Two central banks managed to shock The market by walking the walk The Old Lady jacked By fifteen, in fact Banxico then doubled the talk So, now that it’s all said and done C bankers, a new tale have spun The virus no longer Is such a fearmonger Inflation’s now job number one Talk, as we all know, is cheap, but from the two largest central banks, that’s mostly what we got. While Chairman Powell got a positive market response from his erstwhile hawkish comments initially, yesterday investors started to rethink the benefits of tighter monetary policy and decided equity markets might not be the best place to hold their assets. This is especially true of those invested in the mega-cap tech companies as those are the ones that most closely approximate an extremely long-duration bond. So, the NASDAQ’s -2.5% performance has been followed by weakness around the globe and NASDAQ futures pointing down -0.9% this morning. As many have said (present company included) the idea that the Fed will be aggressively tightening monetary policy in the face of a sharp sell-off in the stock market is pure fantasy. The only question is exactly how far stocks need to fall before they blink. My money is on somewhere between 10% and 20%. Meanwhile, Madame Lagarde continues to pitch her view that inflation remains transitory and that while it is higher than the target right now, by next year, it will be back below target and the ECB’s concerns will focus on deflation again. So, while the PEPP will indeed be wound down, it will not disappear as it is always available for a reappearance should they deem it necessary. And in the meantime, they will increase the APP by €40 billion/month while still accepting Greek junk paper as part of the mix. Even though inflation is running at 4.9% (2.6% core) as confirmed this morning, they espouse no concern that it is a problem. Perhaps the most confusing part of this tale is that the EURUSD exchange rate rallied on the back of a more hawkish Fed / more dovish ECB combination. One has to believe that is a pure sell the news result and the euro will slowly return to recent lows and make new ones to boot. One final word about the major central banks as the BOJ concluded its meeting last night and…left policy unchanged as universally expected. There is no indication they are going to do anything different for a long time to come. However, when you step away from the Big 3 central banks, there was far more action in the mix, some of it quite surprising. First, the BOE did raise the base rate by 15 basis points to 0.25% and indicated that it will be rising all throughout next year, with expectations that by September it will be 1.00%. The MPC’s evaluation that omicron would not derail the economy and price pressures, especially from the labor market, were reaching dangerous levels led to the move and the surprise helped the pound rally as much as 0.7% at one point. Earlier yesterday, the Norges Bank raised rates 25bps, up to 0.50%, and essentially promised another 25bp rise by March. Then, in the afternoon, Banco de Mexico stepped in and raised their overnight rate by 0.50%, twice the expected hike and the largest move since they began this tightening cycle back in June. It seems they are concerned about “the magnitude and diversity” of price pressures and do not want to allow inflation expectations to get unanchored, as central bankers are wont to say. Summing up central bank week, the adjustment has been significant from the last round of meetings with inflation clearly now the main focus for every one of them, perhaps except for Turkey, where they cut the one-week repo rate by 100 basis points to 14.0% and continue to watch the TRY (-7.0%) collapse. It is almost as if President Erdogan is trying to recreate the Weimar hyperinflation of the 1920’s without the war reparations. Will they be able to maintain this inflation fighting stance if global equity markets decline? That, of course, is the big question, and one which history does not show favorably. At least not the current crop of central bankers. Barring the resurrection of Paul Volcker, I think we know the path this will take. This poet is seeking his muse To help him define next year’s views Thus, til New Year’s passed Do not be aghast My note, you’ll not have, to peruse Ok, for my final note of the year, let’s recap what has happened overnight. As mentioned above, risk is under pressure after a poor performance by equity markets in the US. So, the Nikkei (-1.8%), Hang Seng (-1.2%) and Shanghai (-1.2%) all fell pretty sharply overnight. This morning, Europe has also been generally weak, but not quite as badly off as Asia with the DAX (-0.65%) and CAC (-0.7%) both lower although the FTSE 100 (+0.3%) is bucking the trend after stronger than expected Retail Sales data (+1.4%). Meanwhile, Germany has been dealing with soaring inflation (PPI 19.2%, a new historic high) and weakening growth expectations as the IFO (92.6) fell to its lowest level since January and is trending sharply lower. US futures are also pointing lower at this hour. Bond markets, meanwhile, are generally firmer although Treasury yields are unchanged at this time. Europe, though, has seen declining yields across the board led by French OATs (-2.6bps) and Bunds (-1.8bps) with the peripherals also doing well. Gilts are bucking this trend as well, with yields unchanged this morning. In the commodity space, oil (-1.75%) is leading the energy sector lower along with NatGas (-1.9%), but metals markets are going the other way. Gold (+0.5%, and back above $1800/oz) and silver (+0.7%) feel more like inflation hedges this morning, and we are seeing strength in the industrial space with copper (+0.45%), aluminum (+2.1%) and tin (+1.8%) all rallying. Lastly, looking at the dollar, on this broad risk-off day, it is generally stronger vs. its G10 counterparts with only the yen (+0.2%) showing its haven status. Otherwise, NZD (-0.5%) and AUD (-0.4%) are leading the way lower with the entire commodity bloc under pressure. As to the single currency, it is currently slightly softer (-0.1%) but I believe it has much further to run by year end. In the EMG bloc, excluding TRY’s collapse, the biggest mover has actually been ZAR (+0.6%) after it reported that the hospitalization rate during the omicron outbreak has collapsed to just 1.7% of cases being admitted. This speaks to the variant’s less pernicious symptoms despite its rapid spread. Other than that, on the plus side KRW (+0.25%) benefitted from central bank comments that they would continue to support the economy but raise rates if necessary. On the downside, CLP (-0.4%) is opening poorly as traders brace for this weekend’s runoff presidential election between a hard left and hard right candidate with no middle ground to be found. However, beyond those moves, there has been much less activity. There is no economic data today and only one Fed speaker, Governor Waller at 1:00pm. So, the FX market will once again be seeking its catalysts from other markets or the tape. At this point, if risk continues to be shed, I expect the dollar to continue to recoup its recent losses and eventually make new highs. As I mention above, this will be the last daily note for 2021 but the FX Poet will return with his forecasts on January 3rd, 2022, and the daily will follow afterwards. To everyone who continues to read, thank you for your support and I hope everyone has a happy and healthy holiday season. Good luck, good weekend and stay safe Adf
