Tag Archives: #china

A Small Crisis Grows

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Investors are starting to feel
That China has lost its appeal
So, capital flees
From all stocks, Chinese
As Xi brings exploiters to heel

While, thus far the impact’s been small
On markets elsewhere, please recall
That history shows
A small crisis grows
Quite quickly with each margin call

Giving credit where it is due, the Chinese have successfully distracted almost every market participant from tomorrow’s FOMC meeting.  The ongoing rout in Chinese equity markets (Shanghai -2.5%, Hang Seng -4.2%) has been fueled by the government’s hardline stance against several different industries that had become investor favorites.  If you think of the progression of events, it began with private financial firms (remember the Ant IPO that was squashed when Jack Ma was disappeared for a while?) and has continued as the evolution of the DC/EP (China’s digital yuan or CBDC) has forced the two big private payment firms, Alipay and WeChat Pay to fall into line and restrict their offerings going forward.

We have also seen the government address concerns over other tech companies and their capitalist intentions and actions, which has taken the form of questions over data security in Didi Global, the ride hailing app, and Meituan, the food service company.  After all, both of these companies are clarion calls for people to be independent, choosing their work schedule and effort, as opposed to toiling for a proper, state-owned firm.  Naturally, this is anathema to President Xi as he continues to remold the nation into his preferred view.

The latest attack has been on the private education industry, which while nominally teaching the approved curriculum, were clearly seen as an impediment to government control, and more importantly, the appropriate spread of communism.  Remember, the CCP rules the roost in China and President Xi is General Secretary of the Chinese Communist Party.  It was certainly dichotomous that an area of such immense social importance, that preached communism, would be offered by capitalist firms.

The takeaway here, though, is not that things are getting tougher for investors in China, but that history has shown that most financial crises start small and gather momentum.  While many of you may not remember the Asia crisis of 1997, it started as an issue solely confined to Thailand and the Thai baht.  Questions over the country’s ability to repay its creditors, especially as its USD reserves had shrunk and the dollar’s rally was becoming a major problem locally.  But Thailand is not a very large country from an economic perspective, and so it was initially thought this would amount to very little.  Within a month or two of the initial concerns, however, the entire region was in turmoil as it turned out virtually none of the countries there had sufficient USD reserves, and all had borrowed heavily in dollars and were having difficulty repaying those loans.  There was a huge swoon in markets, which ultimately led to Russia defaulting on its debt while Long Term Capital, a famed hedge fund of the time, wound up on the brink and was only saved by the Fed forcing the entire Wall Street community to put up money to save it.  (Ironically, Bear Stearns is the one bank that wouldn’t participate in that rescue and we know what happened to them 10 years later!)

Speaking of the GFC, this too, was seen as a minor problem at the start.  As the housing bubble inflated, the working assumption was that the entire national housing market could never fall all at once, so all of those mortgage-backed derivatives were created and sold as low risk, high return investments throughout the world.  When the first concerns were raised, none other than Fed Chair Bernanke explained that “…the troubles in the subprime sector on the broader housing market will likely be limited.”  We know how that worked out and of course, the problems quickly became global in nature and forced the first invocation of a new emergency program known as QE.

One last example of the ability of seemingly distant events to impact the entire global financial structure comes from China in 2015.  That summer, just 6 years ago, the PBOC surprised markets with a mini-devaluation of the yuan, about 2%, as a relief valve for an equity market that had started to come under pressure several months previously.  But once the PBOC acted, risk appetite disappeared and we saw a severe contraction in global equity markets, a huge bond rally and strength in the dollar as the haven of choice.

The point is that while you may consider the fact that the Chinese government is cracking down on companies that it considers to be ideologically impure, and that it will have nothing to do with your investments in the FANGMAN group of stocks, there is every chance that this action serves as the catalyst for, at the very least, a short-term price adjustment in equity indices around the world. After all, China’s growth has been a key pillar of the global growth scenario.  If that is slipping, there are likely to be problems everywhere.  Be warned and wary.

OK, on to today’s activity where the Chinese rout continues to be ignored by Japan (Nikkei +0.5%), but continues to pressure European indices lower (DAX -0.4%, CAC -0.3%, FTSE 100 -0.4%) as well as US futures, all of which are down around -0.2% at this hour.

Bond markets are a bit more uniform this morning, led by Treasury yields (-2.9bps) although European sovereigns have not rallied as much, with most seeing yield declines of roughly 1 basis point.  (As an aside, yesterday’s price action, which saw US equity markets ultimately rebound, saw Treasuries give up their early gains and close with slightly higher yields on the day.)

In the commodity space, oil is essentially unchanged on the day, as is gold, with neither moving even 0.1%.  Copper is the biggest mover, falling 1.0%, although there is lesser weakness in other base metals.  Agricultural products are mixed with both Soybean and Corn higher by 1.0% while Wheat has slipped 0.4%.

As to the dollar, on this broadly risk-off day, it is broadly higher.  In the G10 bloc, the commodity currencies are the worst performers (NZD -0.7%, NOK -0.5%, AUD -0.4%) while the rest of the bloc has seen less pressure.  Naturally, JPY (+0.25%) is bucking the dollar trend in this type of session.  In the emerging markets, ZAR (-0.7%) is the laggard as traders digest the post-riot relief act from the government and give it two thumbs down.  The next biggest loser is CNY (-0.35%), although at this point, I’ve already described the reasons capital is leaving the country.  Otherwise, most of these currencies are lower, but the movement has been on the order of -0.1% to -0.2%, so not very dramatic.  There is one outlier on the plus side, KRW (+0.4%) which seems to have been on the back of exporters selling dollars after yesterday’s won decline to its lowest level in almost a year.  However, if CNY continues to weaken, I believe KRW will ultimately follow it.

On the data front this morning we see Durable Goods (exp 2.2%, 0.8% ex transport) as well as Case Shiller House Prices (16.33%) and Consumer Confidence (123.8).  The real information overload starts tomorrow with the FOMC and on through the rest of the week with Q2 GDP and Core PCE.

The dollar is back in risk mode.  If equities continue to suffer, look for the dollar to remain bid.  If they rebound, the dollar is likely to soften by the end of the day.

Good luck and stay safe
Adf

Time to Flee

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No longer will President Xi
Allow billionaires to run free
His edict last night
Proved his grip is tight
And showed traders t’was time to flee

The biggest story overnight was the continued crackdown by Chinese authorities on any private industry that has developed a measure of power in the Chinese economy.  While the tale of Didi Chuxing, the Chinese Uber, was seen as a warning, apparently, the government is becoming more impatient over the pace of adherence to the new view.  Briefly, Didi went public and then several days later the Chinese government forced them to remove their app from public availability and crushed their business under the pretext of data security.  Didi shares fell sharply.  Last night the government explained that private education companies, which were teaching the CCP curriculum, were to cease being profit-making companies “hijacked by capitalism”, and essentially will be forced to delist.  It can be no surprise that the prices of these shares fell dramatically, in one case by 98/%, as investors flee as quickly as possible.  This resulted in sharp declines across all indices there with the Hang Seng (-4.1%) and Shanghai (-2.35%) and led to a general risk-off tone.

Apparently, President Xi is no longer willing to accept that anybody else in China can have some measure of power or influence beyond his control.  Other changes involve the payment networks Alipay and Wechat, which are on the verge of being subsumed by China’s upcoming CBDC, the e-yuan.  Exclusive rights for things like music licenses are being removed and essentially, it appears that capitalism with Chinese characteristics is morphing into a full-blown state-owned economy.  We cannot be too surprised by this; after all, Xi Jinping has been ruling with an increasingly tighter grip on all segments of the economy and he is a clear adherent to strict communism.  Remember, the definition of communism is that all property is publicly (read government) owned.  We have not seen the last of this process so be careful going forward.

