian coal imports.)

From an inflation perspective, this has the following consequences: less coal leads to less electricity production which leads to restrictions on electricity use by industry which leads to reduced production of everything.  Given China’s importance in the global supply chain for most products, less production leads to shortages and, presto, higher prices.  And this is not going to end anytime soon.  Much to the Fed’s chagrin, they can print neither coal nor NatGas and help mend those broken supply chains.  Thus, despite their (and every other central bank’s) efforts to repeal the laws of supply and demand, those laws still exist.  So, just as April showers lead to May flowers, less supply leads to higher prices.

The difference in the past week or so is that bond markets worldwide have started to cotton on to the idea that inflation is not transitory after all.  Yields have been rising and curves steepening, but even the front end of yield curves, where central banks have the most impact, have seen yields rise.  So, a quick look at global bond markets today shows yields higher in every major market around the world.  Treasuries (+1.1bps) have not moved that far overnight but are higher by 12bps in the past week.  Gilts (+4.8bps) on the other hand, have seen real selling in today’s session, also rising 12bps in the past week, but on a lower base (10-year Gilts yield 1.125% vs. 1.58% for Treasuries.)  And the same situation prevails in Bunds (+2.6bps, +6.6bps in past week), OATs (+2.5bps) and the rest of Europe.  Asia is not immune to this with even JGB’s (+1.2bps, +4bps in past week) selling off.  The point is that bond investors are starting to recognize that inflation may be more persistent after all.  And if the Fed loses control over their narrative, they have much bigger problems.  Forward guidance remains a key monetary policy tool, arguably more important that the Fed Funds rate these days, so if that is no longer effective, what will they do?

Needless to say, risk attitudes are starting to change somewhat as concern grows that almost the entire central banking community, certainly the Fed and ECB, will be too slow to react to very clear inflation signals.  In this situation, financial assets will definitely suffer.  Keep that in mind as you look ahead.

OK, next we need to look to this morning’s NFP report as that has been a key element of the recent market inactivity.  Investors are looking for confirmation that the Fed is going to begin tapering next month and have certainly been encouraged by both the ADP Employment number as well as yesterday’s much lower than expected Initial Claims data.  Here’s what current median forecasts look like:

Nonfarm Payrolls 500K
Private Payrolls 450K
Manufacturing Payrolls 25K
Unemployment Rate 5.1%
Average Hourly Earnings 0.4% (4.6% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.8%

Source: Bloomberg

Powell explained that as long as this report was not terrible, he felt the tapering would begin.  Interestingly, the range of forecasts is 0K to 750K, a pretty wide range of disagreement as to how things might play out.  Certainly, a number like last month’s 235K could throw a wrench into the tapering process.  Personally, my take is slightly weaker than median, but not enough to change the taper idea.

On a different note, I cannot help but look at the Average Hourly Earnings forecasts and wonder how any Fed speaker can argue that wages aren’t growing rapidly.  Absent the Covid induced gyrations, 4.6% is the highest number in the series by far going back to early 2007.  Again, this speaks to persistent inflationary pressures, not transient ones.

But we will know shortly how things turn out, so a quick recap before then shows that equity markets had a good session in Asia (Nikkei +1.3%, Hang Seng +0.55%, Shanghai +0.7%) but are less giddy in Europe (DAX -0.1%, CAC -0.4%, FTSE 100 0.0%).  Meanwhile, US futures are essentially unchanged ahead of the data.

We’ve already discussed the bond market selloff and cannot be surprised that commodity prices are mostly higher led by oil (+0.8%) and NatGas (+0.1%), but also seeing strength in gold (+0.3%).  Industrial metals are having a rougher go of it (Cu -0.3%, Al -0.4%) and Ags are a bit firmer this morning with all three major grains higher by about 0.55%.

