Prices Rise in a Trice#CPI, #inflationexpectations

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There once was a world where the price
Of stuff stayed the same…paradise
But then central banks
Were born, and now thanks
To them prices rise in a trice

Now, worldwide the story’s the same
As these banks, inflation, can’t tame
They’re all terrified
That stocks might just slide
And they would come in for the blame

“I’d expect price increases to level off, and we’ll go back to inflation that’s closer to the 2% that we consider normal.  In the 70’s and 80’s inflation expectations became embedded in the American psyche.  That isn’t happening now.”  So said Treasury Secretary Yellen yesterday in an interview on NPR.  One has to wonder on what she bases these expectations.  Certainly not on any of the evidence as per the most recent data releases.

For instance, the NY Fed’s latest Inflation expectation survey was released yesterday with 1-year (5.7%) and 3-year (4.2%) both at the highest level in the series’ history since it began in 2013.  She cannot be looking at yesterday’s PPI data (8.6%, 6.8% core) as an indicator given both of these are at their highest level on a final demand basis since PPI started being measured in this manner in 2011.  However, a look a little deeper at the intermediate levels, earlier in the supply chain, show inflation running at levels between 11.8% and 27.8% Y/Y.  While all of these costs are not likely to flow into the price of finished goods, you can be sure that the pressure to raise prices throughout the chain for both goods and services remains great.  And of course, later this morning we will see the CPI data (exp 5.9% Y/Y, 4.3% ex food & energy) with both indicators forecast to show substantial increases from last month.  Secretary Yellen continues to try to sell the transitory story and twelve months of increasing prices later, it is wearing thin.

The US, though, is not the only place with this problem, it is a global issue.  Last night China released its inflation readings with PPI (13.5%) rising far more than expected and touching levels not seen since 1995.  CPI there rose to 1.5%, a tick higher than expected which indicates that either there is a serious lack of final demand in the country or they are simply manipulating the data to demonstrate that the government is in control.  (In fact, it is always remarkable to me when a Chinese data point is released that is not exactly as expected given the control the government exerts on every aspect of the process.)  Regardless, the fact is that price pressures continue to rise in China on the back of rising energy costs and shortages of available energy, and ultimately, given China’s status as the world’s largest exporter, those costs are going to feed into other nations’ import prices.

How about Europe?  Well, German CPI rose 4.5% Y/Y in October, the highest level since September 1993 in the wake of the German reunification which dramatically shook up the economy there.  Remember, too, the German’s have a severe phobia over inflation given the history of the Weimar Hyperinflation, so discontent with the ECB’s performance is growing apace in the country.

Essentially, it is abundantly clear that rising prices have become the norm, and that any idea that we are going to ease back to moderate inflation in the near-term are fantasy.  Naturally, with inflationary pressures abundant, one might expect that central banks would be out to address them by tightening policy.  And yet, while peripheral nations have already done so, the biggest countries remain extremely reluctant to tighten as concern over economic output and employment growth continue to dominate their thoughts.

Historically, central bank decision making always required balancing the two competing goals of pumping up supporting the economy while preventing prices from running away.  Between the GFC and the pandemic, though, there was no need to worry as measured inflation never reared its ugly head, so easy money supported growth with no inflationary consequences.  But post-pandemic fiscal largess has changed the equation and now central banks have to make a decision, with significant political blowback to either choice.  Yet the biggest risk is the lack of a decisiveness may well lead to the worst of all worlds, rising prices and slowing growth, i.e. stagflation.  I promise you a stagflationary environment will be devastating to financial assets all over.

Now, as we await the CPI data, let’s take a look around the markets to see how traders and investors are responding to all the latest news and data.

Equity markets are mostly following the US lead from yesterday with declines throughout most of Asia (Nikkei -0.6%, Hang Seng +0.7%, Shanghai -0.4%) and most of Europe (DAX -0.2%, CAC -0.3%, FTSE 100 +0.4%).  US futures are all pointing lower at this hour as well (DOW -0.3%, SPX -0.3%, NASDAQ -0.5%) so there is little in the way of joy at the current moment.  Risk is definitely under pressure.