The ECB told us that they
Would no longer stand in the way
Of prices that rise
Until they surmise
That growth has made major headway

Now later this week from the Fed
Some pundits think, shortly ahead,
They’ll slow down their buying
Of bonds, as they’re trying,
To counter, inflation, widespread

Inflation (whether CPI or PCE), is a price series that demonstrates characteristics similar to every other price series like stocks or bonds or currencies.  There are trend movements, there are overshoots in both directions that tend to correct and there are periods of consolidation.  One of the best definitions of a trend is a series that makes either higher lows and higher highs, or conversely, lower highs and lower lows.  In other words, something that is trending higher will typically trade to a new high level and then after a period, pull back somewhat, a normal correction, before moving on to further new highs.  When the uptrend is in force, each high is higher than the last, and, more importantly, each low is higher than the last.  I make this point because I am concerned that when looking at the backgrounds of all the FOMC members, not one of them has any trading history.

This is important because, my sense on the inflation story is that it is quite realistic that we see a slowdown in price growth in the next several months, where 5.4% headline CPI falls to 4.8% and 4.5% and so forth, as this price series goes through a correction just like the stock, bond and currency markets.  Of course, if this is what we see, it is almost guaranteed that Chairman Powell, and his band of merry men (and women) will be all over the tape crowing over the transitory nature of inflation.

Alas, my concern is that given what I believe is a strong uptrend in inflation, this retracement in CPI (and PCE) will stop at a higher level than the previous lows and set itself up for another, more powerful move higher.  In the meantime, the Fed will have waved away any concerns over inflation as they continue to pump unlimited liquidity into the system to run the economy as hot as possible.  After all, in their collective mind, they will have proven inflation is transitory.  However, the next leg higher in CPI and PCE is liable to be far more severe, occurring far more quickly than the Fed expects, and lead to a more permanent unanchoring of inflation expectations.

It will also put the Fed in an even tighter bind than they currently find themselves.  This is because if CPI prints 6%, or 7% or more, the market is far less likely to accept their jawboning as a reason to maintain low yields and high stock prices.  Rather, they will be forced to decide between addressing inflation, which means raising interest rates sharply and significantly impacting, in a very negative way, the real economy, as well as asset markets; or they will have to come up with some other way to measure inflation such that it is not rising at such a ferocious clip but is still seen as credible.  One of their dilemmas is that, politically, inflation is already becoming a problem for the Biden administration, and that is at 5%.  Be prepared for the Misery Index (a Ronald Reagan invention that was the sum of CPI and the Unemployment Rate) to become a popular meme from all of President Biden’s opponents going forward.

Oh yeah, if you think that letting inflation run hot like that is going to goose equity market returns, especially when starting from such incredibly steep valuations, you would be wrong.  History shows that when inflation rises above 5%, equity markets do not provide any type of real hedge.  Let me be clear that this is not going to play out by autumn 2021, but could very well be the case come summer or autumn 2022, a particularly difficult time for the incumbent party in Washington as mid-term elections will be upcoming and the party in power tends to get the blame for economic problems.

What about the dollar you may ask?  In this scenario, the dollar is very likely to suffer greatly, so keep that in mind as you look ahead to your hedging needs for next year and beyond.

In the meantime, the Chinese inspired sell-off has led to some risk concerns, but not (yet) a widespread sell-off.  For instance, the Nikkei (+1.0%) managed to rally in the face of the Chinese equity market declines although, outside Japan, the screens are basically all red in Asia.  European bourses are somewhat lower (DAX -0.4%, CAC -0.25%, FTSE 100 -0.25%) as they respond to the general negative tone in risk as well as a much weaker than expected German IFO reading of 101.2, well down from last month’s reading.  However, these levels are well off the session lows, as are US futures, which are down on the order of -0.25%, although were much lower earlier.

Bond markets are a little more mixed as Treasury yields fall 3.2bps (taking real yields to historic lows of -1.12%) but European sovereigns are more mixed with Bunds unchanged and OATs (+0.8bps) and Gilts (-0.8bps) not giving us any direction.

Commodity prices are mostly lower led by oil (-0.8%), although gold (+0.3%) is showing some positive haven characteristics.  Clearly, declining real yields are also supporting the precious metals.  Foodstuffs are softer (about which everyone except farmers are happy) and base metals are mixed with copper (+1.35%) leading the way higher although both Al (-0.4%) and Sn (-0.3%) are under pressure.

Finally, the dollar is not exhibiting its ordinary risk-off attitude this morning, as it is broadly softer vs. its G10 counterparts with only AUD (-0.1%) down on the day, arguably given concerns of changes with the Chinese economy.  But the rest of the bloc is marginally higher as I type led by SEK (+0.35%) and GBP (+0.3%), both of which are seeming to respond to reopening economies.

In the EMG space, however, there are many more decliners than gainers, led by RUB (-0.45%) on the back of oil’s weakness, but also KRW (-0.4%) which is feeling the pinch of the change in tone from China.  This story is going to be the second biggest driver, after the Fed, for a while, I think.

Of course, this week brings the FOMC meeting, but also Q2 GDP and Core PCE, so there is much to look forward to here.

Today New Home Sales 800K
Tuesday Durable Goods 2.0%
-ex Transport 0.8%
Case Shiller Home Prices 16.2%
Consumer Confidence 124.0
Wednesday FOMC Rate Decision 0.00% – 0.25%
IOER 0.15%
Thursday Q2GDP 8.5%
Initial Claims 380K
Continuing Claims 3192K
Friday Personal Income -0.4%
Personal Spending 0.7%
Core PCE 0.6% (3.7% Y/Y)
Chicago PMI 63.3
Michigan Sentiment 80.8

Source: Bloomberg

Obviously, the Fed is the big story as the data that comes before will not be seen as critical.  The GDP print will be quite interesting, but it is widely accepted that this is the peak and we will be slowing down from here.  However, Friday’s Core PCE number will really be scrutinized as another high print will make Powell’s task that much harder with respect to convincing people that inflation is transitory, especially if their favorite indicator keeps running higher.  Ultimately, I expect we will see a short-term retracement on the rate of inflation before the next leg up and that is the one about which we should all be concerned.

As to today’s market, if equity markets manage to shake off their concerns over Chinese activities, the dollar seems likely to continue with today’s soft tone.  If not, though, look for a rebound.

Good luck and stay safe
Adf

Do Not Be Afraid

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Said Jay, “you must listen to me”

And not to the numbers you see

Do not be afraid

Inflation will fade

So, keep up the stock buying spree!

Last week’s FOMC meeting seems to have been an inflection point in the recent market narrative which has resulted in a great many conflicting thoughts about the future.  The dichotomy of the meeting was the virtual absence of discussion on current high inflation readings juxtaposed with the Dot Plot forecasts on interest rates rising in 2023.  Arguably, the Dot Plot reflects the participants’ growing concern that inflation is rising, and that the FOMC will need to address that situation.  One could argue that this dichotomy has been the underlying cause for the increased volatility evident in markets, with sharp gains and losses seen across bonds, equities and currencies.

This afternoon, Chairman Powell will once again regale us with his views as he testifies before the House Select Subcommittee on the Coronavirus Crisis.  His prepared testimony was released yesterday afternoon with some key comments.  “Inflation has increased notably in recent months.  As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”  That pretty much sums up the Fed view and confirms that there is very little concern about inflation over time.  

Yesterday we also heard from three other Fed speakers, NY’s Williams, Dallas’ Kaplan and St Louis’ Bullard, with slightly different messages.  Williams, a permanent voter, remains adamant that it is too soon to consider adjusting policy, although he is willing to discuss the idea of tapering.  Meanwhile, both Kaplan and Bullard, both non-voters, are far more interested in getting the tapering talk off the ground as both see the economy picking up pace and have evidenced concern about overheating areas in the economy.  One can surmise from these comments that both of them are amongst the ‘dots’ above 1.0% for 2023.  In fact, Bullard admitted that he was a 0.6% ‘dot’ for 2022 in comments last week.  

Looking ahead, we have a long list of Fed speakers this week, with Mester, a hawkish non-voter, and Daly, a dovish voter, also set to comment today.  It almost appears as though voting members have been given a set of marching (speaking?) orders to which they are to adhere that express no concern over prices and the need to continue with current policy for the foreseeable future, while non-voting members have no such restrictions.  This is a very different dynamic than what we have become used to seeing, where everybody on the committee was saying the same thing.  Perhaps this is Powell’s solution to being able to maintain the policy he wants while having the Fed overall avoid criticism for groupthink.  But groupthink remains the base case, trust me.

