Category Archives: Uncategorized

Nowhere Near

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Charles Evans, on Tuesday, explained
Inflation can well be contained
In fact, his concern
Is prices could turn
Back lower ere targets are gained

“I’m going to be very regretful if we sort of claim victory on averaging 2% and then we find ourselves in 2023 with about a 1.8% inflation rate, sustainable, going forward. That would be a challenge for our long-run framework,” he [Evans] said. “We ought to be willing to average inflation above 2%—frankly, well above 2%. [author’s emphasis]”

One cannot overstate the hubris associated with the above quote from Chicago Fed President Charles Evans.  The fact that he legitimately believes the Fed’s powers are such that they can fine-tune a $24 trillion economy to the point that measured estimates of particular features of that economy are able to be managed to a decimal place of an annualized percentage outcome is extraordinary.  It is the perfect illustration of the fact that the Fed is completely out of touch with the economy in which you and I live and completely ensconced in a model driven framework where data represents reality.  But it is exactly this hubris that has resulted in the policy decisions that have brought the world negative interest rates and a defense of debt monetization.  As long as central bankers, notably the Fed, continue to believe that their models are the economy, rather than a simplified representation of the economy, they are likely to continue to make decisions with significant unintended consequences from which we all will suffer.

This morning the market awaits
The latest inflation updates
What’s patently clear
Is they’re nowhere near
An outcome to end the debates

Speaking of inflation, this morning brings the latest CPI data with expectations running as follows: Headline (0.5%, 5.3% Y/Y) and ex food & energy (0.4%, 4.3% Y/Y).  Both of those forecasts are slightly lower than the prints seen in July, and if realized, you can be sure that we will hear a chorus of FOMC members highlighting the transitory nature of inflation.  Of course, if the outcomes are higher than forecast, something we have seen in each of the past twelve reports, we will also hear a chorus of FOMC members explaining that this remains a temporary phenomenon and that inflation is transitory.  [Perhaps when Ralph Waldo Emerson wrote in 1841, “a foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines,” he was anticipating the Fed.]  However, financial markets may not be quite as sanguine over the results, especially if they continue their year-long streak of outperforming the median estimate.

Markets, of late, have been starting to discern between those products that will benefit from altered policy and those products that will suffer.  Nowhere is this clearer than in the US equity markets where we have seen the NASDAQ underperform its brethren indices.  Recall, given the NASDAQ’s strong bias toward high growth (and low profit) companies that benefit greatly from extremely low interest rates, the index behaves very much like a very long-duration bond.  So, in a scenario where inflation is rising and market expectations are for tapering of asset purchases to begin soon(ish), it should be no surprise that the NASDAQ falls alongside the price of bonds.  At the same time, if the implication is that rising inflation is being caused by rebounding growth, rather than supply-chain blockages, there is an opportunity for more mundane, value-type companies to outperform.  Hence, the differing performance of the DOW vs. the NASDAQ.
Of course, the place where inflation is likely to have the most direct effect is the bond market, where long-term yields are theoretically supposed to reflect inflation expectations.  And while we have certainly seen yields rise over the past week, there is no way they currently reflect those expectations.  They cannot do so as long the Fed continues to buy all the new issuance, and then some, thus artificially driving up prices and driving down yields.  Ask yourself this, does it make sense that US 10-year yields are at 1.36% if inflation is at 5.4%?  Of course, the answer to that is a resounding ‘No!’  Yet, that is the current situation.  To observe the bond market and believe it is not artificially inflated (everywhere in the world, mind you) is akin to believing that the moon is made of green cheese.  It just ain’t so!

At any rate, ahead of this morning’s CPI release, investors have generally been biding their time as they wait to determine if they need to adjust their world view.  Equity markets are generally a bit firmer as Asia mostly eked out some gains (Nikkei +0.6%, Hang Seng +0.2%, Shanghai 0.0%) with Europe following suit (DAX 0.0%, CAC +0.3%, FTSE 100 +0.5%).  US futures are split with the NASDAQ (-0.2%) slipping following yesterday’s losses, while the other two main indices are essentially unchanged.  All in all, it appears that there is some hope that CPI prints on the low side to allow the Fed narrative to continue apace, and therefore to allow rates to remain lower for longer.

Bond markets, though, are starting to get a bit antsy these days with Treasury yields edging higher again (+1.7bps) with similar type gains seen throughout Europe (Gilts +1.4bps, OATs +1.8bps, Bunds +0.8bps).  At this point, 10-year Treasury yields have risen 0.25% in the space of a week, which is a very substantial move, especially when considering that the base at the beginning was just 1.12%.  One has to believe the Fed is watching extremely closely as they do not want to see the market run too far ahead of their mooted tapering and create Taper tantrum #2 inadvertently.  It is here where a higher than forecast CPI print could have quite an impact and which may force the Fed to reconsider the idea of tapering.  After all, they cannot afford for 10-year yields to rise to 2.0% while they are still purchasing $120 billion per month of paper.

Commodity prices are mixed today with oil (-1.1%) feeling the pressure of higher yields while gold (+0.5%) seems to be ignoring that same pressure.  Of course, gold was just subject to a significant sell-off, so this could easily be a simple trading bounce.  As it happens, both agricultural and base metal prices are showing a mixture of gainers and losers and no real underlying theme.

Finally, the dollar is definitely stronger again this morning.  While the movement vs. its G10 brethren has not been large, it is unanimous, with all currencies in the red today.  A particular shout-out goes to the euro, which is trading just pips from the key support level of 1.1704.  Watch that carefully as a break there is likely to open up much lower levels.  In the emerging markets, KRW (-0.6%) has been the laggard, followed by TRY (-0.5%) and HUF (-0.4%).  The won has been suffering from a combination of rising covid cases, with a record high 2200 reported yesterday, which has been encouraging the liquidation by foreign investors of Korean equities.  Meanwhile, TRY is under pressure as traders are concerned the President Erdogan will once again interfere in the central bank’s business and prevent them from raising rates at tomorrow’s meeting.  Finally, the forint seems to be suffering for the sins of its neighbors as concerns over German growth, a key market, and Polish politics, a close neighbor, have encouraged selling.

And that’s really it for today.  All eyes will be on the CPI at 8:30. More than just watching the tape, I always pay attention to @inflation_guy on Twitter as he does an excellent job breaking down the drivers of the number and offering insight into how things may evolve.  I highly recommend following him.

As to the dollar, the slow grind higher continues and as long as US rates are rising, I think so will the dollar.  If we break the 1.1704 level in the euro, look for a bit of an acceleration.  But don’t be surprised if we reject the move given it is the first test of the support level since it was established back in March.

Good luck and stay safe
Adf

The Chorus has Grown

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T’was only a few months ago
When Kaplan from Dallas said, whoa
The time has arrived
Where growth has revived
And bond buying needs to go slow

Since then, though, the chorus has grown
As seven more members have shown
That they all agree
It’s time for QE
To end and leave markets alone

We continue to hear from more FOMC members that it is time to taper the Fed’s purchases of both Treasuries and mortgage-backed securities.  Last Wednesday, of course, the big news was that Vice-Chairman Richard Clarida came out so hawkishly in his comments, not only calling for tapering bond purchases but also raising rates sooner than the median forecast had anticipated.  Yesterday, three Fed speakers were all on the same page, with Boston’s Eric Rosengren the newest name added to the tapering crew (Bostic and Barkin were already known taperers.)  That takes the count to at least eight (Clarida, Bostic, Barkin, Rosengren, Bullard, Daly, Waller and Kaplan) with the two most hawkish FOMC members, Loretta Mester and Esther George, on the docket for today and tomorrow respectively.  It is not unreasonable, based on their respective histories, to expect both of them to call for tapering as well.  That would make ten of the seventeen members as confirmed supporters of the process.