As to the dollar, it is mixed this morning ahead of the data with the largest gainer NOK (+0.4%) on the back of oil’s strength, while SEK (+0.3%) is also firmer although with no clear driver other than positioning ahead of the data.  On the downside, JPY (-0.15%) continues under pressure as higher US yields continue to attract Japanese investors.

EMG currencies have seen a more negative session with PLN (-0.6%), TRY (-0.5%) and RUB (-0.5%) all under pressure and the APAC bloc mostly falling, albeit not quite as far.  The zloty story seems to be concerns over a judicial ruling that puts Poland further at odds with the EU which has been sufficient to offset the boost from yesterday’s surprise rate hike.  In Turkey, a story that President Erdogan is “cooling” on his view toward the central bank governor seems to have markets nervous while in Russia, rising inflation and limited central bank response has investors concerned despite oil’s rally.

There are no Fed speakers on the calendar today so it will all be about the NFP number.  Until then, don’t look for much, and afterwards, there is typically a short burst of activity and a slow afternoon.  I don’t think the big trend of dollar strength has ended by any means, but it is not clear today will see much of a gain.

Good luck, good weekend and stay safe
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Risks They Have Wrought

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It’s not clear why anyone thought
The ECB ever would not
Continue to buy
More bonds as they try
To safeguard ‘gainst risks they have wrought

So, when PEPP, next March, does expire
A new plan we’ll get to admire
As Christine will ne’er
Be set to foreswear
Her drive to push bond prices higher

If ever anyone was talking their own book, it was Greek central bank president Yannis Stournaras this morning on the subject of the ECB’s potential actions post-PEPP.  “Asset purchases aim at favorable financing conditions, at smooth transition of monetary policy to prevent any kind of fragmentation in jurisdictions in the euro area.  I’m sure that the Governing Council will continue to aim at this.” [author’s emphasis] These comments were in response to a report that the ECB is considering instituting a new asset purchase program when the emergency PEPP expires in March.  This is certainly no surprise as I posited this exact outcome a month ago (Severely Distraught – Sep 7) and the idea has gained credence since then.

One of the features of the ECB’s APP (original QE program from 2015) is that they are required to purchase bonds based on the so-called capital key in order to give the illusion they are not monetizing national debt.  This means that they must buy them in proportion to the relative size of each economy.  Another feature is that the bonds they purchase must be investment grade (IG).  This rules out Greek debt which currently is rated BB-, 3 notches below IG.  The PEPP, however, given the dire emergency created by governments shutting down their economies when Covid-19 first appeared, did away with those inconveniences and was empowered to buy anything deemed necessary.  Not surprisingly, purchases of bonds from the PIGS was far above their relative economic weight which has served to narrow credit spreads across the entire continent.  If the PEPP simply expires and is not replaced, it is unambiguous that PIGS’ debt would fall sharply in price with yields rising correspondingly, and those nations would find themselves in far worse fiscal shape.  In fairness, the ECB can hardly allow that to happen to just a few nations so they will continue their PEPP purchases in some manner or other.  And I assure you they will continue to purchase Greek debt regardless of its credit rating.

It is useful to compare this future to that of the Fed, where Chairman Powell has indicated that as long as the payroll number this Friday is not a complete disaster (currently expected 500K), a reduction in the pace of QE is appropriate. On the surface, it would be quite reasonable to expect the euro to decline further given what is likely to be a divergence in relative yields.  Yesterday’s ADP Employment report (568K) was better than expected and certainly seems to be of sufficient strength to support the Chairman’s view of continued strength in the labor market.  Thus, if the Fed does begin to taper while the ECB discusses its next version of QE, I would look for the euro’s recent decline to continue.

