Tag Archives: #china

Lest Things Implode

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The central banks all through the West
Are trying to figure how best
To, policy, tighten
But not scare or frighten
Investors and so they are stressed

Meanwhile from Beijing data showed
That Chinese growth actually slowed
With prospects now dimmed
The central bank trimmed
Two interest rates, lest things implode

There is a new contest amongst the punditry to see who can call for the most shocking rate policy by the Fed this year.  With the FOMC in their quiet period, they cannot respond to comments by the likes of JPM Chair Jamie Dimon (the Fed could raise rates 7 times this year!) or hedge fund manager and noted short seller Bill Ackman (the Fed should raise rates by 50 basis points in March to shock the market), and so those comments get to filter through the market discussion and creep into the narrative.  A quick look at Fed funds futures shows that the market is now pricing in not only a 25bp rate hike, but a probability of slightly more at the March meeting.

Now, don’t get me wrong, I think the Fed is hugely behind the curve, as evidenced by the fact they are still purchasing assets despite raging inflation, and think an immediate end to asset purchases would be appropriate policy, as well as raising rates in 0.5% increments or more until they start to make a dent in the depth of negative real yields, but I also know that is not going to happen.  Time and again they have effectively explained to us all that while inflation is certainly not a good thing, the worst possible outcome would be a decline in the stock market.  Their deference to investors rather than to Main Street has become a glaring issue, and one that does not reflect well on their reputation.  And yet, Chairman Powell has never given us a reason to believe that he will simply focus on inflation, which is currently by far the biggest problem in the economy.

However, with the market having already priced in a 0.25% rate hike for March, it is entirely realistic they will raise rates at that meeting.  The key question, though, is will they be able to continue to tighten policy when equity markets start to respond more negatively?  For the past 35 years (since Black Monday in 1987) the answer has been a resounding NO.  Why does anybody think this time is different?

Interestingly, at the same time virtually every Western central bank is trying to figure out the best way to fight the rapidly rising inflation seen throughout the world, the Middle Kingdom has their own, unique, issues, namely disappointing economic growth and expanding omicron growth leading up to the Winter Olympics.  Of course, the last thing that President Xi can allow is any inkling that things in China are not running smoothly, and so after the release of weaker than expected IP, Fixed Asset, Retail Sales and GDP data for Q4, the PBOC cut both its Medium-Term Lending and 7-day Reverse Repo rates by 0.10% last night.  In addition to the weaker data came the news that yet another property developer, Logan Group, may have made guarantees that do not appear on their balance sheet to the tune of $812 million.  I have lost count of the number of property developers in China that are now under growing pressure ever since the initial stories about China Evergrande.  But that is the point, the entire property sector is under huge pressure of imploding and property development has been somewhere between 25%-30% of the Chinese GDP growth.  This does not bode well for Chinese GDP growth going forward, which does not bode well for global growth.  PS, one last thing to mention here is the Chinese birth rate fell to its lowest level since 1950!  Only 10.62 million babies were born in 2021, despite significant efforts by the government to encourage family growth.  As demographics is destiny, unless the Chinese change their immigration policies, the nation is going to find itself in some very difficult straits as the population there ages rapidly and the working population shrinks.  Just sayin’.

Ok, with that out of the way, a look around today’s holiday markets shows that risk is on!  Aside from the Hang Seng (-0.7%) overnight, which is where so many property firms are listed, every other major market is in the green.  The Nikkei (+0.75%) and Shanghai (+0.6%) were both solid performers as that PBOC rate cut was seen as encouraging.  In Europe, the DAX (+0.4%), CAC (+0.6%) and FTSE 100 (+0.6%) are all firmer as are the peripheral markets.  Even US futures (+0.1% across the board) are firmer although there is no trading here today due to the MLK holiday.

Bond markets, on the other hand, are under pressure everywhere as Treasury futures are down 13 ticks or about 3 basis points higher, while European sovereigns (Bunds +1.7bps, OATs +2.0bps, Gilts +2.8bps) are all seeing higher yields as well.  In fact, 10-year Bunds are approaching 0.0% for the first time since May 2019.  Asia was no different with only China (-0.8bps) seeing a yield decline and sharp rises in Australia (+6.7bps) and South Korea (+9.7bps).

In the commodity markets, WTI (0.0%) is flat although Brent (-0.3%) is edging down from its multi-year highs.  NatGas (-0.6%) is also edging lower and European gas prices are falling even more significantly as a combination of LNG cargoes and warmer weather eases some pressure on that market.  Gold (+0.2%) is firmer, despite what appears to be a risk-on day, although copper (-0.7%) is under a bit of pressure.  In other words, the noise is overwhelming the signal here.

As to the dollar this morning, mixed is the best description as there are gainers and losers in both G10 and EMG blocs.  Interestingly, despite oil’s lackluster trading, both NOK (+0.3%) and CAD (+0.2%) are the leading gainers in the G10 while JPY (-0.25%) is following its risk history, selling off as equities gain.  In the emerging markets, RUB (-0.55%) is the worst performer as there seems to be growing concern over the imposition of tighter sanctions in the event Russia does invade the Ukraine.  KRW (-0.45%) is next in line after North Korea launched yet two more ballistic missiles, raising tension on the peninsula.  On the plus side, THB (+0.4%) has been continuing its recent gains as the nation opens up more completely from Covid lockdowns.

It is a relatively light data week with Housing the main focus, and with the Fed in their quiet period, we won’t be getting help there either.

Tuesday Empire Manufacturing 25.0
Wednesday Housing Starts 1650K
Building Permits 1700K
Thursday Initial Claims 220K
Continuing Claims 1521K
Philly Fed 19.8
Existing Home Sales 6.41M
Friday Leading Indicators 0.8%

Source: Bloomberg

In truth, it is shaping up to be a quiet week.  Next week brings the central bank onslaught with the Fed, BOJ and BOC, but until then, we will need to take our cues from equities and geopolitical tensions to see if anything occurs that may inspire the jettisoning of risk assets in a hurry.  My gut tells me we will not be seeing anything of that nature, and so a range bound week for the dollar seems in store.

Good luck and stay safe
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Quite a Surprise

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This morning’s report on inflation
Is forecast as verification
The Fed is behind
The curve and must find
The will to cease accommodation

While last night from China we learned
The trend in inflation has turned
In quite a surprise
It fell from its highs
A positive for all concerned

Ahead of this morning’s CPI report (exp 7.0%, 5.4% ex food & energy) investors around the world have been feeling positively giddy about the current situation.  Sure, China’s growth forecasts have been cut due to omicron infection outbreaks and the Chinese response of further lockdowns, but that just means that combined with the first downtick in PPI there since February 2020 (10.3%, exp 11.3%, prev 12.9%), talk has turned to the PBOC cutting interest rates next week by between 5 and 10 basis points.  So, while many other nations are aggressively fighting inflation (Brazil, Mexico, Hungary) or at least beginning to tighten policy (UK, Sweden, Canada), the market addiction to ever increasing liquidity may now be satisfied by China.  While it is still too early to know if lower interest rates are coming from Beijing, what is clear is that the credit impulse in China (the amount of lending) seems to have bottomed and is starting to reverse higher.  That alone augers well for future global growth; so, buy Stonks!