During this period of policy adjustments, or at least narrative adjustments, investors have found themselves without their previous strong signals that all asset prices will rise and that havens serve little purpose.  Instead, we have seen a much choppier market in both stock and bond prices as previously long-held convictions have come into question. The most notable change has been in the shape of the yield curve, which has flattened dramatically.  For instance, the 2yr-10-yr spread, which had reached a high above 160 basis points in early April has seen a decline from 137 to below 110 and a rebound back to 122 in the past three sessions.  Other than March 2020, during the initial Covid confusion, there has not been movement of that nature since President Trump was elected in 2016.  And that was a one-day phenomenon.  At this point, the volatility we are experiencing is likely to continue until a new narrative takes hold.  As to today’s session, so far, we are seeing a modest bond rally with yields softer in Treasuries (-1.7bps after a 5bp rally yesterday) and European sovereigns (Bunds -0.4bps, OATs -1.4bps, Gilts -0.5bps) all slightly firmer on the day.  

Meanwhile, equity markets are also somewhat confused.  Last night, for instance, the Nikkei (+3.1%) rebounded sharply after the BOJ explained they had restarted their ETF buying program on Monday, so all was right with the world.  The Hang Seng (-0.6%) didn’t get that message but Shanghai (+0.8%) did despite rising short-term interest rates in China.  Those climbing rates appear to be a function of quarter end demand for bank funding that is not being supplied by the PBOC.  My sense is once July comes those rates will drift back down.  Europe, has had a more mixed equity session after a nice rally yesterday, with both the DAX and CAC flat on the day and the FTSE 100 (+0.3%) rising a bit, but weakness in the peripheral markets of Spain and Italy, with both of those lower by about 0.5%.  US futures are virtually unchanged at this hour as market participants seem to be awaiting Mr Powell.

Commodity markets are following suit, with some gainers (Au +0.2%, Ag +0.2%, Al +0.1%), some losers (WTI -0.7%, Soybeans -0.7% and Fe -3.2%) and many with little overall movement.  In a market that has lost its direction with respect to both growth and inflation expectations, or at least one which is re-evaluating those expectations, it should be no surprise there is a hodgepodge of price movements.

The dollar, however, is broadly firmer on the day, with GBP (-0.35%) the weakest performer in the G10 as traders await Thursday’s BOE meeting and their latest discussion on the inflation situation in the UK.  This will be BOE Chief Economist Andy Haldane’s last meeting, and he is expected to make some hawkish noises, but thus far, the rest of the committee has not been aligned with him.  Right now, the market is not looking for him to receive any support, hence the pound’s ongoing weakness, but if we do hear some hawkishness from another member or two, do not be surprised if the pound jumps back up.  As to the rest of the G10, losses range from 0.1%-0.25% and are all a reflection of the dollar’s strength, rather than any idiosyncratic stories here.  

Emerging market currencies are also broadly softer this morning, with a mix of laggards across all three blocs.  HUF (-0.5%), ZAR (-0.5%, THB (-0.45%) and MXN (-0.35%) reflect that this is a dollar and Fed story, not an EMG one.  The one exception to this rule is TRY (+1.0%) as hopes for an early lifting of Covid restrictions and a modest rise in Consumer Confidence there has underpinned the lira.

On the data front, we see Existing Home Sales (exp 5.72M) this morning at 10:00, but that seems unlikely to excite the market.  Rather, I expect limited movement until Chairman Powell speaks this afternoon.  

For now, volatility is likely to be the norm as the market adjusts to whatever the new narrative eventually becomes.  The inflation debate continues to rage and when Core PCE is released later this week, there will be more commentary.  However, it will require high inflation readings into the autumn to change the Fed’s stance, in my view, and until then, the idea that the Fed is considering tighter policy is likely to support the dollar for now.  However, that doesn’t mean further strength necessarily, just not any real weakness.

Good luck and stay safe

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Getting Upset

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The Chinese are getting upset

Commodity prices, as yet

Continue to rise

As shrinking supplies

Now pose, to their model, a threat

So, naturally, what did they do?

They ordered state firms to eschew

Stockpiling provisions

As now all decisions

Will come from Beijing ‘pon review

With the FOMC meeting on virtually everyone’s mind this morning, market activity overall has been muted.  However, the one place in the world that doesn’t revolve around the Fed is China, and news from there last night is quite interesting.  You may recall my quick story about the Department of Price two weeks’ ago and how that ‘august’ institution warned commodity hoarders and speculators to stop what they were doing.  Well, apparently, not enough people listened to those warnings as last night two more Orwellian entities in China joined the conversation regarding commodity prices.  The State-owned Assets Supervision and Administration Commission (SASAC) ordered companies under its purview, the SOE’s, to “control risks and limit their exposure to overseas commodities markets”.  This was clearly the stick to accompany the carrot dangled by the National Food and Strategic Reserves Administration, which has indicated it will soon release state stockpiles of copper, aluminum and zinc amongst other metals.

It is obvious that China has figured out that rising commodity prices may soon start to pass through from the factory to the consumer and drive CPI higher on the mainland.  President Xi is clearly concerned that rising prices could lead to some political unrest given that the bargain he has made with his citizens is to enhance their lives economically so he can control all the levers of power.  Thus, if inflation starts to rise more seriously, the population may call his leadership into question.

The problem for China, however, is that while in the past, they had been the marginal buyer of virtually all commodities as they grew their economic capacity dramatically, that situation no longer holds.  Yes, they still have an impact, but in this post-Covid environment where the rest of the world is rebounding very quickly, demand for commodities outside of China is growing rapidly.  But perhaps more importantly, because the previous decade saw commodity prices lag financial prices, investment in the sector was greatly reduced.  This has led to reduced supplies of many critical things and now that demand is resurgent, not surprisingly the prices of copper, steel and other commodities have been rising rapidly even if China isn’t buying as much as they used to.

Adding to this dynamic is the great conundrum of ESG.  On the one hand, ESG’s goals are to reduce environmental impact of economic activity which has largely played out as trying to substitute electricity for fossil fuels as a power source.  On the other hand, in order to electrify economies, the amount of metals like steel and copper required to achieve the stated goals is dramatically higher than the current model.  So, reducing investment in commodity producers results in much higher prices for the very commodities needed to achieve ESG goals in the long run.  While this is not the only argument to rebut the Fed’s transitory inflation story, it is an important part of the inflationists’ views.  China’s actions will only have a very temporary impact on the prices of the commodities in question, but the long-term demand is here to stay.  Until investment in extraction of commodities increases sufficiently to bring more capacity online, odds are that commodity prices will continue to rise, whether Xi Jinping likes it or not.  And if input prices continue to rise, at some point soon, so will prices of end products.  We have been witnessing the beginnings of that trend, but I fear it has much further to go.

Interestingly, despite all the sturm und drang in Beijing about metals prices, after a sharp decline yesterday, this morning they are edging higher (Cu +0.2%, Al +0.1%, Fe +0.5%, Steel +2.8%) although not nearly reversing yesterday’s moves.  If you ever wanted proof that China no longer calls the shots in commodities, here is exhibit A.

Today Chairman Jay will expound

On growth and its stunning rebound

But do not expect

That he will project

Some changes will shortly gain ground

The other story today, really the biggest for our session, is the FOMC meeting.  Broadly speaking, expectations are that the Fed will not make any policy changes of note, although there will clearly be some tweaking to the statement.  They cannot ignore the 5.0% CPI reading, I think, and they will certainly focus on the idea that the employment situation isn’t improving as rapidly as they would like.  And ultimately, for now, it is the latter issue that will continue to inform policy choices.  So tapering is not going to be on the menu, and when Powell is asked in the press conference, as he surely will be, I expect a response along the lines of, substantial further progress needs to be made before they will change things.