What’s interesting is that bonds are not seen as a viable replacement despite declining stock prices as yields in Treasuries (+2.7bps) and throughout Europe (Bunds +0.8bps, OATs +2.1bps, Gilts +3.4bps) are higher.  So, stocks are lower and bonds are lower.  Did I mention that stagflation would be negative for financial assets?

On this very negative day, commodity prices, too, are under pressure with oil (-0.6%), NatGas (-1.8%), gold (-0.35%), copper (-0.3%) and tin (-1.1%) all suffering.  In fact, throughout the entire commodity complex, only aluminum (+2.0%) and corn (+0.5%) are showing gains.  At this point, oil remains in a strong uptrend, so any pullback is likely technical in nature.  NatGas continues to respond to the glorious weather in the northeast and Midwest with reduced near-term demand.  Even in Europe, Gazprom has finally started to let some more gas flow hence reducing price pressures there although it remains multiples of the US price.

Turning to the dollar, it is today’s clear winner, gaining against 9 of its G10 brethren, with CAD (flat) the only currency holding its own.  SEK (-0.6%) and NOK (-0.5%) lead the way lower with the latter tracking oil’s declines while the former is simply showing off its high beta characteristics with respect to dollar movement.  In the EMG bloc, TRY (-1.1%) is the laggard as traders anticipate another interest rate cut, despite high inflation, and there is concern over the fiscal situation given significant foreign debt payments are due next week.  ZAR (-0.9%) is slumping on the commodity story as well as concerns that the budget policy may sacrifice the currency on the altar of domestic needs.  But the weakness extends throughout the space with APAC currencies under pressure as well as LATAM currencies.  This is a dollar story today, with very little holding up to the perceived stability of the buck.

As well as the CPI data, given tomorrow’s holiday, we see Initial (exp 260K) and Continuing (2050K) Claims at 8:30.  There are actually no further Fed speakers today with Bullard yesterday remarking that two rate hikes were likely in 2022.  We shall see.

With the inflation narrative so strong, this morning’s data will be key to determining the short-term direction of markets.  A higher than expected print is likely to see further declines in both stocks and bonds with the dollar benefitting.  A weaker outcome seems likely to unleash yet another bout of risk acquisition with the opposite effects.

Good luck and stay safe
Adf

Damnified

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The market has turned its attention
To Brainerd’s potential ascension
As Chair of the Fed
Thus, bond bulls imbed
The view QE gets an extension

This adds to the growing divide
Twixt nations who’ve identified
Inflation as bad
From those who are mad
Their laxness have been damnified

The dollar is under some pressure this morning as bonds rally (yields decline) and commodity prices pick up further.  If equity markets were higher this would be a classic risk-on session, alas, that picture is mixed, and anyway, whatever movement there is has been modest at best.  (It’s almost as if equity bulls are getting tired at all-time highs with record valuations.)

What, then, you may ask, is driving today’s price action?  I give you Lael Brainerd PhD, current Fed governor, former Under Secretary of International Affairs at the US Treasury, and the woman most likely to be our next Federal Reserve Chair.  The news broke that President Biden interviewed her for the role and there is a growing belief that in the current political zeitgeist, a Democratic woman favored by the progressive wing of the party will be much more palatable than a Republican man with a mixed track record on issues like FOMC membership trading improprieties.  It doesn’t hurt that she has been an unrequited dove since her appointment by President Obama in 2014, nor that she has been vocal on the need for more stringent regulatory control over the big banks.

