The Minutes explained that the Fed
Continues, when looking ahead
To brush off inflation
And seek job creation
Though prices keep rising instead
Meanwhile, there’s a new policy
That came from Lagarde’s ECB
T’won’t be a disaster
If prices rise faster
So, nothing will stop more QE
There is no little irony in the fact that the one-two punch of the Fed and ECB reconfirming that ‘lower for longer’ remains the driving force behind central bank policy has resulted in a pretty solid risk-off session this morning. After all, I thought ‘lower for longer’ was the driver of ongoing risk appetite.
However, that is the case, as yesterday the FOMC Minutes essentially confirmed that while there are two camps in the committee, the one that matters (Powell, Clarida, Williams and Brainerd) remain extremely dovish. Inflation concerns are non-existent as the transitory story remains their default option, and although several members expressed they thought rates may need to rise sooner than their previous expectations, a larger group remains convinced that current policy is appropriate and necessary for them to achieve their goals of average 2% inflation and maximum employment. Remember, they have yet to achieve the undefined ‘substantial further progress’ on the jobs front. Funnily enough, it seems that despite 10 years of undershooting their inflation target, there are several members who believe that the past 3 months of overshooting has evened things out! Ultimately, my take on the Minutes was that the market’s initial reaction to the meeting 3 weeks ago was misguided. There is no hawkish tilt and QE remains the norm. In fact, if you consider how recent data releases have pretty consistently disappointed vs. expectations, a case can be made that we have seen peak GDP growth and that we are rapidly heading back toward the recent trend levels or lower. In that event, increased QE is more likely than tapering.
As to the ECB, the long-awaited results of their policy review will be released this morning and Madame Lagarde will regale us with her explanations of why they are adjusting policies. It appears the first thing is a change in their inflation target to 2.0% from ‘below, but close to, 2.0%’. In addition, they are to make clear that an overshoot of their target is not necessarily seen as a problem if it remains a short-term phenomenon. Given that last month’s 2.0% reading was the first time they have achieved that milestone in nearly 3 years, there is certainly no indication that the ECB will be backing off their QE programs either. As of June, the ECB balance sheet, at €7.9 trillion, has risen to 67.7% of Eurozone GDP. This is far higher than the Fed’s 37.0% although well behind the BOJ’s 131.6% level. Perhaps the ECB has the BOJ’s ratio in mind as a target!
Adding up the new policy information results in a situation where…nothing has changed. Easy money remains the default option and, if anything, we are merely likely to hear that as central banks begin to try to tackle issues far outside their purview and capabilities (climate change and diversity to name but two) there is no end in sight for the current policy mix. [This is not to say that those issues are unimportant, just that central banks do not have the tools to address them.]
But here we are this morning, after the two major central bank players have reiterated their stance that no policy changes are imminent, or if anything, that current ultra-easy monetary policy is here to stay, and risk is getting tossed aside aggressively.
For instance, equity markets around the world have been under significant pressure. Last night saw the Nikkei (-0.9%), Hang Seng (-2.9%) and Shanghai (-0.8%) all fall pretty substantially. While the Japanese story appears linked to the latest government lockdowns imposed, the other two markets seem to be suffering from some of the recent actions by the PBOC and CCP, where they are cracking down on international equity listings as well as the ongoing crackdown on freedom in HK. European bourses are uniformly awful this morning with the DAX (-1.7%) actually the best performer as we see the CAC (-2.25%) and FTSE 100 (-1.9%) sinking even further. Even worse off are Italy (-2.7%) and Spain (-2.6%) as investors have weighed the new information and seemingly decided that all is not right with the world. As there has been no new data to drive markets, this morning appears to be a negative vote on the Fed and ECB. Just to be clear, US futures are down uniformly by 1.4% at this hour, so the risk-off attitude is global.
Turning to the bond market, it should be no surprise that with risk being jettisoned, bonds are in high demand. Treasury yields have fallen 6.5bps this morning, taking the move since Friday to 21bps with the 10-year now yielding 1.25%, its lowest level since February. Is this really a vote for transitory inflation? Or is this a vote for assets with some perceived safety? My money is on the latter. European sovereigns are also rallying with Bunds (-4.1bps), OATs (-2.7bps) and Gilts (-4.8bps) all putting in strong performances. The laggards here this morning are the PIGS, where yields are barely changed.
In the commodity space, yesterday saw a massive reversal in oil prices, with the early morning 2% rally completely undone and WTI finishing lower by 1.7% on the day (3.6% from the peak). This morning, we are lower by a further 0.4% as commodity traders are feeling the risk-off feelings as well. Base metals, too, are weak (Cu -1.75%, Al -0.3%, Sn -0.4%) but gold (+0.7%) is looking quite good as real yields tumble.
As to the dollar, in the G10 space, commodity currencies are falling sharply (NZD -0.75%, AUD -0.7%, CAD -0.6%, NOK -0.6%) while havens are rallying (CHF +0.9%, JPY +0.8%). The euro (+0.45%) is firmer as well, which given the remarkable slide in USD yields seems long overdue.
Emerging market currencies are seeing similar behavior with the commodity bloc (MXN -0.75%, RUB -0.5%) sliding along with a number of APAC currencies (THB -0.65%, KRW -0.6%, MYR -0.5%). It seems that Covid is making a serious resurgence in Asia and that has been reflected in these currencies. On the plus side, the CE4 are all firmer this morning as they simply track the euro’s performance on the day.
On the data front, our last numbers for the week come from Initial (exp 350K) and Continuing (3.35M) Claims at 8:30 this morning. Arguably, these numbers should be amongst the most important given the Fed’s focus on the job situation. However, given the broad risk off sentiment so far, I expect sentiment will dominate any data. There are no further Fed speakers scheduled this week, which means that the FX markets are likely to take their cues from equities and bonds. Perhaps the correlation between yields and the dollar will start to reassert itself, which means if the bond market rally continues, the dollar has further to decline, at least against more haven type currencies. But if risk continues to be anathema to investors, I expect the EMG bloc to suffer more than the dollar.
Good luck and stay safe