There are several central banks which
Are starting to look at a switch
From policy ease
To tight, if you please
As QE they now want to ditch

The Old Lady and RBA
Are two that seem ready to say
Inflation’s too high
And so we must try
To stop it ere it runs away

The dollar is under pressure this morning as investors and traders start to look elsewhere in the world for the next example of policy tightening.  The story of tapering in the US is, quite frankly, getting long in the tooth as it has been a topic of discussion for the past six months and every inflation reading points to the fact that, despite their protestations, FOMC members realize they need to do something.  But in essence, that is already a given in the market, so short of Chairman Powell explaining in his Friday appearance that the FOMC is likely to end QE entirely next month, this is no longer market moving activity.  The dollar has already benefitted from the relatively higher yields that are extant in the Treasury market, and expectations for a further run up are limited.

However, the same is not true elsewhere in the world as central bank plans are only recently crystalizing alongside the universally higher inflation prints.  So, the BOE, which has been more vocal than most, seems to be working hard to prepare markets for a rate hike and the market has taken the ball and run with it.  Thus, UK yields in the short end of the curve have moved rapidly higher with 3-year gilt yields higher by 53 basis points in the past 6 weeks and 15 bps in the past three sessions.  On Sunday we heard from BOE Governor Bailey that they will “have to act” soon to address rapidly rising inflation, and traders continue to push UK yields higher and take the pound along with it.  This morning, pound Sterling is higher by 0.75% and amongst the leading FX gainers on this ongoing activity.

Perhaps more interesting is the market reaction to the RBA Minutes last night, where discussion regarding rising real estate prices and the need to do something about them has encouraged the investment community to push yields much higher, challenging the RBA’s YCC in the 3-year AGB.  In fact, despite the RBA explicitly reiterating that conditions for raising rates “will not be met before 2024”, yields continue to rise sharply as fears that inflation will outpace current RBA expectations grow widespread.  Given this price action, one cannot be surprised that the Aussie dollar (+0.85%) has also risen quite sharply this morning.

The thing is, there are a number of conundrums here as well.  For instance, the euro is performing well this morning, up 0.4%, and there has been absolutely zero indication that the ECB is considering tighter monetary policy.  It is widely known that the PEPP will expire in March, but it is also very clear that the previous QE program, the APP, is going to be expanded and extended in some manner to make up for the PEPP.  The only question here is exactly what form it will take.  Similarly, there is no indication that the BOJ is even considering the end of QE or NIRP or YCC, yet the yen has managed to gain 0.3% this morning as well.

In fact, today’s price action is looking much more like broad-based dollar weakness abetted by some other idiosyncratic features rather than other stories driving the market.  This becomes clearer when viewing the commodity markets where virtually every commodity price is higher this morning led by oil (+1.25%), gold (+0.75%), copper (+1.15%) and aluminum (+1.6%).  Today is very much a classic risk-on type session with the dollar under pressure and other assets performing well in sync.

For instance, equity markets are in the green everywhere (Nikkei +0.65%, Hang Seng +1.5%, Shanghai +0.7%, DAX +0.2%, FTSE 100 +0.1%) with US futures also pointing higher by roughly 0.4% across the board.  At the same time, bond yields are creeping higher (Bunds +1.8bps, OATs +2.1bps, Gilts +1.8bps) as investors jettison their haven assets in order to jump on the risk bandwagon.  Treasury yields, though, are unchanged on the day although still trending higher from the levels seen late last week.

Adding it up; rising equity prices, rising commodity prices, falling bond prices, and a weaker dollar (with EMG currencies also firmer across the board) results in a clear risk-on framework.  This will warm the cockles of every central bankers’ heart as they will all see it as a vote of confidence in the job they are doing.  Whether that is an accurate representation is another question entirely, but you can’t fight the tape.  Risk is clearly in vogue today.

It is, however, worth asking if this positive attitude is misplaced.  After all, the recent data has hardly been the stuff of dreams.  Yesterday’s US releases were uniformly awful (IP -1.3%, Capacity Utilization 75.2%) with both significantly worse than forecast.  The upshot is that the Atlanta Fed GDPNow number fell to 1.165%, another step lower and an indication that despite (because of?) high inflation, growth is slowing more rapidly.  Meanwhile, Eurozone Construction Output fell -1.3% in August, continuing the down trend that began in March of this year.

I recognize it is earnings season and the initial releases for Q2 have been quite positive.  But I ask, is slowing growth and rising inflation really a recipe for continued earnings growth?  History tells us the answer is no, and I see no reason to believe this time is different.  Today’s price action seems anomalous to the big picture ideas, so be cognizant of that fact.  While markets can remain irrational longer than we can remain solvent, that does not mean it is sensible to go ‘all-in’ on risk because there is one very positive market day.  Tread carefully.

This morning’s US data brings Housing Starts (exp 1613K) and Building Permits (1680K) and that is all.  Though these are unlikely to get the market excited, we also hear from four Fed speakers, Daly, Barkin, Bostic and Waller, where efforts at recapturing the narrative will be primary.  It is growing increasingly clear that the Fed is annoyed that the persistent inflation narrative is gaining traction as it may force their hand in tightening policy before they would like.  Just remember, as important as the Fed is (and every central bank in their own economy), the market is much bigger.  And if the market determines that the Fed is no longer leading the way, or will soon need to change tack, it will force the issue.  On this you can depend.

While today everything is coming up roses, the lesson is that the Fed’s control over markets is beginning to wane.  Eventually that will be quite a negative for the dollar, but for now, despite today’s decline, I think the trend remains for a higher dollar.

Good luck and stay safe
Adf