As markets are discounting instruments, ostensibly looking forward a number of months to where things will be rather than where they currently sit, there is a growing belief that a Chairwoman Brainerd will be loath to continue tapering asset purchases and far more comfortable allowing inflation to run even hotter in her desire to achieve an even lower unemployment rate.  Hence, the idea that fed funds rate hikes will be coming sooner has been pushed back further.  In the wake of last week’s very surprising BOE meeting, where the widely anticipate rate hike was delayed, and the Fed’s own extremely dovish tapering message, the idea that a change at the Fed will lean even more dovish than now is music to bond bulls’ ears.  And so, as we survey the largest economies, the US seems to be turning more dovish, the Eurozone continues to burnish its dovish bona fides and the BOJ…well the BOJ is unlikely to ever tighten policy again.

However, as we look elsewhere in the world, the story is very different.  Central banks all over, from smaller G10 nations to large EMG group members have clearly articulated that inflation is a major concern with no clear end in sight and that tighter monetary policy is in order.  In the G10, Canada appears on the cusp of tightening, Norway has done so already and promised another hike next month.  New Zealand has ended QE and raised rates, Australia has given up on YCC and Sweden is hinting at a rate rise coming soon.  The noteworthy link is these are all small, relatively open economies with trade a key part of the mix and rising prices are very evident.

But do not forget the EMG space where we have seen far more dramatic moves already and are almost certain to see more of the same going forward.  The Czech Republic hiked rates 125bps last week, far more than expected, while Russia has already raised rates 2.50% in the past 9 months with no signs of slowing down.  Meanwhile, Polish central bankers are previewing more rapid rate hikes despite a larger than expected 75 basis point move last week.  In LATAM, Brazil has already raised rates 5.25% and is in no mood to stop with inflation running above 10% there.  Mexico, too, is up 0.75% from its lows while Chile (+2.25%), Colombia (+0.75%) and Peru (+1.75%) have all reacted strongly to rising inflation.

The point is this dichotomy between the G3 and the rest of the world seems unlikely to continue forever.  There seem to be two likely scenarios to close this interest rate gap, neither of them to be hoped for; either the G3 will finally blink, recognize inflation is real and raise rates far more rapidly than currently expected, or the transitory story will be correct as the economic imbalances will drive a massive crash with economic growth slowing dramatically into a severe recession and no reason to raise interest rates.  In the first case, financial assets will almost certainly suffer greatly while commodities should perform well.  In the second case, everything will suffer greatly with cash regaining its title as king.

Like I said, neither is a pleasant outcome, but neither is about to happen yet either.  So, looking at today’s activity, the growing assumption of a more dovish Fed (remember that vice-chairs Clarida and Quarles will be out within months as well) has led to lower yields and a somewhat softer dollar along with ongoing higher commodity prices.

Equities, however, remain mixed overall, albeit starting to edge higher in the session.  In Asia, the picture was mixed with the Nikkei (-0.75%) falling on the back of yen strength, while the Hang Seng (+0.2%) and Shanghai (+0.2%) both managed to edge higher.  Europe, which had been mixed to lower earlier in the session has started to turn green with the DAX (+0.2%), CAC (+0.3%) and FTSE 100 (+0.1%) all in positive territory. US futures are generally little changed ahead of this morning’s PPI data, (exp 8.6%, 6.8% ex food & energy) but really with the market focusing on tomorrow’s CPI data.

As mentioned, bonds are having a good day, with Treasuries (-3.1bps) falling back to Friday’s low yields, while European sovereigns (Bunds -3.5bps, OATs -3.7bps, Gilts -1.3bps) all rally as well.  In Europe, the curves are flattening pretty aggressively, hardly a vote of confidence in future activity.

Oil prices (+0.45%) are once again firmer although NatGas (-1.6%) has slipped as warm weather in the mid-Atlantic and Midwest states reduces near term heating demand.  Precious metals, which have been rallying nicely of late are little changed on the day but industrial metals (Cu +0.5%, Al +0.1%, Sn +0.3%) are all a bit firmer.  Agricultural products continue to rise as food inflation worldwide continues to grow.