Apparently, Powell has learned
Why everyone’s been so concerned
With prices exploding
The sense of foreboding
‘Bout ‘flation seemed very well earned
So, Jay and his friends at the Fed
Said by March, that they would stop dead
The buying of bonds
Til ‘flation responds
(Or til stocks fall deep in the red)
By now you are all aware that the FOMC will be reducing QE twice as rapidly as their earlier pace, meaning that by March 2022, QE should have ended. Chairman Powell was clear that inflation has not only been more persistent than they had reason to believe last year but has also moved much higher than they thought possible, and so they are now forced to respond. Interestingly, when asked during the press conference why they will take even as long as they are to taper policy rather than simply stop buying more assets now if that is the appropriate policy, Powell let slip what I, and many others, have been saying all along; by reducing QE gradually, it will have a lesser impact on markets. In other words, the Fed is more concerned with Wall Street (i.e. the stock market) than it is with Main Street. Arguably, despite a more hawkish dot plot than had been anticipated, with the median expectation of 3 rate hikes in 2022 and 3 more in 2023, the stock market rallied sharply in the wake of the press conference. If one is seeking an explanation, I would offer that Chairman Powell has just confirmed that the Fed put remains alive and well and is likely struck far closer to the market than had previously been imagined, maybe just 10% away.
One other thing of note was that Powell referred to the speed with which this economic cycle has been unfolding, much more rapidly than the post-GFC cycle, and also hinted that the Fed would consider reducing the size of its balance sheet as well going forward. Recall, however, what happened last time, when the Fed was both raising the Fed funds rate and allowing the balance sheet to run off by $50 billion/month back in 2018; stocks fell 20% in Q4 and the Powell Pivot was born. FWIW my sense is that the Fed will not be able to raise rates as much as the dot plot forecasts. Rather, the terminal rate will be, at most, 2.00% (last time it was 2.50%), and that any shrinkage of the balance sheet will be minimal. The last decade of monetary policy has permanently changed the role of central banks and defined their behavior in a new manner. While not described as such by those “independent” central banks, debt monetization (buying government bonds) is now a critical role required to keep most economies functioning as debt/GDP ratios continue to climb. In other words, MMT is the reality and it will require a much more dramatic, and long-lasting, negative shock for that to change.
One last thing on this; the bond market has heard what Powell said and immediately rallied. The charitable explanation is that bond investors are now comforted by the Fed’s recognition that inflation is a problem and will be addressed. Powell’s explanation about foreign demand seems unlikely, at least according to the statistics showing foreign net sales of bonds. Of more concern would be the explanation that bond investors are concerned about a policy mistake here, where the Fed is tightening too late and will drive the economy into a recession, as they always have done when they tighten policy.
With Jay and the Fed finally past
The market will get to contrast
The Fed’s hawkish sounds
With Europe’s shutdowns
And watch Christine hold rates steadfast
But beyond the Fed, this has been central bank policy week with so many other central bank decisions today. Last night the Philippines left policy on hold at 1.50%, as did Indonesia at 3.50%, both as expected. Then, this morning the Swiss National Bank (-0.75%) left rates on hold and explained the franc remains “highly valued”. Hungary raised their Deposit rate by 0.30% as expected and Norges Bank raised by 0.25%, also as expected, while promising another 0.25% in March. Taiwan left rates unchanged at 1.125%, as expected and Turkey continue their unique inflation fighting policy by cutting the one-week repo rate by 1.00%, down to 14.00% although did indicate they may be done cutting for now. As to the Turkish lira, if you were wondering, it has fallen another 3.8% as I type and is now well through 15.00 to the dollar. YTD, TRY has fallen more than 51% vs. the dollar and quite frankly, given the more hawkish turn at the Fed, seems like it has further to go!
Which of course, brings us to the final two meetings today, the ECB and the BOE. Madame Lagarde and most of her minions have been very clear that they are not about to change policy, meaning they will continue both the PEPP and APP and are right now simply considering how they are going to manage policy once the PEPP expires in March. That is another way of saying they are trying to figure out how to continue to buy as many bonds as they are now, while losing one of their programs. I’m not worried about them finding a way to continue QE ad infinitum, but the form that takes is the question at hand. While European inflation pressures have certainly lagged those in the US, they are still well above their 2.0% target, and currently show no signs of abating. If anything, the fact that electricity prices on the continent continue to skyrocket, I would expect overall prices to only go higher. But Madame Lagarde is all-in on MMT and will drag the few monetary hawks in the Eurozone down with her. Do not be surprised if the ECB sounds dovish today and the euro suffers accordingly.
As to the BOE, that is much tougher to discern as inflation pressures there are far more prevalent and members of the MPC have been more vocal with respect to discussing how they need to respond by beginning to raise the base rate. But with the UK flipping out over the omicron variant and set to
cancel Christmas impose more lockdowns, it is not clear the BOE will feel comfortable starting their tightening cycle into slower economic activity. Ahead of the meeting, the futures market is pricing in just a 25% probability of a 0.15% rate hike. My money is on nothing happening, but we shall see shortly.