Of course, the big question is, will the Fed continue to taper if the economic situation in the US starts to show much less impetus?  For instance, the Atlanta Fed’s GDPNow forecast is estimating Q3 GDP growth at 1.333%, MUCH weaker than it had been in the past and a MUCH sharper slowdown than the Fed’s own forecasts.  While the number may well be higher than that, it does speak to a run of weaker than expected economic data in the US.  Inflation, meanwhile, shows no signs of abating soon.  The Fed looks set to find themselves in a very uncomfortable position with the following choices: tighten into slowing growth or let inflation run much hotter than targeted for much longer than anticipated.  (If I were Powell, given the trainwreck that is approaching, I don’t think I would accept the offer of reappointment should it be made!)

In sum, while the decision process in Europe is much easier with slower growth and lower inflation, extending monetary largesse still seems appropriate, in the States, some tough decisions will need to be made.  The problem is that there is not a single person in any Federal position who appears capable of making (and owning) a tough decision.  In fact, it is this lack of demonstrated decision-making prowess that leads to the idea that stagflation is the most likely outcome going forward.

But it is still a few weeks/months before these decisions will need to be made and, in the meantime, Buy Stonks!  Well, at least, that seems to be the investor mindset as fleeting fears over contagion from China Evergrande’s slow motion bankruptcy and comments from Vladimir Putin that Russia would, of course, supply the necessary NatGas for Europe, have been sufficient to remind the equity crowd that a 5% decline from an all-time high price level is an amazing opportunity to buy more stocks.  Hence, yesterday morning’s fears have abated and all is once again right with the world.

(As an aside, it strikes me that relying on a key geopolitical adversary to supply the life’s blood of your economy is a very risky strategy.  But Putin would never use this as leverage for something else, would he?  I fear it could be a very long cold winter in Europe.)

OK, with that in mind, let’s look at markets this morning.  Equity markets are green everywhere ranging from the Nikkei (+0.5%) to the Hang Seng (+3.1%) with all of Europe in between (DAX +1.2%, CAC +1.35%, FTSE 100 +1.0%) while China remains closed.  US futures are also firmer, currently pointing to a 0.75% rise on the open.

Bond markets are in pretty good shape as well.  Yesterday, after substantial early session weakness, they rebounded, and this morning are continuing on that trend.  While Treasuries are only lower by 0.2bps, in Europe we are seeing much better buying (Bunds -1.7bps, OATs -2.1bps, Gilts -1.2bps) with PIGS bonds (Italy -5.1bps, Greece -3.0bps) showing even more strength.

Commodity prices are consolidating after what has been a significant run higher with oil (-1.6%) and NatGas (-2.0%) both off highs seen yesterday morning.  Gold is unchanged on the day while copper (+1.1%) has bounced along with other base metals.  Ags, too, are a bit firmer this morning.

This positive risk attitude has seen the dollar cede some of its recent gains with AUD (+0.35%) leading the way in the G10 on the back of stronger commodity prices, followed by SEK (+0.3%) and NZD (+0.3%) both benefitting from better risk appetite as well.  Only NOK (-0.1%) is under pressure on the back of the oil price decline.  EMG currencies are universally stronger led by ZAR (+0.7%), PHP (+0.6%) and RUB (+0.5%).  ZAR is clearly benefitting from the commodity rally while PHP was higher on some positive growth comments from the central bank there.  The ruble seems to be benefitting from the view that a higher than expected CPI print there will force the central bank to raise rates more than previously anticipated.

On the data front, today brings only Initial (exp 348K) and Continuing (2762K) Claims.  Given tomorrow is payroll day, these are unlikely to move the market.  We also hear from Cleveland Fed president Mester, one of the more hawkish voices, discussing inflation, but my sense is all eyes are on tomorrow’s NFP to make sure that the taper is coming.  As such, today is likely to continue to see risk appetite with higher stock prices and a soft dollar.  But large moves seem unlikely.