If I were to assess the risks, it feels like there is more risk of a hawkish outcome than a dovish one as the inflation story will not go away.  But that implies to me that the market is according a hawkish twist some real probability, so the big surprise to markets would be if they were excessively dovish.  However, I think Powell will do everything he can to be as nondescript as possible, stay on message and there will be very little movement.

A brief recap of markets overnight shows that Asian equities suffered, led by Shanghai (-1.1%).  Not only are they dealing with rising commodity prices, but the data released (Retail Sales, IP and Fixed Asset Investment) all disappointed vs. expectations.  China’s negativity bled into the Nikkei (-0.5%) and Hang Seng (-0.7%) as well.  Europe, on the other hand, has gone nowhere ahead of the Fed, with virtually every equity index within 0.1% of yesterday’s closes.  It should be no surprise that US futures markets are also essentially unchanged ahead of the Fed.

As to the bond market, we are beginning to see a touch of strength with yields declining ever so slightly.  Treasuries are lower by 0.5bps, while Bunds (-1.1bps), OATs (-0.9bps) and Gilts (-0.7bps) are also performing reasonably well ahead of this afternoon’s announcements.  It remains remarkable to me that with inflation rising universally, bond yields continue to ignore the situation.  One has to give credit to the central banks for selling their transitory story.

In the FX markets, the picture is mixed with gainers and losers evenly split in the G10.  AUD and NZD (+0.3% each) lead the way higher, although there does not appear to be a clear catalyst implying this is a positioning issue.  GBP (+0.25%) has gained on the back of slightly higher than expected CPI readings (2.1% vs. 1.9% expected), as traders look for more concrete tightening of policy there.  On the downside, both NOK and SEK have fallen by 0.35%, despite oil’s modest gains and a lack of other news.  Again, this feels more technical than fundamental.

EMG currencies are also little changed overall, with a touch of weakness seen in the APAC bloc overnight, but only on the order of -0.1%, while RUB (+0.3%) and MXN (+0.25%) are the leaders, clearly helped by oil’s ongoing gains, but also seeming to benefit from some political stories.

Data this morning bring Housing Starts (exp 1630K) and Building Permits (1730K), but they will not be noticed with the Fed story coming later this afternoon.  Yesterday’s data was mixed at best with Retail Sales disappointing for May but seeing large positive revisions in April to offset, while PPI once again printed at much higher than expected levels (6.6%).  But let’s face it, today is Fed day and we are unlikely to see much movement until at least 2:00 when the statement is released if not until 2:30 when Chairman Powell starts to speak.  At this time, any hawkishness is very likely to support the dollar with the opposite true as well, a dovish tilt will lead to a dollar decline.

Good luck and stay safe

Adf

No Yang, Only Yin

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According to every newspaper

The Fed’s getting ready to taper

With late Twenty-two

The popular view

Of when, QE, they will escape(r)

But what if, before they begin

To taper, to Powell’s chagrin

The bond market tanks

As traders and banks

Believe there’s no yang, only yin

The Fed begins its two-day meeting this morning and the outcome remains the primary topic of conversation within every financial market.  The growing consensus is that there will be some discussion in the meeting of when the Fed should begin to reduce their QE purchases as well as what form that should take.  Given the extraordinary heat in the housing market, there have been numerous calls for the Fed to stop buying mortgage-backed securities first as that market hardly needs any more support.  In the end, however, the details of how they choose to adjust policy matters less than the fact that they are choosing to do so at all.

As pointed out yesterday, the bond market’s rally thus far in Q2 appears to be far more related to the lack of new Treasury supply than increasing demand and declining concerns over future inflation.  If that view is correct, then discussing the timing of tapering QE will seem quite premature.  It is true Treasury Secretary Yellen said that higher interest rates would be a good thing, but it seems highly likely she was not thinking of 10-year yields at 3.0% or more, rather somewhere just south of 2.0%.  In other words, a modest increase from current levels.  History, however, shows that markets rarely correct in a modest manner, rather they tend to move to extremes before retracing to a new equilibrium.  Thus, even if 2.0% is a new equilibrium (and I don’t believe that will be the case) do not be surprised to see yields significantly higher first.

In this view, the impact on markets worldwide is likely to be significant.  It seems unlikely that equity markets anywhere will respond positively to higher interest rates at all, let alone sharply higher rates.  As well, bond markets will, by definition, have been falling rapidly with much higher yields, not just in the US but elsewhere as well.  As to the dollar, it would seem that it will also be a big beneficiary of higher US yields, arguably with USDJPY the most impacted.  A quick look at recent correlations between different currencies and US 10-year yields shows the yen is the only major currency that has a significant correlation to yields (0.46).  But I would not discount the idea that the dollar will rally versus pretty much the rest of the G10 as well as the EMG bloc in a situation where dollar yields are rising sharply.  Consider that in this situation, we will likely be looking at a classic risk-off scenario when the dollar tends to perform best.

Of course, there are many in the camp who believe that the central banking community will remain in control of markets and that inflation is transitory thus allowing them to adjust policy at their preferred pace.  It is this scenario that Ms Yellen clearly is expecting, or at least describing in her desire for higher yields.

And this is the crux of the market’s future decisions; will central banks be able to slowly reduce monetary accommodation as economies around the world slowly return to pre-pandemic levels of activity, or will the dramatic increase in government debt issuance force central banks to maintain their QE programs in order to prevent the economic chaos that could result from sharply higher interest rates?  While my money is on the latter, it remains too soon to determine which broad outcome will occur.  It is also not clear to me that tomorrow’s FOMC announcement is going to be that big a deal in the long run, as it seems doubtful there will be any actual policy changes, even if they begin to discuss how they might do so in the future.  Remember, talk is cheap, even central bank forward guidance!

Markets remain in a holding pattern ahead of tomorrow’s FOMC statement and Powell’s press conference, although there have been some idiosyncratic moves overnight.  For instance, while Japanese equity markets continue to rally (Nikkei +1.0%) on the back of optimism regarding the Olympics and the idea that Covid inspired lockdowns will be ending soon, the same was not true in China where the Hang Seng (-0.7%) and Shanghai (-0.9%) markets both suffered after the PBOC failed to inject any additional liquidity into the money markets there.  With quarter-end approaching, demand for funds by financial institutions is rising and the fact that the PBOC continues to be somewhat parsimonious has been a key support for the renminbi, but not really helped the equity markets there.  Remember, China is quite concerned over what had been a growing housing bubble, and this is designed to help restrict the growth of that situation.

European equity markets are somewhat mixed this morning as the major indices have performed well (DAX +0.5%, CAC +0.4%, FTSE 100 +0.3%) but both Italy (-0.2%) and Spain (-0.5%) are lagging on the day.  The data of note has been CPI which showed that Germany (+2.5%) continues to feel the most inflationary pressure, while both France (+1.8%) and Italy (+1.2%) remain unable to find much inflationary impulse at all.  This is certainly a far cry from the situation here in the US and speaks to the idea that the ECB is not likely to begin tapering anytime soon.  In fact, it would not be surprising if they wind up either extending PEPP or expanding the original QE known as APP.  US futures, meanwhile, are little changed at this hour after yesterday’s mixed session.

Global bond markets are on hold this morning with none of the major nations seeing movement of even 1 basis point, despite yesterday’s Treasury sell-off raising 10-year yields by nearly 6 bps.  That movement has been described as technical in nature given the complete lack of new information seen.

On the commodity front, oil (WTI +0.8%) continues to power higher driving the entire energy complex in that direction but the rest of the space has seen quite a different outcome.  Precious metals (Au -0.2%, Ag -0.8%) continue their recent weak performance while industrial metals (Cu -3.5%, Al -1.3%, Sn -2.1%) have been absolutely crushed.  Agricultural products are mostly softer on the weather story, although soybeans is bucking that trend with a modest gain on the day.

As to the FX market, the dollar is mixed in both G10 and EMG blocs.  In the G10, AUD (-0.2%) has suffered on the back of dovish RBA Minutes released last night as they indicated it was premature to discuss tapering.  CAD (-0.3%) appears to be suffering on the back of the base metals decline and the pound (-0.25%) is on its back foot after slightly disappointing employment data.  Interestingly, NOK is unchanged on the day despite oil’s rally and CHF’s 0.1% gain, which leads the pack appears to be technical in nature.