Oh yeah, tonight we hear from the BOJ, but that is so anticlimactic it is remarkable. There will be no policy shifts there and the yen will remain hostage to everything else that is ongoing. Quite frankly, given the yen has been sliding lately, I expect Kuroda-san must be quite happy with the way things are.
And that’s really the story today. Powell managed to pull off a hawkish turn and get markets to embrace risk, truly an impressive feat. However, over time, I expect that equity markets will decide that tighter monetary policy, especially if central bank balance sheets begin to shrink, is not really a benefit and will start to buckle. But right now, all screens are green and FOMO is the dominant driver.
In the near term, I think the dollar has further to run higher, but over time, especially when equity markets reverse course, I expect the dollar will fall victim to the impossible trilemma, where the Fed can only prop up stocks and bonds simultaneously, while the dollar’s decline will be the outlet valve required for the economy. But that is many months away. For now, buy dollars and buy stocks, I guess.
Good luck and stay safe
In Europe, the UK, and States
The central banks face dire straits
But omicron’s trending
So, what should they do about rates?
First Jay will most certainly say
More tapering is on the way
But Andrew is stuck
With Covid amok
While Christine, a choice, will delay
It is central bank week and all eyes are on the decisions and statements to be made by the Fed on Wednesday and the BOE and ECB on Thursday. In fact, the BOJ will be meeting Friday, but by that time, given the fact that markets are likely to be exhausted from whatever occurs earlier in the week and the assumption nothing there will change, that news seems unlikely to matter much.
By this time, the market narrative (as opposed to the Fed’s preferred narrative) has evolved to the Fed must taper QE even more rapidly with doubling that rate seen as the bare minimum. You may recall that in November, the Fed announced it would be reducing its QE purchases by $15 billion / month until such time as QE ended. At that point, they would then consider the idea about raising interest rates assuming inflation remained a concern. Of course, since then, no matter how you measure inflation, (CPI, core PCE, Trimmed Mean, Sticky) it has risen to levels not seen since the early 1980’s. This has resulted in a near hysterical call by the punditry for much faster tapering and nearly immediate interest rate hikes. The longer the Fed delays the process, the fact that rising inflation forces real yields lower means that monetary conditions are easing during a period of extraordinary fiscal policy led demand. This simply exacerbates the inflation situation feeding this self-reinforcing loop. Quite frankly, I believe the punditry is correct on this issue, but also expect that the Fed will do less than has become widely believed is necessary because inaction is their default setting.
The dollar, which is largely firmer across the board this morning, continues to benefit from the anticipated hawkishness that this new narrative has evoked. Arguably, that sets up the opportunity for a sell-off in the greenback if Powell doesn’t deliver the goods, and realistically, even if he does on a ‘sell the news’ outcome.
Turning to the Old Lady of Threadneedle Street, Governor Andrew Bailey has already drawn the ire of financial markets (and some members of Parliament) with his comments from October that many took as a ‘promise’ to raise the base rate then in an effort to address rising inflation in the UK. But he didn’t do so, and blamed market participants for hearing what he said as such a promise. That led to investors and traders assuming the rate hike would be coming this week, with more to follow, and that the base rate, currently at 0.10%, would be raised to 1.25% by the end of 2022. However, omicron has thrown a wrench into the works as the Johnson government is now considering Plan B, or C or D (I lose count) as their newest lockdown strictures to prevent the spread of the latest variant. Arguably, raising interest rates into a period where the economy is shutting down would be categorized as a policy mistake, and one easily avoided. Thus, the BOE finds itself in a difficult spot, wait to find out more about omicron despite inflation’s rapid and persistent rise, or address inflation at the risk of tightening into a slowing economy.
The pound, despite expectations which had been focused on the BOE leading the interest rate cycle amongst the big four central banks, has traded back down to its lowest level in a year, although realistically to its average over the past five years. The trend, though, is clearly lower and any reasonable hawkishness by the Fed is likely to see Sterling test, and break below, 1.30, in my view. At this point, I feel like the pound is completely beholden to Powell, not Bailey.
Finally, the ECB also announces their policy decisions on Thursday, just 45 minutes after the BOE. Here the discussion has been around what happens when the PEPP, which is due to expire in March 2022, ends and what type of additional support will they be pumping into the economy. It has already become clear that the original QE program, the APP, will be expanded in some form, but one of the things about that was the requirement that the ECB stick to the capital key with respect to its purchases, and the inability of that program to purchase non-IG debt. The problem there is that Greece remains junk credit, but also the Greek government bond market remains entirely dependent on the ECB’s purchases to continue to function. At the same time, Germany, where inflation is running the hottest (Wholesale Prices rose 16.6% in November, the highest level ever in the series back to June 1968) is where the largest proportion of bonds is purchased, easing local financial conditions even further thus exacerbating the inflation story there. In many ways, it is understandable as to why there is less clarity on the ECB’s potential actions. As many problems as the Fed has created for themselves, the ECB probably has more, and Madame Lagarde is not a central banker by trade, but rather a politician. As such, she is far more likely to push for a politically comfortable solution than an economically sound one.
The euro had been trending steadily lower until Thanksgiving when we saw a bounce and it has been consolidating ever since. However, my take is the ECB is likely to be more dovish, rather than less, and in the wake of a Fed that is clearly tightening policy and will be seen to have to tighten further going forward, the euro is likely to feel more pressure to decline going forward. Look for a test of 1.10 sometime early in Q1.