Good luck and stay safe
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Narrative Drift

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Today it is more of the same
As energy traders proclaim
No price is too high
For NatGas, to buy
With policy blunders to blame

As such it is not too surprising
Inflation concerns keep on rising
Prepare for a shift
In narrative drift
Which right now CB’s are devising

Perhaps the most interesting feature of markets since the onset of the Covid-19 pandemic is the realization that prices for different things, be they equities, bonds, commodities, or currencies, can move so much faster and so much further than previously understood.  The simple truth is that markets as a price discovery mechanism are unparalleled in their brilliance.  Recall, for instance, back in April 2020, when crude oil traded at a negative price.  The implication was that crude oil holders were willing to pay someone to take it off their hands, something never before seen in a physical commodity market.  (Of course, in the interest rate markets, that had become old hat by then.)  Well, today European natural gas markets have gone the other way, rising 40% in both Amsterdam and London and taking prices to levels previously unseen.  Now, much to the chagrin of European policymakers, there is no upper limit on prices.  As winter approaches, with NatGas inventories currently just 74% of their long-term average, and with most of the EU reliant on Russia for its gas supplies, it is not hard to foresee that these prices will go higher still.

The first issue (a consequence of policy decisions) is that deciding to allow a geopolitical adversary to control your energy supply is looking to be a worse and worse decision every day.  Gazprom’s own data shows that they have reduced the flow of gas to Europe via Belarus and Poland by 70% and via Ukraine by 20% in the past week.  It cannot be surprising that prices in Europe continue to rise.  And the knock-on effects are growing.  You may recall two weeks ago when a fertilizer company in the UK shuttered two plants because the NatGas feedstock became so expensive it no longer made economic sense to produce fertilizer.  One consequence of that was there was a huge reduction in a byproduct of fertilizer production, pure CO2, which is used for refrigeration and has impaired the ability of food processors to ship food to supermarkets and stores.  Empty shelves are a result.  Just today, a major ammonia producer shuttered its plants as the feedstock is too expensive for profitable production as well.  The point is that NatGas is used as more than a heating fuel, it is a critical input for many industrial processes.  Shuttering these processes will have an immediate negative impact on economic activity as well as push prices higher.  If you are wondering why there are concerns over stagflation returning, look no further.

The bigger problem is that there is no reason to believe these prices will sell off anytime soon.  Arguably, we are witnessing the purest expression of supply and demand working itself out.  As a consequence of these earlier decisions, the EU will now be forced to respond by spending more money and reducing tax income in order to support their citizens and businesses who find themselves in more difficult financial straits due to the sharp rise in the price of NatGas.

Now, a trading truth is that nothing goes up (or down) in a straight line, so there will certainly be some type of pullback in prices in the short run.  However, the underlying supply-demand dynamic certainly appears to point to a supply shortage and consistently higher prices for a critical power source in Europe.  Slower economic growth and higher prices are very likely to follow, a combination that the ECB has never before had to address.  It is not clear that they will be very effective at doing so, quite frankly, so beware the euro as further weakness seems to be the base case.

The other main story of note
Concerns a new debt ceiling vote
Majority wailing
The other side’s failing
May yet, a default, soon promote

Alas, we cannot avoid a quick mention of the debt ceiling issue as the clock is certainly winding down toward a point where a technical default has become possible.  Political bickering continues and shows no sign of stopping as neither side wants to take responsibility for allowing more spending, but neither do they want to be responsible for a default.  (Perhaps that sums up politicians perfectly, they don’t want to take responsibility for anything!)  This is more than a technical issue though as financial markets are failing to see the humor in the situation and starting to respond.  Hence, today has seen a broad sell-off in virtually every asset, with equities down worldwide, bonds down worldwide and most commodities lower (NatGas excepted).  In fact, the only thing that has risen is the dollar, versus every one of its main counterparts.

The rundown in equities shows Asia (Nikkei -1.05%, Hang Seng -0.6%, Shanghai closed) failing to take heart from yesterday’s US price action.  European investors are very unhappy about the NatGas situation with the DAX (-2.2%), CAC (-2.15%) and FTSE 100 (-1.8%) all sharply lower.  It certainly hasn’t helped that German Factory Orders fell a much worse than expected -7.7% in August either.  US futures are currently lower by about 1.25% as risk is clearly not today’s flavor.