The question is, will that be enough?  The Fed’s power core for the last several years has been concentrated in four members, Powell, Clarida, Williams and Brainerd.  Of this group, only Clarida has publicly proclaimed it has come time to taper.  And potentially, his importance is diminishing as his term ends within months and he is seen as highly unlikely to be reappointed.  Rather, the talk of the town is that Chairman Powell is also losing fans in the Senate with respect to his reappointment, and that Governor Lael Brainerd is the new leading candidate to become Fed Chair.  As it happens, neither of those two have come out for tapering soon, and in fact, last week, Ms Brainerd was adamant in her belief it was far too early to do so.  The point is, the Fed has never been a democratic institution although it is an extremely political one.  Having a majority of members agree on a view only matters if it is a majority of the right members.  By my count, that is not yet the case.  Perhaps come Jackson Hole in two plus weeks, we will hear the Chairman agree, but tapering is not yet a done deal.

Traders, however, see the world very differently than pundits, and certainly very differently than the Fed itself.  And what has become very clear in the past several days is that traders are increasingly placing bets that tapering is coming…and coming soon.  The combination of all those Fed speakers talking about tapering, the very strong NFP data as well as yesterday’s JOLTs blowout (>10 million jobs are open), and the constant stream of stories about rising wages (just this morning a BBG story on JPM raising salaries to compete to hold onto staff is simply the latest) have been sufficient to logically conclude that it is time for the Fed to begin removing accommodation.  Hence, Treasury yields have backed up nearly 20 basis points from the lows seen last Wednesday morning, the dollar has risen against all its counterparts and the price of oil has fallen by more than 4%.

Looking ahead, the question becomes, is this likely to continue?  Or have we reached a peak?  It is not unreasonable to assume that both George and Mester will call for tapering this week.  It is also not unreasonable to assume that the CPI data tomorrow is going to point to a still rising price environment, whether it ticks slightly higher or lower than last month’s 5.4% headline print.  Any number in that vicinity remains far above the Fed’s average target of 2.0%.  The point is that there is nothing obvious on the horizon that should cause the tapering hawks to back off, at least not until the end of the month.  As such, hedgers need to be prepared for a continuation of the recent price action.

Meanwhile, a look at today’s markets shows that these recent trends remain intact.  While Asian equity markets continue to follow their own drummer (Nikkei +0.25%, Hang Seng +1.25%, Shanghai +1.0%), European bourses continue to struggle (DAX +0.2%, CAC +0.1%, FTSE 100 -0.1%) as do US futures with all three major indices either side of unchanged.  Asia seems to be benefitting from the view that the PBOC is preparing to ease policy further as China responds to the increased lockdowns due to the delta variant of Covid that has been spreading quite rapidly there, in addition to the fact that the Chinese authorities have not named a new target in its seemingly random crackdown of successful companies.

Bond markets, while edging higher today, have been generally losing ground.  So, while Treasury yields are lower by 0.5bps this morning, they are at 1.32%, well off the lows seen last week.  European sovereigns are generally a touch firmer as well, with yields down by between 0.5bps and 1 bp but they, too, have seen yields climb back a bit lately.

Commodity prices, which have been under severe pressure, are rebounding slightly this morning, although this has the appearance of a trading bounce more than a sea change in view.  Commodity prices are likely to be amongst the hardest hit if the Fed really does start to tighten policy.  But this morning, oil (+2.0%) has rebounded nicely although gold (0.0%) has been unable to bounce from yesterday’s massive sell-off.  Copper (+0.65%) is leading base metals modestly higher and ags have bumped up a bit as well.

As to the dollar, right now it is arguably slightly stronger overall, but only just as there are a mix of gainers and losers vs. the greenback.  In the G10 space, the euro (-0.1%) is continuing toward its test of key support at 1.1704, albeit quite slowly.  The entire space, though, is +/- 0.2% or less, which is indicative of position adjustments rather than news driven activity.

EMG currencies are also mixed with KRW (-0.5%) the weakest of the bunch on the back of concerns over the impact of the delta variant as well as equity market outflows by international investors.  PLN (-0.4%) is the next weakest as central bank comments seemed to delay the timing of a mooted rate hike.  On the flip side, TRY (+0.6%) is the leader as Unemployment data there was released at a much lower than expected 10.6%.

Data today showed that Small Business Optimism has suffered lately with the NFIB Index falling to 99.7.  At 8:30 we see Nonfarm Productivity (exp 3.2%) and Unit Labor Costs (+1.0%), although it is unlikely either will have a big market impact.  Arguably, market participants are all waiting for tomorrow’s CPI data for the next big piece of news.

At this point, the dollar’s modest uptrend remains in place and I see no reason to believe that will change.  At least not until we hear differently from Powell or the data turns much worse.

Good luck and stay safe
Adf

Resolute

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The narrative is resolute
That though prices did overshoot
They’re certain to fall
And that, above all,
The Fed’s in control, absolute

However, concern is now growing
That growth round the world’s started slowing
Though Friday’s report
On jobs was the sort
To help the bull market keep going

Clearly, my concerns over a weak payroll report were misplaced as Friday’s data was strong on every front, although perhaps too strong on some.  Nonfarm payrolls grew a robust 943K with net revisions higher of 119K for the past two months.  The Unemployment Rate crashed to 5.4%, down one-half percent, and Average Hourly Earnings rose 4.0% Y/Y.  It is the last of these that may generate some concern, at least from the perspective of the transitory inflation story.

While it is unambiguously good news for the working population that their wages are rising, something that has been absent for the past two decades, as with Newton’s first law (every action has an equal and opposite reaction) the direct result of rising wages tends to be rising prices.  So, while getting paid more is good, if the things one buys cost more, the net impact may not be as positive.  And in fact, consider that while the 4.0% annual rise is the highest (excluding the distortions immediately following the  Covid-19 lockdowns) in the series since at least the turn of the century, when compared to the most recent CPI data (you remember, 5.4%) we find that the average employee continues to fall behind on a real basis.

When discussing inflation, notice that the Fed harps on things like used car prices or hotel prices as the key drivers of the recent rise in the data.  They also tend to explain that commodity prices play a role, and that is something they cannot control.  But when was the last time Chairman Powell talked about rapidly rising wages or housing prices as an underlying cause of inflation?  In fact, when asked about whether the Fed should begin tapering mortgage-backed securities purchases sooner because of rapidly rising house prices, he claimed the Fed’s purchases have no impact on house prices, but rather it was things like the temporary jump in lumber prices that were the problem.  Oh yeah, and see, lumber prices have fallen back down so there is nothing to worry about.

Of course, wages are not part of CPI directly.  Rising wages are reflected in the rising prices of everything as companies both large and small find it necessary to raise prices to maintain their profitability.  Certainly, there are some companies that have more pricing power than others and so are quicker to raise prices, but in the end, rising wages result in one of two things, higher prices or lower margins, and oftentimes both.  In the broad scheme of things, neither of these outcomes is particularly positive for generating real economic growth, which is arguably the goal of all monetary policies.

Consider, to the extent rising wages force companies to raise the price of their product or service, the result is an upward bias in inflation that is independent of the price of oil or lumber or copper.  In fact, one of the key features of the past 40 years of disinflation has been the fact that labor’s share of the economic pie has fallen substantially compared to that of capital.  This has been the result of the globalization of the workforce as the addition of more than 1 billion new workers from developing nations was sufficient to keep downward pressure on wages.

Arguably, this has also been one of the key reasons corporate profit margins have risen and stock prices along with them.  Now consider what would happen if that very long-term trend was in the process of reversing.  There is a likelihood of rising prices of goods and services, otherwise known as inflation.  There is also a likelihood of a revaluation of equity prices if margins start to decline. And nothing helps margins decline like rising labor costs.

Consider, also, this is the sticky type of inflation, exactly the opposite of all the transitory claims.  This is the widely (and rightly) feared wage-price spiral.  I am not saying this is the current situation, at least not yet, but that things are falling into place that could easily result in this outcome.