OK, now that we’ve set the stage for the week ahead, let’s quickly tour the overnight activity. After yet another rally in the NY afternoon, Asia was mostly higher (Nikkei +0.7%, Hang Seng -0.2%, Shanghai +0.4%) with Europe showing a similar type of performance (DAX +0.9%, CAC +0.15%, FTSE 100 -0.1%). US futures are all pointing a bit higher, but only about 0.2%. Net, risk appetite seems to be modest today ahead of the meetings this week.
Interestingly, despite decent equity market performance, and despite no end in sight for inflation pressures, bond markets have generally rallied today with yields edging lower. Treasury yields have slipped by 1.4bps, while Bunds (-1.0bps), OATs (-1.5bps) and Gilts (-1.7bps) all show similar yield declines. This seems a little odd given the inflation narrative remains strong, but perhaps is a response to concerns over a policy mistake, or three, amongst the central banks.
Commodity prices are mixed this morning with oil (-0.7%) under pressure while NatGas (+1.5%) is making gains based on colder weather. (PS, European NatGas is up 9.3% this morning to $38.33/mmBTU, compared to US NatGas at $3.98/mmBTU). That is NOT a typo, almost 10x the price. It seems that colder weather and the ongoing Russia/Ukraine/Belarus issues are having a big impact. Metals prices are generally firmer with precious (Au +0.4%, Ag +0.4%) looking solid while industrial (Cu +0.3%, Al +1.2%) also perform well although some of the lesser metals like Ni (-0.6%) and Sn (-0.2%) are underperforming.
As to the dollar, it is universally stronger vs. the G10 with NOK (-0.6%) and AUD (-0.5%) the laggards although CAD (-0.3%) is also under the gun. It seems oil is an issue as well as the Chinese economy with respect to the Aussie. EMG currencies are broadly softer, but other than TRY (-2.0%) which continues to trade to new historic lows amid policy blunders, the movement has not been excessive. MYR (-0.4%) is the next worst performer, consolidating recent gains as traders await presumed hawkish news from the Fed, with most other currencies showing similar types of losses on the same story. The exceptions to this rule are ZAR (+0.5%) which rallied on the strength of the metals complex and IDR (+0.2%) which benefitted based on a reduced borrowing plan for the government.
On the data front, ahead of the Fed we see PPI and Retail Sales plus a bit more stuff later in the week.
|Tuesday||NFIB Small Biz Optimism||98.4|
|PPI||0.5% (9.2% Y/Y)|
|-ex food & energy||0.4% (7.2% Y/Y)|
The demand story certainly seems robust based on Retail Sales, and that has to continue to influence the Fed. I find the inventories data interesting as firms evolve from just-in-time to just-in-case models, another inflationary process. But in the end, this week is all about the Fed (and BOE and ECB) so until we know more from there, look for choppy markets with no real direction.
Good luck and stay safe
When most of us think of an APP
It’s something on phones that we tap
But Madame Christine,
The ECB queen,
Fears PEPP’s end would be a mishap
So, word is next week when they meet
Expansion of APP they’ll complete
Thus, PEPP they’ll retire
But still, heading higher
Are PIGS debt on their balance sheet
Over the next seven days we will hear from the FOMC, ECB and BOE with respect to their policies as each meets next week. Expectations are for the Fed to increase the speed at which they are tapering their QE purchases, with most pundits looking for that to double, thus reducing QE by $30 billion/month until it is over. Rate hikes are assumed to follow shortly thereafter. However, if they sound quite hawkish, do not be surprised if the equity market sells off and all of our recent experience shows that the Fed will not allow too large a decline in stock prices before blinking. Do not be envious of Chairman Powell’s job at this point, it will be uncomfortable regardless of what the Fed does.
As to the ECB, recent commentary has been mixed with some members indicating they believe continued support for the economy is necessary once the PEPP expires in March, and that despite internal rules prohibiting the ECB from buying non IG debt, they should continue to support Greece via the Asset Purchase Program. The APP is their original QE tool, and has been running alongside the PEPP throughout the crisis. Both the doves on the ECB and the punditry believe that any unused capacity from the PEPP will simply be transferred to the APP so there is more buying power, and by extension more support for the PIGS. However, we are hearing more from the hawks recently about the fact that QE has been inflating asset prices and inflation, and perhaps it needs to be reined in. When considering ECB activity, though, one has to look at who is running the show, just like with the Fed. And Madame Christine Lagarde has never given any indication that she is considering reducing the amount of support the ECB is providing to the Eurozone economy. Rather, just last week she explained that inflation’s path is likely to be a “hump” which will fall back down to, and below, their 2.0% target in the near future, so there is no need to be concerned over recent data.
Finally, the BOE finds itself in a sticky situation because of the relatively larger impact of the omicron variant in the UK versus elsewhere. While Governor Bailey had indicated back in October that higher rates were on the way, the BOE’s failure to act last month was a shock to the markets and futures traders are now far less certain that UK interest rates will be rising in order to fight rapidly rising prices there. Instead, there is increased discussion of the negative impact of omicron and the fact that the Johnson government appears to be setting up for yet another nationwide lockdown, something that will clearly reduce demand pressure. So, there is now only a 20% probability priced into the BOE raising rates to 0.25% next week from the current 0.10% level. This is not helping the pound’s performance at all.