Finally, the dollar, which had been broadly softer earlier in the session on the dovish discussion, has rebounded slightly, although is hardly rocking.  In the G10, the largest moves have been 0.25% in either direction (AUD -0.25%, JPY +0.25%) however, there have been limited stories to drive perceptions.  Given the yen’s recent bout of significant weakness, this appears to be a corrective move rather than a new direction.  As to Aussie, it too seems more technical than fundamental in nature.

Emerging markets, however, have seen more movement led by THB (+0.8%) and KRW (+0.5%) on the news that both economies are reopening amid a decline in Covid infections and the allowance of more inbound tourist traffic.  RUB (+0.45%) seems to be benefitting from oil’s rise as well.  On the downside, ZAR (-0.6%) fell after a report that foreign holdings of South African sovereign debt fell to its lowest level in 10 years.

On the data front, aside from the PPI, we have already received the NFIB Small Business Optimism number at a disappointing 98.2 (exp 99.5) indicating that the growth impulse in the US is still under pressure.  In addition, there are 4 more Fed speakers today after yesterday’s warnings from Vice-chair Clarida that inflation may be a problem going forward.

For now, the dollar seems to be under modest pressure as it consolidates the latest leg of a slow move higher.  If the Fed tapering is going to diminish, the dollar bulls are going to have a harder road to hoe going forward.  As such, much will depend on who is our next Fed chair.

Good luck and stay safe
Adf

Growing Disdain

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There is now a silver haired queen
Whose role since she came on the scene
Has been to explain,
With growing disdain,
Inflation is still unforeseen
 
Her minions, as well, all campaign
To make sure the message is plain
Though prices are rising
They won’t be revising
Their plans, or so said Philip Lane
 
There is a growing disconnect between the ECB and the rest of the world’s central banks.  While the transitory narrative has been increasingly taken out back and shot, the ECB will not let that story die.  Just today, ECB Chief Economist Philip Lane defended the ECB stance, explaining, “If we look at the situation over the medium term, the inflation rate is still too low, below our 2% target.  This period of inflation is very unusual and temporary, and not a sign of a chronic situation.  The situation we are in now is very different from the 1970’s and 1980’s.”  [author’s emphasis]  In other words, in case Madame Lagarde’s comments from last week that the ECB is “very unlikely” to raise rates next year, were not clear, the ECB is telling us that their mind is made up and there will be no policy tightening in the foreseeable future.
 
In fairness, raising interest rates will not convince Russia to pump more natural gas through the pipelines to help mitigate the dramatic rise in prices there.  Nor will it help build new semiconductor fabs to alleviate that shortage.  However, what it might do is reduce demand for many things thus easing supply constraints and perhaps encouraging prices to fall.  After all, that is exactly what tighter monetary policy is supposed to do.  The problem with that logic, though, is that there isn’t a central banker on the continent that is willing to risk slowing down growth in order to address rapidly rising prices.  The politics of that move would likely bring more rioters into the streets.  Once again, central banks’ vaunted independence is shown to be a sham.  They are completely political and beholden to the government in charge at any given time.
 
And so, we are left with a situation where prices continue to rise throughout the world while the two largest economic areas, the US and Eurozone, maintain the easiest monetary policy in history.  Yes, I know the Fed said it would begin to reduce its QE purchases, but even if they do reduce purchases by $15 billion / month, they are still going to expand their balance sheet by a further $420 billion and interest rates are still at zero.  There remains virtually zero chance that inflation is going to fade as long as the current incentive structure remains in place. 
 
Speaking of the Fed, Friday’s NFP data was substantially better than expected with job growth rising 531K and revisions higher for the previous two months of an additional 235K.  The Unemployment Rate fell to 4.6% and wages continue to climb smartly, +4.9% Y/Y.  (Of course, on a real basis, that is still negative given the current 5.4% CPI with expectations that on Wednesday, the latest release will jump to 5.9%.)  However, Chairman Powell has indicated that the Fed believes there is still a great deal of slack in the labor market, based on the Participation Rate remaining well below pre-pandemic levels, and so raising rates prematurely would be a mistake.  Summing it all up, there is no reason to believe that either US or ECB monetary policy is going to be changing anytime soon, regardless of the data.
 