Now put yourself in Chairman Powell’s shoes.  Prices have begun rising more rapidly as companies respond to rising wage pressures.  The employment situation has been improving more rapidly so there is less concern over the attainment of that part of your mandate.  But…the amount of leverage in the system is astronomical with government debt running at record high levels (Federal government at 127%) and all debt, including household and corporate at 400% of GDP.  Do you believe that the economy can withstand higher interest rates of any substance?  After all, in order to tackle inflation, real rates need to be positive.  What do you think would happen if the Fed raised rates to 6%?  And this is my point as to why the Fed has painted themselves into the proverbial corner.  They cannot possibly respond to inflation with their “tools” because the negative ramifications would be far too large to withstand.  It is also why I don’t’ believe the Fed will make any substantive policy changes despite all the tapering talk.  They simply can’t afford to.

Ok, on to the markets.  One of the notable things overnight was the flash crash in the price of gold, which tumbled $73 as the session began on a huge sell order in the futures market, although has since regained $54 and is currently down 1.1% from Friday’s close.  The other things was the release of Chinese CPI (1.0%) and PPI (9.0%), both of which printed a few ticks higher than expected.  Obviously, there is not nearly as much pass-through domestically from producer to consumer prices in China, but that tends to be a result of the fact that consumption is a much smaller share of the Chinese economy.  However, higher prices on the production side, despite the government’s efforts to stop commodity speculation and hoarding, does not bode well for the transitory story.  And while discussing EMG inflation readings, early this morning we saw Brazil (1.45% M/M) and Mexico (5.86% Y/Y) both print higher than forecast results.  Certainly, it is no surprise that both central banks are in tightening mode.

A quick peak at equity markets showed Asia performed reasonably well (Nikkei +0.3%, Hang Seng +0.4%, Shanghai +1.0%) although Europe has been struggling a bit (DAX -0.2%, CAC -0.1%, FTSE 100 -0.4%).  US futures, meanwhile, are either side of unchanged with very modest moves.

Treasury yields have given back 2 basis points from Friday’s post-NFP surge of 7.5bps, although there are many who continue to believe the short-term down trend has been ended.  European sovereigns are also rallying a bit, with Bunds (-1.3bps), OATs (-1.3bps) and Gilts (-3.5bps) leading a screen that has seen every European bond rally today.

Commodity prices are perhaps the most interesting as oil prices have fallen quite sharply (-4.0%) with WTI back to $65.50/bbl, its lowest level since late May.  This appears to be a recognition of the growth of the Delta variant and how more and more nations are responding with another wave of lockdowns and restrictions on movement, thus less travel and overall economic activity.  As such, it should be no surprise that copper (-1.5%) is lower or that the metals space as a whole is under pressure.

Interestingly, the dollar is not showing a clear trend at all today, with gainers and losers about evenly mixed and no particularly large moves.  In the G10, NOK (-0.3%) is the laggard, clearly impacted by oil’s decline, but away from that, the mix is basically +/- 0.1%, in other words, no real change.  In the emerging markets, ZAR (+0.3%) is the leader, although this appears more to be a response to its sharp weakness last week than to any specific news.  And that is the only EMG currency that moved more than 0.2%, again, demonstrating very little in the way of new information.

Data this week brings CPI amongst a bunch of lesser numbers:

Today JOLTS Jobs Openings 9.27M
Tuesday NFIB Small Biz Optimism 102.0
Nonfarm Productivity 3.2%
Unit Labor Costs 0.9%
Wednesday CPI 0.5% (5.3% Y/Y)
-ex food & energy 0.4% (4.3% Y/Y)
Thursday Initial Claims 375K
Continuing Claims 2.88M
PPI 0.6% (7.1% Y/Y)
-ex food & energy 0.5% (5.6% Y/Y)
Friday Michigan Sentiment 81.2

Source: Bloomberg

At this point, the response to the CPI data will be either of the following; a high number will be ignored (transitory remember), and a low number will be proof they are correct.  So, while we may all be suffering, the narrative will have no such problems!

There are a handful of Fed speakers this week as well, with the two most hawkish voices (Mester and George) on the calendar.  Right now, the narrative has evolved to tapering is part of the conversation and Jackson Hole will give us more clarity.  The market is pricing the first rate hike by December 2022 based on the recent commentary.  We shall see.  Until then, I don’t anticipate a great deal as many desks will be thinly staffed due to summer vacations.  Just be careful if you have a large amount to execute.

Good luck and stay safe
Adf

A New Endeavor

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A trend that is growing worldwide
Shows policy’s been modified
From lower forever
To a new endeavor
That tapering must be applied

But what if the jobless report
Frustrates and the number falls short?
Will traders respond
By buying the bond?
Or will sellers keep holding court?

While today is a summer Friday, which typically holds little excitement except for the anticipation of the weekend, there is a bit more at stake this morning with the release of the July NFP report at 8:30.  Given that we appear to be reaching an inflection point in policymaking circles, today’s data could either cement the changes that seem to be coming, or it could throw cold water on the entire process and take us back to square one.

The one thing that we have heard consistently over the past several weeks is that there is a growing desire by a widening array of FOMC members to begin tapering asset purchases.  While Chairman Powell has not yet indicated he is ready, and a key lieutenant, Governor Lael Brainerd, was forceful in her views that it was way too early to do so, at least six or seven other members are ready to roll, with the latest being vice-chair Clarida and SF President Daly.  But all of this tightening talk is predicated on the idea that not only has the inflation part of their mandate been achieved (gotten out of hand really), but that they have made progress on the employment part.

This brings us to today’s report.  Since December, when the number was negative amid the second wave of the Covid outbreak, we have seen the following numbers: 233K, 536K, 785K, 269K, 583K, 850K. Historically, all of those numbers would be seen as strong, but obviously, given the 20 million job losses at the beginning of the lockdown last year, those numbers represent a very different situation now.  A rudimentary look at the pattern would have you believe that today’s print, expected at 858K, is more likely to come at a much lower number, something like 250K-300K.  Frankly, the thing that has me concerned is that the monthly survey is taken during the week that contains the 15th of the month.  A quick look back at the weekly Initial Claims data for that week in July shows it was a surprisingly high 424K, a relatively high level given the prior trend.  So, it could well be that a quirk in the data may result in a disappointing headline number.  Remember, too, that the ADP Employment number was a MUCH weaker than expected 330K, so another potential sign of impending weakness.  My point is that there is a very real opportunity for a negative surprise this morning.

The question is; if we do get a negative surprise, will markets ignore it?  Or will they reevaluate their current belief set that tapering is on the way?  As it happens, there are no Fed speakers scheduled for today, so it is not obvious that anyone will be able to clarify things in that situation.

Ahead of the number, markets continue to demonstrate their belief that tighter monetary policy is coming to the US.  This is made evident by the dollar’s continuing strength, with the euro (-0.25%) testing the 1.18 level and stronger vs. all of its G10 and most of its EMG counterparts.  It is evident in the continued backing up in Treasury yields, which after trading as low as 1.1275% Wednesday ahead of the Clarida comments, are now higher by 3.3 basis points this morning and trading back at 1.26%.  While this is hardly “high” in a broad sense, the recent movement does demonstrate a clear trend

Equity markets seem to be somewhat less concerned, as yesterday, once again, US markets traded to new all-time highs.  European markets are all modestly in the green this morning and only China, which continues to attack its own companies (the latest being Moutai, the food delivery service that is mooted to be fined >$1 billion for no apparent reason), has seen any real weakness in this space.  But equity investors will continue to claim TINA until yields have really made a comeback.  And despite the modest declines we have seen in bond prices today, we have actually seen negative yielding debt rise further, to $16.9 trillion, as of yesterday, hardly a sign of tighter policy.