In the EMG bloc, TRY (-1.3%) is suffering after the US-Turkey meeting at the G7 meetings was less fruitful than hoped with no breakthroughs achieved.  HUF (-0.7%) is declining after conflicting statements from a central bank member regarding a short-term liquidity facility has traders uncertain if policy accommodation is going to be ended soon or not.  Remember, uncertainty breeds contempt in markets.  Away from those two, however, the rest of the block saw very small movements with no significant stories.

On the data front, we get two important pieces this morning; Retail sales (exp -0.7%, +0.4% ex autos) and PPI (6.2%, 4.8% ex food & energy).  In addition, at 8:30 we see Empire Manufacturing (22.7) and then later we see IP (0.7%) and Capacity Utilization (75.1%).  Retail Sales is likely to dominate the discussion unless PPI is really high, above 7.0%.  But in the end, markets continue to wait for tomorrow’s FOMC, so large movement still seems unlikely today.  That said, if we do see Treasury yields creeping higher, I expect the dollar to perform pretty well.

Good luck and stay safe

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How Long Can They Wait?

Posted on by 
While prices worldwide are all rising
Most central banks keep emphasizing
That they have no fear
And later this year
Their efforts will be stabilizing

But every time data’s released
It seems that inflation’s increased
How long can they wait
Ere they contemplate
It’s time QE should be deceased?

It has been another extremely dull day in financial markets as participants await the next catalyst, arguably coming tomorrow in the form of either a surprise from the ECB, a low probability event, or a surprise from the US CPI release, a higher probability event.  And yet, even if CPI surprises, will it really have much market impact?

For inspiration on the potential impact of a surprising outcome, let us quickly turn to China, where last night inflation data was released with PPI rising 9.0% Y/Y, its highest print since 2008, although CPI rose a less than expected 1.3%.  However, for the world overall, Chinese PPI is of much greater importance as it offers clues to what Chinese manufacturers may be charging for the many goods they sell elsewhere in the world.  If they start raising prices, you can be sure that prices elsewhere will be rising as well.  But the market response to this much higher than expected result was a collective yawn.  Chinese bond yields actually fell 1 basis point while the renminbi slipped 0.2%.  Chinese equities rose 0.3% in Shanghai to complete the triumvirate of markets demonstrating no concern over rising prices.

Is that what we can expect if tomorrow’s CPI data prints at a higher than expected number, perhaps even above 5.0%?  The first thing to note is that the Treasury market is certainly not demonstrating concern, at least in the classical sense of selling off into a rising inflationary situation.  In fact, yields are now back to their lowest level, 1.50%, since early March, the period during which yields were rising rapidly and eventually touched the early-April highs of 1.75%.  But here we are 25 basis points lower and the market seems to have completely bought into the Fed narrative of transitory inflation.  (As an aside, perhaps someone can explain to me why, if inflation is transitory and the Fed need not respond to the recent rises, there is a growing consensus that the Fed is going to start to taper QE purchases.  After all, the implication of transitory inflation is that current policy is fine as is, why change it and rock the boat?)

Another story that has been getting increasing play is about the growing short positions in Treasury bonds and how regardless of tomorrow’s data, we could see a short squeeze and lower yields.  Now, when I look at the CFTC data, I do see that last week open positions fell by nearly 50K contracts, but the overall outstanding position remains net long ~55K and there has been no discernible pattern of building short positions, so I’m not sure where that story has come from.  

So, when considering what we know about the current situation, near-term inflation pressures but central bank certitude it is transitory and recent price action indicating limited concern over inflation, it tells me that a high CPI print, currently forecast at 4.7%, will have no impact of note on the bond market.  As such, it seems unlikely that a high CPI print will have much impact on any market.  We will need to see a series of high prints, and they will need to continue at least through October or November before, it seems, anybody is going to believe that inflation may be more than a transitory phenomenon.  Unfortunately, we will all suffer equally due to the fact that prices are going to continue to rise, regardless of what the Fed or BLS tells us.

Turning to today’s session, price action has been generally similar to yesterday’s session, which means that there have been continued small movements in markets with strong trends difficult to identify.  For instance, equity markets overnight showed the Nikkei (-0.3%) and Hang Seng (-0.1%) both slipping a bit while Shanghai (+0.3%) managed to eke out a gain.  Hardly conclusive evidence of a theme.  Europe, however, is a bit softer, with the DAX (-0.5%) and FTSE 100 (-0.6%) both under a bit of pressure although the CAC (0.0%) has gone nowhere at all.  The German story is one of weaker than expected data, this time a smaller trade surplus with declines of both imports and exports indicating growth there is not quite so robust.  Meanwhile, Brexit issues between the EU and UK have arisen again over Northern Ireland, and this seems to be weighing on sentiment there.  As to US futures markets, they are very little changed at this hour.

Bond markets are clearly not concerned over inflation with Treasury yields down 2.7 basis points and similar declines in Europe (Bunds -2.6bps, OATs -3.0bps, Gilts -2.0bps).  Looking further afield, Italian BTPs have seen yields decline by 5 basis points with Spain and Portugal both falling 4bps or more.  It seems clear the market believes the ECB is going to continue to actively support the European government bond market.

On the commodity front, oil continues to rally with WTI (+0.4%) back over $70/bbl.  Something to consider regarding oil is that as ESG initiatives continue to grow in importance, and many of them are attacking the fossil fuel industry, seeking to prevent funding, there will be less and less exploration for and drilling of new oil sources.  But the transition to eliminating fossil fuels from the economy will take many years, (I’ve seen credible estimates of 30-50 years) meaning demand will not disappear, even if supply shrinks.  It seems pretty clear what will happen to the price of oil in this situation.  Do not be surprised if the previous high of $147/bbl is eclipsed in the coming years.

As to the rest of the commodity space, precious metals are a bit softer while base metals are more mixed today (Cu -0.9%, Al -0.15%, Ni +0.3%).  And finally, the grains are giving back some of their recent gains with all three down about 1.0%.

Finally, in FX, the dollar is broadly softer, but the movement has been very modest.  In G10 space, NOK (+0.3%) is the leader along side CAD (+0.3%) as they both follow oil’s rise.  After that, though, the movement is between 0.0% and 0.2%, with no stories to discuss.  In the Emerging Markets, HUF (+0.6%) is the big winner, as CPI continues to print above 5.0% and the central bank is tipped to raise rates at its meeting tomorrow.  But aside from that, there are more winners than losers although they are all just modest gains on the order of 0.1%-0.2%.  Weakness was seen in some APAC currencies overnight, but that, too, was very modest.

There is no important data to be released today, nor are there any Fed speakers, so my take is the market will continue to trade on the back of the Treasury market movement.  If yields continue to slide, look for the dollar to stay under some pressure.  If they reverse, I think the dollar will as well.

Good luck and stay safe
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Crucial Advice

Posted on by

The Chinese Department of Price

Is proffering crucial advice

Don’t think about hoarding

It won’t be rewarding

And don’t make us speak to you twice!

There really is such a thing as the Department of Price in China.  It is part of the National Development and Reform Commission, the Chinese economic planning agency, although I have to admit it sounds more like something from Atlas Shrugged than a real agency.  But soaring commodity prices during the past year have become quite the problem for China, resulting in rising inflation and shortages of inputs for their manufacturers.  Apparently, President Xi is not pleased with this result and so this obscure (absurd?) government agency is now tasked with preventing prices from rising across a range of commodities.  Their tactics include threats against buyers deemed to be hoarding, against speculators in commodity trading firms and against manufacturers for passing on rising input costs to their final customers.  While one cannot help but chuckle at the futility of this effort (prices of things in demand will rise or shortages will result) it also highlights just how much of a concern inflation is to the Chinese and helps explain the recent PBOC action regarding FX reserves in order to stop/reverse the renminbi’s recent strength.  While a stronger renminbi would help ease inflationary pressures, its impact on exports, especially with input prices rising, was just too much to take.  For the foreseeable future, you can expect USDCNY to rise in a slow and steady manner.

Along with the FOMC

Investors are anxious to see

The payroll release

With forecast increase

To offset last month’s perigee

Turning to today’s news, markets remain quiet and rangebound ahead of this morning’s NFP report.  Last month’s abysmal outcome, just 266K new jobs, hugely below the nearly one million expected has increased the concern today.  While yesterday’s ADP Employment report was spectacular at 978K, last month it was nearly 750K and we still got that huge surprise.  Estimates this morning range from 335K to 1000K which tells us that nobody really knows, and none of the econometric models out there are well tuned to the current economic circumstances.  Here are the current median forecasts according to Bloomberg:

Nonfarm Payrolls 674K
Private Payrolls 610K
Manufacturing Payrolls 25K
Unemployment Rate 5.9%
Average Hourly Earnings 0.2% (1.6% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.8%
Factory Orders -0.3%

Following yesterday’s ADP report, the dollar, which had been drifting higher, got a huge boost and rallied strongly versus all its counterparts.  In addition, we saw sharp declines in precious metals prices and more modest declines in bond prices (yields on the 10-year rose about 4bps).  Arguably, that is exactly what one would expect with news that the US economy is growing more rapidly than previously thought.  But that begs the question for today, has the market already priced in a much larger number and so become subject to some serious profit-taking on a ‘sell the news’ meme?  My sense is that we will need to see a very large number, something on the order of 1.3 million to continue yesterday’s price action in markets.  Anything less, even if above the median forecast, will likely be seen as toppish and given it is a summer Friday, traders will be quick to square up positions.

Obviously, the FOMC is watching this data closely.  Recall, their stated goal is maximum employment and they continue to harp on the 8.1 million jobs that have not yet been replaced due to the Covid shutdown as well as the 2 million jobs that would have otherwise been created based on trend growth prior to the shutdown.  The point is that, given the transitory inflation pressures theme that has been universally repeated by every FOMC member, the Fed seems very likely to maintain the current policy settings for a while yet.  So, while today’s number is important for the market’s understanding of the current situation, I don’t believe there is any number that will change Fed policy.  At least no large number.  On the flipside, a second consecutive weak number might just encourage discussion that the current QE is not sufficient.  It will certainly raise eyebrows and cause a great deal of angst at the next FOMC meeting in two weeks’ time.

At this point, however, there is nothing we can do but wait.  A recap of the overnight activity shows that equity markets had minimal movements with no major index moving more than 0.4% (Nikkei -0.4%) and US futures essentially unchanged at this time.  Bond markets are exhibiting the same lack of direction, with movements less than 1 basis point ahead of the release across Treasuries and European sovereigns.  Commodity prices, after yesterday’s spectacular declines in the precious metals of more than 2%, have stabilized with oil drifting slightly higher (WTI +0.3%), and metals and agricultural prices either side of unchanged.

Finally, the dollar has also been ranging with no G10 currency having moved more than 0.2% from yesterday’s closing level and an even spread of gainers and losers.  In other words, everyone is biding their time here.  EMG currencies have displayed a bit more weakness, but much of that is due to last night’s APAC session where most currencies fell in response to the ADP number, just like everything else did during yesterday’s NY session.  Looking at the EEMEA currencies, only PLN (-0.4%) is showing any type of noteworthy movement and that mostly appears to be a reaction to the fact it has been amongst the best performers over the past month, having gained more than 3.0%, and so is subject to more profit-taking.  In other words, every market is simply biding its time ahead of the release.

Away from the payroll report, Chairman Powell does speak this morning, but the focus is on climate change, not monetary policy, so it seems unlikely we will learn very much.  And after this, the Fed is in its quiet period ahead of the meeting, so we are left to our own devices to determine what will happen.

My sense is we will see a strong showing today, maybe 750K as well as a revision up to last month’s data, which was abnormally weak given other indicators, but I am hard pressed to see the dollar repeat yesterday’s gains.  Rather, consolidation into the weekend seems the most likely outcome.

Good luck, good weekend and stay safe

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Quite Premature

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In Europe, to pundits’ surprise

The rate of inflation did rise

The ECB’s sure

It’s quite premature

To think prices will reach new highs

Meanwhile at the PBOC

They altered FX policy

Banks there must now hold

More money, we’re told

Preventing the yuan to run free

Two big stories presented themselves since we last observed markets before the Memorial Day holiday in the States; a policy change by the PBOC raising FX reserve requirements in order to encourage less renminbi buying dollar selling, and the release of Eurozone CPI showing that rising demand into supply bottlenecks does, in fact, lead to rising prices.  In line with the second story, let us not forget that Friday’s core PCE reading of 3.1%, was not only higher than anticipated but reinforced the idea that inflation is rising more rapidly than central bankers would have you believe.

But let’s start with China, where the renminbi has been appreciating very steadily since last May, rising more than 11% in that time.  initially, this was not seen as a concern as the starting point for USDCNY was well above 7.0, which is a level that had widely been seen as concerning for the PBOC with respect to excessive weakness.  But twelve months later, it has become clear that the PBOC now believes enough is enough.  Remember, the Chinese economy continues to be heavily reliant on exports for total activity, and an appreciation of that magnitude, especially for the low value items that are produced and exported, can be a significant impediment to growth.  Remember, too, that while a strong renminbi helps moderate inflation in China, it effectively exports that inflation to its customers. (We’ll get back to this shortly.)

Ultimately, China’s goal is to continue to grow their economy as rapidly as possible to insure limited unemployment and increased living standards for its population.  To the extent that a strengthening currency would disrupt that process, it is no longer a welcome sight.  Hence the PBOC’s move to reign in speculation for further CNY appreciation.  By raising the FX reserve requirement, they reduce the amount of onshore USD available (banks must now simply hold onto them) hence counting on the dollar to rise in value accordingly.  Or at the very least, to stop sliding in value.  Consider that China’s long-term stated goal is to further internationalize the renminbi, which means that direct intervention is an awkward method of control.  (International investors tend to shy away from currencies that are subject to the whims of a government or central bank).  This effort to change the FX reserve ratio, thus altering the supply/demand equation is far more elegant and far less intrusive.  Look for this ratio, now set at 7%, to rise further should the renminbi continue to appreciate in value.

As to the inflation story, this time Europe is the setting where prices are rising more rapidly than anticipated.  This morning’s CPI print of 2.0% is the first time it has printed that high since November 2018.  Now, price pressures in Europe are not yet to the level seen in the US, where Friday’s data was clearly an unwelcome surprise, but based on the PMI data releases, with the Eurozone composite rising to a record high of 63.1, and the fact that the latest spate of European lockdowns is coming to an end within the next week or two, it appears that economic activity on the continent is set to grow.  So, the demand side of the equation is moving higher.  meanwhile, the rising value of the CNY has raised input prices for manufacturers as well as retail prices directly.  While margins may be compressed slightly, the fact that Eurozone aggregate savings are at an all-time high suggests that there is plenty of money available to spend on higher priced items.  It is this combination of events that is set to drive inflation.

There is, however, a dichotomy brewing as bond markets, both in the US and Europe, do not seem to be indicating a great deal of concern over higher inflation.  Typically, they are the first market to demonstrate concern, usually forcing a central bank response.  But both here in the States, where Friday’s PCE data resulted in a collective yawn (Treasury yields actually fell 1 basis point) and  this morning in the Eurozone, where across major Eurozone countries, German bunds 0.1 bp rise is the only gain, with yields declining slightly elsewhere, the market is telling us that bond investors agree with the central banks regarding the transitory nature of the current rising inflation.  

Perhaps they are right.  While it is difficult to go to the store, any store, and not see that prices for many items have increased during the post-pandemic period, rising inflation means that those price rises will continue for a long time to come, not a simple one-off jump. Both the Fed and the ECB are certain that supply bottlenecks will be loosened soon, thus describing the temporary nature of their inflation views.  However, it is not as clear to me that is the case.  one of the defining features of the global economy during the past decade has been the adjustment of investment priorities at the corporate level, from investing and building new capacity to repurchasing outstanding shares.  This financialization of the economy is not well prepared to expand actual output.  I fear it may take longer than central banks anticipate to loosen those bottlenecks, which means price pressures are likely to be with us for a lot longer than central banks believe.  