And lastly, the PBOC
Adjusted a rare policy
Was raised to a bar
Two points o’er its prior degree
One last piece of news this morning was the PBOC announcement that they were raising the FX Reserve Ratio Requirement from 7% to 9% effective the same day the RRR for bank capital is being cut. This little-known ratio is designed to help the PBOC in its currency management efforts by forcing banks to increase their FX liquidity. This is accomplished by local banks buying dollars and selling renminbi. It is a clear sign that the PBOC was getting uncomfortable with the renminbi’s recent strength. Today is the second time they have raised the FX RRR this year with the first occurring at the end of May. Prior to that, this tool had not been used since 2007! Also, if you look at the chart, following this move in May, USDCNH rose 2.25% in the ensuing three weeks. Since the announcement at 6:10 this morning, USDCNH is higher by 0.5% already. It can be no surprise that the Chinese are fighting the strength of the yuan as it remains a key outlet valve for economic pressures. And while Evergrande is officially in default, as well as several other Chinese property developers, the PBOC maintains that is not a problem. But it is a problem and they are trying to figure out how to resolve it without flooding the economy with additional liquidity and without losing face.
With all that in mind, let’s see how markets have behaved. Yesterday’s ongoing rebound in US equity markets only partially carried over to Asia with the Nikkei (-0.5%) failing to be inspired although the Hang Seng (+1.1%) and Shanghai (+1.0%) both benefitted from PBOC comments regarding the resolution of Evergrande. European bourses are in the red, but generally not by that much (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%). There was little in the way of data released in the Eurozone or UK, but Schnabel’s comments about PEPP purchases inflating assets have put a damper on things. US futures, too, are sliding this morning with all three major indices lower by about -0.4% or so.
One cannot be surprised that bonds are rallying a bit, between the large declines seen yesterday and the growing risk-off sentiment, so Treasuries (-2.2bps) are actually lagging the move in Europe (Bunds -3.6bps, OATs -3.8bps, Gilts -4.7bps) and even PIGS bond yields have slipped. Clearly bonds feel like a better investment this morning.
After a 1-week rally of real significance, oil (-0.7%) is consolidating some of those gains and a bit softer on the day. NatGas (-0.7%) is also lower and we are seeing weakness in metals prices, both precious (Au -0.2%. Ag -0.7%) and industrial (Cu -1.4%). Foodstuffs are also under pressure this morning, but at this time of year that is far more weather related than anything else.
As to the dollar, it is broadly stronger this morning with the only G10 currency to gain being the yen (+0.1%) and the rest of the bloc under pressure led by NOK (-1.0%) and AUD (-0.45%) feeling the heat of weaker commodity prices. I must mention the euro (-0.3%) which seems to be adjusting based on the slight change in tone of the relative views of FOMC and ECB policies, with the ECB dovishness back to the fore.
EMG currencies are also mostly softer although there are a few outliers the other way. The laggards are ZAR (-1.0%) on the back of softer commodity prices and TRY (-0.9%) which continues to suffer from its current monetary policy stance and should continue to do so until that changes. We’ve already discussed CNY/CNH and see HUF (-0.5%) also under pressure as the 0.2% rise in the deposit rate was not seen as sufficient by the market to fight ongoing inflation pressures. On the plus side, the noteworthy gainer is CLP (+0.5%) which seems to be responding to the latest polls showing strength in the conservative candidate’s showing. Also, I would be remiss if I did not highlight BRL’s 1.5% gain since yesterday as the BCB raised rates by the expected 1.50% and hawkish commentary indicating another 1.50% rate rise in February.
On the data front, Initial (exp 220K) and Continuing (1910K) Claims are really all we see this morning, neither of which seem likely to have an FX impact. Tomorrow’s CPI data, on the other hand, will be closely watched.
The current narrative remains the Fed is quickening the pace of tapering QE in order to give themselves the flexibility to raise rates sooner given inflation’s intractable rise. As long as that remains the story, the dollar should remain well supported, and I think that can be the case right up until the equity markets respond negatively. Any sharp decline will be met with a dovish Fed response and the dollar will suffer at that point. Be prepared.
Good luck and stay safe
There once was a concept, inflation
That frightened the heads of each nation
As prices would rise
They could not disguise
The fact it was just like taxation
But now, though it seems quite insane
Most governments try to explain
No need for dismay
There’s no reason you should complain
The latest example is from
The UK, where people’s income
Continues to lag
Each higher price tag
And prospects for growth are humdrum
It certainly is becoming more difficult to accept the idea that the current inflationary surge being felt around the world is going to end anytime soon. I keep trying to imagine why any company would cut prices in the current macroeconomic environment given the amount of available funds to spend held by consumers everywhere. So called ‘excess’ savings, the amount of savings that are available to consumers above their long-term trend, exceed $3 trillion worldwide, with more than $2 trillion of that in the US alone. If you run a company and are being faced with higher input costs (energy, wages, raw materials, etc.) and there has been no reduction in demand for your product, the most natural response is to continue to raise prices until you find the clearing price where demand softens. It is a pipe dream for any central bank to expect that the current situation is going to resolve itself in the near future.
And yet…the major central banks (Fed, ECB, BOE and BOJ) continue to be committed to maintaining ultra-easy monetary policy. For instance, today’s inflation data from the UK is a perfect case in point. CPI rose a more than expected 4.2% Y/Y, more than double the BOE’s price target. Core CPI rose 3.4%, also more than expected and RPI (Retail Price Index, the price series that UK inflation linked bonds track), rose 6.0%, the highest level since 1991. And yet, the BOE is seemingly no closer to raising rates. You may recall that despite what appeared to be clear signaling by the BOE they would be raising interest rates at their meeting earlier this month, they decided against doing so, surprising the market and leading to significant volatility in UK interest rate markets. In fact, BOE Governor Bailey fairly whined afterwards that it was not the BOE’s job to manage the economy. (If not, what exactly is their job?) At any rate, the growing concern in the UK is that growth is slowing more rapidly while prices continue to rise. This has put the BOE in a tough spot and will likely force a decision as to which issue to address. The problem is the policy prescriptions for each issue are opposite, thus the conundrum.