So, overall, we are mostly given mixed signals by markets and policymakers and need to sort things out for ourselves.  The first thing to do is look at what is expected this morning

Nonfarm Payrolls 858K
Private Payrolls 709K
Manufacturing Payrolls 26K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $23.0B

Source: Bloomberg

Between the widening spread of the delta variant, which is clearly disrupting supply chains around the world as well as causing more lockdowns and thus slowing economic activity, and the statistical noise and patterns, I have a feeling we are going to get a pretty bad number.  A print below 500K, which is my guess, is likely to force at least some rethinking of the timing for tapering.  Remember, while the Fed has admitted that some progress toward their goals has been achieved, their standard of “substantial further progress” remains “a ways away” according to Chairman Powell’s last comments.  A low print today will certainly delay the tapering talk.

In that event, how can we expect markets to respond?  Well, as the equity market sees all news as good news, it will clearly rally under the guise of easy money for longer.  Bond markets are also likely to push higher with yields slipping as concerns over a taper in the near-term dissipate.  But arguably, the biggest mover will be the dollar, which I believe has rallied sharply on the tapering talk, and if/when that fades, the short-term case for being long dollars will fade with it.

If I am wrong, and we get a strong number then the taper talk will intensify.  This should lead to further bond weakness (higher yields), a dollar rally and likely test of the key euro support at 1.1704, and … an equity rally since that is what stocks seem to do.

Good luck, good weekend and stay safe
Adf

Dire Straits

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The Vice-Chair explained he foresees
A time when the Fed, by degrees
Will taper their buying
Of bonds while they’re trying
To offset the spread of disease

Soon after they finish that deed
Most members already agreed
To raise interest rates
Unless dire straits
In markets don’t let them succeed

Fed Vice-Chair Richard Clarida certainly surprised markets yesterday with his speech as he laid out his reasoning that the tapering of the Fed’s current QE purchases will occur sooner than many had previously expected.  While he started out with the caveat that the Fed will not be responding to forecasts, but rather to actual economic outcomes, he then proceeded to forecast the exact sequence of events that will occur and create the proper environment for the Fed to first, taper bond purchases and second, eventually raise interest rates.  The market response was immediate, with the bond market selling off sharply, the dollar rallying and equity markets ceding early gains alongside most commodity prices.  After all, a tighter Fed is not nearly as supportive of risk assets, but neither does it imply lower interest rates.  It is also worth noting that coincident with the release of the text of his speech was the release of the ISM Services number which printed at a much higher than expected, and record level, 64.1.  So, a positive data print and a hawkish Fed speaker were sufficient to change a lot of opinions.

But not this author’s, at least not yet.  My baseline view continues to be that the Fed remains in an extremely difficult position where inflation continues at much higher levels than which they expected or with which they are comfortable, but the employment market remains far away from their restated goal of maximum employment.  As well, as Clarida noted yesterday, and as has been repeated by numerous other Fed speakers, they promise they are not going to move on forecasts or survey data, but instead wait for actual numbers (read the NFP data and core PCE) to achieve their preferred levels before altering policy.  This means that tomorrow’s NFP data will be scrutinized even more closely than usual, as Clarida’s comments yesterday imply that even more FOMC members are ready to move.

One problem with the early taper thesis is that the data may not meet the FOMC’s requirements, at least not in the near term.  For instance, yesterday’s ADP Employment release printed at 330K, less than half the expected 690K and basically one-third of the forecasts for NFP tomorrow.  While the month to month correlation between the two data points is not perfect (0.784 over the past 5 years) it is certainly high enough to imply a strong relationship between the two.  The point is that if tomorrow’s NFP number disappoints, which cannot be ruled out, and assuming that the Fed is true to their word regarding waiting for actual data to reach their preferred levels, it would certainly suggest a delay to the tapering story.  Keep in mind, as well, that the Citi Economic Surprise Index, which measures actual releases vs. forecasts, remains in negative territory, implying that the economy is slowing further rather than extending gains seen earlier in the year.  In fact, after the much worse than expected GDP print last week, it appears that growth is already slipping back toward pre-Covid trends of 1.5% – 2.0%.  Oh yeah, none of this includes the impact of the delta variant, which has resulted in numerous lockdowns around the world and augers still slower growth.

On the flip side, though, is the fact that we have seen an increasing number of FOMC members start to accept the idea that tapering will soon be appropriate.  In addition to Clarida, yesterday we also heard from SF Fed President Daly, an avowed dove, who said, “Fed will do something on asset purchases end ’21 / early ’22.”  By my count, that makes at least six different FOMC members who have indicated tapering is coming soon.  Of this group, Clarida is by far the most important, but if even the doves like Daly are coming round to that view, tapering cannot be ruled out.

To taper or not remains the $64 trillion question for all markets, and while the recent trend of the narrative seems to be pushing in that direction, without support from ongoing improvements in employment data (after all, inflation is well through their target), it will still come to naught.

One last thing on inflation.  As the Fed tries to retake the narrative from the market, be prepared for a new description of inflation.  No longer will it be transitory, but rather, perhaps, tolerable.  In other words, they will accept that it is running hotter than their target and make the excuse that it is far more important to get the nation back to work first, at which point they can use those vaunted tools they frequently mention to address rapidly rising prices.

With all this in mind, the next question is, how will these changes impact the markets?  Yesterday’s price action is likely to be a very good case study if the data continues to support an early tapering of purchases.  Any interruption in the flow of money into the capital markets will be felt by both equities and bonds in the same way, they will fall in price, while the dollar is very likely to find a lot of support vs. both G10 and EMG counterparts.  As to commodities, my inclination is that the past year’s rally will pause, at the very least, but given they remain massively undervalued vs. other asset classes, they likely still have some upside.

On to today.  Overnight price action was mixed with the Nikkei (+0.5%) rising somewhat while Chinese shares (Hang Seng -0.8%, Shanghai -0.3%) were under pressure as stories about the next sectors to feel the wrath of regulators (sin stocks) were rampant with those falling and dragging the indices with them.  fortunately, they represent a much smaller portion of the market than the tech sector, so will have a smaller negative impact if that is, indeed, the situation.  Europe is mixed this morning (DAX +0.1%, CAC +0.35%, FTSE 100 -0.2%) as the morning data was inconclusive and investors there are far more concerned with the Fed than anything else.  As to US futures, they are all modestly higher this morning, about 0.2%.

Bond markets are showing the difference between central bank policy this morning with Treasuries consolidating yesterday’s declines and unchanged on the day, while European sovereigns (Bunds -1.0bps, OATs -1.2bps) continue to see support from an ECB that is nowhere near tightening policy.  Gilts (+2.0bps) on the other hand, are selling off a bit as the BOE meeting, just ending, revealed several things.  First, they are prepared to go to negative interest rates if they need to.  Second, they will continue their current QE pace of £3.4 billion per week, and third, that they expect inflation to reach 4.0% in Q4 of this year.  They did, however, explain that if things proceed as expected, some tightening, read higher interest rates, may be appropriate.  while the initial move in the GBP was a sharp jump higher, it has already retraced those steps and at +0.2% is only modestly up on the day.

Commodity prices are mixed with oil consolidating after yesterday’s rout and unchanged on the day.  In fact, the same is true of precious and most base metals, as traders are trying to figure out their next move, so likely waiting for tomorrow’s data.

And the dollar, interestingly, is modestly softer vs. the G10 this morning, but that is after a strong rally yesterday in the wake of the Clarida speech.  The commodity bloc is leading the way (AUD +0.35%, NOK +0.3%, NZD +0.25%) despite the lack of commodity price action.  And this also sems to ignore the 6th lockdown in Melbourne since the pandemic began last year, as the delta variant continues to wreak havoc around the world.  The rest of the G10 though, has seen much less movement.  In the emerging markets, PHP (-1.0%) was by far the worst performer overnight as the covid caseload soared to record numbers and concerns over growth expanded.  After that, TRY (-0.6%) is the next worst, as President Erdogan came out with calls for a rate cut despite rampant inflation.  However, away from those two currencies, movement has been on the order of +/- 0.2%, indicating nothing very special.  Essentially, these markets have ignored Clarida.  One last thing to note here is yesterday, the central bank of Brazil raised its SELIC rate by 1.0% to 5.25%, as inflation is exploding there.  However while BRL has been modestly stronger over the past several sessions, this was widely priced in so there was no big movement.