Meanwhile, I think it is valuable to consider what we heard from Chairman Powell yesterday at his renomination hearings, as well as what the two erstwhile hawks, Esther George and Loretta Mester, had to say about things.  Mr Powell, when asked why the Fed was continuing to purchase assets with inflation well above target and unemployment near historic lows inadvertently let the cat out of the bag as to the most important thing for the Fed, that if they were to move at a more aggressive pace, it could upset markets and there could be declines in both the stock and bond markets.  Apparently, the unwritten portion of the Fed’s mandate, prevent markets from falling, remains the most important goal.  While Powell paid lip service to the idea that the Fed would seek to prevent the inflationary mindset from becoming “entrenched”, he certainly didn’t indicate any sense of urgency that the Fed’s glacial pace of change was a problem.

Perhaps more surprisingly, neither Mester nor George were particularly hawkish, with both explaining that the Dot Plot from December was a good guide and there was no reason to consider a rate hike as soon as March.  Regarding QT, neither was anxious to get that started either although both wanted to see it eventually occur.  Finally, this morning, former NY Fed President (and current Fed mouthpiece) Bill Dudley explained in a Bloomberg column that there was no hurry to reduce the size of the balance sheet and that when it begins, the impact would be “like watching paint dry.”  Now, where have we heard that before?  Oh yeah, I remember.  Then Fed Chair Yellen used those exact same words to describe the last attempt to shrink the balance sheet right up until Powell was forced to pivot after the equity market’s sharp decline in 2018.  Apparently, the dynamics of drying paint are more interesting than we have been led to believe.

For those seeking proof that investors welcomed yesterday’s comments, one need only look at market behavior in their wake.  US equity markets rallied after the testimony and never looked back all day.  Treasury bonds did very little, with the sharp trend higher in yields having hit a key resistance and unable to find the will to push through.  Finally, the dollar took it on the chin, declining vs virtually every major and emerging market currency yesterday with many of those moves continuing overnight.  Recapping: higher stocks, unchanged bonds and a weaker dollar are not a sign that the market expects much tighter policy from the Fed.

Ok, so how are things looking this morning?  Well, in the equity market, the screen is entirely green. Last night, Asia followed the US lead  with gains across the board (Nikkei +1.9%, Hang Seng +2.8%, Shanghai +0.8%), and European bourses are also higher (DAX +0.35%, CAC +0.5%, FTSE 100 +0.7%) as data from the continent showed much better than expected Eurozone IP growth (2.3% vs 0.2% exp) as well as the first indication that inflation might be peaking in Germany with PPI there “only” printing at 16.1%, down from last month’s record 16.6%.  As to US futures, they are modestly higher ahead of the data, between 0.1%-0.2%.

In the bond market, while 10-year Treasury yields have edged higher by 0.7bps at this hour, they remain just below 1.75% and have shown no inclination, thus far, of breaking out much higher.  Arguably this implies that market participants are not yet full believers in the Fed tightening policy aggressively, and after yesterday’s performances, I think that is a good bet.  Meanwhile, European sovereign bonds are all rallying with yields falling nicely (Bunds -1.8bps, OATs -1.7bps, BTPs -1.3bps) as it remains clear that there is not going to be any tightening of note by the ECB this year.

On the commodity front, we continue to see strength in energy (WTI +0.5%, NatGas +5.2%) as well as industrial metals (Cu +2.9%, Zn +2.2%) although both gold -0.2%, and silver -0.2% are consolidating after strong moves higher yesterday.

Looking at FX markets, I would say the dollar is modestly weaker overall, albeit only in a few segments.  In the G10, NOK (+0.7%) and CAD (+0.2%) are the largest movers, by far, with both benefitting from oil’s continued rise.  The rest of the bloc, quite frankly, is tantamount to unchanged this morning.  In emerging markets, the picture is a bit more mixed with both gainers and losers about evenly split.  However, only 3 currencies have shown any real movement, BRL (-0.4%), KRW (+0.4%) and CLP (+0.3%).  The real seems to be consolidating some of its massive gains from yesterday, when it rallied 1.7% on the back of central bank comments implying that though inflation would fall back in 2022, it would require continued tight policy to achieve that outcome.  On the flip side, the won benefitted from a better than expected employment report showing more than 770K jobs added in the last year and indicating better economic growth going forward.  Finally, the Chilean peso seems to be benefitting from copper’s strong rally today.

Aside from this morning’s CPI report, we also see the Fed’s Beige Book at 2:00pm which has, in the past, been able to move markets if the narrative was strong enough.  Only one Fed speaker is on the docket, Kashkari, and even he, an uber-dove, is calling for 2 rate hikes this year as per his last comments.

The Fed tightening narrative is definitely having some difficulty these days which implies to me that the market has fully priced in its expectations and those expectations are that the Fed will not be able to tighten policy very much.  If the Fed is restrained, and tighter policy continues to get pushed further out in time, the dollar will suffer much sooner than I anticipated.  For those with opex and capex needs, perhaps moving up the timetable to execute makes some sense.

Good luck and stay safe
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Out of Place

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The holiday season has passed
And this year the reigning forecast
Is for higher rates
Right here in the States
Thus, dollars will soon be amassed

But frequently, as is the case
Consensus is, here, out of place
Though some nations will
Raise rates, like Brazil
The Fed soon will turn about-face

Reading the many forecasts that are published this time of year, the consensus certainly appears to be that the Fed is going to continue to tighten policy and the only question is how soon they will begin raising interest rates; March, May or June?  The Fed narrative has evolved from there is no inflation, to inflation is transitory to inflation is persistent and we will address it with our tools.  But will they?  Since Paul Volcker retired as Fed Chair (1979-1987) we have had a steady run of people in that seat who like to talk tough, but when there is any hiccup in the market, are instantly prepared to add more liquidity to the system.  Starting with the Maestro himself, in the wake of the October 1987 stock market crash, to Bennie the Beard, the diminutive Ms Yellen and on up to today’s Chair Powell, history has shown that there is always a reason NOT to tighten policy because the consequences of doing so are worse than those of letting things run hotter.  Ultimately, I see no reason for this time to be any different than the past 35 years and expect that as interest rates begin to climb here, and equity markets reprice assumptions, the Fed will not be able to withstand the pain.

But for now, the higher US interest rate story remains front and center.  This was made clear yesterday when 10-year yields rallied 12 basis points in a thin session, trading back to levels last seen in November.  Perhaps not surprisingly, the dollar reversed its late year losses as well, rallying vs. almost all its counterparts with the yen (-0.7%) by far the worst performer in the G10.  It seems that the Japanese investor community has decided that a 155 basis point spread in the10-year, in an environment where expectations for a stronger dollar are rampant is a sufficient reason to sell yen and buy dollars.

And the truth is that given inflation is a global phenomenon these days, there are only a handful of nations where expectations don’t include higher interest rates.  For instance, Japan, though they have stopped QE are not even contemplating higher interest rates.  The ECB has indicated QE will be reduced to some extent (they claim cut in half, but I will believe that when I see it) but is certainly not considering higher interest rates.  Turkey is kind of a special case as President Erdogan continues to try his unorthodox inflation fighting methodology, but if the currency reprises the late 2021 collapse, which is entirely realistic, if not probable, that is subject to change.