Funnily enough, bond markets are also under pressure today, with Treasuries (+1.6bps), Bunds (+1.6bps), OATs (+2.2bps) and Gilts (+3.0bps) all seeing heavy selling.  It seems that inflation concerns are a more important determinant than risk concerns as the evidence of rising prices being persistent continues to grow.

In the commodity space, pretty much everything, except NatGas (+0.6% to $6.33/mmBTU) is lower as well, although this appears to be consolidation rather than the beginning of a new trend.  So, oil (-0.6%), gold (-0.5%), copper (-1.0%) and aluminum (-0.85%) are all under pressure.  Given the dollar’s strength, this should not be that surprising, although overall, I continue to expect a rising dollar and rising commodity prices.

As to the dollar, it is king today, rising 1.1% vs NZD, despite a 0.25% interest rate increase by the RBNZ last night, 1.0% vs. NOK and 0.85% vs SEK with the latter seeing a negative monthly GDP outcome in a huge surprise, thus marking down growth expectations significantly for the year.  But the rest of the G10 is much softer save JPY, which is essentially unchanged on the day.  Meanwhile, the euro has fallen a further 0.5% and is now approaching modest support at 1.1500.  Look for further declines there.

As to emerging market currencies, all that were open last night or today are lower with MXN (-1.2%) leading the way on a combination of lower oil and higher inflation, but HUF (-0.9%), ZAR (-0.8%) and CZK (-0.8%) all suffering on either weaker commodity prices are concerns over insufficient monetary tightening in an inflationary economy.  Even INR (-0.7%) is feeling the heat from rising inflationary pressures.  It is universal.

On the data front, only ADP Employment (exp 430K) is due this morning and there are no Fed speakers scheduled.  Right now, it feels like the dollar is primed to continue to move higher regardless of the data, or anything else.  Fear is growing among investors and they are searching for the safest vehicles they can find.  The steepening of the yield curve indicates the demand is in the 2yr, not the 10yr space, which makes sense, as in an inflationary environment, you want to hold the shortest duration possible.  Beware the FAANG stocks as they are very long duration equivalents.  Instead, it feels like the dollar is a good place to hang out.

Good luck and stay safe
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Prices Ascend

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As energy prices ascend
More problems they seem to portend
Inflation won’t quit
While growth takes a hit
When will this bad dream ever end?

Another day, another new high in the price of oil.  We have now reached price levels not seen in seven years and there is no indication this trend is going to end anytime soon.  Rather, given the supply and demand characteristics in the marketplace, it is not hard to make a case that we will be seeing $100/bbl oil by Q1 2022, if not sooner.  OPEC+ just met and, not surprisingly, decided that they were quite comfortable with rising oil prices thus saw no reason to increase production at this time.  Meanwhile, Western governments continue to do everything in their power to prevent the expansion of energy production, at least the production of fossil fuels.  This combination of policies seems likely to have some serious side effects, especially as we head into winter.

For instance, while I have highlighted the price of energy in Europe and Asia, which remains far higher than in the US, it is worth repeating the story.  Natural gas in Europe is now trading at $37.28/mmBTU, compared with just under $6/mmBTU in the US.  Storage levels are at 74% of capacity which means that any cold snap is going to put serious pressure on the Eurozone economy as NatGas prices will almost certainly rise further in response.  In addition, Europe remains highly dependent on Russia as a supplier which seems to open them to some geopolitical risk.  After all, Vladimir Putin may not be the friendliest supplier in times of crisis.

