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On Edge

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Two fears have the market on edge
Inflation that many allege
Will drive bond yields higher
Thus, causing a dire
Result, pushing stocks off the ledge

But right now, the bulls rule the roost
As inflation has not been produced
So, Jay and Christine
Have no need to wean
The market from QE’s large boost

Yesterday morning’s CPI release was a touch softer than expected, thus helping to abate fears of the much-mooted inflationary surge arriving soon.  (PS, it is clear that starting next month the CPI data will be much higher, given the year over year comps, with the key question being will that continue through the summer and beyond.)  In the meantime, bond investors, who had clearly been concerned over the rising inflation story, relaxed a bit and bought more Treasuries.  The result was that the early morning rise in yields was unwound.  Of course, the other big news yesterday was the 10-year Treasury auction which was received by the market with general aplomb.  While there was a 1 basis point tail, the bid-to-cover ratio at 2.37 was right in line with recent averages.  One little hiccup, though, was indirect bidders (usually foreign governments) continued their declining participation, falling to 56.8%, with the implication that natural demand for Treasuries is truly sinking.  This latter point is critical because, given the amount of new money the Treasury will need to borrow this year and going forward, it will increase pressure on the Fed to absorb more (i.e. increase QE), or yields will definitely climb.

However, that apparently, is a story for another day.  Equity markets reveled in the low inflation print and modest bond market rally, while the dollar fell pretty much across the board, reversing all of its early gains.

Which brings us to this morning’s ECB meeting, where the question is not about a change in policy, as quite clearly no policy change is in the offing, but rather about the ECB’s utilization and reaction function of its current policy programs.  While sovereign yields have stabilized for the past several sessions, the fact remains that they have not fallen back anywhere near the levels seen at the beginning of the year.  The question market participants have is exactly what will constitute a tightening in financial conditions that might bring a response.

As mentioned yesterday, the ECB has been consistently underutilizing the PEPP compared to recent months, with weekly purchases falling to a net €12 billion despite the rise in yields.  So, it would seem that the ECB does not believe the current yield framework is a hindrance to the economy.  However, you can be sure that Madame Lagarde will field several questions on the topic at this morning’s press conference as market participants try to determine the ECB’s pain threshold.  The last we heard on the topic was that they were carefully watching the market with some of the more dovish members calling for a more active stance to prevent a further climb in yields.

And remember, the ECB is not only focused on sovereign yields, but on the exchange rate as well, which is also officially a key indicator.  With the US inflation story getting beaten back, and US yields slipping, the euro’s concomitant rise will not be welcome.  Now, we remain well below the early January highs in the single currency, but if the euro has bottomed, and more importantly starts that long-term rise that is so widely expected, the ECB will find themselves in yet another sticky situation.  These, however, are stories for a future date, as today the euro is firmly in the middle of recent ranges while sovereign yields are slipping a bit.

With two potential landmines behind us, risk appetite has been reawakened, with asset purchases across virtually all classes.  For instance, overnight saw equity market strength across the board (Nikkei +0.6%, Hang Seng +1.65%, Shanghai +2.4%) although Europe’s early gains have mostly diminished and markets are little changed ahead of the ECB (DAX -0.1%, CAC +0.1%, FTSE 100 -0.35%).  US futures, though, are largely booming, led by the NASDAQ (+1.9%) but seeing solid gains in the other indices as well.

On the bond front, Treasury yields are lower by 1.9 basis points, back to 1.50%, while we are seeing more modest declines in the major European bond markets, on the order of 0.5bps for all of them.

Oil prices are firmly higher (WTI +1.2%) as is the entire energy complex.  Metals prices, too, are rising with both precious and base seeing a resumption of demand.  Meanwhile agricultural prices are generally moving up in sync.  Once again, to the extent that commodity price rises are a harbinger of future inflation, the signs are clearly pointing in that direction.

The dollar, meanwhile, which reversed yesterday’s early gains to close lower across the board, has continued in that direction with further losses this morning.  CHF (+0.5%) leads the way in the G10, which given the fact it had been the biggest loser over the past month, falling more than 5.6%, should be no surprise.  But the rest of the bloc is seeing gains in the commodity focused currencies with AUD (+0.45%), NZD (+0.4%) and CAD (+0.3%) next in line.  Perhaps the biggest surprise is that NOK (0.0%) is not along for the ride.

EMG currencies are also broadly firmer led by BRL (+1.6%) which is following on yesterday’s 2.5% rally as the central bank has been actively intervening to stem the real’s recent weakness.  Concerns remain over rising inflation, and expectations for rising policy rates are growing there, which would likely support the currency even more.  But we are seeing strength in ZAR (+1.0%), CLP (+1.0%) and MXN (+0.65%) as well, clearly all benefitting from the commodity story.  However, virtually the entire bloc is firmer given today’s increasing risk-on attitude.

Aside from the ECB meeting, with the statement published at 7:45 and the press conference at 8:30, we see Initial Claims (exp 725K), Continuing Claims (4.2M) and the JOLTs Job Openings survey (6.7M).  Again, no Fed speakers so look for the dollar to follow risk attitude and the movement in real yields.  Those are both pointing toward a lower dollar as the day progresses, and I see no reason to fight that absent comments from a surprising source.  Unless Madame Lagarde fumbles the press conference, look for this little risk bounce to continue.

Good luck and stay safe
Adf

Powell’s Dismay

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The ECB’s Christine Lagarde
Is finding that markets are hard
As bond yields keep climbing
She needs more pump priming
Or Europe will truly be scarred

Meanwhile in the US today
The 10-year sale gets underway
A sloppy result
Just might catapult
More QE, to Powell’s dismay

Markets have had a relatively uneventful evening as participants await some important new information.  The first clue will come this afternoon when the results of the US 10-year bond auction are released.  Remember, this interest rate is arguably the most important rate in the world, as it serves as the basis for trillions of dollars of debt in both the public and private sectors.  And while the on-the-run 10-year bond is probably the single most liquid security in the world, its recent volatility belies that statement.  In fact, this morning, ahead of the auction, we are seeing selling pressure with the yield rising 3.3 basis points to 1.56%, within spitting distance of its recent highs and up a pretty remarkable 65 basis points year-to-date.

The reason today’s auction of $38 billion is being so keenly watched is that two weeks ago, the 7-year note auction was flat out awful, with a long tail and low indirect interest.  This means that there wasn’t really that much demand, especially from investors, as opposed to the primary dealers who are forced to bid.  That auction served as the catalyst for the 15-basis point rise in the 10-year the last week of February.  You may recall that coincided with a 100-point decline in the S&P 500 and commensurate declines in equity markets around the world.

And that is why this is seen as so critical.  With the knowledge that the House is voting on the $1.9 trillion stimulus bill today, and it will certainly pass along a party-line vote, investors recognize that there is going to be a lot more issuance upcoming.  After all, the government will need to borrow a lot of money to fund that stimulus.  If this benchmark auction goes poorly, meaning it doesn’t generate substantial bidding interest outside the primary dealers, we could well be in for another sharp decline in equity markets as the bond market sells off further.  Remember, too, the Fed is in its quiet period so will not be able to make comments in order to support the market.

Yesterday saw an impressive rebound by equity markets around the world after a serious bout of selling almost everywhere.  A good result today is likely to help keep that going, but a poor auction will almost certainly show that yesterday was the proverbial “dead cat bounce.”  And folks, if the auction goes poorly, look for the dollar to make new highs against pretty much every currency, especially emerging market counterparts., but the G10 too.

Which brings us to the ECB and Madame Lagarde.  Today is the first day of the ECB’s March meeting and the market is putting pressure on them as well.  As Treasury yields have climbed, so too have European government bond yields, with, for instance, 10-year bund yields 30 basis points higher on the year, albeit still firmly in negative territory at -0.30%.  But the question being raised is why the ECB hasn’t been more active with its PEPP program during this yield rally.  After all, we have heard from a number of different ECB members that they are closely monitoring sovereign yields and they explicitly told us that was a key benchmark for them.  And yet, their net purchases through the PEPP have declined during the past several weeks to €14.8 billion a week, down from the more than €18 billion they had been purchasing previously.  So, clearly, they have the capacity to do more.  Why then haven’t they been more active?  At this point, nobody really knows, and you can be certain that at tomorrow’s press conference it will be a hot topic.