Data-wise, today brings Initial Claims (exp 383K), Continuing Claims (3255K) and the Trade Balance (-$74.2B), none of which seem likely to change any opinions.  Rather, at this point, all eyes are on tomorrow’s NFP data.  We also hear from two Fed speakers, Governor Waller and Minneapolis President KashKari, who is arguably the most dovish of all.  certainly if he starts talking taper, then the die is cast.  We shall see.

As I said, if tapering is on the cards, the dollar will likely test its highs from March/April, so be prepared.

Good luck and stay safe
Adf

Some Water to Tread

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The quickening pace of the spread
Of delta means looking ahead
The prospects for both
Inflation and growth
Seem likely, some water, to tread

The upshot is central bank staff
Will trot out some chart or some graph
Highlighting that rates
In all nation states
Should once more be cut, least in half

The talk of the markets is the pace of the spread of the delta variant of Covid and how the latest wave of lockdowns and other measures has reduced growth forecasts for the second half of the year.  This is especially true throughout Asia as nations that had seemingly weathered the initial wave of Covid with aplomb find themselves woefully unprepared for the current situation.  A combination of less widespread vaccinations and less effective health infrastructure has resulted in the fast spreading virus wreaking havoc.  China, for instance, finds itself in this position as half of its 32 provinces are reporting cases and officials there have closed major tourist destinations because of the spread.  This is a far cry from their earlier claims of having controlled the virus better than anyone else.  But the same situation exists throughout Europe and the Americas as the delta variant runs its course.

The clearest market response to this situation has been from bond markets where yields continue to fall around the world on the weaker prospects for growth.  The amount of negative yielding debt worldwide has risen back to $16.7 trillion, up from $12.9 trillion at the end of June, although still below the $18.3 trillion reached in December of last year.  However, the trajectory of this move, which is approaching vertical, offers the possibility that we could easily take out those old highs in the next week or two.

The problem is that rapidly declining bond yields do not accord easily with higher inflation or inflation expectations.  Yet higher inflation continues to be present and inflation expectations continue to rise.  This is the great conundrum in markets right now.  How can markets be anticipating slower growth while inflation measures continue to rise?  Shouldn’t slower growth lead to lower inflation?

In ordinary economic environments, there has certainly been a strong relationship between growth and inflation, but I challenge anyone to describe this economic situation as ordinary.  Rather, as a result of collective government responses to the pandemic, with whole swaths of various economies around the world being closed, along with massive fiscal and monetary stimulus being added to those same economies, a series of supply shocks have been created.  Thus, when the artificially stoked demand (from the stimulus) meets the constrained supply (from the lockdowns) the natural response is for prices to rise in order to achieve a new equilibrium.  The point is that the supply constraints continue to drive much of the pricing behavior, and therefore the inflation story, while the central banks can only really affect the demand side of the equation.  After all, while they may be able to print lots of money, they cannot print chickens, toilet paper or semiconductors, all things that have seen supply reduced.

A large part of the central banks’ transitory inflation theme stems from the fact that their models tell them that supply will be replenished and therefore prices will ease.  Alas, there has been little indication that the real world is paying attention to central bank models, as we continue to see shipping delays, manufacturing delays and higher raw materials prices as the supply infrastructure remains under significant strain.

Perhaps the most telling feature regarding the current views on inflation, even more than the rise in economic statistics, is the growth in the number of stories in the mainstream media regarding why different ordinary products and services have become more expensive.  Just this morning, the WSJ explained why both vacations and patio furniture are more expensive, and a quick Google trends search shows the term “more expensive” is being searched at near peak levels virtually daily.  The central bank community has put themselves in a significant bind, and while some nations are beginning to respond, the big 3, Fed, ECB and BOJ, show absolutely no signs of changing their behavior in the near term.  As such, the outlook is for more printed money, the same or few available goods and higher prices across the board.

Turning to markets, all that money continues to be a positive for equity investors as a great deal of that liquidity keeps finding its way into equity markets.  While Japan (Nikkei -0.2%) lagged last night, the rest of Asia rebounded with both the Hang Seng and Shanghai indices rising 0.9%.  Europe, too, continues to perform well with the DAX (+0.8%), CAC (+0.4%) and FTSE 100 (+0.4%) all in the green after PMI Services indices were released.  While all of those data points were strong, they all missed expectations and were slightly softer than last month.  In other words, the trajectory continues to be lower, although the absolute readings remain strong.  Perhaps despite what Timbuk 3 explained, you won’t need shades for the future after all.

As to the bond market, we continue to see demand as yields are lower almost everywhere.  Treasury yields have fallen 1 basis point, with European sovereigns even stronger (Bunds -1.7bps, OATs -2.0bps, Gilts -1.3bps).  In fact, the only bond market to sell off overnight was in New Zealand (+5bps) as comments from the central bank indicated they are likely to raise rates next week, and as many as 3 times by the end of the year as inflation continues to rise while the unemployment rate fell to a surprisingly low 4.0%.

Commodity prices continue to lack direction, although the negativity on the economy has impacted oil prices which are down 1.1% this morning.  However, gold (+0.4%) is looking up, as are agricultural prices with the big three products all higher by between 0.3%-0.6%.  Base metals, though, are under pressure (Cu -0.4%, Sn -0.3%) which given the evolving economic sentiment makes some sense.

Finally, the dollar is ever so slightly softer this morning with only NZD (+0.7%) showing real movement and dragging AUD (+0.3%) along with it.  Otherwise, the rest of the G10 is +/- 0.1% from yesterday’s closing levels.  The EMG picture is a bit more mixed with gainers and losers on the order of 0.4%, although even that is only a few currencies.  The leader today is KRW (+0.4%) which responded to increased expectations that the BOK would be raising interest rates soon, perhaps later this month, with some analysts even floating the idea for a 50bp hike.  We have seen a similar gain in HUF (0.4%) as the market continues to digest hawkish commentary from the central bank there, but after those two, gainers have been far less impressive.  On the downside, TRY (-0.4%) is the laggard du jour as the market grows increasingly concerned that the central bank will not be able to keep up with rising inflation there.  Elsewhere, THB (-0.35%) fell on weakening growth prospects and the rest of the space was less interesting.

Two notable data points are to be released today with ADP Employment (exp 683K) early and then the ISM Services (60.5) index released at 10:00. The ADP number will be seen by many as a harbinger of Friday’s NFP, so could well have a big impact if it surprises in either direction.

Interestingly, the dollar continues to hold its own lately despite declining yields as it appears investors are buying dollars to buy Treasuries.  After all, as more and more debt turns into negative yields, Treasuries look that much more attractive.  At least until the Fed admits that inflation is going to be more persistent than previously discussed.

Good luck and stay safe
Adf

Down in Flames

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The nation that built the Great Wall
Has lately begun to blackball
Its best and its brightest
For even the slightest
Concerns, causing prices to fall

Last night it was TenCent’s new games
Which suffered some unfounded claims
Concerns have now grown
They’ll need to atone
So their stock price went down in flames

The hits keep coming from China where last night, once again we were witness to a government sanctioned hit on a large private company, in this case Tencent.  In fact, Tencent is was the largest company in China by market cap but has since fallen to number two, after an article in an official paper, Xinhua News Agency’s “The Economic Information Daily” wrote about online gaming and how it has become “spiritual opium” for young people there.  While the government did not actually impose any restrictions, the warning shot’s meaning was abundantly clear.  Tencent’s stock fell 6.5% and Asian equity markets overall fell (Nikkei -0.5%, Hang Seng -0.2%, Shanghai -0.5%) as investors continue to fret over President Xi’s almost nightly attacks on what had been considered some of the greatest success stories in the country.  Apparently, that has been the problem; when companies are considered a greater success than the government (read communist party) they cease to serve their purpose.  It seems that capitalism with Chinese characteristics is undergoing some changes.