China, too, is having problems as not only has the price of oil risen sharply, but so, too, has the price of thermal coal (+5.25% today, +200% YTD).  China still burns a significant amount of coal to produce electricity throughout the country with more than 1000 plants still operating and nearly 200 more under construction.  It is this situation which causes many to question President Xi Jinping’s commitment to reining in carbon emissions.  Unsurprisingly, the inherent conflicts in the desire to reduce carbon, thus capping coal production, while trying to generate enough electricity for a growing economy have resulted in the Chinese abandoning the carbon issues.  Last week, Xi ordered coal mines to produce “all they can” rather than adhere to the strict quotas that had been put in place.  Right now, there is a power crisis as utilities have cut back electricity production reducing service to both industrial and residential users.  Again, winter is coming, and insufficient electricity is not going to be acceptable to President Xi.  When push comes to shove, you can be sure that the primary goal is generating enough electricity for the economy not reducing carbon emissions.

Ultimately, this story is set to continue worldwide, with the tension between those focused on economic activity and growth continually at odds with those focused on carbon dioxide.  Until nuclear power is accepted as the only possible way to create stable baseload power with no carbon emissions, nothing in this story will change.  The implication is that energy prices have further, potentially much further, to run given the inelasticity of demand for power in the short-term.  And this matters for all other markets as it will impact both growth and inflation for years to come.

Consider bond markets and interest rates.  While the Fed and other central banks may choose to ignore energy prices in their policy decisions, the market does not ignore rising energy prices.  The ongoing increase in inflation around the world is going to result in higher interest rates around the world.  While central banks may cap the front end, absent YCC, back end yields will rally.  A rising cost of capital is going to have a negative impact on equity markets as well, as both future earnings are likely to suffer and the discount factor for those who still consider DCF models as part of their equity analysis, is going to reduce the current value of those future cash flows.  The dollar, however, seems likely to benefit from rising oil and energy prices, as most energy around the world (in wholesale markets) is priced in USD.  Essentially, people will need to buy dollars to buy oil or gas.  Adding all this up certainly has the appearance of a more substantial risk-off period coming soon.  We shall see.

This morning, however, that is not entirely clear.  While Asian equity markets saw more red than green (Nikkei -2.2%, Sydney -0.4%, Hang Seng +0.3%, Shanghai closed), Europe is feeling positively giddy with gains across the board (DAX +0.35%, CAC +0.8%, FTSE 100 +0.65%) as PMI data showed more winners than losers although it also showed the highest price pressures seen since 2008, pre GFC.  US futures, after markets had a tough day yesterday, are pointing higher at this hour, with all three main indices higher by about 0.35%.

Bond markets are a bit schizophrenic this morning as Treasury (+1.9bps) and Gilt (+2.0bps) yields climb while we see modest declines in Europe (Bunds -0.2bps, OATs -0.3bps).  While yields remain low on a historic basis, and real yields remain extremely negative, it certainly appears that the trend in yields is higher.  There is every possibility that central banks blink when it comes to fighting inflation and ultimately do prevent yields from rising much further, but so far, they have not felt compelled to do so.  This is something we will be watching closely going forward.

Turning to commodities, oil (WTI +1.05%) shows no signs of slowing down.  Nor does NatGas (+3.0%) or coal (+5.25%).  Energy remains in demand.  Precious metals, on the other hand, continue to flounder with both gold (-0.85%) and silver (-0.7%) under pressure.  Copper (-1.75%) too, is feeling it today along with the rest of the industrial metal space save aluminum (+0.6%).  Ags are softer as well.

The dollar, however, is having a much better day, rallying against most of its major counterparts.  For instance, JPY (-0.3%) continues to suffer as the market demonstrates a lack of excitement over the new PM and his team.  Meanwhile, EUR (-0.2%) has reversed its consolidation gains and appears set to resume its recent downtrend.  Technically, the euro looks pretty bad with a move toward 1.12 quite realistic before the end of the year.  AUD (-0.2%) found no support from the RBA’s message last night as they continue to look toward 2024 before interest rates may start to rise.  On the plus side, only NOK (+0.2%) on the back of oil’s gains, and GBP (+0.2%) on the back of a stronger than expected PMI release are in the green.