However, there is one more nation of note that is almost certainly going to be working against the grain of higher interest rates this year, China.  President Xi has a growing list of economic problems that will result in further policy ease regardless of any inflationary consequences at this time.  The fundamental flaw is the Chinese property market, which has obviously been under severe pressure since the problems at China Evergrande came to light.  This is fundamental because it represents more than 30% of the Chinese economy and has been THE key reason that Chinese GDP has been growing as rapidly as it has over the past two decades.  With Evergrande and several (many?) other property developers going to the wall, the property sector is going to have a much slower growth trajectory, if it is positive at all, and that is going to drag on the entire economy.  After all, if they are not going to build ghost cities (Evergrande’s specialty), they don’t need as much concrete, steel, copper, etc., and the whole support framework that has been created for the industry will slow down as well.  The upshot is that the PBOC seems highly likely to continue to ease policy in various ways including RRR cuts, as well as reductions in interest rates.

On the surface, one would expect that to work against CNY strength and fit smoothly with the stronger dollar thesis.  However, the competing view is that President Xi is more focused on the long-term viability of the renminbi as a stable store of value and strong currency, and I expect that imperative will dominate this year and in the future.  Thus, while your textbooks would explain the renminbi should fall, I beg to differ this year.  We shall see as things evolve.

Ok, starting the year, there is clearly a solid risk appetite.  Yesterday saw strong gains in the US equity market which was followed by the Nikkei (+1.8%) last night, although Shanghai (-0.2%) and the Hang Seng (0.0%) failed to follow suit.  Europe (DAX +0.7%, CAC +1.4%, FTSE 100 +1.4%) are all bullish this morning as are US futures (+0.35% across the board).  Record Covid infections are clearly not seen as a problem anymore.

After yesterday’s dramatic sell-off in Treasuries, this morning yields there have consolidated and are essentially unchanged.  In Europe, though, there has been a mixed picture with Gilts (+8.3bps) following the US lead, while the continent (Bunds -1.5bps, OATs -2.5bps) are clearly more comfortable that interest rates have no reason to rise sharply there anytime soon.

In the commodity markets, oil (+0.3%) is continuing its run higher from last year and, quite frankly, shows no sign of stopping.  This is a simple supply demand imbalance with not nearly enough supply for ongoing demand.  NatGas (+1.8%) continues to trade well as cold weather in the NorthEast and much of Europe and a lack of Russian deliveries to the continent continue to demonstrate the supply demand imbalance there as well.  Gold (+0.25%) has bounced after getting roasted yesterday, although it spent the last weeks of the year grinding higher, so we remain around $1800/oz.  Industrial metals, though, are mixed with copper (-0.8%) under some pressure while aluminum (+1.4%) and zinc (+2.4%) are both having good days.

As to the dollar, aside from the yen’s sharp decline, the rest of the G10 is +/- 0.15% or less, not enough to consider for a story rather than position adjustments at the beginning of the year.  In the EMG space, though, the dollar has had a bit more positivity with ZAR (-0.9%) and RUB (-0.8%) the worst performers (I need to ignore TRY given the insanity ongoing there).  In both cases, rapidly rising inflation continues to outpace the central bank efforts to rein it in and the currency is weakening accordingly.  In fact, that is largely what we are seeing throughout this bloc, with central banks throughout lagging the rise in prices.  In the EMG space, this trend has room to run.

On the data front, we get a decent amount of stuff this week, culminating in the payroll report:

Today ISM Manufacturing 60.0
ISM Prices Paid 79.3
JOLTS Job Openings 11,100K
Wednesday ADP Employment 420K
FOMC Minutes
Thursday Initial Claims 195K
Continuing Claims 1682K
Trade Balance -$81.0B
Factory Orders 1.5%
-ex transport 1.1%
ISM Services 67.0
Friday Nonfarm Payrolls 424K
Private Payrolls 384K
Manufacturing Payrolls 35K
Unemployment Rate 4.1%
Average Hourly Earnings 0.4% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.9%

Source: Bloomberg

In addition to the data, we start to hear from FOMC members again with Kashkari, Bullard, Daly and Bostic all on the calendar this week.  My impression is that investors and traders will be looking for hints as to the timing of rates liftoff.  But we are a long way from that happening yet.

For now, though, the narrative is clear, and a firmer dollar seems the most likely outcome in the near term.

Good luck and stay safe
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Not Quite Right

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The data from China last night
Could, President Xi, give a fright
While IP was fine
Consumption’s decline
Show’s everything there’s not quite right

Now, turning our focus back home
The question that’s facing Jerome
Is should he increase
The speed that they cease
QE?  Or just leave it alone?

Clearly, the big news today is the FOMC meeting with the statement to be released at 2:00 and Chair Powell to face the press 30 minutes later.  As has been discussed ad nauseum since Powell’s Congressional testimony two weeks ago, expectations are for the Fed to reduce QE purchases more quickly than the previously outlined $15 billion/month with many looking for that pace to double.  If that does occur, QE will have concluded by the end of March.  This timing is important because the Fed has consistently maintained that they would not raise the Fed funds rate while QE was ongoing.  Hence, doubling the pace of reduction opens the door for the first interest rate hike as soon as April.

And let’s face it, the Fed has fallen a long way behind the curve with the latest evidence yesterday’s PPI data (9.6%, 7.7% core) printing much higher than expected and at its highest level since the series was renamed the PPI from its previous Wholesale Price Index in 2010.  Prior to that, it was in the 1970’s that last saw prices rising at this rate.  So, ahead of the meeting results, investors are trying to analyze just how quickly US monetary policy will be changing.  Recall, yesterday I made a case for a slower reduction than currently assumed, but as of now, nobody really knows.

What we do know, however, is that the economic situation in China is not playing out in the manner President Xi would like.  Last night China released its monthly growth data which showed Retail Sales (3.9% Y/Y) Fixed Asset Investment (5.2% Y/Y) and Property Investment (6.0% Y/Y) all rising more slowly than forecast and more slowly than last month. Only IP (3.8% Y/Y) managed to grow.  As well, Measured Unemployment rose to 5.0%, higher than expected and clearly not the goal.  For the past several years China has been ostensibly attempting to evolve its economy from the current mercantilist state, where production for export drives growth, to a more domestically focused consumer-led economy like the West.  Alas, they have been unable to make the progress they would have liked and now have to deal with not only Covid, but the ongoing meltdown in the property sector which will only serve to hold the consumer back further.  Interestingly, the PBOC did not adjust the Medium-term Lending Rate as some pundits had expected, keeping it at 2.95%, and so, it should not be that surprising that the renminbi has maintained its strength, although has appeared to stop rising.  A 2.95% coupon in today’s world remains quite attractive, at least for now, and continues to draw international investment.

Aside from these stories, the other headline of note was UK inflation printing at 5.1%, its highest level since 2011 and clearly well above the BOE’s 2.0% target.  Remember, the BOE (and ECB) meet tomorrow and there remains a great deal of uncertainty surrounding their actions given the imminent lockdown in the UK as the omicron variant spreads rapidly.  Can the BOE really tighten into a situation where growth will clearly be impaired?  It is this uncertainty that has pushed the timing of the first interest rate hike by the BOE back to February, at least according to futures markets.  But as you can see, the BOE is in the same position as the Fed, inflation is roaring but there are other concerns that prevent it from acting to stem the problem.  In sum, the betting right now is the Fed doubles the pace of taper and the BOE holds off on raising rates until February, but either, or both, of those remain far less than certain.  Expect some more market volatility across all asset classes today and tomorrow.

With all that in mind, here’s a quick look at markets overnight.  Equities in Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.4%) mostly followed the US declines of yesterday, although Japan did manage to eke out a small gain and stop its recent trend lower.  Europe, on the other hand, is having a better go of it with the DAX (+0.3%) and CAC (+0.6%) both performing well as inflation data there was largely in line with expectations, albeit far higher than targets, and there is little concern the ECB is going to do anything tomorrow to rock the boat.  In the UK, however, that higher inflation print is weighing on equities with the FTSE 100 (-0.2%) underperforming the rest of Europe.  Ahead of the open, and the FOMC, US futures are little changed in general, although NASDAQ futures continue to slide, down (-0.25%) as I type.

The rally in European stocks has encouraged a risk-on attitude and so bond markets are selling off a bit with yields edging higher.  Well, edging except in the UK, where Gilts (+3.7bps) are clearly showing their concern over the inflation print.  But in the US (Treasuries +0.3bps), Germany (Bunds +1.2bps) and France (OATs +0.9bps) things are far less dramatic.  Given the imminent rate decisions, I expect that there is a chance for more movement later and most traders are simply biding their time for now.

The commodity picture is a little gloomier this morning with oil (-1.2%) leading the way lower and weakness in metals (Cu -1.5%, Ag -0.5%, Al -1.4%) widespread.  Gold is little changed on the day and only NatGas (+2.1%) is showing any life.  These markets are looking for a sign to help define the next big trend and so are also awaiting the FOMC outcome today.

Finally, the dollar continues to consolidate its recent gains but has been range trading for the past month.  The trend remains higher, but we will need confirmation from the FOMC today to really help it break out I believe.  In the G10, the biggest gainer has been AUD (+0.4%), but that appears to be positional, as Aussie has been sliding for the past week and seems to be taking a breather.  Otherwise, in this bloc there are an equal number of gainers and laggards with none moving more than 0.2%, so essentially trendless.

In the emerging markets, TRY (-2.1%) continues its decline toward oblivion with no end in sight.  Elsewhere, ZAR (-0.6%) has suffered on continue high inflation and the SARB’s unwillingness to fight it more aggressively.  INR (-0.5%) suffered on the back of a record high trade deficit and concerns that if the Fed does tighten, funding their C/A gap will get that much more expensive.  Beyond those, though, there has been far less movement and far less interest overall.

We do have some important data this morning led by Empire Mfg (exp 25.0) and Retail Sales (0.8%, 0.9% ex autos) at 8:30 and then Business Inventories (1.1%) at 10:00 before the FOMC at 2:00.  The inventory data bears watching as an indication of whether companies are beginning to stockpile more and more product given the supply chain issues that remain front and center across most industries.

And that’s really what we have at this point in time.  A truly hawkish Fed should help support the dollar further, while anything else is likely to see the dollar back up as hawkish is the default setting right now.

Good luck and stay safe
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Somewhat Weak

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In China, the PBOC
Whose policy, previously
Consisted of planks
Instructing the banks
To buy more and more renminbi

Has seemingly now changed its mind
With prop trading now much maligned
Instead, what they seek
Is yuan, somewhat weak
And banks that object will be fined

Let’s face it, constantly harping on inflation is getting tiresome.  While it remains the biggest topic in the market, we have discussed it extensively, and in fact, until there is some clarity as to the next Fed chair, it is very difficult to even try to determine how the Fed will respond going forward.  The word is that President Biden will be revealing his nomination tomorrow at which point we can game out potential future scenarios.

In the meantime, we have seen large movements in some emerging market currencies, and we have heard about some potential changes in policies underlying one of the less volatile ones, the Chinese renminbi.  One of the more surprising features of the dollar’s rally since summertime has been the fact that the renminbi has actually strengthened about 0.6% while the euro has declined nearly 8%.  In fairness, the euro has many self-inflicted problems that have been underlying its recent weakness, but the dollar, as measured by the Bloomberg dollar index, has risen by nearly 6%, implying there has been a lot of broad-based dollar strength.  This begs the question, why hasn’t the renminbi followed suit?

There are several potential answers to this question with the likelihood that each has been a part of the process.  Remember, for a mercantilist economy like China’s, a weaker currency tends to be the goal in an effort to improve the competitiveness of its exporters.  So, acceptance of a stronger currency demonstrates other priorities.

If nothing else, China plays the long game, historically willing to sacrifice short-term economic performance for the sake of a longer-term goal, often a political one.  And one of the things China is very keen to achieve is de-dollarization of its economy.  Given the growing antagonism between the US and China, President Xi has determined his nation is better served by an alternative to the US dollar in as many areas as possible.  One of those areas is in trade with other developing nations.  To the extent that the Chinese can convince other Asian, Middle Eastern or African nations to accept renminbi in exchange for their products, rather than dollars, it both strengthens Xi’s grip on those nations’ economies as well as reduces his reliance on the US led SWIFT system thus preventing any interference by the US.  As such, it is incumbent upon Xi to insure that CNY is a strong and stable currency, the exact words the PBOC uses to describe the renminbi in almost every press release.

Now, while this may have been at odds with short-term potential benefits, Xi understood the long-term benefits of removing as much of the Chinese economy from the dollar’s global sphere of influence as possible.  And it seems, that a major tool used to help maintain the renminbi’s strength has been the encouragement of local Chinese banks prop trading desks to continue to buy the currency.  There have long been stories of the PBOC whispering in the ear of Chinese banks to do just that, with the implication that the PBOC would prevent any significant weakness.

But that was then.  It seems now that the ongoing malaise in the Chinese economy, where growth forecasts continue to slide and expectations for another 50 basis point RRR cut are growing, has the PBOC apparently cracking down on prop desks buying too much CNY.  They have been instructed to monitor client activity and keep it at more ‘normal’ levels.  Some see that as a tacit admission that the previous policy, which was never explicit, was in fact a reality.  In addition, much will be made of the fixing, which last night was printed 0.2% weaker than expected.  Now, while 0.2% may not seem like much, in a currency with historical volatility around 3%, it is a signal.  In addition, the PBOC indicated that it would be ready to allow a “more flexible currency”, their code for weakness.  This is not to say the CNY is going to collapse, just that the unusual strength we have seen over the past six plus months is likely coming to an end.  Be warned.

Turning to the rest of the market this morning, the situation is somewhat mixed, with equity markets showing both gains and losses, although bond markets are under universal pressure.  Starting with equities, Asia gave no directional cues with the Nikkei (+0.1%) little changed while the Hang Seng (-0.4%) and Shanghai (+0.6%) gave confusing signals.  It seems that there is a very large sell order making the rounds in Evergrande stock, which is weighing on HK, while Shanghai responded to the first hints of easing by the PBOC.  Europe, which was modestly higher earlier in the session, has drifted to a mixed performance as well with the DAX (-0.1%) and CAC (-0.2%) both a touch softer although the FTSE 100 (+0.1%) has eked out a gain.  In the absence of any data releases, it seems that traders are biding their time for the next big thing.  US futures, on the other hand, are all firmer by about 0.35%, despite talk of a faster taper by more Fed speakers late last week.

Bond markets, though, are having a rougher time of things with Treasuries (+3.3bps) leading the way, but Bunds (+1.3bps) and Gilts (+2.5bps) both following along.  OATs are unchanged on the day, although have spent the bulk of the session with modestly higher yields.  The thing about yields, though, is that they remain range-bound and have shown little impetus to trend in either direction.  This is a market waiting for the next central bank discussion.

In the commodity space, oil continues under pressure as the thought of SPR releases in a coordinated manner from a number of nations continues to dog the price.  NatGas (-5.4%), interestingly, has tumbled after a larger than expected build in inventories, something US homeowners will welcome.  In the metals space, gold (-0.2%) is slightly softer and copper (-0.6%) is feeling a bit more strain.  However, aluminum (+0.6%) and nickel (+2.1%) show that this is not a universal issue.

As to the dollar, in the G10 the story is mixed with AUD (+0.3%) the best performer while SEK (-0.4%) is the worst.  However, these appear to be flow related movements as there has been no data or commentary from either nation.  The rest of the bloc has barely moved, +/- 0.1% for most of them, as traders await the next big idea.  In the emerging markets, CLP (+3.0%) is the big gainer as yesterday’s presidential election resulted in the conservative candidate performing far better than expected and investors now hoping that the country will maintain its investment friendly policies.  On the downside, RUB (-1.3%) and HUF (-0.6%) are in the worst shape with the former feeling pain based on concerns recent troop movements near the Ukraine border will result in an invasion and potential further sanctions, while the forint is suffering despite a more aggressive central bank as inflation there continues to ramp higher.  Expectations are growing for yet another rate hike as the fear is they are falling further behind the curve.

With the holiday before us, data is all crammed into the first three days this week, and most of it is on Wednesday:

Today Existing Home Sales 6.18M
Tuesday Manufacturing PMI 59.1
Services PMI 59.0
Wednesday Initial Claims 261K
Continuing Claims 2052K
GDP 2.2%
Durable Goods 0.2%
-ex Transport 0.5%
Personal Income 0.2%
Personal Spending 1.0%
Core PCE 0.4% (4.1% Y/Y)
New Home Sales 800K
Michigan Sentiment 66.9
FOMC Minutes

Source: Bloomberg

Consider that on the day before Thanksgiving, we are going to see some of the most important data of the month, and there will be relatively few people around.  If there is any surprise, we could see significant volatility.  In fact, for the week as a whole, the lack of liquidity is likely to result in a choppier market.  Keep that in mind if you need to execute anything of substance, but overall, the dollar’s recent rally seems likely to continue.

Good luck and stay safe
Adf

A Touch of Despair

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Protests Are Growing

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In China the growth impulse waned
As policy makers have strained
To maintain control
While reaching the goal
Of growth that Xi has preordained

In other news protests are growing
By pundits that markets are showing
Too much in the way
Of rate hikes today
Since wags think inflation is slowing

Risk is getting battered this morning, but interestingly, so are many havens.  It seems that the combination of slowing growth and higher inflation is not all that positive for assets in general, at least not financial ones.  Who would have thunk it?

Our story starts in China where Q3 GDP was released at a slower than expected 4.9% down from 7.9% in Q2 and 18.3% in Q1.  If nothing else, the trend seems to be clear.  And, while Retail Sales there rose a more than expected 4.4%, IP (3.1%) and Fixed asset Investment (7.3%), the true drivers of the Chinese economy, both slumped sharply from last quarter and were well below estimates.  In other words, the Chinese economy is not growing as quickly as the punditry, and arguably, the market had expected.  This is made clear by the ongoing lackluster performance in Chinese equity markets which are also being accosted by President Xi’s ongoing transformation of the Chinese economy to one more of his liking.  (In this vein, the latest is the attack on the press such that all media must now be state-owned.  Clearly there is no 1st Amendment there.)  Of course, if the press is state-controlled, it is much easier for the government to prevent inconvenient stories about things like Evergrande from becoming widespread inside the country.  That being said, we know the Evergrande situation is under control because the PBOC told us so!

Ultimately, this matters to markets because China has been a significant growth engine for the global economy and if it is slowing more rapidly than expected, it doesn’t bode well for the rest of the world.  Apparently ongoing energy shortages in China continue to wreak havoc on manufacturing companies and hence supply chains around the world.  But don’t worry, factory gate inflation there is only running at 10.7%, so there seems little chance of inflationary pressures seeping into the rest of the world.  In the end, risk appetite is unlikely to increase substantially if the narrative turns to one of slower growth ahead, unable to support earnings expectations.

With this in mind, it is understandable why equity markets are under pressure this morning which has been true in almost every major market; Nikkei (-0.15%), Shanghai (-0.1%), DAX (-0.5%), CAC (-0.8%), FTSE 100 (-0.2%). US futures (-0.3%), with only the Hang Seng (+0.3%) bucking the trend.  Funnily enough, though, bond markets are also under universal pressure (Treasuries +4.4bps, Bunds +4.4bps, OATs +4.7bps, Gilts +6.7bps, Australia GBs +9.0bps, China +5.3bps, and the pièce de résistance, New Zealand +15.5bps) as it seems investors are beginning to fret more seriously over inflation and ensuing policy action by central bankers.

Yesterday, BOE Governor Andrew Bailey explained that the BOE will “have to act” to curb inflationary forces.  That is a pretty clear statement of intent and one based on the reality that inflation is well above their target and trending higher.  Interest rate markets quickly priced in rate hikes in the UK with the first expected next month and a second by February.  In fact, by next September, the market is now pricing in 4 rate hikes, expecting the base rate to be 1.00% vs. the current rate of 0.10%.  In New Zealand, meanwhile, CPI printed at 4.9% last night, well above the expected 4.2% and the market quickly adjusted its views on interest rates there as well, with a 0.375% increase now price for the late November meeting and expectations that in one year’s time, the OCR (overnight cash rate) will be up at 1.95% compared to today’s 0.50%.

Naturally, this price action doesn’t suit the central bank narrative and so there has been a concerted push back on the higher inflation story from many sectors.  My personal favorite is from the pundits who are focusing on the Fed staff economists with the claim that they are far more accurate than the Street and their current forecast of 2022 inflation of 1.7% should be the baseline.  But we have heard from others with vested interests in the low inflation narrative like Blackrock (who gets paid by the Fed to manage the purchases of assets) as well as a number of European central bankers (Villeroy and Vizco) who maintain that it is critical the ECB keep policy flexibility when PEPP ends.  This appears to be code for ignore the inflation and keep buying bonds.

The point of today’s story is that the carefully controlled narrative that has been fostered by the central banking community is under increasing pressure, if not falling apart completely.  Markets are pricing in rate hikes despite protests by central bankers, as they see rising inflation trends as becoming much more persistent than those central bankers would like you to believe.  At this point, no matter what inflation statistic you consider (CPI, PCE, trimmed-mean CPI, median CPI, sticky CPI) all are running well above the Fed’s 2.0% target and all are trending higher.  The same situation obtains in almost every major nation as the combination of 18 months of excessive money-printing and significant fiscal spending seems to have done the trick with respect to reviving both inflation and inflation expectations.  If I were the Fed, I’d be taking a victory lap as they have been fighting deflation for a decade.  Clearly, they have won!

So, if stocks and bonds are both falling, what is rising?  I’m sure you won’t be surprised that oil (+1.6%) is leading the way higher as demand continues to rise while supply doesn’t.  OPEC+ has refused to increase production any further and the US production situation remains under pressure from Biden administration policies.  While NatGas in the US is softer (-1.8%), in Europe, it is much firmer again (+16.2%) as Russia continues to restrict supply.  Precious metals remain unloved (Au -0.2%, Ag -0.2%) but industrial metals are firm (Cu +0.9%, Al +0.45%, Sn +1.2%) along with the agriculturals.

Finally, the dollar is definitely in demand rising against 9 of its G10 brethren (only NOK has managed to hold its own on the back of oil’s rally) but with the rest of the bunch falling between 0.1% and 0.5% on general dollar strength. After all, if neither NZD (-0.1%) nor GBP (-0.15%) can rally after interest rate markets have jumped like they have, what chance to other currencies have today?

EMG currencies are also under pressure this morning led by ZAR (-1.0%) and followed by MXN (-0.6%) with both falling despite rising oil and commodity prices.  Both seem to be suffering from a general malaise regarding EMG currencies as concerns grow that rising inflationary pressures are going to slow growth domestically, thus pressuring their central banks to maintain easier policy than necessary to fight rising inflation.  Stagflation is a b*tch.

Turning to the data front, this week sees much less of interest with housing being the focus:

Today IP 0.2%
Capacity Utilization 76.5%
Tuesday Housing Starts 1615K
Building Permits 16680K
Wednesday Fed Beige Book
Thursday Initial Claims 300K
Continuing Claims 2550K
Philly Fed 25.0
Leading Indicators 0.4%
Existing Home Sales 6.08M

Source: Bloomberg

On the Fed front, 10 more speakers are on the docket across a dozen different venues including Chairman Powell on Friday morning.  At this point, with inflation rising more rapidly than expected everywhere in the world and the market pricing in rate hikes far more aggressively than central banks deem appropriate, the case can be made that the central banks have lost control of the narrative.  I expect this week’s onslaught of commentary to try very hard to regain the upper hand.  However, as I have long maintained, at some point the Fed will speak and act and the market will not care.  We could well be approaching that point.  In that event, the only thing that seems certain is that volatility will rise.

As to the dollar today, I think we need to see some confirmation that this modest corrective decline is over, but for now, the medium-term trend remains for a higher dollar.  I see nothing to change that view yet.

Good luck and stay safe
Adf

Something Awry

Posted on by

It’s not clear why there’s a concern
Inflation could cause a downturn
Cause stocks keep on rising
Though Jay’s emphasizing
The Fed, QE’s, set to adjourn

But still there is something awry
In how traders, every dip, buy
With growth clearly slowing
Though wages are growing
The value of stocks seems too high

One has to be remarkably impressed with the price action of risk assets these days and their ability to completely ignore growing signs that long-delayed problems are fast approaching.  The first of these problems is clearly inflation, something that has been ignored for decades by investors as long-term factors like globalization and demographics, as well as technological innovation, have served to suppress any significant inflationary impulse throughout the developed world.  Certainly, there were some EMG nations (Argentina, Venezuela, Zimbabwe) that managed to buck that trend and impose policies so horrendous as to negate the long-term benefits of stable prices, but generally speaking, inflation has not been a problem.

Then, Covid came along and the policy response was truly draconian dramatic, essentially shutting down much of the global economy for a number of months.  In hindsight, it cannot be surprising that the disruption to finely tuned supply chains that was imposed has been difficult to repair.  After all, it took years to achieve the true just-in-time nature of manufacturing and distribution across almost every industry.  While there are currently herculean efforts to get things back to the way they were, I suspect we will never again return to the previous situation.  A combination of policy decisions and population adaptations has altered the underlying framework thus there is no going back.

Consider the current energy situation (crisis?) as an example.  What is very clear now is that the price of energy is rising rapidly with both oil (+69% YTD, 0.85% today) and NatGas (+127% YTD, 1.0% today) continuing to climb with no end in sight.  Arguably, there have been a number of deliberate policy choices as well as some investing fashions which have dramatically reduced the investment in the production of these two key energy sources thus not merely reducing current supply but prospects for future supply as well.  Pressure from environmentalists to prevent this investment has done wonders for driving up prices, alas the mooted renewable replacements have yet to demonstrate their long-term effectiveness as uninterrupted power sources.  And this situation is manifest not only in the West, but in China as well, where they are currently suffering from major power shortages amid rapidly rising prices for LNG and coal as well as oil.  This morning’s WSJ has a lead article on how the rising price of NatGas is going to drive up winter heating bills substantially and the negative consequences for lower- and middle-income folks.

And yet…risk appetite remains robust.  You can tell because regardless of the news, equity prices consistently rise.  I grant it is not actually every day, but the trend remains quite clearly higher.  In traditional analysis, it would be difficult to rationalize this price movement as while the current situation may be working fine for companies, the fact is there are numerous issues that are coming, notably rising wages and a shrinking labor force, that are going to pressure margins, and arguably profits, going forward.  Clearly, however, that tradition is dead.  In its stead is the investor view that as long as the Fed keeps supplying liquidity to the markets economy, it will prevent any significant price dislocation.  Trickle Down theory remains alive and well on Wall Street.  This is evident today, where equity markets worldwide are higher, and has been evident in the fact that the recent Evergrande induced scare that resulted in a 5% correction was the first correction of that magnitude in more than a year.  The current investment zeitgeist remains; stocks only go up so buy more.  While I recognize I sound curmudgeonly on this topic, remember, reality is a b*tch and it will win out in the end.  Until then, though, it is unclear what type of catalyst is needed to change views, so risk assets are likely to remain in favor regardless of everything else.

And of course, today is a perfect example where equity markets are all green (Nikkei +1.8%, Hang Seng +1.5%, Shanghai +0.4%) in Asia and Europe (DAX +0.3%, CAC +0.4%, FTSE 100 +0.3%) as well.  Don’t worry, US futures are all pointing higher by 0.25%-0.35% at this hour, so all our 401K’s still look good.

Meanwhile, bonds are not required in a risk-on scenario so it should be no surprise that yields are rallying today with Treasuries (+3.3bps) leading the way but higher yields throughout Europe as well (Bunds +2.0bps, OATs +2.3bps, Gilts +3.7bps).  These price movements have been seen throughout the rest of the continent and in Asia last night with yields rising universally.

Commodity prices are broadly firmer, although with risk appetite robust, precious metals (Au -0.85, Ag -1.2%) are unwanted.  We discussed oil prices and we are seeing strength in the industrial metals (Cu +2.4%, Al +2.4%) as well as the Ags (corn +1.2%, wheat +1.4%, soybeans +0.7%).  In other words, risky assets are the place to be.

You should not be surprised that the dollar (and yen) are suffering on this movement given haven assets serve no purpose today!  In the G10 space, GBP (+0.6%) is leading the way higher followed by NOK (+0.55%) and then everything else is just modestly higher except JPY (-0.6%).  The sterling story seems to revolve around continued belief in BOE rate hikes coming early next year while NOK is simply following oil for now.

Of more interest, I believe, is the yen, which admittedly has been falling quite rapidly, down nearly 5% in the past three weeks, and quite frankly, shows no signs of stopping.  At this point, it doesn’t seem so much like Japanese investment outflows as it does like a speculative move that has discerned there is limited real demand for the currency.  Amazingly, last night, the new FinMin, Shunichi Suzuki, felt compelled to explain that, “stability in currencies is very important.” He further indicated that there was concern a weaker yen could cause prices to rise, especially energy prices.  Now, call me crazy but, BOJ policy for the past decade explicitly and the past three decades with less verve, has been to drive inflation higher.  Abenomics was all about achieving 2.0% inflation, something that had not been seen since before the Japanese bubble collapsed in 1989.  Now, suddenly, with inflation running at 0.2%, they are starting to get concerned that higher energy prices are going to be a problem?  Are they going to raise rates?  Are they going to intervene?  Absolutely not in either case.  Sometimes you have to wonder what animates policy maker comments.

As to EMG currencies, ZAR (+0.6%) and KRW (+0.4%) are the leaders this morning with the former benefitting from higher metals prices while the latter is responding to comments from the BOK governor that a rate hike could be coming at the November meeting.  On the downside here, TRY (-0.4%) continues to suffer from Erdogan’s capriciousness with respect to his central bankers, while THB (-0.3%) appears to be consolidating after a strong rally over the past week.

We have a bunch more data this morning led by Retail Sales (exp -0.2%, +0.5% ex autos) as well as Empire Manufacturing (25.0) and Michigan Sentiment (73.1).  There are two more Fed speakers, Bullard and Williams, but it seems unlikely that either will change the current narrative of a taper coming soon.

The reality is you can’t fight the tape.  As long as risk appetite remains buoyant, the dollar and yen are likely to remain on their back foot.  For the dollar, I see no long-term danger as I believe it will consolidate further before making its next move higher.  the yen, on the other hand, could be a bit more concerning.  If fear has gone missing, and with yields rising elsewhere in the world, a much weaker yen remains a real possibility.

Good luck, good weekend and stay safe
Adf

A Gordian knot

Posted on by

Now, what if inflation is not
As transit’ry as Powell thought?
And what if there’s slowing
Instead of more growing?
Would that be a Gordian knot?

Well, lately the bond market’s view
Appears to be, in ‘Twenty-two
Inflation will soar
Much higher before
The Fed figures out what to do

The Fed has been pushing the transitory inflation narrative for quite a while now, but lately, they have been struggling to get people to accept it at face value.  You can tell this is the case because pretty much every third story in any newsfeed is about rising prices in some product or service.  Commodities are particularly well represented in these stories, especially energy, as oil, NatGas and coal have all seen dramatic price rises in the past month or so.  It is also important to understand that despite the durm und strang regarding the continued use of coal as an energy source, it remains the largest source of electricity worldwide.  I bring this up because the situation in China is one where the country is restricting energy use due to a lack of coal available to burn.  (Perhaps one of the reasons for this is the Chinese, in a snit over Australia calling them out as to the origins of Covid-19, banned Australian coal imports.)

From an inflation perspective, this has the following consequences: less coal leads to less electricity production which leads to restrictions on electricity use by industry which leads to reduced production of everything.  Given China’s importance in the global supply chain for most products, less production leads to shortages and, presto, higher prices.  And this is not going to end anytime soon.  Much to the Fed’s chagrin, they can print neither coal nor NatGas and help mend those broken supply chains.  Thus, despite their (and every other central bank’s) efforts to repeal the laws of supply and demand, those laws still exist.  So, just as April showers lead to May flowers, less supply leads to higher prices.

The difference in the past week or so is that bond markets worldwide have started to cotton on to the idea that inflation is not transitory after all.  Yields have been rising and curves steepening, but even the front end of yield curves, where central banks have the most impact, have seen yields rise.  So, a quick look at global bond markets today shows yields higher in every major market around the world.  Treasuries (+1.1bps) have not moved that far overnight but are higher by 12bps in the past week.  Gilts (+4.8bps) on the other hand, have seen real selling in today’s session, also rising 12bps in the past week, but on a lower base (10-year Gilts yield 1.125% vs. 1.58% for Treasuries.)  And the same situation prevails in Bunds (+2.6bps, +6.6bps in past week), OATs (+2.5bps) and the rest of Europe.  Asia is not immune to this with even JGB’s (+1.2bps, +4bps in past week) selling off.  The point is that bond investors are starting to recognize that inflation may be more persistent after all.  And if the Fed loses control over their narrative, they have much bigger problems.  Forward guidance remains a key monetary policy tool, arguably more important that the Fed Funds rate these days, so if that is no longer effective, what will they do?

Needless to say, risk attitudes are starting to change somewhat as concern grows that almost the entire central banking community, certainly the Fed and ECB, will be too slow to react to very clear inflation signals.  In this situation, financial assets will definitely suffer.  Keep that in mind as you look ahead.

OK, next we need to look to this morning’s NFP report as that has been a key element of the recent market inactivity.  Investors are looking for confirmation that the Fed is going to begin tapering next month and have certainly been encouraged by both the ADP Employment number as well as yesterday’s much lower than expected Initial Claims data.  Here’s what current median forecasts look like:

Nonfarm Payrolls 500K
Private Payrolls 450K
Manufacturing Payrolls 25K
Unemployment Rate 5.1%
Average Hourly Earnings 0.4% (4.6% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.8%

Source: Bloomberg

Powell explained that as long as this report was not terrible, he felt the tapering would begin.  Interestingly, the range of forecasts is 0K to 750K, a pretty wide range of disagreement as to how things might play out.  Certainly, a number like last month’s 235K could throw a wrench into the tapering process.  Personally, my take is slightly weaker than median, but not enough to change the taper idea.

On a different note, I cannot help but look at the Average Hourly Earnings forecasts and wonder how any Fed speaker can argue that wages aren’t growing rapidly.  Absent the Covid induced gyrations, 4.6% is the highest number in the series by far going back to early 2007.  Again, this speaks to persistent inflationary pressures, not transient ones.

But we will know shortly how things turn out, so a quick recap before then shows that equity markets had a good session in Asia (Nikkei +1.3%, Hang Seng +0.55%, Shanghai +0.7%) but are less giddy in Europe (DAX -0.1%, CAC -0.4%, FTSE 100 0.0%).  Meanwhile, US futures are essentially unchanged ahead of the data.

We’ve already discussed the bond market selloff and cannot be surprised that commodity prices are mostly higher led by oil (+0.8%) and NatGas (+0.1%), but also seeing strength in gold (+0.3%).  Industrial metals are having a rougher go of it (Cu -0.3%, Al -0.4%) and Ags are a bit firmer this morning with all three major grains higher by about 0.55%.

As to the dollar, it is mixed this morning ahead of the data with the largest gainer NOK (+0.4%) on the back of oil’s strength, while SEK (+0.3%) is also firmer although with no clear driver other than positioning ahead of the data.  On the downside, JPY (-0.15%) continues under pressure as higher US yields continue to attract Japanese investors.

EMG currencies have seen a more negative session with PLN (-0.6%), TRY (-0.5%) and RUB (-0.5%) all under pressure and the APAC bloc mostly falling, albeit not quite as far.  The zloty story seems to be concerns over a judicial ruling that puts Poland further at odds with the EU which has been sufficient to offset the boost from yesterday’s surprise rate hike.  In Turkey, a story that President Erdogan is “cooling” on his view toward the central bank governor seems to have markets nervous while in Russia, rising inflation and limited central bank response has investors concerned despite oil’s rally.

There are no Fed speakers on the calendar today so it will all be about the NFP number.  Until then, don’t look for much, and afterwards, there is typically a short burst of activity and a slow afternoon.  I don’t think the big trend of dollar strength has ended by any means, but it is not clear today will see much of a gain.

Good luck, good weekend and stay safe
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Prices Ascend

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As energy prices ascend
More problems they seem to portend
Inflation won’t quit
While growth takes a hit
When will this bad dream ever end?

Another day, another new high in the price of oil.  We have now reached price levels not seen in seven years and there is no indication this trend is going to end anytime soon.  Rather, given the supply and demand characteristics in the marketplace, it is not hard to make a case that we will be seeing $100/bbl oil by Q1 2022, if not sooner.  OPEC+ just met and, not surprisingly, decided that they were quite comfortable with rising oil prices thus saw no reason to increase production at this time.  Meanwhile, Western governments continue to do everything in their power to prevent the expansion of energy production, at least the production of fossil fuels.  This combination of policies seems likely to have some serious side effects, especially as we head into winter.

For instance, while I have highlighted the price of energy in Europe and Asia, which remains far higher than in the US, it is worth repeating the story.  Natural gas in Europe is now trading at $37.28/mmBTU, compared with just under $6/mmBTU in the US.  Storage levels are at 74% of capacity which means that any cold snap is going to put serious pressure on the Eurozone economy as NatGas prices will almost certainly rise further in response.  In addition, Europe remains highly dependent on Russia as a supplier which seems to open them to some geopolitical risk.  After all, Vladimir Putin may not be the friendliest supplier in times of crisis.

China, too, is having problems as not only has the price of oil risen sharply, but so, too, has the price of thermal coal (+5.25% today, +200% YTD).  China still burns a significant amount of coal to produce electricity throughout the country with more than 1000 plants still operating and nearly 200 more under construction.  It is this situation which causes many to question President Xi Jinping’s commitment to reining in carbon emissions.  Unsurprisingly, the inherent conflicts in the desire to reduce carbon, thus capping coal production, while trying to generate enough electricity for a growing economy have resulted in the Chinese abandoning the carbon issues.  Last week, Xi ordered coal mines to produce “all they can” rather than adhere to the strict quotas that had been put in place.  Right now, there is a power crisis as utilities have cut back electricity production reducing service to both industrial and residential users.  Again, winter is coming, and insufficient electricity is not going to be acceptable to President Xi.  When push comes to shove, you can be sure that the primary goal is generating enough electricity for the economy not reducing carbon emissions.

Ultimately, this story is set to continue worldwide, with the tension between those focused on economic activity and growth continually at odds with those focused on carbon dioxide.  Until nuclear power is accepted as the only possible way to create stable baseload power with no carbon emissions, nothing in this story will change.  The implication is that energy prices have further, potentially much further, to run given the inelasticity of demand for power in the short-term.  And this matters for all other markets as it will impact both growth and inflation for years to come.

Consider bond markets and interest rates.  While the Fed and other central banks may choose to ignore energy prices in their policy decisions, the market does not ignore rising energy prices.  The ongoing increase in inflation around the world is going to result in higher interest rates around the world.  While central banks may cap the front end, absent YCC, back end yields will rally.  A rising cost of capital is going to have a negative impact on equity markets as well, as both future earnings are likely to suffer and the discount factor for those who still consider DCF models as part of their equity analysis, is going to reduce the current value of those future cash flows.  The dollar, however, seems likely to benefit from rising oil and energy prices, as most energy around the world (in wholesale markets) is priced in USD.  Essentially, people will need to buy dollars to buy oil or gas.  Adding all this up certainly has the appearance of a more substantial risk-off period coming soon.  We shall see.

This morning, however, that is not entirely clear.  While Asian equity markets saw more red than green (Nikkei -2.2%, Sydney -0.4%, Hang Seng +0.3%, Shanghai closed), Europe is feeling positively giddy with gains across the board (DAX +0.35%, CAC +0.8%, FTSE 100 +0.65%) as PMI data showed more winners than losers although it also showed the highest price pressures seen since 2008, pre GFC.  US futures, after markets had a tough day yesterday, are pointing higher at this hour, with all three main indices higher by about 0.35%.

Bond markets are a bit schizophrenic this morning as Treasury (+1.9bps) and Gilt (+2.0bps) yields climb while we see modest declines in Europe (Bunds -0.2bps, OATs -0.3bps).  While yields remain low on a historic basis, and real yields remain extremely negative, it certainly appears that the trend in yields is higher.  There is every possibility that central banks blink when it comes to fighting inflation and ultimately do prevent yields from rising much further, but so far, they have not felt compelled to do so.  This is something we will be watching closely going forward.

Turning to commodities, oil (WTI +1.05%) shows no signs of slowing down.  Nor does NatGas (+3.0%) or coal (+5.25%).  Energy remains in demand.  Precious metals, on the other hand, continue to flounder with both gold (-0.85%) and silver (-0.7%) under pressure.  Copper (-1.75%) too, is feeling it today along with the rest of the industrial metal space save aluminum (+0.6%).  Ags are softer as well.

The dollar, however, is having a much better day, rallying against most of its major counterparts.  For instance, JPY (-0.3%) continues to suffer as the market demonstrates a lack of excitement over the new PM and his team.  Meanwhile, EUR (-0.2%) has reversed its consolidation gains and appears set to resume its recent downtrend.  Technically, the euro looks pretty bad with a move toward 1.12 quite realistic before the end of the year.  AUD (-0.2%) found no support from the RBA’s message last night as they continue to look toward 2024 before interest rates may start to rise.  On the plus side, only NOK (+0.2%) on the back of oil’s gains, and GBP (+0.2%) on the back of a stronger than expected PMI release are in the green.

EMG currencies have also seen many more laggards than gainers led by HUF (-0.5%) and PLN (-0.3%) both high beta plays on the euro, and MXN (-0.2%) and RUB (-0.2%) both of which are somewhat surprising given oil’s continued rise.  The bulk of the APAC currencies also slid, albeit only in the -0.1% to -0.2% range, with several simply adjusting after several days with local markets closed.  ZAR (+0.35%) is the only gainer of note as the Services PMI data printed at a better than expected 50.7.

On the data front, the Trade Balance (exp -$70.8B) and ISM Services (59.9) are on the slate and we hear from Vice-Chair Quarles on LIBOR transition.  In other words, not much of note here.  While I believe oil prices remain the key driver right now, there is certainly some focus turning to Friday’s payroll data as that is the last big data point before the Fed’s November meeting.

The dollar’s trend remains higher and I see no reason for anything to halt that for now.  My take is the modest correction we saw Friday and Monday is all there is for now, and a test of the recent highs is coming soon to a screen near you.

Good luck and stay safe
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