A quick tour of markets this morning shows that regardless of Chinese activity or inflation concerns, risk is ON.  While Asia was mixed (Nikkei -0.2%, Hang Seng +1.1%, Shanghai +0.2%), Europe is a green machine (DAX +1.5%, CAC +0.9%, FTSE 100 +1.1%) after strong PMI data across the board.  US markets are not to be left out of this rally with futures in all three major indices rising by about 0.4% at this hour.

As mentioned above, the bond market is far less interesting this morning.  While Treasury yields have backed up 2bps, Europe is going the other way, save Gilts (+1.1bps).  Clearly there is no inflation concern there right now.  And this is despite the fact that oil prices are much higher (WTI +2.8%, Brent +2.1% and >$70/bbl) along with copper (+4.7%) although wedid see Aluminum slip (-0.6%).  Grains are rising as well as is Silver (+0.75%), although gold, which was higher earlier, is back to flat on the day.

The dollar, this morning, is mixed, with roughly an equal number of currencies higher and lower, although the gains are much greater than the losses.  For instance, NOK (+0.7%) is clearly responding to oil’s rise, while SEK (+0.5%) is benefitting from continued strong PMI data.  However, the rest of the G10 space is +/- 0.2% with the pound (-0.25%) the most noteworthy decliner after concerns were raised that a new Covid variant could delay the reopening of the economy.

In the EMG space, KRW (+0.4%) and THB (+0.3%) have been the best performers as both are thriving amid improving economic performance and anticipation that China’s recovery will help support them further.  Meanwhile, on the flipside, TRY (-0.5%) is the laggard followed by INR (-0.4%) and ZAR (-0.3%).  CNY (-0.2%) slipped in the wake of the PBOC action, while INR is suffering as Covid cases continue to surge.  The same is true in South Africa, and Turkey suffered after higher inflation readings than expected.

Data this week is big starting with ISM and culminating in the payroll report.

TodayConstruction Spending0.5%
 ISM Manufacturing60.9
 ISM Prices Paid89.0
WednesdayFed’s Beige Book 
ThursdayADP Employment650K
 Initial Claims395K
 Continuing Claims3.615M
 ISM Services63.0
FridayNonfarm Payrolls650K
 Private Payrolls600K
 Manufacturing Payrolls25K
 Unemployment Rate5.9%
 Average Hourly Earnings0.2% (1.6% Y/Y)
 Average Weekly Hours34.9
 Participation Rate61.8%
 Factory Orders-0.2%

Source: Bloomberg

In addition to this data we will hear from six more Fed speakers, including Chairman Powell on Friday.  All ears will be tuned toward the tapering debate and how this week’s speakers address the situation.  However, if you consider it, if inflation is transitory and growth is going well, why would they need to taper?  After all, they appear to have achieved the nirvana of  explosive growth with no inflation. 

Needless to say, not everyone believes that story.  However, the one story that is gaining credence everywhere is that the dollar is likely to decline going forward.  That was the consensus view at the beginning of the year, and after a quarter of concern, it appears to be regaining many adherents.  To date, the relationship between the dollar and 10-year Treasury yields has been very strong.  It has certainly appeared that the bond drove the dollar.  However, recent activity has been less conclusive.  I still believe that relationship holds, but will be watching closely.  That said, the dollar does feel heavy these days.

Good luck and stay safe

Adf

‘Bout Enough

Posted on by

A storm in the bond market’s brewing

As some central banks start eschewing

The idea QE

Forever, should be

Thus, traders, their longs are undoing

Meanwhile, in the markets for stuff

The Chinese have had ‘bout enough

As prices there soar

Xi’s minions call for

Restraint, or they’ll have to get tough

Heading into the Memorial Day weekend in the US, there are two stories making the rounds this morning.  The first is the latest discussion regarding tapering of QE by central banks around the world while the second is a growing discussion on the commodity markets and the impact the Chinese are having via both economic growth and governmental efforts to prevent prices from rising further. 

During the past month we have gained more clarity from four key central banks on their future QE activities, but the big three (Fed, ECB and BOJ) have not yet come out with any real guidance.  Certainly, we have heard several members of the FOMC opining that the time is coming soon where they will start to consider the idea, if growth continues at its current accelerated pace and if the employment situation improves dramatically.  This is, however, by no means the universal view in Washington, at least not yet.  With respect to the BOJ, the next MPC member who talks about tapering JGB buying will be the first one to do so.  The Japanese have been so invested in this strategy for more than 20 years it will be extraordinarily difficult to even consider a change.

In Frankfurt, however, there is far more disagreement as to the proper steps forward.  Unfortunately for the ECB, the lack of a common fiscal framework in the Eurozone is becoming a bigger problem as they remain the only institution capable of supporting the entire group of nations.  This is made clear by recent data, which shows that there are very different growth and inflation scenarios, potentially requiring different monetary policy responses, in different countries.

For instance, inflation in Germany, at 2.3% is running a lot hotter than in Italy, at 1.0%.  And while the Continent’s average may be around 1.6% right now, it is the Germans that see things as more problematic.  Consider that while the Weimar hyperinflation of nearly 100 years ago may seem ancient to most, it was the most searing economic event in the nation’s history and has informed the entire German zeitgeist of thrift and frugality.  (Contrast this to the Great Depression, with the concomitant deflation that occurred in the US, and which has informed the US zeitgeist with respect to fear of prices and the economy collapsing.)  Remember, the only way to get the Germans to agree to the euro was to promise that the ECB would essentially be a clone of the Bundesbank.  That meant keeping a lid on inflation at all times.  However, the current situation, where the economic circumstances across the continent are so widely disparate, has put the ECB in a bind.  Efforts to support those economies that remain weak with a low inflationary impulse, like Italy, Ireland and Greece, will result in increasing price pressures on those economies that are further ahead in the economic rebound like Germany and the Netherlands.

It is this conundrum that has different ECB speakers saying different things.  On the one hand, we have recently heard from Italy’s Panetta, France’s Villeroy and Madame Lagarde that tapering is not appropriate.  Yet this morning, Germany’s Isabel Schnabel was far more circumspect with respect to maintaining current policy as she commented, “Rising yields are precisely what we want to see.”  That does not seem the comment of someone keen to keep buying bonds.  However, for now, the Germans remain in the minority and so the idea that the ECB will mention the tapering of asset purchases at the June meeting seems unlikely.

As to the commodity story, in the past two weeks we have heard from at least seven different Chinese officials and key organizations about the need for both reducing upward pressure on commodities as well as reducing upward pressure on the renminbi.  For the past twenty years, China has been the marginal buyer of most commodities as their economy has grown at a remarkable pace and they have built up extraordinary infrastructure of roads, airports and cities.  Thus, they have consumed countless tons of steel, copper and other industrial materials.  However, a little considered impact of the pandemic was the dramatic reduction in the capex of mining for industrial metals, which means that future supplies are likely to be less available as the world continues to reopen and growth expands.  The natural result has been rising prices as markets anticipate surplus demand relative to forecast supply. 

Apparently, the powers that be in China have figured out that rising prices are not conducive to their domestic plans and are now caught between a situation where they benefit from a stronger currency if it puts downward pressure on inflation, but suffer from a stronger currency if it reduces the attractiveness of their export sector.  They seem to believe that if they can prevent further strength in CNY while simultaneously talking down commodity prices, they can achieve both their ends.  While they have had some success over the past several weeks on the commodity front, CNY has steadily appreciated, gaining more than 3.25% since April 1st.  I guess this is one of the difficulties of trying to manage growth, inflation and your currency’s value simultaneously.  Something’s gotta give.  Right now, it looks like the currency and further strength there should not be a surprise.

As to our holiday shortened session, European equity markets are uniformly higher this morning (DAX +0.6%, CAC +0.7%, FTSE100 +0.3%) although Asia had a more mixed picture with the Nikkei (+2.1%) quite strong but the Hang Seng (0.0%) and Shanghai (-0.2%) less enthusiastic about things.  US futures are all green to the tune of about 0.5%, so pending this morning’s data, the rally should continue.