Of course, it may be that they want to leave themselves extra ammunition in the event the Treasury auction goes poorly and there is another bond market rout.  But that is a far more cynical stance than I would attribute to any central bank.  The risk for the ECB is that European sovereign yields begin to rise faster than Treasury yields both crimping economic support and simultaneously supporting the euro.  And the one thing we know is the ECB wants a weaker euro, in fact they desperately need a weaker euro to help their exporting economies as well as to try to stoke their much-desired inflation.  As Ricky Ricardo used to say, ‘Christine, you got some ‘splainin’ to do!’

So, as we await the results of the auction, let’s take a quick tour of the overnight price action.  The best description of markets is mixed, with modest overall activity.  In the equity space, the Hang Seng (+0.5%) led the way on the high side, while both the Nikkei and Shanghai were essentially flat on the session.  Australia’s ASX 200, meanwhile, fell 0.8%.  As I said, mixed.  The story is no different in Europe with the CAC (+0.6%) the leader with the DAX (+0.3%) doing fine but the FTSE 100 (-0.2%) slipping back a bit.  And so, it cannot be surprising that US futures are behaving in the same manner, with NASDAQ (-0.3%) suffering while DOW (+0.25%) is slightly higher and SPX futures are little changed.

Other than the Treasury market, the yield picture is also mixed, with major European bond markets +/- 0.5bps or less.  This looks like a market biding its time for the two big stories to come.  Intrigue continues to build in Japan where the results of the BOJ’s review will be announced at their meeting next week and we have heard from Kuroda-san that there will be no change in the 10-year yield curve target while a key deputy, Amamiya-san, has left the door open to a widening of that 0.20% range around 0.0%.

In the commodity world oil (+0.5%) is firmer, but just looking at the products, that modest rally is not universal.  Metals are mixed (that word keeps coming up) with copper and aluminum both higher while tin and zinc are lower.  Precious metals are modestly softer as well after a huge rally yesterday.

And finally, the dollar is the one thing not really mixed, but rather broadly higher this morning.  Against the G10, only NOK (0.0%) has managed to hold its own on the back of the oil rally, while CHF (-0.4%) and JPY (-0.3%) are both suffering on what appears to be their lagging interest rate performance.  In the EMG bloc, TRY (+0.5%) is the only gainer of note, however, its movement appears to be positioning related rather than fundamental.  On the downside, there is a broad range of weaker currencies across all three main geographies, although none is weaker by more than 0.3%.  Again, it appears that traders are biding their time for news.

On the data front, today is CPI day with expectations for a 0.4% M/M (1.7% Y/Y) headline rise and a 0.2% M/M (1.4% Y/Y) ex food & energy print.  Based on the past 9 months, I would expect the odds are for a beat on the high side as we have seen in 6 of those readings.  And then it’s the auction.  We remain in the Fed’s quiet period, so look for the dollar to meander this morning and take its cues from the auction like every other market starting at 1:00pm when the results are released.  My money is on a less than stellar auction, higher yields, lower stocks and a stronger dollar.  We shall see.

Good luck and stay safe
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Right From the Script

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While last night, the 10-year yield slipped
It’s still reading right from the script
Of trading much higher
As growth does transpire
And vaccines are rapidly shipped
 
Investors, though, caution, have shown
As high yields have caused a full-blown
Correction in tech
And currency wreck
Just proving the future’s unknown
 
Price action throughout markets overnight has largely been a correction of what has turned out to be a surprising rout in tech stocks and a surprising rally in the dollar.  Quickly recapping the consensus views as the year began, the combination of more fiscal and monetary stimulus and a ramped up vaccination rate would lead to a reopening of the US (and world) economy, much faster growth, higher Treasury yields, rising stock prices and a weaker dollar as increased risk appetite led to dollar selling.  Positioning for those views was both widespread and large as investors looked forward to another banner year.  Oops!
 
As so often happens in markets, even if views are correct in the long run, when a new consensus is reached it means that, pretty much all the investment that is heading in that direction has already arrived, and the result is that those positions tend to lose out as the excitement fades.  And arguably, that is what we have seen in general, although not universally.  Despite last night’s modest bond rally (Treasury yields -5.9bps), the yield curve remains both higher and steeper than at the beginning of the year and appears to have room for further movement in that direction.
 
One of the strongest views that exists is that the Fed will not (cannot) allow Treasury yields to rise beyond a certain, unknown, point, as the cost to the government would be devastating.  That has certainly been my view and informs my belief that when that happens, the dollar will reverse its recent strength and decline sharply alongside real US yields.  But what if the Fed means what they say when describing the rise in long-term yields as a good thing?  How might that play out?
 
The first thing to note is that the yield curve (which I will define as the 2yr-10yr spread) is currently at 137bps, obviously well above the levels seen at the beginning of the year and showing no signs of stopping.  The one thing of which we can be confident right now is that the 2yr yield seems unlikely to move with the Fed maintaining ZIRP up front, so the spread will be entirely dependent on the movement in the 10-year.  But a quick look at the history of the spread shows that the current level is merely in the middle of the range with at least five different times in the past 30 years where this spread rose well over 200 basis points, the most recent being during the Taper Tantrum in 2013 when it reached 260 basis points.  Now, ask yourself what would happen if 10-year Treasury yields rose to 2.75%.  How do you think that would play out in the equity market?  In FX? And for the economy as a whole?
 
Arguably, this type of interest rate movement would be the result of much faster growth and inflation in the US than currently forecast and seen elsewhere in the world.  (As an aside, the OECD today raised their forecast for US GDP growth in 2021 to 6.5%).  If that forecast is accurate, and if inflation simply gets to the Fed’s 2.0% target, that means nominal GDP will be 8.5%!  How can that square with a 10-year yield of 2.75%, let alone today’s 1.55%.  It would seem that something has to give here.  Two potential relief valves are the dollar, which would need to rally much more sharply than we have seen (think EURUSD at 1.05-1.10) or inflation rising more than 2.0%, perhaps as high as 3.5%-4.0%.  History has shown that in situations like that, equity markets tend to underperform.  And maybe that’s the key.  Most of these forecasts for the strong equity, higher interest rate, weaker dollar outcome were based on the idea that central banks and governments could find the perfect mix of policies to achieve these goals.  If there is anything about which we can be sure, other than 2-year yields are not going to rise, it is that neither central banks nor governments have any idea what the proper mix of policies is to achieve those goals.  This is why economic and market activity remain volatile, because the constant tweaks and changes have many unexpected side effects.
 
This is not to imply that the yield curve is going to steepen that much, just that it cannot be ruled out, and if that happens, you need to be ready for a great deal more market volatility.
 
Which takes us to the current session. 
 
In China, the powers that be
Are worried they’re starting to see
A market decline
That could well define
New weakness in President Xi
 
Overnight saw mixed risk appetite with both the Nikkei (+1.0%) and Hang Seng (+0.8%) rising, but Shanghai (-1.8%) having a rough session.  In fact, the decline in stocks on the mainland has been so great that the Chinese government has called in the plunge protection team, which saw action last night to try to prevent a further rout (Shanghai -10% in pat 3 weeks), although obviously they were unable to prevent the process continuing.  As China continues to register concern over bubbles, it is reasonable to expect further declines in this market, as well as many of the other Asian markets that are linked.
 
Europe, on the other hand, is feeling better this morning with gains pretty much across the board (DAX +0.3%, CAC +0.3%, FTE 100 +0.6%), which seem to have ignored modes downward revisions to some Q4 economic data (GDP -0.7%).  And finally, US futures are all firmly higher, notably NASDAQ (+2.2%), which is rebounding from its 11% decline over the past 3 weeks.
 