EMG currencies have also seen many more laggards than gainers led by HUF (-0.5%) and PLN (-0.3%) both high beta plays on the euro, and MXN (-0.2%) and RUB (-0.2%) both of which are somewhat surprising given oil’s continued rise.  The bulk of the APAC currencies also slid, albeit only in the -0.1% to -0.2% range, with several simply adjusting after several days with local markets closed.  ZAR (+0.35%) is the only gainer of note as the Services PMI data printed at a better than expected 50.7.

On the data front, the Trade Balance (exp -$70.8B) and ISM Services (59.9) are on the slate and we hear from Vice-Chair Quarles on LIBOR transition.  In other words, not much of note here.  While I believe oil prices remain the key driver right now, there is certainly some focus turning to Friday’s payroll data as that is the last big data point before the Fed’s November meeting.

The dollar’s trend remains higher and I see no reason for anything to halt that for now.  My take is the modest correction we saw Friday and Monday is all there is for now, and a test of the recent highs is coming soon to a screen near you.

Good luck and stay safe
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The Ceiling for Debt

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To traders, the ceiling for debt
Is starting to grow as a threat
As Yellen explained
She’ll soon be constrained
From paying our bills, just not yet

Some folks claim an alternate way
Exists which could help save the day
To quickly influx
A cool trillion bucks
Just mint a new coin to help pay

In addition to all the Congressional drama over the Biden spending agenda, the US is also being buffeted by the debt ceiling drama.  We’ve all seen this movie before, where US law requires Congress to approve the amount of debt that can be issued by the Treasury in order to pay for the spending that Congress mandates.  (A little-known fact is that the debt ceiling was not enacted to impose discipline on Congress, in fact it was the opposite.  Prior to the debt ceiling’s implementation, Congress was required to vote on the funding for each spending bill they enacted on an individual basis.  The debt ceiling was created to allow Treasury to fund the Congressional spending mandates in a smoother and more efficient manner.  My how things have changed!)  But back to our story… the current situation is that the debt ceiling has been reached and the Treasury is not empowered to issue any new debt (it can roll over maturing debt) in the current situation.  While the Treasury does have some cash on hand, and can move funds around in its various accounts, by most measures, it appears that there are about 2 weeks of funding left before the government will have to default on paying some bills on a timely basis.

Now default was never contemplated by the Founding Fathers, with them going so far as to explain in Section 4 of the 14th Amendment of the Constitution:

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void. [author’s emphasis]

It is this confluence of events which has led to a somewhat creative thought regarding how the government can overcome their problem, minting a trillion-dollar platinum coin.  One thing that is clear is that the Treasury has the legal right to mint coinage, which is why despite the talk of the Fed printing money, the actual money printer is the Treasury department.  Those $20 bills in your wallet are printed at the US Mint, a part of the Treasury.  And the right to print money is fiercely protected by every nation as it is a good source of revenue (known as seignorage).  Consider, they print money and can use it to buy real stuff, whether tanks, or medicines or anything else.  All of those things cost far more than the paper that money is printed on.  As well, paper money is considered part of the Treasury’s coinage capability.

Now, in economic terms, $20 bills are actually zero-coupon perpetual bonds.  A claim on a fixed notional of assets with no interest rate paid and no maturity date.  The same is true with quarters and dimes and nickels, no maturity date, no interest rate, some ascribed value.  This has led to the idea that the Treasury can mint a coin with a notional value of $1 trillion (made of platinum to denote its high value), deliver it to the Fed and get $1 trillion of spending power in their general account.  This idea was first mooted in 2011 as a similar split in Congress brought the US government very close to an actual default.  Ten years later, as the concept of MMT has become more widely accepted as a viable path forward (it’s NOT), the idea is once again gaining traction.  It certainly solves some problems, notably it prevents a default, but more importantly to the Democrats in Congress, it prevents a distasteful political vote that can be used as a cudgel by Republican opponents in the next election.