The question at hand, then, is what will this mean for markets in general and the dollar in particular?  As long as new, excess liquidity continues to flood the markets, there is little reason to believe that the ongoing bull market in equities, commodities, real estate, and bonds is going to end.  While history has shown that rising inflation will eventually hurt both bonds and stocks, we are not yet at that point, and quite frankly don’t appear to be approaching it that rapidly.  Though there remains a small cadre of old-timers (present company included) who have a difficult time accepting current valuations as normal and who have actually lived through inflationary times, the bulk of the market participants do not carry that baggage and so are unencumbered by negative thoughts of that nature.  But, as an example of how inflation can degrade equity markets, from Q4 1968 through Q1 1980, the S&P 500 fell 1% in nominal terms while inflation averaged 7.1% per year with a high print of 14.8%.  The point is that the last time we had an inflation situation of the current magnitude, holding equities did not solve the problem.  As George Santayana famously told us back in 1905, “Those who cannot remember the past are condemned to repeat it.”
 
With this in mind, let us take a look at markets and the week ahead.  Aside from the ECB comments this morning, arguably the most impactful news from the weekend was the story that Elon Musk is planning to sell $20 billion worth of stock in order to pay his upcoming tax bill.  Not surprisingly Tesla’s stock is lower by nearly 6% on the news and it seems to have put a damper on all equity activity.  After all, if Tesla isn’t going higher, certainly nothing else can have value!
 
Looking at equity markets, Asia (Nikkei -0.35%, Hang Seng -0.4%, Shanghai +0.2%) were mixed but leaning weaker.  That is an apt description of Europe as well (DAX -0.2%, CAC +0.2%, FTSE 100 -0.1%) although overall, the movement has not been that significant.  US futures, meanwhile, are little changed although NASDAQ futures are slightly lower while the other two major indices are edging higher.
 
Bonds, on the other hand, are all under pressure with Treasuries (+2.8bps) leading the way although this was after a major rally on Friday that saw the 10-year yield fall 7bps and a total of 15bps since the FOMC last Wednesday.  But European sovereigns, too, are all lower with yields rising (Bunds +2.0bps, OATs +2.1bps, Gilts +2.9bps).  Perhaps bond investors are beginning to register their concern over the inflation story.
 
On that front, commodity prices are rebounding off the lows seen last week led by energy with oil (+1.25% and back over $82/bbl) and NatGas (+1.1%) both having good days.  The rest of the space, though, is more mixed with copper (+0.2%) and tin (+0.4%) both firmer this morning, while aluminum (-0.2%) and iron ore (-3.25%) are both suffering.  Precious metals are little changed although Friday saw a sharp rally in the barbarous relic.  And yes, the cryptocurrency space is rocking today as well.
 
As to the dollar, it has had a mixed performance this morning with both gainers and losers across the G10 and EMG spaces.  In the G10, NZD (+0.6%) is the clear leader as the government is talking of ending the draconian lockdown measures by the end of the month.  In fact, we saw similar behavior in the EMG currencies as THB (+0.8%) and IDR (+0.5%) rallied on similar news.  On the flip side, BRL (-0.8%) continues to decline despite the central bank being one of the most aggressive in its rate hike path having raised the SELIC rate from 2% in March to 7.75% last month with expectations growing for yet another hike in December.  Of course, inflation is running at 10.25% there, so real yields remain firmly negative.
 
On the data front, this is inflation week with both the PPI and CPI on the docket.
 