Bond markets are little changed this morning with Treasuries, which saw yields rise 3.5bps yesterday essentially unchanged this morning.  EGB’s are generally a tick or two higher with yields lower by less than 1 basis point, as there is much more focus on stocks today.

In the commodity space, oil (+0.5%) continues to rebound from last week’s dip while precious metals are modestly softer this morning (Au -0.2%, Ag -0.8%).  The Chinese seem to be having some success in their efforts to push down metals prices with Cu (-1.0%) and Al (-0.4%) leading the way lower.

The dollar, despite the positive risk sentiment in equities, is stronger vs. all its G10 peers, with NZD (-0.85%) and AUD (-0.6%) the worst performers on the day.  In truth, the magnitude of this move smacks of position adjustments after the RBNZ’s surprisingly hawkish tone earlier this week led to significant buying in both currencies.  But the dollar’s strength is universal as generally positive data releases throughout Europe have not been able to encourage currency buying. 

Emerging markets have seen a different picture as the dollar was universally soft overnight and APAC currencies all showed strength while those markets were open, but since then, EEMEA and LATAM currencies have come under pressure.  The most notable mover here has been TRY (-0.95%) as ongoing inflation worries continue to undermine faith in the currency both at home and internationally.

The data story today has the chance to be quite interesting with Personal Income (exp -14.2%), Personal Spending (0.5%) and Core PCE (0.6% M/M, 2.9% Y/Y) all coming at 8:30.  Then at 10:00 we see Chicago PMI (68.0) and Michigan Sentiment (83.0).  In my mind, Core PCE is the number that matters.  Given the current market discussion on tapering, a higher than anticipated number there could easily see a bond market sell-off and further support for the dollar.  Frankly, based on the fact that every inflation reading this month has been higher than forecast, I see no reason for this to be any different.  Look for a high print and the dollar to remain well-bid into the weekend.

Good luck, good weekend and stay safe

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Not Really There

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There once was a Fed Reserve Chair
Whose minions explained with fanfare
Though prices were climbing
With all the pump priming
Inflation was not really there

Investors responded with glee
And bought everything they did see
So, risk was a hit
While yields fell a bit
As money remains largely free

Brainerd, Bostic and Bullard, though sounding like a law firm, are actually three FOMC members who spoke yesterday.  In what has been a remarkably consistent performance by virtually every single member of the committee (Robert Kaplan excepted), they all said exactly the same thing: prices will rise due to bottlenecks and shortages in the near-term, but that this was a short-term impact of the pandemic response, and that soon those issues would abate and prices would quickly stabilize again.  They pointed to ‘well-anchored’ inflation expectations and reminded one and all that they have the tools necessary to combat inflation in the event their version of events does not come to pass.  You have to give Chairman Powell credit for convincing 16 ostensibly independent thinkers that his mantra is the only reality.

The market response was one of rainbows and unicorns, with rallies across all assets as risk was snapped up everywhere.  After all, it has been nearly two weeks since the CPI print was released at substantially higher levels than anticipated raising fears amongst investors that the Fed was losing control.  But two weeks of soothing words and relatively benign data has been sufficient to exorcise those inflation demons.  In the meantime, the Fed continues to purchase assets and expand its balance sheet as though the economy is teetering on the brink of destruction while they await the “substantial progress” toward their goals to be met.

One consequence of the Fed’s QE program has been that high-quality collateral for short term loans, a critical part of the financial plumbing of the US (and global) economy has been in short supply.  For the past two months, Treasury bill issues have been clearing at 0.00%, meaning the government’s cost of financing has been nil.  This is due to a combination of factors including the Treasury running down the balances in the Treasury General Account at the Fed (the government’s checking account) and the ongoing Fed QE purchases of $80 billion per month.  This has resulted in the Treasury needing to issue less T-bills while simultaneously injecting more funds into the economy.  Banks, meanwhile, wind up with lots of bank reserves on their balance sheets and no place to put them given the relative dearth of lending.  The upshot is that the Fed’s Reverse Repurchase Program (RRP) is seeing unprecedented demand with yields actually starting to dip below zero.  This is straining other securities markets as well given the bulk of activity in markets, especially derivatives activity, is done on a margin, not cash, basis.  While so far, there have not been any major problems, as the stress in this corner of the market increases, history shows that a weak link will break with broader negative market consequences.  For now, however, the Fed is able to brush off any concerns.

The result of the constant commentary from Fed speakers, with three more on the schedule for today, as well as the fading of the memories of the high CPI print has been a wholesale reengagement of the risk-on meme.  Growth continues to rebound, while zero interest rates continue to force investors out the risk curve to find a return.  What could possibly go wrong?

Today, the answer is, nothing.  Risk is back with a vengeance as evidenced by a strong equity session in Asia (Shanghai +2.4%, Hang Seng +1.75%, Nikkei +0.7%) and a solid one in Europe as well (DAX +0.8%, CAC +0.15%, FTSE 100 0.0%).  The Chinese (and Hong Kong) rally seems to be a product of the PBOC focusing their attentions on the commodity market, not equities, as the source of imbalances and a potential target of interventionist policies thus allowing speculators there to run free.  German equities are the beneficiary of better than expected ZEW data, with both the current conditions (95.7) and Expectations (102.9) indices leading the way.  While yesterday’s US equity rally faded a bit late in the day, futures this morning are all pointing higher by about 0.3%.

Arguably, the FOMC trio had a bigger impact on the bond market, where 10-year Treasury yields are now back below 1.60%, down 1 basis point this morning and at their lowest level in more than two weeks.  It is certainly hard to believe that the bond market is remotely concerned about inflation at this time.  Remember, though, Friday we see the core PCE print, which is the number the Fed truly cares about, and while it is forecast to print above the 2.0% target, (0.6% M/M, 2.9% Y/Y) we also know that the Fed strongly believes this is transitory and is no reason to panic.  Markets, however, if that print is even stronger, may not agree with that sentiment.

Commodity prices are having a less positive day as the ongoing concerns about Chinese actions to prevent price rises continues to weigh on sentiment.  Oil has slipped just a bit (-0.3%) but we are seeing declines in Cu (-0.4%), Al (-1.1%) and Fe (-3.1%), all directly in the crosshairs of the Chinese government.  Agricultural product prices are mixed today while precious metals remain little changed.

Finally, the dollar is mostly lower this morning with broad weakness seen in the EMG bloc, but less consistency in G10.  While SEK (+0.5%) leads the way higher, the rest of the bloc has been more mixed.  NOK (-0.2%) is clearly suffering from oil’s decline, while JPY (-0.2%) seems to be giving ground as havens are unloved.  EUR (+0.25%) has been helped by that German ZEW data as well as the beginnings of a perception that the Fed is going to be more aggressively dovish than the ECB for a long time to come.  In that event, the euro will certainly rise further, although it has a key resistance level at 1.2350 to overcome.

ZAR (+0.7%) leads the emerging market parade higher as concerns over inflation there abate, and South Africa continues to have amongst the highest real yields in the world.  KRW (+0.4%) is next in line as consumer sentiment in South Korea rose to its highest level in 3 years.  The other noteworthy move has been CNY (+0.2%) not so much for the size of the move as much as for the fact that it has breached the 6.40 level and the government has indicated they are going to be taking additional steps to open the FX market in China to help local companies hedge their own FX risks. The only laggard of note is TRY (-0.3%) which is suffering as President Erdogan has replaced yet another member of the central bank’s board, inviting concerns inflation will run higher with no response.

Data today shows Case Shiller Home Prices (exp +12.5%) as well as New Home Sales (950K) and Consumer Confidence (119.0), none of which are likely to change either Fed views or market opinions.   As mentioned above, three Fed speakers will regale us with their sermon on transitory inflation, and I expect that the dollar will remain under pressure for the time being.  In fact, until we see core PCE on Friday, it is hard to make a case that the dollar will turn around and only then if the number is higher than expected.

Good luck and stay safe
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