There is, perhaps, another lesson that we can learn from the ongoing purge of private sector success in China, that it has far less impact on global risk opinion than the activities in other geographies, namely the US.  While China has grown to the second largest economy in the world and is widely tipped to become the largest in the next decade or two, its capital markets remain significantly smaller on the world stage than those elsewhere.  So, when idiotic idiosyncratic situations arise like we have seen lately, with ideological attacks on successful companies, investors may reduce risk in China, but not necessarily everywhere else.  This is evident this morning where we see gains throughout Europe (DAX +0.15%, CAC +0.9%, FTE 100 +0.4%) as well as in the US futures markets (DOW and SPX +0.4%, NASDAQ +0.2%).  Despite last night’s poor performance in Asia, risk remains in vogue elsewhere in the world.

Away from the ongoing theatrics in China, last night we also heard from the RBA, who not only left policy on hold, as universally expected, but explained that they remain on track to begin tapering their QE purchases, down from A$ 5 billion/week to $A 4 billion/week, come September, despite the recent Covid lockdowns in response to the spread of the delta variant.  They see enough positive news and incipient credit demand to believe that tapering remains the proper course of action.  While there were no expectations of a policy change currently, many pundits were expecting the lockdowns to force a delay in tapering and the result was a nice little rally in the Aussie dollar, rising 0.5% overnight.

But, as we have just entered August, the month where vacations are prominent and government activity slows to a crawl, there were few other interesting tidbits overnight.  At this point, markets are looking ahead to Thursday’s BOE meeting, where there is some thought that tapering will be on the agenda, as well as Friday’s NFP report.  One final story that is gaining interest is the US financing situation with the debt ceiling back in place as of last Saturday.  Congress is on its summer recess, and Treasury Secretary Yellen has been forced to adjust certain cash outlays in order to continue to honor the government’s debt obligations.  As it stands right now, Treasury cannot issue new debt, although it can roll over existing debt.  However, that will not be enough to pay the bills come October.  There is no reason to believe this will come to a messy conclusion, but stranger things have happened.

As to the rest of the markets, bonds are under a bit of pressure today with Treasury yields rising 1.5bps, and similar size moves throughout Europe.  Of course, this is in the wake of yesterday’s powerful bond rally where yields fell 5bps after ISM data once again missed estimates.  In fact, we continue to see a pattern of good data that fails to match forecasts which is a strong indication that we have seen the peak in economic growth, and it is all downhill from here.  Trend GDP growth prior to Covid was in the 1.5%-1.7% range, and I fear we will soon be right back at those levels with the unhappy consequence of higher inflation alongside.  It is an outcome of this nature that will put the most stress on the Fed as the policy prescriptions for weak growth and high inflation are opposite in nature.  And it is this reason that allowing inflation to run hot on the transitory story is likely to come back to haunt every member of the FOMC.

Commodity markets today are offering less clarity in their risk signals as while oil prices are higher, (WTI +0.5%), we are seeing weakness throughout the rest of the space with precious metals (Au -0.2%), base metals (Cu -0.85%, Al -0.5%) and agriculturals (Soybeans -0.7%, Corn -0.9%, Wheat -0.5%) all under pressure today.

Finally, the dollar is falling versus virtually all its main counterparts today, with the entire G10 space firmer and the bulk of the EMG bloc as well.  NOK (+0.75%) leads the G10 group as oil’s rally bolsters the currency along with general dollar weakness.  Otherwise, NZD (+0.6%) and AUD (+0.5%) have benefitted from the RBA’s relative hawkishness.  The rest of the bloc is also higher, but by much lesser amounts.  I do want to give a shout out to JPY (+0.1% today, +2.3% in the past month) as it seems to be performing well despite the risk preferences being displayed in the market.  something unusual seems to be happening in Japan, and I have not yet been able to determine the underlying causes.  However, I also must note that last night, exactly zero 10-year JGB’s traded in the market, despite a JGB auction.  If you were wondering what a dysfunctional market looked like, JGB’s are exhibit A.  The BOJ owns 50% of the outstanding issuance, and the idea that there is a true market price of interest rates is laughable.

As to emerging markets, we are seeing strength throughout all three regional blocs led by ZAR (+0.8%), HUF (+0.7%) and PHP (+0.6%), with the story in all places the sharp decline in US rates leading to investors seeking additional carry.  While BRL is not yet open, it rallied 0.7% yesterday as the market is beginning to believe the central bank may hike rates by 100 bps tomorrow, a shockingly large move in the current environment, but one that is being driven by rapidly rising inflation in the country.

Data today brings Factory Orders (exp 1.0%) and Vehicle Sales (15.25M), neither of which is likely to distract us from Friday’s payroll report.  We also hear from one Fed speaker, governor Bowman, who appears to be slightly dovish, but has not make public her opinions on the tapering question as of yet.

Yesterday saw modest dollar strength despite lower interest rates.  Today that strength is being unwound, but net, we are not really going anywhere.  And that seems to be the best bet, not much direction overall, but continued choppy trading.

Good luck and stay safe
Adf

Jay Powell’s Story

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This weekend the Chinese reported
That PMI growth has been thwarted
This likely implies
They’ll increase the size
Of stimulus, when all is sorted

Meanwhile, as the week doth progress
Investors will need to assess
If Jay Powell’s story
About transitory
Inflation means more joblessness

The conventional five-day work week clearly does not apply to China.  On a regular basis, economic data is released outside of traditional working hours as was the case this past weekend when both sets of PMI data, official and Caixin (targeting small companies), were reported.  And, as it happens, the picture was not very pretty.  In fact, it becomes easier to understand why the PBOC reduced the reserve requirement for banks several weeks ago as growth on the mainland is quite evidently slowing.  The damage can be seen not only in the headline manufacturing numbers (PMI 50.4, Caixin 50.3) but also in the underlying pieces which showed, for example, new export orders fell to 47.7, well below the expansion/contraction line.

While it is one of Xi’s key goals to wean China from the dominance of exports as an economic driver, the reality is that goal has come nowhere near being met.  China remains a mercantilist, export focused economy, where growth is defined by its export sector.  The fact that manufacturing is slowing and export orders shrinking does not bode well for China’s economy in the second half of the year.  To the extent that the delta variant of Covid is responsible for slowing growth elsewhere in the world, apparently, China has not escaped the impact as they claim.

However, in today’s upside-down world, weakening Chinese growth is seen as a positive for risk assets.  The ongoing ‘bad news is good’ meme continues to drive markets and this weaker Chinese data was no exception.  Clearly, investors believe that the Chinese are going to add more stimulus, whether fiscal or monetary being irrelevant, and have responded by snapping up risk assets.  The result was higher equity prices in Asia (Nikkei +1.8%, Hang Seng +1.1%, Shanghai +2.0%) as well as throughout Europe (CAC +0.8%, FTSE 100 +0.95%, DAX +0.1%) with the DAX having the most trouble this morning.  And don’t worry, US futures are all higher by around 0.5% as I type.

But it was not just Chinese equities that benefitted last night, investors snapped up Chinese 10-year bonds as well, driving yields lower by 5bps as expectations of further policy ease are widespread in the investment community there. That performance is juxtaposed versus what we are witnessing in developed market bonds, where yields are actually slightly firmer, although by less than 1 basis point, as the risk-on attitude encourages investors to shift from fixed income to equity weightings.

Of course, all this price action continues to reflect the fact that the Fed, last week, was not nearly as hawkish as many had expected with the tapering question remaining wide open, and no timetable whatsoever with regard to rate movement.  And that brings us to the month’s most important data point, Non-farm Payrolls, which will be released this Friday.  At this early point in the week, the median forecast, according to Bloomberg, is 900K with the Unemployment Rate falling to 5.7%.