Tuesday

NFIB Small Biz Optimism

99.5

 

PPI

0.6% (8.6% Y/Y)

 

-ex food & energy

0.5 (6.8% Y/Y)

Wednesday

Initial Claims

263K

 

Continuing Claims

2050K

 

CPI

0.6% (5.9% Y/Y)

 

-ex food & energy

0.4% (4.3% Y/Y)

Friday

JOLTS Job Openings

10.4M

 

Michigan Sentiment

72.5

Source: Bloomberg
 
Of course, the Fed doesn’t care about CPI as its models work better with core PCE, which also happens to be designed to be permanently lower.  The rest of us, however, know better and recognize the pain.  We have a number of Fed speakers on the calendar this week as well, with Chairman Powell headlining 9 planned appearances.  My sense is that there will be a strenuous effort to press the storyline that inflation may take a little longer to fall back, but don’t worry, it will fall again.
 
If pressed, I would say the dollar is far more likely to continue to grind higher, but that any movement will be slow.  While Treasury yields are not supportive right now, the reality is that amid major currency bonds, Treasuries continue to offer the best combination of yield and liquidity so remain in demand.  I think that along with the need for other economies to buy dollars to buy energy will maintain the bid in the buck.
 
Good luck and stay safe
Adf
 

Their Latest Excuse

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While prices worldwide keep on rising
Most central banks are still devising
Their latest excuse
For why money, loose,
Is still the least unappetizing

On Wednesday Chair Powell explained
That QE would slowly be drained
Then Thursday the Bank
Of England helped sank
Gilt yields, leaving traders bloodstained

Now Friday’s arrived and we’re all
Concerned that a Payrolls curveball
Could quickly defuse
The new dovish views
With hawks back for their curtain call

If you sell stuff in the UK, or hold assets there, I sure hope you’ve hedged your currency exposure.  In what can only be described as shocking, the Bank of England left policy on hold yesterday after numerous hints from members, including several explicitly from Governor Andrew Bailey, that something needed to be done about rising inflation. The combination of rising inflation prints, rising inflation forecasts and comments from BOE members had the market highly convinced that a 0.15% base rate hike was coming yesterday, with the idea it would then allow the central bank to hike further in 25 basis point increments with futures pointing to the base rate at 1.00% come next December.  But it was not to be.  Instead, in a 7-2 vote, the BOE left policy rates unchanged and will continue its current QE program which has £20 billion left to buy to reach their target.

The result was a massive repricing of markets as interest rates tumbled across the entire curve and the pound tumbled along side them.  In what is perhaps the most brazen lie audacious statement from a major central banker lately, Bailey explained in a Bloomberg TV interview that it was “not our job to steer markets.”  Seriously?  That is all every central banker ever tries to do.  If financial stability is one of the goals enumerated for central banks, the BOE failed dismally yesterday.  Tallying up the impact shows that 10-year Gilt yields fell 13 basis points (and another 4.1 this morning), OIS markets saw the 1-year interest rate decline 20 basis points and the pound fell 1.4% yesterday and a further 0.5% this morning.  It was ugly.

Perhaps the lesson to learn here is that as central banks around the world try to adjust monetary policy going forward, there are going to be a lot more bumps along the way, with market expectations being left unfulfilled and severe market reactions accordingly.  Forward guidance, which has become a critical tool for central banks over the past decade plus is no longer going to be as effective.  When Ben Bernanke highlighted the idea in 2009, it was thought to be a great addition to the central bank toolkit, the ability to adjust markets without adjusting policy.  And while that may have been true when monetary policy was being eased for years, it turns out that forward guidance is a bit more difficult to handle in the other direction.  Market volatility, across all markets, is likely to increase over the next couple of years as the coordinated central bank activities we have become used to seeing disappear.  Consider that while the Fed, ECB, BOJ and BOE have all pushed back on raising rates soon, the Norgesbank, BOC, RBNZ, RBA and a host of emerging market central banks are starting the process or already well along the way.