European bond markets are rallying alongside Treasuries, with Bunds (-5.3bps) and OATs (-5.2bps) a good descriptor of the entire continent’s price action.  Given the type of movement we have seen throughout government bonds worldwide, it would not be a huge surprise to see a further correction before the next leg higher in yields.
 
On the commodity front, oil prices are leading things higher (+0.6%) although the decline in yields has also supported gold (+1.4%) which is coming off a very difficult stretch.  Base metals are mixed as are agriculturals, with the current price action almost certainly a consolidation before the next leg higher for both segments.
 
And finally, the dollar, which is almost universally weaker this morning.  In the G10, AUD (+0.65%) is the leading gainer, but is merely emblematic of the commodity price action as we have seen the other commodity linked currencies in this bloc perform well (NOK +0.6%, CAD +0.45%).  In the EMG space, TRY (+1.5%) is the leading gainer, which during a risk on session is quite normal, with ZAR (+0.9%) and MXN (+0.8%) joining in the fun.  CE4 currencies are also performing well (CZK +0.8%, PLN +0.6%).  However, there are a couple of laggards, notably BRL (-0.7%), KRW (-0.6%) and TWD (-0.5%).  The latter two suffered from ongoing equity outflows from international investors, linked to China’s equity woes, while BRL is suffering from concerns over new political problems President Bolsonaro.
 
On the data front, NFIB Small Business Optimism was released this morning at a worse than expected 95.8, which, while better than expected, demonstrates some still ongoing concerns over the state of the economy.  Clearly, there are no Fed speakers today, so FX is very likely to follow the risk appetite today.  This modest dollar correction lower seems more like a reaction to what had been a surprisingly powerful dollar rally than a reversal.  So my gut tells me that the dollar will rebound along with yields as the week progresses.
 
Good luck and stay safe
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Covid’s Predations

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There once was a time when reflation
Was cause for widespread celebration
Because it implied
That growth nationwide
Recovered from Covid’s predation

But lately concerns have been rising
That markets are destabilizing
As data that’s good
Does more than it should
To raise yields, thus need tranquilizing

There is an ongoing battle in markets these days, between the G10 central banks, led by the Fed, and the bond market and its investors and traders.  What we know with certainty is that the central banks are keen to maintain their easy money policies for a much longer period of time as they await clear economic recovery and a higher, but steady, inflation level.  In the past week we have heard from a number of different central bank speakers, notably Jay Powell and Christine Lagarde, that current policy settings are appropriate, and that while the sharp move higher in 10-year yields has “caught their eye” there is no indication they will respond.

But the other thing of which we are pretty certain is that markets love to test central banks when they think they have an edge.  And while the equity market mantra for the past decade has been, ‘don’t fight the Fed’, that is not really a bond market sentiment.  Rather, bond investors and traders will frequently make their collective views known via significant selling pressure driving interest rates up to a point where the central bank blinks.  And it certainly feels like that is an apt description of the current market price action.

The problem for the central banks is that they currently find themselves fighting this battle with one hand tied behind their back, and it is their own fault.  Remember, one of the key ‘tools’ that central banks use is forward guidance and verbal intervention to sway market opinion.  But the current timing is such that both the ECB and Fed have meetings upcoming and are in their self-imposed quiet periods, where central bank members are not supposed to make public comments that could impact markets.  And this means that they are unable to make comments implying imminent action if markets continue to misbehave.  Of course, the Fed could simply start buying longer dated debt in the market without announcing that is what they are doing, but while that may have been an acceptable methodology thirty years ago, the Fed’s MO these days is that they feel they must explain everything they do, so seems highly unlikely.

Thus we have a situation where bond investors see news stories like the passage by the Senate of the $1.9 trillion stimulus bill, the increased rate of vaccinations throughout the US population and the rapidly declining pace of infection and have jumped to the conclusion that the recovery in the US is going to be both sooner and more robust than earlier forecasts.  This, in turn, has them believing that inflation is going to pick up and that the Fed will be forced to raise rates to cool the economy.  At the same time, Powell (and Lagarde) could not have been more explicit in their comments that current policy is appropriate, and they have no intention of adjusting it until they achieve their goals.  And, by the way, those goalposts have moved quite a bit since the last tightening cycle, such that headline gains in economic data is not nearly good enough, instead they are focused on subsectors of that data like minority employment and wage growth, historically the last part of the economy to benefit from a recovery.

Add it all up and you have a situation where the bond market is observing much faster growth and raising rates accordingly while the Fed is looking at the pockets of the economy where things move more slowly and trying to boost them.  The Fed’s problem is higher rates are not helping their cause, nor are they helping to maintain easy financial conditions.  And their other current problem is they can’t even talk about it for another 9 days.  Markets can wreak a great deal of havoc in a period that long as evidenced by this morning’s rising 10-year yields and declining stock futures during the first day of that quiet period.

Which is a perfect segue into today’s session, where risk is largely under pressure.  Last night saw weakness throughout Asian equity indices with the Nikkei (-0.4%), Hang Seng (-1.9%) and Shanghai (-2.3%) all lower although there were pockets of strength in the commodity producing countries.  Europe, on the other hand, is broadly higher this morning led by Italy’s FTSE MIB (+2.0%) but seeing strength elsewhere (DAX +1.3%, CAC +0.9%) on news that the European vaccination program is scheduled to pick up the pace.  US futures, though, are continuing to feel the pressure from higher US yields, especially in the tech space as the NASDAQ (-1.5%) leads the decline with the S&P (-0.5%) and DOW (-0.1%) not nearly as badly impacted.

But Treasury yields continue to rise with the 10-year higher by another 2.5 basis point this morning and pressing 1.60% again, a level it touched Friday after the much better than expected payroll report.  However, in Europe, bonds are mixed with Bunds (+0.7bps) a bit softer while OATs and Gilts have both seen yields edge lower by 0.5bps.

Commodity prices continue to perform well in response to the improving data and increasing vaccination rates with oil (+0.3%) modestly higher and maintaining the highest levels seen in more than 2 years.  In the metals markets, base metals are mixed while precious metals continue to suffer from rising US yields.  And finally, agricultural products continue their steady rise higher.

Lastly, the dollar continues to benefit from higher yields as it is higher vs. literally every one of its counterparts in both the G10 and EMG.  There is no need to discuss specific stories here as this is a universal dollar strength situation, where investors are beginning to unwind emerging market positions as well as their short dollar views.  While those positions remain elevated in comparison to historical levels, they have been reduced by about 40% from the peak shorts seen last
August.

On the data front, arguably the most important data point this week is Wednesday’s CPI, but there is a bit more than that coming out.

Tuesday NFIB Small Biz Optimism 96.5
Wednesday CPI 0.4% (1.7% Y/Y)
-ex food & energy 0.2% (1.4% Y/Y)
Thursday ECB meeting -0.5% (unchanged)
Initial Claims 725K
Continuing Claims 4.2M
JOLTs Job Openings 6650K
Friday PPI 0.4% (2.7% Y/Y)
-ex food & energy 0.2% (2.6% Y/Y)
Michigan Sentiment 78.0

Source: Bloomberg

I think it could be instructive to see that PPI data as well, which could be a harbinger of CPI in the coming months.  Now I know that Jay has explained this will be transient, and he may well be right, but history shows the bond market will need to see proof inflation is transient before calming down.

Obviously, there are no Fed speakers scheduled and we don’t hear from the ECB until Thursday, so market participants have free reign to do what they see is correct.  Currently, rising rates has called into question the validity of the tech stock boom and seen a rotation into value stocks.  Meanwhile, rising rates has also seen general pressure on stock indices and the dollar continues to benefit from that scenario.  As I have written many times, historically a steeper US yield curve meant a strong dollar, and as the curve continues to bear steepen, it is hard to call a top for the greenback.

Good luck and stay safe
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Not On His Watch

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Rumors were rampant
Kuroda would let yields rise
Oops! Not on his watch
 
Perhaps Chairman Powell should look east for clues on how to manage bond market expectations, as his efforts yesterday can only be termed a disaster.  However, Haruhiko Kuroda was quite successful in talking down the back end of the JGB curve, and the BOJ didn’t have to spend a single dime yen. 
 