Given we appear to be at an inflection point in some FOMC members’ thinking, I believe Friday’s number may have more importance than an August release would ordinarily demand.  Recall, the recent trend of US data has been good, but below expectations.  Another below expectations outcome here would almost certainly result in a strong equity and bond rally as investors would conclude that the tapering story was fading.  After all, the Fed seems highly unlikely to begin tapering into a softening economy.  Last week’s GDP data (6.5%, exp 8.5%) and core PCE (3.5%, exp 3.7%) are just the two latest examples of a slowing growth impulse in the US.  That is not the time when the Fed would historically tighten policy, and I don’t believe this time will be different.

There is, however, a lot of time between now and Friday, with the opportunity for many new things to occur.  Granted, it is the beginning of August, a time when most of Europe goes on vacation along with a good portion of the Wall Street crowd and investment community as a whole, so the odds of very little happening are high.  But recall that market liquidity tends to be much less robust during August as well, so any new information could well lead to an outsized impact.  And finally, historically, August is one of the worst month for US equities, with an average decline of 0.12% over the past 50 years.

Keeping this in mind, what else has occurred overnight?  While bad news may be good for stock prices, as it implies lower rates for even longer, slowing growth is not an energy positive as evidenced by WTI’s (-1.8%) sharp decline.  Interestingly, gold (-0.25%) is not benefitting either, as arguably the reduced inflation story implies less negative real yields.  More surprisingly, copper (+0.7%) and Aluminum (+0.6%) are both firmer this morning, which is a bit incongruous on a weaker growth story.

As to the dollar, it is broadly weaker, albeit not by much, with G10 moves all less than 0.2% although we have seen some much larger gains in the EMG space.  On top of that list sits ZAR (+1.15%) and TRY (+1.1).  The former is quite surprising given the PMI data fell by a record amount to 43.5, 14 points below last month’s reading as rioting in the wake of the Zuma arrest had a huge negative impact on business sentiment and expectations.  Turkey, on the other hand, showed a solid gain in PMI data, which bodes well for the economy amid slowing growth in many other places.  After those two, the gains were far more modest with HUF (+0.5%) and RUB (+0.35%) the next best performers with both the forint and the ruble benefitting from more hawkish central bank comments.

Obviously, it is a big data week as follows:

Today ISM Manufacturing 60.9
ISM Prices Paid 88.0
Construction Spending 0.5%
Tuesday Factory Orders 1.0%
Wednesday ADP Employment 650K
ISM Services 60.5
Thursday Initial Claims 382K
Coninuing Claims 3260K
Trade Balance -$74.0B
Friday Nonfarm Payrolls 900K
Private Payrolls 750K
Manufacturing Payrolls 28K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $22.0B

Source: Bloomberg

Beyond the data, surprisingly, we only hear from three Fed speakers as many must be on holiday.  But at this point, the market is pretty sure that it is only a matter of time before the Fed starts to taper, so unless they want to really change that message, which I don’t believe is the case, they can sit on the sidelines for now.  of course, that doesn’t mean they are going to taper, just that the market expects it.

While the dollar is opening the week on its back foot, I don’t expect much follow through weakness, although neither do I expect much strength.  I suspect many participants will be biding their time ahead of Friday’s report unless there is some exogenous signal received.

Good luck and stay safe
Adf

Thrilled…Chilled

Posted on by

The ECB just must be thrilled
Inflation they’ve tried hard to build
Is finally growing
Though Germany’s showing
The growth impulse there has been chilled

The news from the Continent this morning would seem to be pretty good.  GDP, which rose 2.0% Q/Q in Q2 was substantially higher than the forecast 1.5%.  The growth leadership came from Spain (2.8%) and Italy (2.7%) although France (0.9%) was somewhat lackluster and Germany (1.5%) was extremely disappointing, coming in well below expectations.  At the same time, Eurozone CPI rose to 2.2% in July, above both the expected 2.0% print, and the ECB’s target rate.  Given everything we have heard from Madame Lagarde and virtually every ECB speaker over the past months, this must be quite exciting as it is a demonstration of success of their policies.  It seems that buying an additional €3.3 trillion in assets was finally sufficient to drive inflation higher.  (Well, arguably, what that did was drive up the price of virtually every commodity while government lockdowns were able to reduce productive capacity sufficiently to create massive bottlenecks in supply chains forcing prices higher.)  Nonetheless, the ECB gets to take a victory lap as they have achieved their target.

As an aside, you may recall yesterday’s data that showed German CPI rose a shockingly high 3.8%, a level at which the good people of that nation are very likely horrified.  While the Eurozone, as a whole, continues to recover pretty well, there must be a little concern that Germany is facing a period of stagflation, with subpar growth and higher prices.  Of course, this is the worst possible outcome for policymakers as the remedy for the two aspects require opposite policies and thus a choice must be made that will almost certainly result in greater pain for the economy initially.  Forty years ago, Fed Chair Paul Volcker was able to withstand the political heat when making this decision, but I fear there is not a central banker in the seat who could do so today.

Perhaps the most disappointing aspect of all this is that European equity markets are all in the red, with not a single one responding positively to the data.  Ironically, Spain’s IBEX (-1.0%) is the laggard, despite Spain’s top of the list growth.  Then comes the DAX (-0.8%) and the CAC (-0.25%).  For good measure, the FTSE 100 (-0.9%) is following suit although its GDP data won’t be published for two more weeks.  Arguably, despite this positive news, the ongoing spread of the delta variant seems to be undermining both confidence and actual activity at some level.

Of course, European markets tend to take their cues from what happens in Asia before they open, and last night was another risk-off session there with the Nikkei (-1.8%), Hang Seng (-1.35%) and Shanghai (-0.4%) all sliding.  There are two stories here, one Japanese and one Chinese.  From Japan, the issue is clearly the resurgence of Covid as the recently imposed emergency lockdown has been extended further amid a spike in daily cases to near 10K, higher than the peaks seen in both January and May of this year.  The rapid spread of the disease has policymakers there quite flustered and investors are beginning to show their concern.

China, on the other hand, assures us that they have no Covid problems, rather markets there are suffering over policy decisions.  One observation that might be made is that the government is enhancing regulations on very specific segments of the economy in order to achieve their stated goals from the most recent 5-year plan.  So, education is very clearly seen as critical, far too important for capitalism to have any influence, and I would expect that this industry sector will ultimately privatize and turn into the suggested non-profit organizations.  On the tech side, China is all about hardware type tech, and will do all they can to support companies in that space.  However, companies like Didi, AliBaba and Tencent don’t produce anything worthwhile, they simply consume resources to provide retail services, none of which lead toward Xi Jinping’s ultimate goals.  As such, they are likely to find increasing restrictions on what they do in order to reduce their influence on the economy.

And as I hinted at the other day, there appears to be growing concern that the real estate bubble that exists in China has been a key feature of their demographic problems.  Couples are less likely to have children if they cannot afford to buy a house, and the damage from China’s one-child policy will take generations to repair, although that is a key focus of the government.  As such, do not be surprised if real estate firms come under pressure with respect to things like restrictions on margins and pricing as the government tries to deflate that bubble.  This opens the possibility that yet another sector of the Chinese equity market is going to come under further pressure.  To the extent that Asian markets set the tone for the global day, that does not bode well for the near future.

Interestingly, despite a lackluster performance by the European and Asian equity markets (and US futures, which are all lower this morning), the bond markets are not exactly on fire.  While it is true that Treasury yields have slipped 2.5bps, European sovereigns are either side of unchanged today, with nothing moving more than 0.3bps in either direction.  I would have expected a bit better performance given the equity risk-off signal.