Turning to this morning’s data, if you recall, the last two NFP numbers were quite disappointing, with both coming in well below expectations.  The only thing we know about the labor market is that we don’t really know what is going on there anymore.  Clearly, based simply on the JOLTS data we know there are more than 10 million job openings in the country.  (That is also made obvious whenever you leave your home and see all the help wanted signs in store windows.)  But despite clearly rising wages, it has thus far not been enough to entice many people back into the labor force.  So, the Unemployment Rate remains far higher than it was pre-pandemic, but there are plenty of jobs available.  In this situation I feel for the Fed, as there is no clarity available with conflicting data rampant.  At any rate, here are the forecasts heading into the release:

Nonfarm Payrolls 450K
Private Payrolls 420K
Manuacturing Payrolls 30K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%

Source: Bloomberg

One interesting thing is that excluding the pandemic stimulus checks, the current Y/Y Earnings data is the highest since the series began in 2006.  And worse still, it is lagging CPI by at least a half-point.  My sense is that we are likely to see another weaker than expected number as the kinks in the labor market have not yet been worked out.

Ok, a quick look at markets shows that Asia had a rough go of it last night (Nikkei -0.6%, Hang Seng -1.4%, Shanghai -1.0%) as continued concerns over the Chinese property market weigh on the economy there while Japan looks more like position adjustment ahead of the weekend.  Europe, on the other hand, is doing much better (DAX +0.15%, CAC +0.6%, FTSE 100 +0.55%) despite much weaker than expected IP data from both Germany (-1.1%) and France (-1.3%) in September.  Too, Eurozone Retail Sales (-0.3%) badly missed expectations in September, but revisions helped ameliorate some of those losses.  Regardless, I would argue that the weak data has encouraged investors and traders to believe that all the talk of tightening to address inflation is ebbing.  Meanwhile, US futures, which had spent the bulk of the evening essentially unchanged are now higher by about 0.25%.

Bond yields are generally lower again this morning with most European sovereigns seeing declines of around 1 basis point except for Gilts, pushing 4bps.  Treasuries, which had seen softer yields earlier in the session have now turned around and edged lower (higher yields) but are still less than a basis point different from yesterday’s close.

Commodity prices also had a wild session yesterday with oil initially rallying $2/bbl before abruptly reversing and falling $5/bbl to close back below $80 for the first time in a month.  Given that backdrop, this morning’s 0.6% rise seems less interesting and it is still below $80.  NatGas (-0.5%) has slipped this morning, while the rest of the commodity complex is showing no trends whatsoever, with both gainers and losers.  Like every other market, traders are trying to come to grips with the new central bank situation.

The one consistency has been the dollar, which rallied yesterday and is continuing today.  In the G10, the pound (-0.5%) is the worst performer but we are seeing weakness in AUD (-0.4%), CHF (-0.4%) and NOK (-0.35%) as well with the entire bloc under pressure.  NOK is clearly still being impacted by yesterday’s oil moves while the others seem to be feeling the heat from suddenly more dovish thoughts regarding policy.  In the EMG space, PHP (+0.55%) is the outlier, rallying on comments from the central bank that it will continue to support the economy and news that the Covid infection rate has been falling.  Otherwise, the bulk of the bloc is in the red led by ZAR (-0.45%), PLN (-0.4%) and MXN (-0.35%).  Of these, the most noteworthy is PLN, where the central bank, which had just been touting its hawkish bona fides, has completely reversed and indicated that further rate hikes may not be necessary.  This seems odd given inflation is running at 6.8%, and forecast to top 8.0% next year, while the base rate was just raised to 1.25%.  It feels to me like PLN could fall further.

So, for now, we all await the payroll data and then get to reevaluate our views and expectations of Fed actions.  Nothing has changed my view that inflation will continue higher and nothing has changed my view that growth is going to slow.  So, while the Fed may begin to taper, I still believe they will stop before the end.  However, for now, the Fed is the most hawkish dove out there, so the dollar can continue to rally.

Good luck, good weekend and stay safe
Adf

It’s Still Transitory

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Feathered and Tarred

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Extinct

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Qui Vive!

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

Good luck and stay safe
Adf

Costs are Aflame

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

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

A Touch of Despair

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf