Tapering Talk

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Despite all the tapering talk
The market did not walk the walk
Now sovereigns worldwide
Have seen their yields slide
While stocks are where people all flock

Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing?  That was so two days ago.  With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion.  Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion.  Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals.  In other words, tapering is still a long way in the future.

This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so.  Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals.  Do not be misled into believing the Fed is on the cusp of removing accommodation.  They are not!

A quick look at yesterday’s data highlights why they are still a long way off.  While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth.  As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever.  But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem.  Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.

Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon.  While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.

Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing.  The interesting thing is the contrast between the data from Asia and that from Europe.  It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5.  While a slight decline from the previous month, it is still well into growth territory.  However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7.  There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.

European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end.  As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength.  Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact.  While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.

Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening.  The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.

Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.

Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%).  Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there.  Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day.  US futures are all modestly higher at this point, by roughly 0.25%.

As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps.  But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads.  The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.

Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer.  However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.

Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above.  In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May).  But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4.  In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.

On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00.  Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.

Nothing has changed my view that as go 10-year yields, so goes the dollar.  If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain.  If, however, yields reverse higher, the dollar will find its footing immediately.

Good luck, good weekend and stay safe
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Retrogression

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To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression

“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”  This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity.  Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.

No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything.  So, is this really as hawkish as the commentariat would have us believe?  Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report.  Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy.  Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time.  Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).

The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis.  That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”

Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do.  The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion.  In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco.  Of that group, Chicago’s Evans and SF’s Daly are uber-dovish.  Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all.  This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months.  Do not get overexcited about the Fed tapering.

Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive.  Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released.  Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session.  In other words, it was hardly a rout based on the Minutes.  The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit.  Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.

As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%.  But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps.  This is hardly the sign of a market preparing for a Fed change of heart.  European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps).  Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.

Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%).  However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions.  The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day.  Agricultural products, though, maintain their bids with small gains across the board.

Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April.  This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.

Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes.  Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%).  Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night.  However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.

Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%).  All of these are benefitting from the broad based, but mild, dollar weakness.  The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.

Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0).  Then at 10:00 we see Leading Indicators (1.3%).  On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.

Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment.  Look for the dollar to drift lower on the day.

Good luck and stay safe
Adf

Somewhat Dismayed

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The ECB’s somewhat dismayed
That risk appetite, as conveyed
By stocks is excessive
And has made a mess of
Their plans.  Now they’re really afraid

It is interesting that two of the most memorable battle cries in financial markets were coined by men of the driest character and background.  We all remember the beginning of the Eurozone debt crisis, not ten years ago, when the so-called doom loop created by banks in a given country owning excessive amounts of their own government’s debt and when that debt became suspect (Portugal, Italy, Greece, Spain) the banks in those nations went to the wall.  The ECB was forced to step in to save the day, and did so, but things did not calm down until Super Mario Draghi, then ECB President (and now Italian PM) uttered his famous, off-the-cuff, remark of the ECB doing “whatever it takes” to save the euro.

Less of us were involved in the markets in December 1996 when then Fed Chair Alan Greenspan uttered the other famous market expression, “irrational exuberance” while speaking about the inflating of the tech bubble (which inflated for another 3 ½ years) and questioning if prices at that time had run too far ahead of sensible valuations.

In hindsight, both of the problems about which these catch phrases were created were the result of policy failures on the part of governments (debt crisis) or the central bank itself (tech bubble), but in neither case was the speaker able to take an objective view, thus calling out forces beyond their control as the cause of the problem.

Since then, both phrases have become part of the financial lexicon as shorthand for a situation that exists and the willingness of central bankers to address a problem.  This leads us to this morning’s release by the ECB of their Financial Stability Review where a subsection was titled “Financial markets exhibited remarkable exuberance as US yields rose. (author’s emphasis)”  Arguably, the title pales in comparison to ‘irrational exuberance’, but more importantly, it highlights, once again, the inability of a central bank to recognize that the folly of their own policies is what is driving the problems in markets and economies.

Ostensibly they are concerned that a mere 10% decline in US equity markets could result in “…a significant tightening of euro-area financial conditions, similar to around a third of the tightening witnessed after the coronavirus shock in March 2020.”  Wow!  A 10% decline?  If one were looking for a prime example of a fragile economy, clearly the Eurozone is exhibit A.  Once again, what we see is a central bank that is unwilling, or unable, to recognize that the fallout from its own policies is the underlying problem while seeking an alternative scapegoat explanation in order to present themselves in the best possible light.  After all, if the US markets decline, its not the ECB’s fault!

Inadvertently, perhaps, but clearly, the ECB has outlined one truth; given the synchronicity of central bank policies around the world, all economies are more tightly linked together and will rise and fall together.  Although there are those who claim particular markets have better prospects than others, the reality has become that correlations between equity markets around the world are very high, with the only real question how equities correlate to bonds.  It is this last issue where we have seen significant changes lately.  For quite a long time, the correlation between the S&P 500 and the 10-year US Treasury was positive, meaning that both bond and stock prices rallied and fell together.  However, since about February 2021, that relationship has turned around and is now solidly negative, with bond prices rising and stock prices falling.  It is this latter relationship that is the classic risk-on / risk-off meme, something that had gone missing for years.  Apparently, it is coming back, and that terrifies the ECB.

The timing of the report’s release could not have been better as this morning is a very clear risk-off session.  Yesterday afternoon, US equity markets sold off pretty sharply in the last half-hour of the session.  That sell-off has persisted throughout Asia (Nikkei -1.3%, Shanghai -0.5%, Hong Kong was closed) and Europe (DAX -1.3%, CAC -1.1%, FTSE 100 -1.1%).  US futures are also in the red (Dow -0.6%, SPX -0.8%, Nasdaq -1.2%), so the concerns are global in nature.

A bit more interestingly is the bond market’s behavior, where it appears that owning sovereign paper from any nation is unpopular today.  Treasury yields have backed up 2 basis points and we are seeing higher yields throughout Europe as well (Bunds +1.3bps, OATs +0.5bps, Gilts +2.1bps).  Apparently, the bond market concerns stem from the UK’s inflation report which showed that while CPI rose, as expected to 1.5%, RPI (Retail Price Index) rose much more than expected to 2.9% Y/Y.  While both are designed to be measures of average price increases over time, the RPI considers housing prices and mortgages.  Not surprisingly, given the explosion in housing prices, RPI is much higher and rising faster.  It also may represent a more accurate representation of people’s cost of living.  (Here’s a thought experiment: what would US RPI be right now given CPI just jumped to 4.2%?)  At any rate, it appears investors are shunning both stocks and bonds this morning.

Are they buying commodities?  Not on your life!  Prices in this sector are down across the board led by WTI (-1.8%) but seeing Gold (-0.6%) and Silver (-2.0%) suffering along with base metals (Cu -2.4%, Al -0.9%, Zn -0.85%) and foodstuffs (Soy -0.8%, Wheat -1.7%, Corn -0.3%).  Oh yeah, bitcoin, which many believe is a hedge of some sort, is lower by 16% in the past 24 hours and more than one-third in the past week.

So, what are investors buying?  Pretty much the only thing higher today is the dollar which has rallied vs. every currency we track.  In the G10, NZD (-0.9%) is the laggard followed by NOK (-0.8%) and AUD (-0.7%) with the strong theme there being weakness in the commodity sector.  But the European currencies are all under pressure as well, with EUR (-0.2%) and GBP (-0.3%) suffering.  Even JPY (-0.4%) is not holding up its end of the risk-off bargain, declining vs. a robust dollar.

Emerging markets are seeing similar activity with every currency flat to down led by TRY (-0.6%), ZAR (-0.45%) and MXN (-0.4%), all suffering from commodity weakness.  CE4 currencies are also under pressure, following the euro down while APAC currencies had less angst overnight, sliding on the order of 0.2%.

On the data front, today only brings the FOMC Minutes from the April meeting, which will be scrutinized to see how much discussion on tapering took place, if any, but let’s face it, other than Robert Kaplan of Dallas, it seems pretty clear from everybody else that has spoken, that it is not a current topic of conversation.  As it happens, we will hear from 3 more Fed speakers (Bullard, Quarles and Bostsic) as well, but all of them have been on message since the meeting so don’t look for any changes.

Certainly, based on today’s price action, the idea that 10-year yields are driving the dollar remains alive and well.  If yields continue to back up, the dollar will remain bid, and after all, given its recent decline, it has room to move as a simple correction.  I continue to look at 1.2350 as the critical level in the euro, and by extension the dollar writ large.  A break above there opens the chance for a much more substantial dollar decline.  But that does not appear to be on the cards for today.

Good luck and stay safe
Adf

Gazumped

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While measured inflation has jumped
And stock markets, Powell has pumped
The dollar is queasy
As money this easy
Has bulls concerned they’ll get gazumped

But its not just Powell who’s saying
That QE and ZIRP will be staying
Almost to a man
The Fed’s master plan
Is printing and buying…and praying

Once again, yesterday, we heard from several FOMC members and each of them highlighted that the data has not yet come close to describing the “substantial progress” they are seeking with respect to reduced unemployment and so it is not nearly time to begin even thinking about tapering.  Well, except for the lone quasi-hawkish voice of Dallas Fed President Robert Kaplan, who did express concern that the Fed’s actions were part of the reason that asset prices are so high.  But not to worry, Mr Kaplan will not be a voter until 2023, so will not even be able to officially register his disagreement with policy for two more years.  In other words, based on everything we continue to hear, we can expect a series of 9-0 votes every six weeks to maintain current policy.

It is this ongoing messaging, which comes not only from the Fed but from the ECB and BOJ as well, that continues to drive the narrative as well as market prices.  Inflation?  Bah, it’s transitory and while 2021 may see some higher readings, it will all disappear by 2022.  Bubbles?  Bah, central banks cannot detect them and, even if they could, it is not their job to deflate them.  It has become abundantly clear that the three big central banks have jointly decided that the only thing that matters is the unemployment rate, and until that data is back at record low levels, regardless of what else is happening in the economy, the current state of QE and ZIRP/NIRP is going to remain in place.

Thus, it cannot be that surprising this morning that the dollar has begun to slide a bit more in earnest, while risk appetite, as measured by equity prices remains robust.  A very large segment of the punditry continue to harp on concerns over rising inflation and how the Fed and other central banks will be forced to adjust their policy to prevent it from getting out of hand.  But simply listening to virtually every central banker tells us that nothing is going to change.

“Through that April employment report, we have not made substantial further progress,” said Fed Vice-Chair Richard Clarida yesterday.  Meanwhile, from the ECB, Francois Villeroy de Galhau explained this morning, “Today there’s no risk of a return of lasting inflation in the euro area, and so there’s no doubt that the ECB’s monetary policy will remain very accommodative for a long time.  I want to say that very clearly.”  I don’t know about you, but it seems pretty clear that the concept of tapering QE purchases, let alone raising interest rates, is not even on the table.

Now, smaller central banks have changed their tune, notably the Bank of Canada and Sweden’s Riksbank, with the former actually reducing QE purchases while the latter has promised to do so shortly.  As well, the Bank of England has begun the discussion about reducing policy support as the economy there continues to open rapidly, and growth picks up.  As such, it should not be that surprising that those three currencies (GBP +2.75%, CAD +2.1%, SEK +1.9%) are the leading gainers vs. the dollar so far this month.

Perhaps what is also interesting is that the euro is strengthening so clearly vs. the dollar despite the strong words by ECB members regarding the maintenance of easy money.  It appears that the market has a stronger belief in the Fed’s willingness to ignore the repercussions of their policy choices than that of the ECB.  Remember, in the end, Europe remains reliant on Germany as its engine of growth and largest economy, and German DNA, ever since the Weimar hyperinflation in the 1920’s favors tighter policy, not looser.  Madame Lagarde will have a tougher battle to maintain easy policy if the data starts to point higher than will Chairman Powell.  Right now, however, that is all theoretical regarding both banks.  Easy money is here for the foreseeable future, which means that risk appetite is likely to remain strong, driving up stock and commodity prices while the dollar sinks.

What about bonds, you may ask?  Haven’t they been the key driver?  The answer is that they have been the key driver,  but a close look at statistics like inflation breakevens, and more importantly, the shape of the breakeven curve, offer indications that even though near-term expectations are for much higher inflation, more and more investors are buying the transitory story.  If that is, in fact, the case, then there is ample room for bonds to rally as well, which would be quite the shock to all the inflationistas out there.

This morning is exhibit A regarding the impact of increased risk appetite.  Equity markets around the world are higher with Asia (Nikkei +2.1%, Hang Seng +1.4%, Shanghai +0.3%) putting in some very strong performances while Europe (DAX +0.25%, CAC +0.2%, FTSE 100 +0.4%) are all green, but have come off their best levels of the morning.  US futures are also pointing higher, with gains ranging from 0.2% (Dow) to 0.7% (Nasdaq).

The bond market, meanwhile, is directionless, with yields for Treasuries (-0.5bps) and European sovereigns (Bunds 0.0bps, OATs -0.7bps, Gilts +0.7bps) all trading in narrow ranges.  If you consider that given the increase in risk appetite as evidence by stocks, commodities and the dollar, the very fact that bonds are not selling off is actually a bullish sign.

Speaking of commodities, Brent crude (+0.6%) traded above $70/bbl for the first time since November 2018 this morning and WTI is firmer by a similar amount.  Metals prices continue to rally (Au 0.0%, Ag +0.8%, Cu +1.0%, Al +0.7%), as do foodstuffs (Soybeans +0.6%, Wheat +0.75%, Corn +1.7%).  While it is not clear how much longer commodity prices will rally, it seems abundantly clear, based on their price action, that the rally has more legs.

And finally, the dollar, which as mentioned above is under pressure, is having a really bad day.  Versus its G10 counterparts, the dollar is softer across the board with NZD (+0.7%), NOK (+0.6%) and CHF (+0.55%) leading the way.  But the euro (+0.45%) is also much firmer and now trading above 1.22 for the first time since early February.  If you recall, 1.2350 was the high seen the first week of January, and in order to truly change opinions, the euro will have to trade through that level.  With the dollar so weak, it certainly seems like there is a good chance to get there soon.

EMG markets are also seeing pretty uniform gains with ZAR (+0.7%), HUF (+0.65%) and PLN (+0.6%) leading the way, the former on the back of commodity price strength while the two CE4 currencies are benefitting from the belief that both central banks may be tightening policy shortly as well as the euro’s strength.  But we saw strength overnight in the APAC currencies as well (KRW +0.4%, SGD +0.4%, TWD +0.35%) as they all are responding to the broad-based dollar weakness.

On the data front, today brings Housing Starts (exp 1702K) and Building Permits (1770K), with both simply showing that the housing market remains on fire.  Meanwhile, only Robert Kaplan is scheduled to speak, but we already know what he thinks (tapering needs to start soon) and we also know his is a lone voice in the wilderness.  It would not surprise me if we had a surprise series of comments from another FOMC member just to counter his views.

Looking ahead to the session, there is no reason to believe that the dollar’s weakness is going to change anytime soon.  Unless Treasury yields start to back up smartly, risk appetite is the dominant story today, and that bodes ill for the dollar.

Good luck and stay safe
Adf

To ZIRP They’ll Adhere

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The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt

In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere

It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions.  For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm.  Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year.  Which means that the entire argument is based on dueling forecasts of the future beyond that.  In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.

What is transitory?  Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now.  According to Merriam-Webster, it describes something of brief duration or temporary.  Which begs the question, what is brief?  Is 3 months brief?  6 months?  Longer?  Arguably, brief depends on the context involved.  For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.

There continue to be strong arguments in favor of both sides of the argument.  On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years.  No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices.  As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items.  Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral.  In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.

Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains.  In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices.  We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation.  Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support.  As they are wont to say, the Fed can’t print copper or corn.  The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?

Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets.  By now, you are all aware I remain in the inflationist camp and have been for a while.  I cannot ignore the rising prices I see every time I go into a store.  But the deflationists make excellent points.  This argument discussion will rage for at least another two months and the July CPI release.  Until then, the one thing that seems clear is that market volatility is likely to remain significant.

As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed.  At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well.  US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.

Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively.  Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.

Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).

Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs.  Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%).  Much of this movement seems to be on the back of positioning rather than fundamental news.  On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.

EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region.  CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line.  On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.

Not a ton of data this week, but here is what we see:

Today Empire Manufacturing 23.9
Tuesday Housing Starts 1705K
Building Permits 1770K
Wednesday FOMC Minutes
Thursday Initial Claims 455K
Continuing Claims 3.64M
Philly Fed 41.9
Friday Existing Home Sales 6.08M

Source: Bloomberg

The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total.  Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.

With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck.  This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along.  If you are in the deflationist camp, it’s the opposite.  But remember, at a point in time, inflation will undermine the dollar’s value.  Just not right away.

Good luck and stay safe
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They Haven’t the Nerve

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It’s not just the Federal Reserve
Who thinks that inflation’s steep curve
Is likely short-term
And so reconfirm
For rate hikes, they haven’t the nerve

In Mexico, Chile, Peru
Each central bank chose to eschew
The chance to raise rates
For like in the States
They pray that inflation’s not true

Inflation remains the key talking point in every market these days.  This means not just equity, bond and commodity markets, but also geographically, not just the US, but literally every country in the world.  And in every one of these situations the two camps remain strongly at odds over the likely permanence of rising prices.  In the US, of the 16 current members of the FOMC, only one, Dallas’s Richard Kaplan, is concerned that inflation may be more than transitory.  Meanwhile the Bank of Canada has already made their move to begin tapering QE over concerns that rising inflation may become a bigger problem in the future.

Of course, inflation is not just a G10 phenomenon, it is a global one, arguably more so an issue in emerging markets than in developed ones.  Given the timing of recent central bank actions, I thought it would be interesting to take a quick look at Latin America for a sense of how other nations are dealing with rising prices.

Mexico – Banco de Mexico left its overnight rate at 4.00% for the third consecutive month yesterday despite the fact that CPI is running at 6.08% and they are currently focused on targeting 3.0% inflation.  Clearly, those numbers don’t seem to go together well, but the explanation is that the disappointingly slow rebound in the economy after last year’s Covid induced disaster has the central bank determined to help support economic growth at the risk of allowing higher inflation to become entrenched.  Not only that, they have committed to maintaining policy rates here until growth picks up further.  Look for higher inflation going forward.

Chile – Banco Central de Chile left its overnight rate at a record low of 0.50% yesterday for the 13th consecutive month despite the fact that inflation is running at 3.3%, above its 3.0% target, and trending sharply higher.  While the rise in copper prices has been an extraordinary boon to the country, given its reliance on the metal for so much of its export earnings (nearly 30%), the economy is still recovering from last year and the central bank deemed economic support, especially in this time of political uncertainty, more important than price stability.

Peru – Banco Central de Reserva del Peru left its rate at 0.25%, also a record low, for the 13th consecutive month despite the fact that inflation is running at 2.4% vs. BCRP’s 2.0% target.  Here, too, political considerations are in the mix given the upcoming second round of presidential elections and the concern that a little known left-wing school teacher may become president next month.  Here, too, the board explained that policy was appropriate for the current situation despite higher than desired inflation.

These moves contrast with Brazil, which raised rates last week by 0.75%, to 3.50%, for the second consecutive meeting and are set to do so again in June.  Of course, CPI in Brazil, which is targeted at 3.0%, is currently running at 6.76% and climbing quickly.  If it weren’t for Argentina (CPI 46.3%) Brazil would be suffering the worst inflation in Latin America.  (I exclude Venezuela here as it is impossible to measure the inflation rate given the utter collapse of the economy and monetary system.)

It seems that the central banking community is filled with a great number of people who are either innumerate or highly political.  Neither of these characteristics make for an effective and independent central bank, and given the plethora of central bankers worldwide who exhibit these tendencies, it is a fair bet that rising prices are going to be a feature of our lives, no matter where we live, for a long time to come.  The point is, it is not just the Fed that is willfully blind to the evidence of rising prices, it is a widely held viewpoint.

Today, however, the markets have decided to agree with the predominant central bank view that inflation is a transitory phenomenon as evidenced by the fact that risk appetite is back in vogue.  It starts with the bond market, where Treasury yields are falling (-1.9bps) and now 6 basis points below the levels reached after Wednesday’s CPI data.  Yesterday’s PPI data, though also higher than expected, had virtually no impact on markets.  In Europe, Gilts (-3.1bps) are also rallying along with Bunds (-0.8bps) although French OATs are flat on the day.

This renewed confidence in a lack of inflation scare has had a much bigger impact on the equity markets, where once again, buying the dip seemed to be the correct move.  Asia saw robust gains (Nikkei +2.3%, Hang Seng +1.1%, Shanghai +1.8%) and Europe is having a solid day as well (DAX +0.7%, CAC +0.7%, FTSE 100 +0.7%).  US futures are pointing to a continuation of yesterday’s rally with NASDAQ (+1.0%) leading the way, but all three indices higher by at least 0.5%.

Commodity prices are rising led by oil (+1.25%) and precious metals (Au +0.5%, Ag +0.7%) although the base metals are a bit more mixed (Cu -0.8%, Fe -5.2%) after China instituted price restrictions against steel producers in order to try to quash the recent explosion higher in steel prices.

As to the dollar, it should be no surprise that it is broadly softer this morning against both its G10 and EMG counterparts.  NOK (+1.1%) leads the way higher on the back of oil’s rally but we are seeing solid gains in NZD (+0.6%) and SEK (+0.5%) on the back of broadly positive risk appetite.  In the EMG bloc, only TWD (-0.03%) managed to lose any ground after another day of significant foreign equity outflows and an uptick in Covid cases.  Otherwise it is all green led by TRY (+0.85%), HUF (+0.6%) and MXN (+0.45%).  Turkey’s lira, which is approaching all time lows appears to be seeing a simple trading bounce as there is no news to drive things.  Mexico is clearly benefitting from the oil rally while Hungary’s forint is the beneficiary of a growing belief that the central bank there is going to raise rates to fight rising inflation.  As I said, there are several central banks that still try to focus on reality rather than wishful thinking, but they seem to be few and far between.

This morning brings Retail Sales (exp 1.0%, 0.6% ex autos) as well as IP (0.9%), Capacity Utilization (75.0%) and Michigan Sentiment (90.0).  On the central bank front, only Richard Kaplan, the lone hawk standing, speaks today, so look for more discussion about the need to think about tapering QE.  The thing is, the market is fully aware that he has no support in this stance and so it will not likely have any impact.

With the inflation scare behind us for at least another two weeks (Core PCE will be released at the end of the month), it seems the way is open for more risk-on sentiment.  This means bond yields are unlikely to rise very much and the dollar will therefore remain under pressure.

Good luck, good weekend and stay safe
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Don’t Get Carried Away

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The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away

But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned

Wow!  That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected.  To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase.  Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%.  To give some context, the core 0.9% gain was the highest print since 1981.  It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.

The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible.  His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out.  As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month.  That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.

House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down.  The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live.  The statistics show that there is the smallest inventory of homes available in decades.  As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material.  And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace.  A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know.  As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining.  However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI.  That, my friends, will be harder to pass off as transitory.

The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates.  However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control.  While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.

The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money.  Rising inflation is the last thing equity markets can abide, so these declines can not be surprising.  The question, of course, is will they continue?  A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story.  It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels.  A loss of confidence that the past is prologue could well see a very sharp correction.

Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session.  It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move.  While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between.  Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.

Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months.  The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.

Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative.  We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%).  At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.

This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy).  Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday.  In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory.  I guess they hope if they say it often enough, people may begin to believe them.  But that is hard to do when the prices you pay for stuff continues to rise.

Treasuries remain the key.  If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher.  If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.

Good luck and stay safe
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Far From our Goals

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Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls

There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel.  In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come.  On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’.  I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future.  After all, the Fed’s forecasting record is unparalleled…in its futility.

However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.

The problem with this attitude is that it seems to ignore the reality on the ground.  Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014.  In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump.  But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least.  At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.

It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020.  Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation.  The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited.  There is a growing belief that we are embarking on a so-called commodity super-cycle.  This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.

This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise.  Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y.  The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand.  As such, the market seems entirely prepared for a very large number.  From my vantage point, the Y/Y number is not so important today, but the M/M number is.  Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.

We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy.  We continue to hear them explain that any inflation readings will be transitory.  And maybe they are correct.  However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply.  Talk about a Hobson’s Choice!

Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%).  US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).

Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level.  There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case.  European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts).  Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.

Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%).  The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.

The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own.  NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought.  However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected).  EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst.  KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data.  Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.

Other than the CPI data and the Treasury auction, there is no other news or data.  Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately.  The one thing we know is that they are unlikely to change their tune.

Which brings us back to the 10-year Treasury.  It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa.  I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact.  My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late.  In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar.  Just beware.

Good luck and stay safe
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Devil-May-Care

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It wasn’t all that long ago
When Powell and friends let us know
That prices might rise
But that in their eyes
T’was something we soon would outgrow

And lately it seems they were right
As chains of supply get more tight
But so far, they’re clear
The Fed has no fear
Inflation could rise overnight

Investors, though, don’t seem to share
That attitude, devil-may-care
Instead they’re rebelling
And stocks they are selling
While bond markets, too, they forswear

Perhaps as a prelude to tomorrow’s CPI data here in the US, last night we saw Chinese inflation data.  Chinese data, though, has a very different meaning than US data.  From China, markets care far more about PPI than about CPI, as China continues to be the world’s factory floor.  So, a rising PPI in China may presage rising retail prices elsewhere in the world.  Consider this when looking at the Chinese data, where PPI rose a more than expected 6.8%, it’s highest print since October 2017, while CPI there rose only 0.9%, a tick less than forecast.  The proximate cause of the sharp rise in PPI has been the ongoing explosion higher in commodity prices.  All their input costs are rising (iron ore, steel, copper, energy, etc.) thus producers are forced to raise their prices.  While retailers have not yet passed through all the cost increases in China, manufacturers and retailers elsewhere in the world have not been so sanguine on the issue.  Instead, the combination of rising commodity prices and shortages in key intermediate goods, like semiconductors, has been more than sufficient to push up prices.

It should be no surprise that markets, in general, are not applauding this outcome, and in fact, are concerned that this is just the beginning of the move in prices.  On the one hand, we continue to hear from both the Fed and the ECB that there is no reason to consider tightening policy at this time as neither bank has achieved their policy aims.  On the other, there is no sign that the supply side damage that was caused by the pandemic is anywhere close to being repaired.  Reduced supply meeting ongoing artificially high demand is guaranteed to raise prices.  I guess the Fed and ECB will soon be quite pleased with themselves for having created inflation.  The rest of us?  Not so much.

However, this policy mistake action in the face of the current conditions is what is driving market prices, which today are wholly in the red, and in substantial size.  Equity markets worldwide (Nikkei -3.1%, Hang Seng -2.1%, DAX -2.2%, CAC -2.0%, FTSE 100 -2.2%) have been under severe pressure ever since yesterday’s US tech slump, but bond markets, too, are seeing significant selling pressure, with Bunds, OATs and Gilts all seeing yields climb by 4 basis points this morning.  In other words, investors are explaining they don’t want to hold financial assets in an inflationary environment.  In fact, there is a great deal of buzz in the markets about some of the large interest rate bets that are being made in both Eurodollar and Euribor futures markets, where very large size option trades are being executed with the aggressor buying put options as part of large risk reversals.  It seems there is very little concern over interest rates declining from current levels, and rightly so, but expectations for higher rates well before either the Fed or ECB has indicated they are considering changing tack are the new normal.

What, you may ask, has this done for the dollar?  That is a much tougher question to answer as the outcome has been far less clear.  I have been adamant that the 10-year Treasury yield has been the key driver of the dollar’s value for virtually all of 2021, and despite the sell-off in European sovereigns this morning, Treasury yields are unchanged at 1.60%.  Heading into tomorrow’s CPI data, as well as another round of Treasury refunding starting with today’s 3-year auction of $40 billion (a total of $108 billion will be auctioned this week), it appears that investors and traders are not certain what to do.  Despite economic data that points to quickening growth, we continue to hear from Fed speaker after Fed speaker that they are not even close to considering tapering QE, let alone raising interest rates.  Well, except for the lone(ly) hawk, Dallas Fed President Robert Kaplan.  But yesterday, both Chicago’s Mike Evans and SF’s Mary Daly were clear it is far too early to consider tapering QE.  Today brings six more Fed speakers, none of whom have a history of hawkishness.

In the end, if inflation continues to rise while Treasury yields remain rangebound due to QE, as real yields decline, look for the dollar to follow.  Breakeven inflation rates continue to trade at multi-year highs (5-year 2.73%, 10-year 2.53%) and are indicating a strong belief that inflation is picking up pace. While the Fed continues to tell us they “have the tools” necessary to combat any potential inflation, the only thing of which we can be sure is they not only “have the tools” required to support markets (and the economy by extension), but that they will use those tools. When it comes to fighting the inflation battle, though, not a single current FOMC member is battle tested.  Given this asymmetry, it is not surprising that we are seeing an increase in market bets on higher interest rates.

Back to the dollar, which is actually under a bit of pressure this morning, along with all those other assets. In the G10, only CHF (-0.1%) is softer as we are seeing gains from the European bloc (NOK, SEK +0.4%, EUR +0.3%) leading the way.  Arguably, this is on the back of the much better than expected German ZEW expectations index, which printed at its highest level in more than 10 years.  Meanwhile, the pound (+0.1%) and commodity bloc here are having a much less interesting session.

In the emerging markets, Asian currencies felt pressure overnight on the tech stock decline with KRW (-0.5%), TWD (-0.4%) and MYR (-0.3%).  On the other hand, the CE4 have all followed the euro higher and we are seeing strength in ZAR (+0.5%), RUB (+0.6%) and MXN (+0.5%), despite oil’s small slide (-0.8%).

All in all, today is shaping up as another one that will be driven by the yield story.  In order for the dollar to really turn around its recent weakness, we will need to see a very significant risk-off event, with Treasuries rallying and fear abundant.  But so far, the current equity decline has not been sufficient to get those juices flowing.  As such, I still would err on the side of a weaker dollar.

Good luck and stay safe
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To Make Jay Concerned

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On Friday the payroll report
Surprised folks by coming up short
Is growth really slowing?
Or else, is this showing
A government data distort?

This morning, though, all eyes have turned
To metals and stuff that is burned
As those prices soar
They seem to have more
Potential to make Jay concerned

With all that anticipation leading up to the payroll report on Friday, it sure turned out differently than expected.  You may recall that the median forecast for the headline number was a cool million new jobs, with a survey range from 700K to 2.1 million.  The result, 266K plus a reduction of 140K from the previous month was, in a word, awful.  In fact, it was the largest statistical miss since the data began.  Now, the analyst community is busy trying to figure out what went wrong.

There are a couple of possible answers, each with its own implications.  The simplest explanation is that the combination of exiting from an unprecedented, government-imposed economic shutdown is not easily modeled and when combined with the vagaries of seasonal adjustments to the data, analysts’ models were simply wrong.  It is important to remember that the seasonal adjustments in this data stream are quite large relative to the reported data, so this is quite a viable explanation.

A second possible explanation, and one favored by the current administration, is that the data shows the economy needs more government support as too many people are falling through the cracks.  On the other hand, the business community continues to complain how difficult it is to hire qualified employees, especially in the service sector, as the ongoing government unemployment largesse is paying more than many low paying service sector jobs.  (The story of the entire workforce of a Dollar General store upping and quitting en masse is the quintessential symbol of this concept.)  Another facet of this argument is the skills mismatches that exist as, for example, erstwhile airline staff may not be able to analyze data for an IT firm, effectively resulting in a hiring need and unemployed worker at the same time.

While skills mismatches certainly exist, they always have, arguably one way for businesses to obtain staffing is to pay more for the roles in question.  The risk in that strategy is, especially for small businesses, increased labor costs will force companies to raise prices at the risk of losing business.  Based on Friday’s report, this is clearly not yet the default choice of the small business owner.  Odds are, though, especially as demand for all products and services increases with the reopening of the economy more generally, that this is going to be the outcome.  Higher wages to get workers and higher prices for goods and services.

Occam’s Razor suggests that the first explanation, data uncertainty, is the most likely cause for Friday’s massive statistical miss.  However, don’t expect the other two arguments to disappear as they are each very compelling for the currently competing political narratives.  Ultimately, we will find out more through the data for the rest of this month and get to do this all over again in June.

On the topic of rising prices, though, this morning has much more to offer, specifically in the commodity space.  The big weekend news has been about a cyberattack on Colonial Pipeline, which happens to be the largest pipeline for oil products like gasoline and diesel, to the East Coast.  With the pipeline shut, (apparently the pipeline can still carry the products, but the company cannot track how much fuel is being consumed, and thus charge accordingly), gasoline and product prices are rising, dragging up oil prices as well (WTI +0.5%).  But of more interest is the metals sector where prices are exploding higher.  Not only are precious metals (Au +0.45%, AG +1.25%) higher, but industrial base metals are really rocking (Fe +5.1%, Cu +2.6%, Al +1.9%, Ni +0.8%).  This is, of course, one of the key features of the inflation is coming narrative, sharply rising commodity prices will work their way into the price of stuff.  But inflation is a measure of the ongoing change in prices over time.  The Fed’s argument is that these prices will have an impact in the short run, but unless commodity prices continue rise year after year, the effect will be ‘transitory’.

The counter to the Fed’s argument is that we are currently embarking on the beginning of a commodity super-cycle, a price phenomenon where prices trend in one direction for many years on end, often 10-15 years.  If this argument is correct, and the prices of copper and iron ore are just beginning their climb, then the Fed is going to find themselves with a whole lot of trouble in the future.  But right now, it is merely dueling forecasts and narratives, so nothing is clear.

With all the excitement in commodities, things are pretty quiet in the financial markets.  Equity markets in Asia were a bit higher (Nikkei +0.55%, Hang Seng 0.0%, Shanghai +0.25%) while European bourses are mixed (DAX -0.25%, CAC -0.2%, FTSE 100 +0.15%).  US futures are also mixed with Dow (+0.3%) continuing last week’s rally while NASDAQ (-0.25%) continues to feel pain from the ongoing rotation out of tech.

Bond markets are not buying the inflation narrative at this point with Treasuries (-0.5bps) seeing slightly lower yields while Bunds and OATs are essentially unchanged on the day.  The only real mover is the Gilt market (+1.7bps) which has rallied after weekend elections failed to give the Scottish National Party a majority in the Scottish Parliament and thus the prospect of a referendum to allow Scotland to leave the UK seems to be pushed back.

The outcome of the Scottish vote helped the pound as well, with GBP rallying 0.9% this morning, far and away the best performer in the FX markets.  Amid broad-based dollar weakness, the pound’s performance still stands out.  Next in line, in the G10, is AUD (+0.5%) which is a clear beneficiary of the rise in commodity prices.  In fact, iron ore is Australia’s largest commodity export.  NZD and CAD (both +0.2%) are lesser beneficiaries and the rest of the block, save JPY (-0.2%) is slightly firmer.  The yen seems to be suffering from the latest poll showing PM Suga’s popularity continuing to slide and bringing some uncertainty to the situation there with an election due by the end of the year.

Asian currencies were the big beneficiary in the EMG space led by KRW (+0.7%), IDR (+0.6%) and CNY (+0.3%).  The story there continues to be the anticipated strong growth rebound combined with the dollar’s weakness.  Remember, Chairman Powell has essentially promised that US rates are going to remain at zero regardless of what happens for at least another year.  As it happens, TWD (+0.3%) has traded to its strongest level since 1997, as the robust economic situation, plus the huge demand for semiconductors has more than offset any geopolitical concerns.

Data this week is back-loaded as follows:

Tuesday NFIB Small Biz Optimism 100.8
JOLTs Job Openings 7.5M
Wednesday CPI 0.2% (3.6% Y/Y)
-ex food & energy 0.3% (2.3% Y/Y)
Thursday Initial Claims 495K
Continuing Claims 3.64M
PPI 0.3% (5.8% Y/Y)
-ex food & energy 0.4% (3.7% Y/Y)
Friday Retail Sales 1.0%
-ex autos 0.9%
IP 1.0%
Capacity Utilization 75.1%
Michigan Sentiment 90.1

Source: Bloomberg

Obviously, CPI will be very interesting, as will Retail Sales.  We also hear from 13 more Fed speakers this week, all of whom are certain to repeat the mantra that the economy needs more support and they will not be changing policy anytime soon.  Remember, inflation is transitory…until it’s not.

The dollar is starting the week off on the back foot.  If we continue to hear Fed speakers insist that policy is not going to change, and we continue to see inflationary consequences rise, the dollar will weaken further.  In the end, 10-year Treasury yields remain the key number to watch.  As long as they remain within the recent range, the dollar is likely to remain soft.  If they should break higher, though, watch out.

Good luck and stay safe
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