The bigger problem is that this conundrum exists in every major economy. The growth statistics we have seen have clearly been supported by the massive fiscal and monetary policy expansion everywhere. In the US, that number is greater than $10 trillion or 40% of the economy. The fear is that organic growth, outside the stimulus led measures, is much weaker and if policy support is removed too early, economies will quickly fall back into recession. In fact, that is the most common refrain we hear from policymakers around the world, premature tightening will be a bigger problem. Ultimately, a decision is going to need to be made by every central bank as to which policy problem is more important to address immediately. For the past four decades, the only policy issue considered was growth and how to support it. But now that inflation has made a comeback, it is a much tougher choice. We shall see which side the major central banks choose over the coming months, but in the meantime, the one thing which is abundantly clear is that prices are going to continue to rise.
A reasonable question would be, how have markets responded to the latest data and comments? And the answer is…no change in attitude. Risk appetite remains relatively robust as the money continues to flow from central banks, although certain risk havens, notably gold, are finding new supporters as fears of significantly faster inflation grow.
So, let’s survey today’s markets. Equities have had a mixed session with Asia (Nikkei -0.4%, Hang Seng -0.25%, Shanghai +0.45%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 -0.3%) all, save China, remaining near all-time highs (in the case of the Nikkei they are merely 31 year highs from after the bubble there), but certainly showing no signs of backing off. US futures are showing similar price action with very modest movement either side of flat.
Bonds, as well, are little changed and mixed on the day with Treasuries (-0.5bps) catching a modest bid after having sold off sharply over the past week. In Europe, the price action is similar with Bunds (-0.3bps), OATs (+0.2bps) and Gilts (-0.5bps) all within a few tics of yesterday’s closing levels. I would have expected Gilts to suffer somewhat more given the UK inflation data, but these days, it appears that inflation doesn’t have any impact on interest rates.
Commodity prices are softer this morning led by oil (-1.3%) and NatGas (-1.75%), although European NatGas is higher by more than 7.3% this morning as Russia continues to restrict flows to the continent. (I have a feeling that the politicians who made the decision to rely on Russia for a critical source of power are going to come under increasing pressure.) In the metals markets, industrials are mostly under pressure (Cu -1.0%, Sn -0.1%, Zn -0.8%) but we are seeing a slight rebound in aluminum (+0.6%) and precious metals are doing fine (Au +0.6%, Ag +1.1%). It seems that inflation remains a concern there.
As to the dollar, it has outperformed a few more currencies than not, with TRY (-1.25%) the biggest loser as the central bank there has clearly made the decision that growth outweighs inflation and is expected to cut interest rates further despite inflation running at nearly 20%. Elsewhere in the EMG bloc, the losers are less dramatic with MYR (-0.3%) and CLP (-0.3%) the next worst performers. On the plus side, RUB (+0.8%) is the clear leader, shaking off the decline in oil prices as inflows to purchase Russian bonds have been enough to support the ruble. Otherwise, there are a handful of currencies that have edged higher, but nothing of note.
In the G10, the picture is also of a few more losers than gainers but no very large moves at all. surprisingly, GBP (+0.1%) has done very little in the wake of the CPI data and actually SEK (+0.35%) is the best performer on the day. However, given the krona’s recent performance, where it has fallen more than 4% in the past week, a modest rebound should not be much of a surprise. Overall, the dollar has retained its bid as evidenced by the euro (-2.8%) and the yen (-2.0%) declining during the past week with virtually no rebound. It appears that the market continues to believe the Fed is going to be the major central bank that tightens policy fastest and the dollar is benefitting accordingly.
This morning’s data brings Housing Starts (exp 1579K) and Building Permits (1630K), neither of which seem likely to move markets. Yesterday’s Retail Sales and IP data were much stronger than expected, which clearly weighed on bond markets a bit, and supported the dollar, but had little impact elsewhere. We hear from seven! Fed speakers today, as they continue to mostly double down on the message that they expect inflation to subside on its own and so it would be a mistake to act prematurely. There is a growing divide between what the market believes the Fed is going to do and what the Fed says they are going to do. When that resolves, it will have a large market impact, we just don’t know when that will be.
For now, you cannot fight the dollar rally, but I will say it is getting a bit long in the tooth and a modest correction seems in order during the next several sessions. Payables hedgers should be picking spots and layering into hedges because the longer-term situation for the dollar remains far more tenuous.
Good luck and stay safe
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:
|Average Hourly Earnings||0.4% (4.9% Y/Y)|
|Average Weekly Hours||34.8|
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
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
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
There are several central banks which
Are starting to look at a switch
From policy ease
To tight, if you please
As QE they now want to ditch
The Old Lady and RBA
Are two that seem ready to say
Inflation’s too high
And so we must try
To stop it ere it runs away
The dollar is under pressure this morning as investors and traders start to look elsewhere in the world for the next example of policy tightening. The story of tapering in the US is, quite frankly, getting long in the tooth as it has been a topic of discussion for the past six months and every inflation reading points to the fact that, despite their protestations, FOMC members realize they need to do something. But in essence, that is already a given in the market, so short of Chairman Powell explaining in his Friday appearance that the FOMC is likely to end QE entirely next month, this is no longer market moving activity. The dollar has already benefitted from the relatively higher yields that are extant in the Treasury market, and expectations for a further run up are limited.