Last night, Kuroda-san was speaking to parliament on a number of issues when he was asked, point blank, if the BOJ was considering widening the yield band on 10-year JGB’s.  He replied, “Personally, I believe it’s neither necessary nor appropriate to expand the band.  There’s no change in the importance of keeping the yield curve stable at a lower level.”  And just like that, JGB yields tumbled across the board with 10-year yields falling 5bps to 0.05%.  The genesis of the question came about as rumors have been constant that during the ongoing BOJ policy review, with conclusions set to be announced later this month, the BOJ would allow a wider band around their 10-year YCC target of 0.0% as a means of steepening the yield curve to help the banking sector.  But clearly, that is not on the cards, so whatever changes may be announced next month, it seems that portion of the current policy is remaining unchanged. The market response was immediate in bond markets, but also in FX as the yen quickly fell 0.5% and is now trading at its weakest level since last June.  Perhaps what is more interesting about the yen’s move is the trajectory of its declines, which are starting to go parabolic.  Beware a much weaker yen, with a short-term test of 110 seemingly on the cards.
 
Chair Jay tried quite hard to explain
That joblessness is still the bane
Of policy goals
Thus, rising payrolls
Are needed ere rates rise again
 
But what he said, and markets heard
Was different and that is what spurred
A bond market rout
And stock buying drought
While dollar buys were undeterred
 
Meanwhile, back at the ranch…Chairman Powell made his last comments yesterday before the quiet period begins ahead of the mid-March FOMC meeting.  In an interview he explained that the FOMC remains quite far from its goals of maximum employment and stable (2% inflation) prices and that they would not be altering policy until those goals are achieved.  However, he did not indicate that they would be expanding their current easy money stance, either by expanding QE or extending the tenor of purchases, and he remained sanguine when asked about the steepening of the yield curve, explaining that it was a positive sign of growth expectations.
 
Alas, it is not that simple for the Fed as they have put themselves in a very difficult position.  Financial conditions, while seemingly an amorphous term, actually has some precision.  The Chicago Fed has an index with 105 variables but Goldman Sachs has created a much simpler version with just 4 variables; riskless interest rates (10-year yields), equity valuations (S&P 500), Credit Spreads (CDX) and the exchange rate (DXY).  Directionally, conditions are tightening when yields rise, stocks fall, credit spreads widen and the dollar rises, which is exactly what is happening right now!  In fact, in the wake of the Powell comments, they all got tighter.  Now, I’m pretty sure that was not Powell’s intention, but nonetheless, it was the result. 
 
The problem Powell and the Fed have is that, like Pavlov’s dogs, markets begin to drool at the sound of a Powell speech in anticipation of further easy money to prop things up.  But the market has extended this concept to the back end of the curve, not just the front, and the Fed, unless they change policy, has far less control out there.  It was this setup that put the pressure on Powell to ease policy further, and when he did not change his tune, the market had a little fit. 
 
Now, remember, the Fed is in its quiet period for the next 12 days, 8 of which will see markets open and trading.  Markets have a history of testing the Fed when they want something, and the Fed’s reaction function, ever since Maestro Alan Greenspan was Fed Chair in 1987 during the Black Monday stock market rout, has been to flood the market with more liquidity when markets sell off.  With that in mind, I would not be surprised to see 10-year yields test 2.0% in the next two weeks as the market tries to force the Fed’s hand.  Be prepared for more volatility and tighter financial conditions as defined by the index I described above.
 
Which leads us to today’s market activity, where risk is clearly under some pressure ahead of the payroll report this morning.  In Asia, equities were broadly, but not deeply, lower (Nikkei -0.25%, Hang Seng -0.5%, Shanghai -0.1%) while in Europe, early losses every where have eased and the picture is now mixed (DAX -0.6%, CAC -0.3%, FTSE 100 +0.4%).  US futures, which had been in negative territory all evening have turned higher and are currently up by roughly 0.15%.
 
Bonds, however, are universally softer with yields rising everywhere (except JGB’s last night).  So, Bunds (+1.2bps), OATs (+1.5bps) and Gilts (+4.2bps) lead the yield parade higher with Treasuries currently unchanged, although this is after yesterday’s 8bp rout.  Australian ACGBs continue to sell off sharply with yields higher by another 6bps overnight which takes that move to 63bps in the past month.
 
On the commodity front, OPEC+ surprised markets yesterday by leaving production unchanged vs. an expectation that they would increase it by 1 million bpd, which resulted in a sharp rally in oil prices which has continued this morning.  WTI (+2.5%) is now above $65/bbl for the first time since October 2018.  Base metals have rallied as well while precious metals are still suffering from the higher real yields attached to higher nominal yields.
 
And finally, the dollar, which is higher vs. almost every one of its counterparts this morning, with only NOK (+0.2%) and RUB (+0.3%) benefitting from the oil rally enough to overcome the dollar’s yield effect.  But elsewhere in the G10, AUD (-0.7%) and NZD -0.75%) are leading the way lower with GBP (-0.55%) also under the gun.  Now, we are seeing yields rise in all these currencies, but a big part of this move is clearly position unwinding as the massive short dollar positions that have been evident since Q4 2020 are starting to feel more pressure and getting unwound.  The euro, too, is softer, -0.3%, which has taken it below its previous correction lows, and technically opens up a test of the 200-day moving average at 1.1825.
 
In the EMG bloc, the weakness is widespread with CE4 currencies leading the euro lower, LATAM currencies (CLP -0.65%, MXN -0.6%, BRL -0.25%) all under pressure and most APAC currencies having performed poorly overnight, including CNY (-0.3%) which fell despite the new Five Year plan forecasting GDP growth above 6.0% this year.
 
And finally, the data story where we have payrolls this morning:
 

Nonfarm Payrolls

198K

Private Payrolls

195K

Manufacturing Payrolls

15K

Unemployment Rate

6.3%

Participation Rate

61.4%

Average Hourly Earnings

0.2% (5.3% Y/Y)

Average Weekly Hours

34.9

Trade Balance

-$67.5B


Source: Bloomberg
 
The thing is, while this number usually means a lot, I think there is asymmetric risk attached today.  A weak number will not do anything, while a strong number could well see the next leg of the bond market rout and ensuing stock market weakness.  Traders, when they are in the mood to test the Fed, will jump on any excuse, and this would be a good one.
 
For right now, the dollar has the upper hand, and I see no reason for that to change until we hear something different from the Fed.  And that is two weeks away!
 
Good luck, good weekend and stay safe
Adf
 
 
 
 
 
 
 

No Paradox

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In Europe, the ECB hawks
Explained in their most recent talks
The rising of late
In THE 10-year rate
Was normal and no paradox

At home, hawks are also reduced
To cheering the 10-year yield’s boost
Since Powell’s a dove
And rules from above
The hawks can’t shake him from his roost

In a world where every central bank is adding massive amounts of liquidity, how can you determine which central bankers are hawks and which are doves?  Since no one is allowed to make the case that short-term rates should be raised to try to slow down rising inflation, the next best thing for the hawks to do is to cheer on the rise in longer term yields.  And that continues to be the number one story in markets around the world, rising bond yields.  Yesterday saw Treasury yields rise 9 basis points as investors continue to see US data point to rising inflationary pressures.  The ISM Services Price Index rose to its highest level since 2008, just like we saw in the Manufacturing Index on Monday.  Even official inflation measures continue to print a bit higher than forecast, a sign that underlying price pressures are quite widespread.

In the past, this type of economic data would encourage the hawkish contingent of every central bank to argue for raising the short-term rate.  But hawkish views appear to have been written by Dr Seuss, as they have been removed from the canon of financial discussion.  Which leaves the back end of the curve the only place where they can express their views.  And so, we now hear from Klaas Knot, Dutch central bank president that rising government bond yields are a “positive story”, while Jens Weidmann, Bundesbank president explained that these moves are not “a particularly worrisome development.”  We have heard the same thing from Fed speakers as well, although not universally, as the doves, notably Lael Brainerd, hint at Fed action to prevent an unruly market.  My take is an unruly market is one that goes in the opposite direction to their desires.

But despite the central bank commentary, it is becoming ever clearer that inflationary pressures are rising around the world.  We have spent the past 40 years in an environment of constantly decreasing inflation as a combination of globalization and technological advancement have reduced the cost of so many things.  And while technology continues to march forward, globalization is under severe attack, even from its previous political cheerleaders.  This is evident in the current US administration, where strengthening and localizing supply chains is a goal, something that will clearly increase costs.  Add to that increased shipping costs alongside capacity shortages and rising energy costs, and you have the makings of a higher price regime.  (An anecdote on rising price pressures: a friend of mine who lives in Paris told me the prices of the following foods; fresh salmon €60/kg, 1 grapefruit €2.25 and 1 avocado €2.65.  I checked my supermarket app and found the following prices here in New Jersey; fresh salmon $9.99/lb, 1 grapefruit $1.00 and 1 avocado $2.50.  Prices are high and rising everywhere!)

The final piece of this puzzle is broad economic activity, which the data continues to show has seen a real burst in the US, although there is still concern over the employment situation.  Every survey has shown the US economy growing rapidly in Q1 with the Atlanta Fed’s GDPNow forecast currently at 10%.  Adding it all up leads to the following understanding; it is not only the Fed that is willing to run the economy hot, but every G10 central bank, which means that monetary support will continue to flow for years to come.  Combining that activity with the massive fiscal support and the still significant supply bottlenecks that were a result of the government shutdowns in response to Covid brings about a scenario where there is a ton of money in the system and not enough goods to satisfy the demand.  If central banks don’t tap the breaks, rising prices and price expectations will lead to rising yields, and ultimately to declining equities.  The only asset class that will continue to perform is commodities, because owning “stuff” will be a better trade than owning paper assets.  And that’s enough of those cheery thoughts.

On to today’s markets, where, alas, risk is being jettisoned around the world.  After yesterday’s tech led selloff in the US, Asian equity markets really got hammered (Nikkei -2.1%, Hang Seng -2.1%, Shanghai -2.1%) and European markets are also under the gun (DAX -0.45%, CAC -0.3%, FTSE 100 -1.0%).  US futures?  All red at this hour, down about 0.3%, although that is off the lows seen earlier this morning.

Bond yields, meanwhile, despite my discussion of how they are rising, have actually slipped back a bit this morning in classic risk-off price action.  So, Treasuries (-1.9bps), Bunds (-2.6bps), OATs (-2.1bps) and Gilts (-4.1bps) are all rallying.  But this is not a trend change, it is merely indicative of the fact that now that yields have backed up substantially, the concept of government bonds as an effective risk mitigant is coming back in vogue.  After all, when 10-yr Treasuries yield 0.7%, it hardly offers protection to a portfolio, but at more than double that rate, it is starting to help a little in times of stress.

Commodity prices are mixed this morning with oil taking back early session losses to sit unchanged as I type, but base metals in the midst of a modest correction after a remarkable rally for the past several months.  This morning copper (-4.1%) and Nickel (-8.2%) are leading the way lower, but with the ongoing economic activity and absence of new capacity, these are almost certainly temporary moves.  Gold, which has been under significant pressure lately seems to have found a floor, perhaps only temporarily, at $1700, but given the dollar’s ongoing strength, it cannot be surprising gold remains under pressure.

As to the dollar, I would say it is very modestly stronger today, although what had earlier been virtually universal has now ebbed back a bit.  In the G10, CHF (-0.4%) and JPY (-0.3%) are the worst performers, which given the risk attitude is actually quite surprising.  I think the Swiss story is actually a Polish one, where Poland has refused to support local banks who took out CHF loans and have been suffering from currency strength far outstripping the interest rate benefits.  It seems, concern is growing that these loans may be restructured and ultimately impact the Swiss banks and Swiss economy.  Meanwhile, the yen’s weakness stems from a poor response to a 30-year bond sale last night, where yields rose 3.5 bps amid a very weak bid-to-cover ratio for the sale.  Perhaps even the Japanese are getting tired of zero rates!  But away from those two currencies, the rest of the bloc is +/- 0.2% or less, indicating nothing of real interest is going on.

EMG currencies are also mixed with Asian currencies suffering amid the broad risk off environment overnight and CE4 currencies lower on the back of euro weakness.  On the plus side, BRL (+0.7%) and MXN (+0.6%) are the leading gainers, which appears to be an ongoing reaction to aggressive central bank of Brazil intervention to try to prevent further weakness there.  In this space too, the broad risk appetite will continue to remain key.

On the data front we see a bunch of stuff starting with Initial Claims (exp 750K) and Continuing Claims (4.3M), but we also see Nonfarm Productivity (-4.7%), Unit Labor Costs (6.6%) and Factory Orders (2.1%) this morning.  Perhaps of more importance we hear from Chairman Powell today, right at noon, and all eyes and ears will be focused on how he describes recent market activity as well as to see if he hints at any type of Fed response.  Many pundits, this one included, believe there is a cap to how high the Fed will allow yields to rise, the question is, what is that cap.  I have heard several compelling arguments that 2.0% is where things start to become uncomfortable for the Fed, but ultimately, I believe that it will depend on the data.  If the data starts to show that the economy is under pressure before 2.0% is reached, the Fed will step in at that time and stop the madness.  Until then, as we have heard from central bankers worldwide, higher yields in the back end are a good thing, so they will continue to be with us for the foreseeable future.  And yes, that means that until US inflation data starts to print higher, and real yields start to decline, the dollar is very likely to retain its bid.

Good luck and stay safe
Adf

More Terrified

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The narrative starting to form
Is bond market vol’s the new norm
But Jay and Christine
Explain they’re serene
Regarding this new firestorm

However, the impact worldwide
Is some nations must set aside
Their plans for more spending
As yields are ascending
And FinMins grow more terrified

Confusion is the new watchword as investors are torn between the old normal of central bank omnipotence and the emerging new normal of unfettered chaos.  Now, perhaps unfettered chaos overstates the new normal, but price action, especially in the Treasury and other major government bond markets, has been significantly more volatile than what we had become used to since the first months of the Covid crisis passed last year.  And remember, prior to Covid’s appearance on the world stage, it was widely ‘known’ that the Fed and its central bank brethren had committed to insuring yields would remain low to support the economy.  Of course, there was the odd hiccup (the taper tantrum of 2013, the repo crisis of 2018) but generally speaking, the bond market was not a very exciting place to be.  Yields were relatively low on a long-term historical basis and tended to grind slowly lower as debt deflation central bank action guided inflation to a low and stable rate.

But lately, that story seems to be changing.  Perhaps it is the ~$10 trillion of pandemic support that has been (or will soon be) added to the global economy, with the US at $5 trillion, including the upcoming $1.9 trillion bill working its way through Congress, the leading proponent.  Or perhaps it is the fact that the novel coronavirus was novel in how it impacted economies, with not only a significant demand shock, but also a significant supply shock.  This is important because supply shocks are what tend to drive inflation with the OPEC oil embargos of 1973 and 1979 as exhibits A and B.

And this matters a lot.  Last week’s bond market price action was quite disruptive, and the terrible results of the US 7-year Treasury auction got tongues wagging even more about how yields could really explode higher.  Now, so far this year we have heard from numerous Fed speakers that higher yields were a good sign as they foretold a strong economic recovery.  However, we all know that the US government cannot really afford for yields to head that much higher as the ensuing rise in debt service costs would become quite problematic.  But when Chairman Powell spoke last week, he changed nothing regarding his view that the Fed was committed to the current level of support for a substantially longer time.

Yesterday, however, we heard the first inkling that the Fed may not be so happy about recent bond market volatility as Governor Brainerd explained that the sharp moves “caught her eye”, and that movement like that was not appropriate.  This is more in sync with what we have consistently heard from ECB members regarding the sharp rise in yields there.  At this point, I count at least five ECB speakers trying to talk down yields by explaining they have plenty of flexibility in their current toolkit (they can buy more bonds more quickly) if they deem it necessary.

But this is where it gets confusing.  Apparently, at least according to a top story in Bloomberg this morning which explains that ECB policymakers see no need for drastic action to address the rapidly rising yields of European government bonds, everything is fine.  But if everything is fine, why the onslaught of commentary from so many senior ECB members?  After all, the last thing the ECB wants is for higher yields to drive the euro higher, which would have the triple negative impact of containing any inflationary impulses, hurting export industries and ultimately slowing growth.  To me, the outlier is this morning’s story rather than the commentary we have been hearing.  Now, last week, because of a large maturity of French debt, the ECB’s PEPP actually net reduced purchases, an odd response to concerns over rising yields.  Watch carefully for this week’s action when it is released next Monday, but my sense is that number will have risen quite a bit.

And yet, this morning, bond yields throughout Europe and the US are strongly higher with Treasuries (+5.3bps) leading the way, but Gilts (+3.6bps), OATs (+2.7bps) and Bunds (+2.4bps) all starting to show a near-term bottom in yields.  The one absolute is that bond volatility continues to be much higher than it has been in the past, and I assure you, that is not the outcome that any central bank wants to see.

And there are knock-on effects to this price action as well, where less liquid emerging and other markets are finding fewer buyers for their paper.  Recent auctions in Australia, Thailand, Indonesia, New Zealand, Italy and Germany all saw much lower than normal bid-to-cover ratios with higher yields and less debt sold.  Make no mistake, this is the key issue going forward.  If bond investors are unwilling to finance the ongoing spending sprees by governments at ultra-low yields, that is going to have significant ramifications for economies, and markets, everywhere.  This is especially so if higher Treasury yields help the dollar higher which will have a twofold effect on emerging market economies and really slow things down.  We are not out of the woods yet with respect to the impact of Covid and the responses by governments.

However, while these are medium term issues, the story today is of pure risk acquisition.  After yesterday’s poor performance by US equity markets, Asia turned things around (Nikkei +0.5%, Hang Seng +2.7%, Shanghai +1.9%) and Europe has followed along (DAX +0.9%, CAC +0.6%, FTSE 100 +0.8%).  US futures are right there with Europe, with all three indices higher by ~0.6%.

As mentioned above, yields everywhere are higher, as are oil prices (+1.5%).  However, metals prices are soft on both the precious and base sides, and agricultural prices are mixed, at best.

And lastly, the dollar, which had been softer all morning, is starting to find it footing and rebound.  CHF (-0.3%) and JPY (-0.25%) are the leading decliners, but the entire G10 bloc is lower except for CAD (+0.1%), which has arguably benefitted from oil’s rally as well as higher yields in its government bond market.  In what cannot be a great surprise, comments from the ECB’s Pablo Hernandez de Cos (Spanish central bank president) expressed the view that they must avoid a premature rise in nominal interest rates, i.e. they will not allow yields to rise unopposed.  And it was these comments that undermined the euro, and the bulk of the G10 currencies.

On the EMG front, overnight saw some strength in Asian currencies led by INR (+0.9%) and IDR (+0.55%) as both were recipients of foreign inflows to take advantage of the higher yield structure available there.  On the downside, BRL (-0.7%) and MXN (-0.5%) are the laggards as concerns grow over both governments’ ongoing response to the economic disruption caused by Covid.  We have seen the Central Bank of Brazil intervening in markets consistently for the past week or so, but that has not prevented the real from declining 5% during that time.  I fear it has further to fall.

On the data front, ADP Employment (exp 205K) leads the day and ISM Services (58.7) comes a bit later.  Then, this afternoon we see the Fed’s Beige Book.  We also hear from three more Fed speakers, but it would be shocking to hear any message other than they will keep the pedal to the metal for now.

Given all the focus on the Treasury market these days, it can be no surprise that the correlation between 10-year yields and the euro has turned negative (higher yields leads to lower euro price) and I see no reason for that to change.  The story about the ECB being unconcerned with yields seems highly unlikely.  Rather, I believe they have demonstrated they are extremely concerned with European government bond yields and will do all they can to prevent them from moving much higher.  While things will be volatile, I have a sense the dollar is going to continue to outperform expectations of its decline for a while longer.

Good luck and stay safe
Adf

Fated To Burst

Posted on by

While here in the US the word
Is stimulus, more, is preferred
The UK is thinking
‘Bout how they’ll be shrinking
Their deficit, or so we’ve heard

Meanwhile, China, last night, explained
That excesses would be contained
The bubble inflated
By Powell is fated
To burst, as it can’t be sustained

If you look closely enough, you may be able to see the first signs of governments showing concern about the excessive policy ease, both fiscal and monetary, that has been flooding the markets for the past twelve months.  This is not to say that the end is nigh, just that there are some countries who are beginning to question how much longer all this needs to go on.

The first indication came last night from China, remarkably, when the Chairman of the China Banking and Insurance Regulatory Commission, and Party secretary for the PBOC, explained that aside from reducing leverage in the Chinese property market to stay ahead of systemic risks, he was “very worried” about the risks from bubbles in the US equity markets and elsewhere.  Perhaps bubbles can only be seen from a distance of 6000 miles or more which would explain why the PBOC can recognize what is happening in the US better than the Fed.  Or perhaps, the PBOC is the only central bank left in the world that has the ability, in the words of legendary Fed Chair William McChesney Martin “to take away the punch bowl just as the party gets going”.  We continue to hear from Fed speakers as well as from Treasury secretary Yellen, that the Fed has the tools necessary if inflation were to return, and that is undoubtedly true.  The real question is do they have the fortitude to use them (take away that punch bowl) if the result is a recession?

The second indication that free money and government largesse may not be permanent comes from the UK, where Chancellor of the Exchequer Rishi Sunak is set to present his latest budget which, while still offering support for individuals and small businesses, is now also considering tax increases to start to pay for all the previous largesse.  The UK budget deficit is running at 17% of GDP, which in peacetime is extremely large.  And, as with the US, the bulk of that money is not going toward productive investment, but rather to maintenance of the current situation which has been crushed by government lockdowns.  However, the UK does not have the world’s reserve currency and may find that if they continue to issue gilts with no end, there is a finite demand for them.  This could easily result in the worst possible outcome, higher interest rates, slowing growth and a weakening currency driving inflation higher.  The pound has been amongst the worst performers during the past week, falling 1.4% (-0.1% today), as investors start to question assumptions about the ability of the UK to continue down its current path.

But not to worry folks, here in the US, the $1.9 trillion stimulus bill is starting to get considered in the Senate, where some changes will need to be made before reconciliation with the House, but where it seems certain to get the clearance it needs for passage and eventual enactment within the next two weeks.  So, the US will not be heeding any concerns that going big is no longer the right strategy, despite what has been a remarkable run of economic data.  In the current Treasury zeitgeist, as we learned from Florence + The Machine in 2017, “Too Much is Never Enough”!

Where does that leave us today?  Well, risk struggled in the overnight session on the back of the PBOC concerns about bubbles and threats to reduce liquidity (Nikkei -0.9%, Hang Seng -1.2%, Shanghai -1.2%), but after a weak start, European bourses have decided that Madame Lagarde will never stop printing money and have all turned positive at this time (DAX +0.5%, CAC +0.5%, FTSE 100 +0.6%).  And, of course, that is a valid belief given that we continue to hear from ECB speakers that the PEPP can easily be adjusted as necessary to insure continued support.  The most recent comments come from VP Luis de Guindos, who promised to prevent rising bond yields from undermining easy financing conditions.  US futures, meanwhile, while still lower at this hour by about 0.2%, have been rallying back from early session lows of greater than -0.7%.

Treasury yields continue to resume their climb higher, up another 2.9 basis points this morning, although they remain below the 1.50% level.  In Europe, bunds (+2.0bps), OATs (+2.7bps) and Gilts (+0.6bps) are all giving back some of yesterday’s rally, as risk appetite is making a comeback.  Also noteworthy are ACGBs Down Under with a 5.2 bp rise last night although the RBA did manage to push 3-year yields, their YCC target, even lower to 0.087%.

Commodity prices seem uncertain which way to go this morning, with oil virtually unchanged, although still above $60/bbl, and gold and silver mixed.  Base metals are very modestly higher with ags actually a bit softer.  In other words, no real direction is evident here.

As to the dollar, the direction is higher, generally, although not universally.  In the G10, NOK (+0.6%) is the leading gainer followed by AUD (+0.3%) which has held its own after the RBA stood pat and indicated they would not be raising rates until 2024! That doesn’t strike me as a reason to buy the currency, but that is the word on the Street.  But the rest of the bloc is softer, although earlier declines of as much as 0.5% have been whittled down.

EMG currencies have also seen a few gainers (RUB +0.4%, INR +0.25%) but are largely softer led by BRL (-0.7%) and ZAR (-0.7%).  It is difficult to derive a theme here as the mixed commodity markets are clearly impacting different commodity currencies differently.  However, the one truism is that the dollar is definitely seeing further inflows as its broad-based strength is undeniable today.

There is no data released today in the US, although things certainly pick up as the week progresses from here.  On the speaker front we hear from two arch doves, Brainerd and Daly, neither of whom will indicate that a bubble exists or that it is time to cut back on any type of stimulus.  Perhaps at this point, markets have priced in the full impact of the stimulus bill, and the fact that the Fed is on hold, and is looking at other central bank activities as the driver of rates.  After all, if other central banks seek to expand policy, as we have heard from the ECB, then those currencies are likely to come under pressure.

Here’s the thing; investors remain net short dollars against almost every currency, so every comment by other central banks about further support is going to increase the pain level unless the Fed responds.  Right now, that doesn’t seem likely, but if yields do head back above 1.5%, don’t be surprised to see something out of the FOMC meeting later this month.  However, until then, the dollar seems likely to hold its recent bid.

Good luck and stay safe
Adf

Their Bond Vigilantes

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Down Under, the RBA bought
Four billion in bonds as they fought
Their bond vigilantes
Who came back from Dante’s
Ninth circle with havoc they wrought

Investors responded by buying
More bonds and more stocks fortifying
The view central banks
All still deserve thanks
For making sure markets keep flying

Atop the reading list of every G10 central banker is the book written by Mario Draghi in 2012 and titled, How to Keep Interest Rates Lower for Longer*, and every one of those bankers is glued to page one.  At this point, there is no indication that higher interest rates will be tolerated for any length of time, and while jawboning is always the preferred method of moving markets in the desired direction, sometimes these bankers realize they must act.  And act they did, well at least Phillip Lowe, the RBA Governor, did.  Last night, the RBA bought $4 billion in 3-year ACGB’s, doubling the normal and expected amount of purchases as he fought back against the idea that the RBA would not be able to maintain control of the yield curve as they have announced.  The response must have been quite gratifying as not only did 3-year yields nose back below 0.10%, the target, but 10-year yields tumbled 0.25% as investors regained their confidence and took advantage of the sudden increase in yields available to increase their holdings.

So, last week’s price action is now deemed to have been nothing more than a hiccup, or a bad dream, with market activity today seen as the reality.  At least that is the story all the world’s central banks keep telling themselves, and arguably will continue to do for as long as possible.  It seems that the fact the RBA was willing to be so aggressive was seen by investors as a harbinger of what other central banks are willing and capable of enacting with the result being a massive asset rally worldwide.  Think about that for a moment, the purchase of an extra $1.5 billion of ACGBs has resulted in asset price increases on the order of $1 trillion worldwide.  That, my friends, is bang for your buck!

Of course, the question that remains is, will investors continue to accept this worldview, or will data, and ever-increasing debt supply, return us to last week’s market volatility and force a much bigger response by much bigger players?  My money is on the latter, as there is no sign that deficit spending is being reined in, and the signs of higher inflation remain clear, even in Europe!

But clearly, today is not one for calling out central bankers.  While ongoing conversations in Tokyo highlight the question of whether the BOJ needs to intervene ahead of their mid-month meeting when they are to present their Policy Review, and ECB members continue to warn about unwarranted tightening of financial conditions, thus far, we have not seen any increase in activity by either central bank.  However, at 9:45 this morning we will see the latest data from the ECB regarding their purchases during the last week in the PEPP, and it will be instructive to see if those purchases increased, or if they simply maintained their regular pace of activity.  An increase could be taken positively, shoring up investor belief that the ECB has their back, but given how poorly the European government bond market performed last week, it could also be seen as a sign that the ECB is losing its sway in markets.

The one truism is that market volatility, despite central banks’ fervent desire for it to decrease, remains on a higher trajectory as the possible economic outcomes for the world as a whole, as well as for individual countries, diverge.  And this is, perhaps, the hardest thing for investors to accept and understand; after a forty year period of declining inflation and volatility, if the cycle is turning back higher for both of these characteristics, which have a high correlation, then the future will be more difficult to navigate than the recent past.

So, just how impressive was the RBA’s action?  Pretty impressive.  For instance, equity markets in Asia all rose sharply (Nikkei +2.4%, Hang Sent +1.6%, Shanghai +1.2%) and are all higher in Europe as well (DAX +0.7%, CAC +1.1%, FTSE 100 +1.0%).  US futures, meanwhile, are powering ahead by approximately 1.0% across the board.

As to bonds, while the ACGB move was the most impressive, we did see a halt to the rise in 10-year JGB yields, and in Europe, the rally is powerful with Bunds (-5.0bps), OATs (-5.5bps) and Gilts (-4.1bps) all paring back those yield hikes from last week.  Interestingly, Treasury yields (+2.2bps) are not holding to this analysis, as perhaps the news that the $1.9 trillion stimulus package passed the House this weekend has investors a bit more nervous.  After all, passage implies increased issuance of $1.9 trillion, and it remains an open question as to how much demand there will be for these new bonds, especially after last week’s disastrous 7-year auction.  And that’s really the key question, will there be natural demand for all this additional paper, or will the Fed need to expand QE in order to prevent yields from rising further?

On the commodity front, we are seeing strength across the board with oil (+1.0%) leading energy higher on the reflation idea, both base and precious metals markets rallying and agricultural products seeing their ongoing rallies continue.  Stuff continues to cost more, despite the Fed’s claims of low inflation.

As to the dollar, it is mixed this morning, with commodity currencies performing well (NOK +0.4%, CAD +0.35%, AUD +0.3%) while the European commodity users are all under pressure (SEK -0.5%, CHF -0.5%, EUR -0.25%).  The euro’s weakness seems a bit strange given the manufacturing PMI data released this morning was positive and better than expected.  As well, German CPI, which is released on a state by state basis, is showing a continued gradual increase.

In the emerging markets, TRY (+2.5%) is the runaway leader as the lira offers the highest real yields around and as fear recedes, hot money flows there quickest.  But away from that, RUB (+0.6%) on the back of oil’s rally, and CLP (+0.45%) on the back of copper’s ongoing rally are the best performers.  With the euro softer, the CE4 are all weaker and we saw desultory price action in Asian currencies overnight.

On the data front, this is a big week, culminating in the payroll report.

Today ISM Manufacturing 58.6
ISM Prices Paid 80.0
Wednesday ADP Unemployment 180K
ISM Services 58.6
Fed’s Beige Book
Thursday Initial Claims 755K
Continuing Claims 4.3M
Nonfarm Productivity -4.7%
Unit Labor Costs 6.7%
Factory Orders 1.8%
Friday Nonfarm Payrolls 180K
Private Payrolls 190K
Manufacturing Payrolls 10K
Unemployment Rate 6.4%
Participation Rate 61.4%
Average Hourly Earnings 0.2% (5.3% Y/Y)
Average Weekly Hours 34.9
Trade Balance -$67.4B
Consumer Credit $12.0B

Source: Bloomberg

In addition to all this, we hear from Chairman Powell on Thursday, as well as six other Fed speakers a total of nine times this week.  But we already know what they are going to say, rising long end yields are a positive sign of growth and with unemployment so high, we are a long way from changing our policy.  History shows that the market will test those comments, especially once the Fed goes into its quiet period at the end of the week.