Commodity markets are generally a bit softer with oil (-0.2%) slipping a bit although it has recovered almost all of its losses from two weeks ago and sits at $73.50/bbl.  Gold, after a huge rally yesterday is unchanged this morning, while base metals are mixed (Cu -0.2%, Al +1.4%, Sn +0.15%).  Finally, ags are all softer this morning as weather conditions in key growing areas have improved lately.

Lastly, the dollar can best be described as mixed, with NOK (-0.4%) and AUD (-0.35%) the laggards amid softer oil and  commodity prices while EUR (+0.1%) and CHF (+0.1%) have both edged higher on what I would contend is the ongoing decline in real US interest rates.

Emerging market currencies have performed far better generally with TRY (+0.6%) and PHP (+0.6%) the leaders although both EEMEA and other APAC currencies have performed well.  The lira responded to the Turkish central bank raising its inflation forecast thus implying rates would remain higher there for the foreseeable future.  Meanwhile, the peso seemed to benefit from the idea that the renewed covid lockdown would reduce its balance of payments issues by reducing its trade deficit.  On the other side of the ledger was KRW (-0.3%) which continues to suffer from the uncertainty over Chinese business activity.

On the data front today, we get the Fed’s key inflation reading; Core PCE (exp 3.7%) as well as Personal Income (-0.3%), Personal Spending (0.7%), Chicago PMI (64.1) and Michigan Sentiment (80.8).  Clearly all eyes will be on the PCE number, where a higher print will likely encourage more taper talk.  However, if it is below expectations, look for a very positive market response.  We also hear from two Fed speakers, Bullard and Brainerd, the former who has turned far more hawkish and has been calling for a taper, while Ms Brainerd is not nearly ready for such action.  And in the end, Brainerd matters more than Bullard for now.

I expect the market will take its cues from the PCE data, with a higher print likely to undermine the dollar while a softer print could well see a bit of a rebound from the past several sessions’ weakness.

Good luck, good weekend and stay safe
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The Tapering Walk

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For those who expected a hawk
When Powell completed his talk
T’was somewhat depressing
That Jay was professing
They’d not walk the tapering walk

Then last night, from China, we learned
A falling stock market concerned
The powers that be
Thus, they did agree
To pander to those who’d been burned

Apparently, the Fed is not yet ready to alter its policy in any way.  That is the message Chairman Powell delivered yesterday through the FOMC statement and following press conference.  Though it seems clear there was a decent amount of discussion regarding the tapering of asset purchases, in the end, not only was there no commitment on the timing of such tapering, there was no commitment on the timing of any potential decision.  Instead, Chairman Powell explained that while progress had been made toward their goals, “substantial further progress” was still a ways away, especially regarding the employment situation.

When asked specifically about the fact that inflation was currently much higher than the FOMC’s target and whether or not that met the criteria for averaging 2%, he once again assured us that recent price rises would be transitory.  Remember, the dictionary definition of transitory is simply, ‘not permanent’.  Of course, the question is exactly what does the Fed mean is not going to be permanent?  It was here that Powell enlightened us most.  He explained that while price rises that have already occurred would likely not be reversed, he was concerned only with the ongoing pace of those price rises.  The Fed’s contention is that the pace of rising prices will slow down and fall back to levels seen prior to the onset of the Covid pandemic.

Of course, no Powell Q&A would be complete without a mention of the “tools” the Fed possesses in the event their inflation views turn out to be wrong.  Jay did not disappoint here, once again holding that on the off chance inflation seems not to be transitory, they will address it appropriately.  This, however, remains very questionable.  As the tools of which they speak, higher interest rates, will have a decisively negative impact on asset markets worldwide, it is difficult to believe the Fed will raise rates aggressively enough to combat rising inflation and allow asset markets to fall sharply.  In order to combat inflation effectively, history has shown real interest rates need to be significantly positive, which means if inflation is running at 5%, nominal rates above 6% will be required.  Ask yourself how the global economy, with more than $280 Trillion of debt outstanding, will respond to interest rates rising 600 basis points. Depression anyone?

At any rate, the upshot of the FOMC meeting was that the overall impression was one of a more dovish hue than expected going in, and the market response was exactly as one might expect.  Equity markets rebounded in the US and have continued that path overnight.  Bond markets rallied a bit in the US, although with risk appetite back in vogue, have ceded some ground this morning.  Commodity prices are rising and the dollar is under pressure.

Speaking of risk appetite, the other key story this week had been China and the apparent crackdown on specific industries like payments and education.  While Tuesday night’s comments by the Chinese helped to stabilize markets there, that was clearly not enough.  So, last night we understand that the China Securities Regulatory Commission gathered a group of bankers to explain that China was not seeking to disengage from the world nor prevent its companies from accessing capital markets elsewhere.  They went on to explain that recent crackdowns on tech and educational companies were designed to help those companies “grow in the proper manner”, a statement that could only be made by a communist apparatchik.  But in the end, the assurances given were effective as equity markets in Hong Kong and China were sharply higher and those specific companies that had come under significant pressure rebounded on the order of 7%-10%.  So, clearly there is no reason to worry.

Now, I’m sure you all feel better that things are just peachy everywhere.  The combination of Chairman Powell removing any concerns over inflation getting out of hand and the Chinese looking out for our best interests regarding the method of growth in its economy has led to a strongly positive risk sentiment.  As such, it should be no surprise that equity prices are higher around the world.  Asia started things (Nikkei +0.75%, Hang Seng +3.3%, Shanghai +1.5%) and Europe has followed suit (DAX +0.45%, CAC +0.7%, FTSE 100 +0.9%).  US futures have not quite caught the fever with the NASDAQ (-0.2%) lagging, although the other two main indices are slightly higher.

In the bond market, investors are selling as they no longer feel the need of the relative safety there, with Treasury yields higher by 3bps, while Bunds (+2bps), AOTs (+1bp) and Gilts (+2.7bps) are all under pressure.  But remember, yields remain at extremely low levels and real yields remain deeply negative, so a few bps here is hardly a concern.

Commodity prices have waived off concerns over the delta variant slowing the economy down and are higher across the board.  Oil (+0.25%), gold (+0.85%), copper (+1.1%) and the entire agricultural space are embracing the renewed growth narrative.

Finally, the dollar, as would be expected during a clear risk-on session and in the wake of the Fed explaining that tapering is not coming to a screen near you anytime soon, is lower across the board.  In the G10 space, NZD (+0.6%) and NOK (+0.55%) are leading the way higher, which is to be expected given the movement in commodity prices.  CAD (+0.45%) is next in line.  But even the yen (+0.1%) has edged higher despite the positive risk attitude.  One could easily describe this as a pure dollar sell-off.

In the emerging markets, HUF (+0.85%) is the leader as traders are back focused on the hawkishness of the central bank and an imminent rate hike, now ignoring the lack of EU funding that remains an open issue.  ZAR (+0.8%) is next on the commodity story with KRW (+0.7%) in the bronze medal position as exporters took advantage of the weakest won in nearly a year to sell dollars and then Samsung’s earnings blew away expectations on the huge demand for semiconductors, and funds flowed into the equity market.

We get our first look at Q2 GDP this morning (exp 8.5%) with the Consumption component expected to rise 10.5% on a SAAR basis.  We also see Initial Claims (385K) and Continuing Claims (3183K).  Recall, last week Initial Claims were a much higher than expected 419K, so weakness here could easily start to cause some additional concern at the Fed and delay the tapering discussion even further.  With the FOMC behind us, we can look forward to a great deal more Fedspeak, although it appears many of the committee members are on vacation, as we only have two scheduled in the next week, and they come tomorrow.  I imagine that calendar will fill in as time passes.

Putting it all together shows that any Fed hawks remain in the distinct minority, and that the party will continue for the foreseeable future.  Overall, the dollar has been trading in a range and had been weakly testing the top of that range.  It appears that move is over, and we seem likely to drift lower for the next several sessions at least, but there is no breakout on the horizon.

Good luck and stay safe
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