However, the same is not true elsewhere in the world as central bank plans are only recently crystalizing alongside the universally higher inflation prints. So, the BOE, which has been more vocal than most, seems to be working hard to prepare markets for a rate hike and the market has taken the ball and run with it. Thus, UK yields in the short end of the curve have moved rapidly higher with 3-year gilt yields higher by 53 basis points in the past 6 weeks and 15 bps in the past three sessions. On Sunday we heard from BOE Governor Bailey that they will “have to act” soon to address rapidly rising inflation, and traders continue to push UK yields higher and take the pound along with it. This morning, pound Sterling is higher by 0.75% and amongst the leading FX gainers on this ongoing activity.
Perhaps more interesting is the market reaction to the RBA Minutes last night, where discussion regarding rising real estate prices and the need to do something about them has encouraged the investment community to push yields much higher, challenging the RBA’s YCC in the 3-year AGB. In fact, despite the RBA explicitly reiterating that conditions for raising rates “will not be met before 2024”, yields continue to rise sharply as fears that inflation will outpace current RBA expectations grow widespread. Given this price action, one cannot be surprised that the Aussie dollar (+0.85%) has also risen quite sharply this morning.
The thing is, there are a number of conundrums here as well. For instance, the euro is performing well this morning, up 0.4%, and there has been absolutely zero indication that the ECB is considering tighter monetary policy. It is widely known that the PEPP will expire in March, but it is also very clear that the previous QE program, the APP, is going to be expanded and extended in some manner to make up for the PEPP. The only question here is exactly what form it will take. Similarly, there is no indication that the BOJ is even considering the end of QE or NIRP or YCC, yet the yen has managed to gain 0.3% this morning as well.
In fact, today’s price action is looking much more like broad-based dollar weakness abetted by some other idiosyncratic features rather than other stories driving the market. This becomes clearer when viewing the commodity markets where virtually every commodity price is higher this morning led by oil (+1.25%), gold (+0.75%), copper (+1.15%) and aluminum (+1.6%). Today is very much a classic risk-on type session with the dollar under pressure and other assets performing well in sync.
For instance, equity markets are in the green everywhere (Nikkei +0.65%, Hang Seng +1.5%, Shanghai +0.7%, DAX +0.2%, FTSE 100 +0.1%) with US futures also pointing higher by roughly 0.4% across the board. At the same time, bond yields are creeping higher (Bunds +1.8bps, OATs +2.1bps, Gilts +1.8bps) as investors jettison their haven assets in order to jump on the risk bandwagon. Treasury yields, though, are unchanged on the day although still trending higher from the levels seen late last week.
Adding it up; rising equity prices, rising commodity prices, falling bond prices, and a weaker dollar (with EMG currencies also firmer across the board) results in a clear risk-on framework. This will warm the cockles of every central bankers’ heart as they will all see it as a vote of confidence in the job they are doing. Whether that is an accurate representation is another question entirely, but you can’t fight the tape. Risk is clearly in vogue today.
It is, however, worth asking if this positive attitude is misplaced. After all, the recent data has hardly been the stuff of dreams. Yesterday’s US releases were uniformly awful (IP -1.3%, Capacity Utilization 75.2%) with both significantly worse than forecast. The upshot is that the Atlanta Fed GDPNow number fell to 1.165%, another step lower and an indication that despite (because of?) high inflation, growth is slowing more rapidly. Meanwhile, Eurozone Construction Output fell -1.3% in August, continuing the down trend that began in March of this year.
I recognize it is earnings season and the initial releases for Q2 have been quite positive. But I ask, is slowing growth and rising inflation really a recipe for continued earnings growth? History tells us the answer is no, and I see no reason to believe this time is different. Today’s price action seems anomalous to the big picture ideas, so be cognizant of that fact. While markets can remain irrational longer than we can remain solvent, that does not mean it is sensible to go ‘all-in’ on risk because there is one very positive market day. Tread carefully.
This morning’s US data brings Housing Starts (exp 1613K) and Building Permits (1680K) and that is all. Though these are unlikely to get the market excited, we also hear from four Fed speakers, Daly, Barkin, Bostic and Waller, where efforts at recapturing the narrative will be primary. It is growing increasingly clear that the Fed is annoyed that the persistent inflation narrative is gaining traction as it may force their hand in tightening policy before they would like. Just remember, as important as the Fed is (and every central bank in their own economy), the market is much bigger. And if the market determines that the Fed is no longer leading the way, or will soon need to change tack, it will force the issue. On this you can depend.
While today everything is coming up roses, the lesson is that the Fed’s control over markets is beginning to wane. Eventually that will be quite a negative for the dollar, but for now, despite today’s decline, I think the trend remains for a higher dollar.
Good luck and stay safe
In London on Threadneedle Street
The Old Lady’s not been discrete
Some hikes are impending
With rates soon ascending
Before they shrink their balance sheet
The BOE has made it quite clear that they are itching to raise interest rates pretty soon in order to address rising inflation. Today’s employment data, which saw the Unemployment Rate fall to 4.5% while employment grew by 235K on a 3M/3M basis, has helped to cement the idea that the economy is continuing to rebound sharply and price pressures are likely to continue to grow. With CPI at 3.2%, already well above the 2.0% target, and tipped to rise much further by the end of the year given the rapid rise in energy and commodity prices, the BOE has come to believe they need to do something to prevent inflation from getting out of control. Unlike the Fed, the BOE has also indicated they are quite comfortable raising interest rates before shrinking their balance sheet back to pre-pandemic levels.
The risk they face, which has become the talk of the market today, is that by raising rates so soon, especially before the Fed acts, they will simultaneously destroy the nascent growth impulse while failing to address the cause of the inflation. And in truth, that could well happen. Alas, that is a result of trying to address a stagflationary environment with the limited tools available to a central bank. For the time being, the biggest decision a central bank has is to determine which affliction is a bigger problem, rising prices or slowing economic activity. Since this seems to be the situation in almost every developed nation, we are going to witness a lot of variations on this theme going forward.