Of course, my question is, why would they stop at $1 trillion?  After all, if current spending plans are for $5 trillion, why not mint five coins, or ten so they have some spare change?  You can see the danger of this slippery slope, especially in the current economic environment where inflation is already running rampant.  The addition of $1 trillion or $5 trillion more into the economy without the creation of new products or services would really turbocharge inflation.

While thus far, it seems this idea remains at the margin, given the dysfunctionality of Congress these days, and the shrinking timeline for action, it cannot be ruled out.  My sense is that while it could have a short-term positive impact on the dollar and markets, it would relatively quickly be understood to be a massively inflationary action with both bonds and the dollar suffering accordingly.

OK, with that food for thought, let us take a look at market activity today.  The first thing to note is that China is in the midst of its Golden Week holidays, which means there are no markets there until next week.  Hong Kong (-2.2%) and Tokyo (-1.1%), however, were both open, although neither had a very positive session.  Hong Kong suffered as they halted trading in Evergrande shares and other real estate companies fell sharply.  Europe, on the other hand has edged slightly higher this morning, (DAX +0.0%, CAC +0.2%, FTSE 100 +0.2%) although it is hard to get too excited over the movement.  US futures, on the other hand, are all pointing a bit lower, on the order of -0.4% at this hour.

Bond markets are seeing some selling this morning with 10-year Treasury yields higher by 3.5bps, although since the very sharp move last week, they have been consolidating either side of 1.50% yields.  European sovereigns are also under some pressure with yields there moving up (Bunds +1.8bps, OATs +1.6bps, Gilts +2.0bps), although there has been precious little news on which to trade.

In the commodity market, oil prices continue to trade higher (WTI +0.3%) as does Nat Gas (+2.3%).  While precious metals are under some pressure (Au -0.6%), industrial metals are firm this morning (Cu +1.35%, Al +0.6%) and agricultural prices are mixed in slow trading.

As to the FX market, the dollar is definitely under some pressure this morning with CHF (+0.45%) leading the way higher in the G10 with NOK (+0.4%) and GBP (+0.4%) next in line.  The only laggard today is JPY (-0.15%) which is confusing given the Swiss franc’s performance as otherwise, one could consider this a somewhat risk-on day.  But US equity futures are not helping that story either.  In the EMG space, things are a little clearer as the CE4 (HUF +0.75%, PLN +0.6%, CZK +0.3%) are the top performers as all of them continue to get supported by central bank comments regarding tighter monetary policy.  On the downside, MXN (-0.45%) is suffering the opposite as Banxico comments indicated that there would be no 50 basis point rate hikes anytime soon, something the market was beginning to price in.  Net, the dollar is probably slightly softer, but the recent uptrend remains intact.

Data this week is fairly slow up until Friday’s payroll report:

Today Factory Orders 1.0%
Tuesday Trade Balance -$70.6B
ISM Services 59.9
Wednesday ADP Employment 430K
Thursday Initial Claims 350K
Continuing Claims 2770K
Consumer Credit $17.5B
Friday Nonfarm Payrolls 470K
Private Payrolls 450K
Manufacturing Payrolls 25K
Unemployment Rate 5.1%
Average Hourly Earnings 0.4% (4.6% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%

Source: Bloomberg

A couple of things worth mentioning are that last week, the NFP forecast was 535K, so starting to slip.  Also, we continue to hear that there is no wage inflation, yet 4.6% Y/Y will be the highest non-Covid related level since before the GFC.  On the Fed speaker circuit, this week is far less noisy with only 4 speakers, none of whom are going to change the narrative.

As to the dollar overall, I believe we are in an uptrend for now, having broken through previous strong resistance, and I expect that we are likely to see this trend continue.  Use pullbacks to hedge, but they will not be large in my view.

Good luck and stay safe
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