More Systemic

The winding down of the pandemic

Has fostered a massive polemic

Will rising costs fade

As Powell’s portrayed

Or are they a bit more systemic?

The inflation debate continues to be topic number one amongst market participants as the outcome is seen, rightly, as the key to future economic activity and correspondingly future market price action.  This is true across all asset classes which is why everyone cares so much.

However, not every day brings us new and exciting news on the debate which leaves the markets to seek other catalysts for movement, sometimes really stretching to find a good narrative.  Thus far, today falls under the heading of ‘looking for something to say.’

There has been limited new information released overnight which is likely why the fact that the Bank of Korea, though leaving their policy rate unchanged at 0.50%, has been a topic of conversation as they displayed a more hawkish sentiment, raising both GDP growth and inflation forecasts for 2021, and hinted that they would be looking to end their ultra-expansive monetary policy sooner than previously thought.  Earlier expectations had been rates would not begin to rise until 2023, but now the market is pricing in two 25 basis point rate hikes in 2022.  This is the fourth (BOC, BOE and RBNZ are the others) central bank of a major country that is discussing the beginning of the end of easy money.  Granted, the combined GDP of these four nations, at a touch over $7 trillion, is less than one-third that of the US, but three of them are amongst the ten largest economies in the world and the fourth, New Zealand, has a history of leading the way in monetary policy on a global basis, at least since 1988 when they ‘invented’ the inflation targeting mantra that is prevalent today.

This sentiment of considering when to end easy money is making its way more clearly into the Fed’s talking points as well.  Yesterday, Fed Vice-Chair Quarles remarked, “If my expectations about economic growth, employment and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.”  He is at least the fourth Fed speaker this week to talk about talking about tapering asset purchases which tells us that the discussion is actively ongoing at the Marriner Eccles Building in Washington.  

Perhaps what is even more interesting is the fact that the Treasury market is so nonplussed by the fact that the Fed is clearly considering the timing of a reduction in purchases at the same time we are printing the highest inflation numbers in years and the Federal government is sending out more stimulus checks and spending money like crazy.  You may disagree with Chairman Powell’s policy actions, but you cannot deny the effectiveness of his recent communication policy.  Based on price action in both bond and inflation markets, Powell’s story of transitory inflation has become the accepted truth.  I sure hope he’s right, but my personal, anecdotal observations don’t agree with his thesis.  Whether I’m looking at my cost of living or take a more monetarist view and look at the expansion of the monetary base, both point to a steady rise in prices with no end in sight.  The market, however, cares little about the FX poet’s circumstances and a great deal about Chairman Powell’s pronouncements so until he is proven wrong, it has become clear the market has accepted the transitory story.

With this in mind, a survey of market activity shows pretty limited movement in every asset class.  Equity markets had a mixed session in Asia (Nikkei -0.3%, Hang Seng -0.2%, Shanghai +0.4%) and are having a similiarly mixed session in Europe (DAX -0.3%, CAC +0.5%, FTSE 100 -0.1%).  In other words, there is no theme of note on the risk side.  Meanwhile, US futures are pointing slightly lower on the open, with the worst performer NASDAQ at -0.4% and the others with lesser declines.  None of this points to a major risk theme.

Bond prices are generally a touch softer this morning with Treasury yields higher by 1.2 basis points while Bunds (+1.0bps), OATs (+0.5bps) and Gilts (+1.7bps) have all sold off slightly.  However, in the bigger picture, all of these key bond markets are currently trading with yields right in the middle of their past three month’s activity.  Again, it is hard to define a theme from today’s price action.

Commodity prices add to the mixed view with oil (WTI -0.8%) slightly softer as it consolidates after last month’s powerful rally.  In the metals markets, precious metals are essentially unchanged this morning while industrial metals continue with the mixed theme as Cu (+0.5%) and Zn (+0.3%) are firmer while Al (-0.4%) and Sn (-0.3%) are softer. Ags have seen similar price action with Soybeans softer while both Wheat and Corn are firmer.  One of the stories here has been the recent consolidation across most commodities which has been attributed to China’s efforts to prevent inflation and the expansion of bubbles in property and housing markets.

The dollar, however, is the one thing which has shown some consistency this morning, falling almost across the board.  In fact, in G10, the dollar has fallen against all its counterparts with GBP (+0.4%) the firmest currency, but solid gains in NZD (+0.35%) and CAD (+0.3%) as well.  The pound’s jump has been in the past few minutes responding to the BOE’s Gertjan Vlieghe’s comments that rate hikes are likely to begin in 2022, again, earlier than the market had been figuring.  

EMG currencies are also gaining this morning led by the CE4 (HUF +0.65%, PLN +0.5%) as well as ZAR (+0.4%).  APAC currencies performed well overnight with CNY (+0.25%) rising for the 12th session in the 15 so far this month.  It has become abundantly clear that the PBOC is willing to allow CNY to continue to strengthen despite the potential impact on exports.  This seems to be driven by their desire to cap inflation, especially in commodity prices, as well as the fact that the inflation narrative elsewhere in the world has shown that export clients have been able to absorb some level of price rises.  To achieve both these aims, a modestly stronger renminbi is an excellent help.

On the data front, this morning brings Initial Claims (exp 425K), Continuing Claims (3.68M), the second look at Q1 GDP (6.5%) and Durable Goods (0.8%, 0.7% ex transport).  However, while this is the biggest tranche of data so far this week, tomorrow’s core PCE release remains the most important number of the week in my view as excessive strength there seems to be the only thing that could give the Fed pause in their current views.  Interestingly, we do not hear from another Fed speaker, at least in a scheduled appearance, until next Tuesday, so the data will be our best indication of what is happening.  

Looking at the dollar’s recent price action, we have seen weakness but it has run into pretty strong support.  The link between Treasury yields and the dollar remains strong, and I expect that to be the case until at least the Fed’s June meeting.  In truth, the dollar’s weakness today feels a bit overdone so I anticipate no further declines and potentially, a little rebound.

Good luck and stay safe