The interesting thing about the pound is that its behavior amid pending rate hikes, as well as the market narrative about the pound, seems to be quite negative. For some reason, there has been a connection made between an early rate hike in the UK and a falling pound. This is opposite what we have seen in most other countries, where those rate hikes have been supportive of the currency as would normally be expected. But there is now talk that the UK is going to make a policy error by tightening ahead of the Fed. This argument seems specious, however, as economic growth has rarely been a short-term driver of exchange rates, while interest rate changes are critical. The idea that suddenly traders and investors are critiquing the long-term ramifications of the BOE is preposterous. Instead, I would offer that any pound weakness, although an early decline after the data release has already been reversed, is far more likely due to the dollar’s continuing broad strength. So, as I type, the pound is essentially unchanged on the day.
Of course, this begs the question, is the Fed going to start to tighten policy with their potential tapering decision next month. My answer is leaning towards no. The reasoning here is that we will have already seen the first estimate of Q3 GDP by the time the Fed meets, and the early indications are that GDP growth has really declined sharply with the Atlanta Fed’s GDPNow forecast declining to 1.306% after the payroll data on Friday. Tightening policy into a clearly slowing economy seems highly improbable for this Fed regardless of the inflation situation. It seems far more likely that a weak GDP print will result in the Fed walking back their tapering language by describing the slowing growth as an impediment from achieving that vaunted “substantial further progress” on their employment goals and thus tapering is not yet appropriate. Remember, after nearly a decade of worrying about deflation, not inflation, concern over rising prices is not their normal response. Despite talk of the tools they have available to fight inflation, there is no indication the Fed has the gumption to use them if the result would be a recession, or more frighteningly for them, a stock market decline.
Thus, the question that remains is, how will the market respond to a Fed that decides not to taper with inflation still rising? Much of the current discussion regarding the Treasury market is around the idea that tapering is the driver of the steeper yield curve, although there is a strong case to be made it is simply consistently higher inflation readings doing the work. For our purposes in the FX markets, it’s not clear the underlying driver matters that much. The key is where do rates and yields go from here. If they continue to rise, I expect the dollar has further room to rise as well.
Ok, with markets back to full strength today, a look around sees a pretty negative risk sentiment. Equities in Asia (Nikkei -0.95%, Hang Seng -1.4%, Shanghai -1.25%) were all under pressure with the latter two dealing with yet another property company that is defaulting on a USD bond. The China story appears to be getting a bit less comfortable as we watch what seems to be a slow motion implosion of the real estate bubble there. As to Europe, its all red there as well (DAX -0.4%, CAC -0.5%, FTSE 100 -0.4%) as London is suffering despite the strong data and Germany seems to be feeling the weight of stagflation after PPI (+13.2% Y/Y in Sept) rose to its highest level since 1974 while the ZEW Surveys all fell even further than expected. At this hour, US futures are either side of unchanged.
On this risk off day, bond markets are seeing a bit of a bid, but in truth, it is not that impressive, especially given how far they have fallen recently. So, Treasury yields (-1.6bps) have edged just below 1.60% for now while European sovereigns (Bunds -0.6bps, OATs -0.8bps, Gilts -1.4bps) have also seen very modest demand.
Oil prices (+0.4%) continue to lead the way higher for most commodities, although today’s movement has been less consistent. The trend, however, remains firmly upward in this space. So, while NatGas (-1.6%) is lower on the session, we are seeing gains in gold (+0.5%) and aluminum (+0.7%) although copper (-0.25%) is consolidating today. Many less visible commodity prices are rising though, things like lumber (+5.5%) and cotton (+2.3%) which are all part of the same trend.
Finally, the FX markets have seen a very slight amount of dollar weakness net, although there are quite a number of currencies that have fallen vs. the greenback as well. In the G10, NOK (+0.7%) is the leader on oil price rises while AUD (+0.4%) and NZD (+0.4%) are following on the broader commodity price trend. Interestingly, JPY (0.0%) is not seeing any bid despite a declining risk appetite. This seems to be a situation where the spread between Treasuries and JGB’s has widened sufficiently to interest Japanese investors who are selling yen/buying dollars to buy bonds. As long as Treasury yields continue to rise, look for USDJPY to follow. After all, it has risen 1.7% in the past week alone.
In the emerging markets, THB (+1.3%) has been the big winner after the government eased restrictions for travelers entering the country thus opening the way for more tourism, a key part of the economy there. ZAR (+0.85%) and MXN (+0.5%) are the next best performers on the strength of the commodity story. On the downside, many APAC currencies (TWD (-0.35%, KRW -0.3%, INR -0.2%) saw declines on a combination of continued concerns over the potential implications of the Chinese real estate issue as well as rising commodity prices as all these nations are commodity importers.
Data-wise, NFIB Small Business Optimism was just released at a slightly weaker than expected 99.1, hardly a harbinger of strong future growth, while the JOLTS Jobs report (exp 10.954M) is due at 10:00 this morning. There are three Fed speakers on the slate with vice-Chair Clarida at the World Bank/IMF meetings and Bostic and Barkin also due. It will be interesting to see the evolution of the narrative as it becomes clearer that GDP growth is slowing rapidly. But given that has not yet happened, I expect more taper talk for now.
There is no reason to think that the dollar’s recent strength has reached its peak. If anything, my take is we are consolidating before the next leg higher so hedge accordingly.
Good luck and stay safe