As for today, risk is quite clearly ‘on’ and it seems unlikely that will change without a completely new catalyst.  The RBA has fired the shot across the bow of the pessimists, and for now it is working.  While the euro seems to be under pressure on the assumption the ECB will act as well, as long as commodities continue to rally, that is likely to support the growth story and commodity currencies.

Good luck and stay safe
Adf

*a fictional work conceived by the author

The Fed’s Nonchalance

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The view from the Fed’ral Reserve
When viewing the present yield curve
Is that higher rates
Show, here in the States
The ‘conomy’s showing some verve

Contrast that with Europe’s response
To rising yields, where at the nonce
Ms Schanbel’s the third
Of speakers we heard
All lacking the Fed’s nonchalance

All I can say about yesterday’s market activity was that we cannot be too surprised that the imbalances that have been building up for the past year (or more accurately 13 years) resulted in some significant market volatility across every asset class.  Perhaps the most interesting thing was that virtually every asset class was sold aggressively, with no obvious havens available.  Stocks fell, bonds fell, gold fell, the dollar fell, Bitcoin fell; just what did people buy with those proceeds?

But of more interest to me was the central bank responses we have seen to the recent rise in long-term yields around the world.  Arguably, this has been the catalyst to all the market activity, so remains the first place we need to look for answers.

And what did we hear?  Well, four separate FOMC members (Williams, Bostic, Bullard and George) explained that rising yields were a good thing as it shows confidence in the economic growth story.  And oh, by the way, yields are still quite low so they shouldn’t have a negative impact on the economy.  While they may well be sincere in those views, these comments smack more of whistling past the graveyard than wholehearted support of market price action.  After all, the one thing the Fed has demonstrated since the GFC in 2008 is that unrestrained market price action is the last thing they want to see.  Rather, they want to make sure they control the game and the market price action proceeds slowly and calmly in their preferred direction.  You know, like watching paint dry.

And of course, in the broad scheme of things, yields do remain quite low.  Even at yesterday’s high point, the 10-year Treasury was yielding only 1.61%, which is still in the lowest decile of yields during the 10-year’s history.  Interestingly, the ECB has not been quite as sanguine regarding bond yields, despite the fact that bond yields throughout the entire continent are much lower than US yields.  On Monday Madame Lagarde explained they were “closely monitoring” bond yields.  Yesterday, ECB Chief Economist, and the ECB member with the most policy chops, Philip Lane, explained they would use the flexibility of the PEPP to prevent any undue tightening in financial conditions.  Then this morning, Isabel Schnabel, an Executive Board member, was more forthright, explaining the ECB may need to boost policy support if real long-term yields rise too early in the recovery process.  In other words, since they don’t believe that inflation is coming, rising yields need to be stopped.

What if, however, all these central bankers are completely wrong about the future of inflation?  What if, they have been reading their own narrative and now believe that there is no inflation on the way, thus rates should never need to rise?  That, my friends, has the chance to lead to some serious policy errors going forward.

So, let’s take a look at the most recent inflation indicators we have seen, and consider the situation.  Last night, Tokyo CPI was released at -0.3% Y/Y, which while obviously low, was higher than last month and forecast.  Then, this morning French PPI printed positive (+0.4%) for the first time in more than a year while French CPI rose a more than expected 0.7% in February.  Meanwhile, German Import Prices rose a much more than expected 1.9% in January, the biggest jump since September 1990!  And finally, here in the States, the GDP is released with a price index which rose to 2.1%, a tick above expectations.  Now, none of this is a description of raging inflation, but boy, there does seem to be a decent amount of price pressure building in the system.  Perhaps, just perhaps, bond yields are rising on rising inflation concerns, whether economic growth is present or not.

This idea is important because a key ingredient for market forecasts this year has been the trajectory of real interest rates.  At face value, the combined comments of Fed and ECB speakers this week tells us that the Fed is going to allow long-term yields to continue to rise while the ECB is going to step in and stop the madness.  If that is actually how things play out, I assure you that the euro will be hard pressed to move any higher, and that a sharp decline could be in the offing.  In fact, that is true for virtually every currency, where the dollar may very well reassert itself if that is the interest rate scenario that plays out.

Of course, I don’t believe the Fed will allow yields to simply rise unabated, as the cost to the Federal government in increased interest payments will be extremely uncomfortable, so I still look for QE to be expanded and extended, perhaps as soon as the March meeting if yields continue to rally from here.  At 1.75% on the 10-year, the Fed will be feeling the pinch, especially if equity markets continue to suffer under a rising yield scenario.  Thus, I am still in the camp of the dollar eventually falling more sharply as rising inflation rates outstrip capped interest rates.  But the latest comments from the central banks have certainly raised the risk on that view!

Ok, we all know that yesterday was a rout in the markets.  This morning, is unfortunately, not looking much better. Asian equity markets last night followed the US lead and fell sharply (Nikkei -4.0%, Hang Seng -3.6%, Shanghai -2.1%) and European markets, which all fell yesterday, are lower again this morning (DAX -0.8%, CAC -1.1%, FTSE 100 -1.4%).  And, don’t be looking for a bounce in the US as futures are pointing lower as well, between -0.3% and -0.6% at this hour.

Bonds?  Well, Asian yields continued to rise, notably Australia’s ACGBs (+17.2bps), but most of Europe has reversed course this morning after the trio of ECB speakers seem to have calmed some jitters.  So, Bunds (-1.6bps) and OATs (-1.7bps) have seen modest rallies.  Gilts (+4.0bps), though, have had no commentary to support them and continue to sell off.  Treasury yields are lower by 4.1bps at this hour, which feels very much like a trading reaction (after all yields rose 26bps since Tuesday), but all eyes will be on this morning’s Core PCE data, which if it does print higher than the expected 1.4%, could well start the selling all over again.

Oil prices (-2.2%) are having their worst session in more than two months, but the uptrend remains intact.  Precious metals prices continue to suffer as well, as real yields rise alongside nominal yields, although base metals are holding in a bit better.

And finally, the dollar is stronger pretty much across the board this morning. With AUD (-1.5%) the worst G10 performer and the two havens (CHF and JPY) both lower by just -0.1%.  Down Under, the market finally forced the RBA’s hand regarding their YCC, and the RBA bought $A3 billion of 3-year notes to push yields back below their 0.10% target.  This had the additional impact of discouraging FX investors from owning the currency.  In fact, this is exactly what I would expect of the euro if (when) the ECB does the same thing.

On the EMG side of things, Asian markets last night tried to catch up with the routs seen in LATAM and EEMEA markets yesterday, with INR (-1.4%) and KRW (-1.4%) the leading decliners, but substantial weakness even in the more stable currencies like SGD (-0.3%) and CNY (-0.2%).  This morning, CLP (-0.9%) and MXN (-0.7%) are leading the way lower in this time zone.  And, of course, this is all the same story of shedding risk.

On the data front, a bunch more is coming starting with Personal Income (exp 9.5%), Personal Spending (2.5%) and the aforementioned Core PCE (1.4%) all at 8:30.  Then later in the morning we see Chicago PMI (61.0) and Michigan Sentiment (76.5), but I believe the PCE number is the most important.  Mercifully, there are no further Fed speakers today, but after all, we already know what they think.  Accommodation is going to be with us for a looooong time and higher yields are a sign of confidence, so no problem.

The wrinkle in the higher inflation argument is if the Fed truly does let yields run higher and other countries cap theirs, the stronger dollar will rein in price pressures.  And for now, that appears to be what the market is starting to believe.  I maintain the Fed will not allow yields to continue running higher unabated, but until they act, the dollar should perform well.  Maybe we do retest the 1,1950 level in the euro, and who knows, 107.00 USDJPY is not out of the question.

Good luck, good weekend and stay safe
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