Policy, Tighter

Apparently, seven percent
Defined for Chair Jay the extent
Of just how high prices
Can rise in this crisis
Ere hawkishness starts to foment

But is it too little too late?
As he’s not yet out of the gate
Toward, policy, tighter
Despite a speechwriter
That claims he won’t fail his mandate

There is no shame in being confused by the current market situation because, damn, it is really confusing!  On the one hand we see inflation not merely rising, but fairly streaking higher as yesterday’s 7.04% Y/Y CPI reading was the highest since June 1982.  With that as a backdrop, and harking back to our Economics 101 textbooks, arguably we would expect to see interest rates at much higher levels than we are currently experiencing.  After all, in its simplest form, real interest rates, which are what drive investment decisions, are simply the nominal interest rate less inflation. As of today, with effective Fed Funds at +0.08% and the 10-year Treasury at 1.75%, the calculated real interest rates are -6.96% in the front end and -5.29% in the 10-year, both of which are the lowest levels in the post WWII era.  The conclusion would be that investment should be climbing rapidly to take advantage.  Alas, most of the investment we have seen has been funneled into share repurchases rather than capacity expansion.

With this in mind, it makes sense that dollar priced assets are rising in value, so stocks and commodities would be expected to climb, as would the value of other currencies with respect to the dollar.  However, the confusion comes when looking at the bond market, where not only are real yields at historically depressed levels, but there is no indication that investors are selling bonds and seeking to exit the space.

Our economics textbook would have us believe that negative real yields of this magnitude are unsustainable with two possible pathways to adjustment.  The first pathway would be nominal yields climbing as investors would no longer be willing to hold paper with such a steep negative yield.  Back in the 1990’s, the term bond vigilantes was coined to describe how the bond market would not tolerate this type of activity and investors would sell bonds aggressively thus raising the cost of debt for the government.  So far, that has not been evident.  The second pathway is that the inflation would lead to significant demand destruction and ultimately a recession which would slow inflation and allow bondholders to get back to a positive real yield outcome.  Not only would that be hugely painful for the economy, it will take quite a while to complete.

The problem is, neither of those situations appear to be manifest.  The question of note is, is the bond market looking at the current situation and pricing in much slower growth ahead?  Certainly, the punditry is not looking for that type of outcome, but then, the punditry is often wrong.  Neither is the Fed looking for that type of outcome, at least not based on their latest economic projections which are looking for GDP growth of 3.6%-4.5% this year and 2.0%-2.5% next with nary a recession in sight in the long run.

This brings us back to the $64 trillion question, why aren’t bonds selling off more aggressively?  And the answer is…nobody really knows.  It is possible that investors are still willing to believe that this inflationary spike is temporary, and we will soon see CPI readings falling and the Fed declaring victory, so bond ownership remains logical.  It is also possible that given the fact that the BBB bill was pulled and seems unlikely to pass into legislation, that Treasury issuance this year will decline such that the fact the Fed will no longer be purchasing new debt will not upset the supply/demand balance and upward pressure on yields will remain absent.  At least from a supply perspective.  The problem with this idea is that pesky inflation reading, which, not only remains at extremely high levels, but is unlikely to decline very much at all going forward.

Ultimately, something seems amiss in the bond market which is disconcerting as bond investors are typically the segment that pays closest attention to the reality on the ground.  While the hawkish cries from Fed members are increasing in number and tone (just yesterday both Harker and Daly said they expected raising rates in March made sense and 4 rate hikes this year would be appropriate), that implies Fed Funds will be 1.0% at the end of the year, still far below inflation and not nearly sufficient to slow those rising prices.

It seems to me there are three possible outcomes here; 1) bond investors get wise and sell long-dated Treasuries steepening the yield curve significantly; 2) the Fed gets far more aggressive, raising rates more than 100 basis points this year and pushes to invert the yield curve and drive a recession; or 3) as option 1) starts to play out, and both stocks and bonds start to decline sharply, the Fed decides that YCC is the proper course of action and caps Treasury yields while letting inflation run much hotter.  My greatest fear is that 3) is the answer at which they will arrive.

With all that cheeriness to consider, let’s look at how markets are behaving today.  Despite a modest equity rally in the US yesterday, risk has been less in demand since.  Asia (Nikkei -1.0%, Shanghai -1.2%, Hang Seng +0.1%) was generally lower and Europe (DAX 0.0%, CAC -0.5%, FTSE 100 -0.1%) is also uninspiring.  There has been virtually no data in either time zone, so this price action is likely based on growing concerns over the inflationary outlook.  US futures at this hour are basically unchanged.

As to the bond market, no major market has seen a move of even 0.5 basis points today with inflation concerns seeming to balance risk mitigation for now.

Commodity markets are mixed with oil (-0.1%) edging lower albeit still at its highest levels since 2014, while NatGas (-4.5%) has fallen as temperatures in the NorthEast have reverted back to seasonal norms.  Gold (-0.1%) has held most of its recent gains while copper (-0.7%) seems to have found a short-term ceiling after a nice rally over the past few sessions.

Finally, turning to the dollar, it is somewhat softer vs. most of its G10 brethren with NZD (+0.35%) leading the way, followed by CHF (+0.3%) and CAD (+0.2%) as demand for any other currency than the dollar begins to show up.  In EMG currencies, excluding TRY (-2.5%) which remains in its own policy driven world, the picture is more mixed.  RUB (-0.75%) has fallen in the wake of the news from Geneva that there was no progress between Russia, the US and NATO regarding the escalating situation in the Ukraine with the threat of economic sanctions growing.  BRL (-0.55%) is also under some pressure although this looks more like profit taking after a nearly 3% rally in the past two sessions.  On the plus side, THB (+0.5%) and PHP (+0.3%) are leading the way as they respond to the broadly weaker dollar sentiment.

Data today brings Initial (exp 200K) and Continuing (1733K) Claims as well as PPI (9.8%, 8.0% ex food & energy), but the latter would have to be much higher than expected to increase the pressure on the inflation narrative at this point. From the Fed we hear from Governor Brainerd as she testifies in her vice-chair nomination hearing, as well as from Barkin and Evans.  Given the commentary we have been getting, I expect that the idea of 4 rate hikes this year is really going to be cemented.

The dollar has really underperformed lately and quite frankly, it feels like it is getting overdone for now.  While I had always looked for the dollar to eventually decline this year, I did expect strength in Q1 at least.  However, given positioning seemed to be overloaded dollar longs, and with the Treasury market not participating in terms of driving yields higher, it is beginning to feel like a modest correction higher in the dollar is viable, but that the downtrend has begun.

Good luck and stay safe

Quite a Surprise

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

No Delay

Investors have not yet digested
The truth of what Jay has suggested
There’ll be no delay
QT’s on the way
(Unless the Dow Jones is molested)

Given the change in tone from the Fed and a number of other central banks, where suddenly hawkishness is in vogue, the fact that risky assets (read stocks) have only given back a small proportion of their year-long gains is actually quite remarkable.  The implication is that equity investors are completely comfortable with the transition to positive real interest rates and that valuations at current nosebleed levels are appropriate.  The problem with this thesis is that one of the key arguments made by equity bulls during the past two years has been that negative real interest rates are a crucial support to the market, and as long as they remain in place, then stocks should only go higher.

But consider how high the Fed will have to raise interest rates to get back to real ZIRP, let alone positive real rates.  If CPI remains at its current level of 6.8% (the December data is to be released on Wednesday and is expected to print at 7.0%), that implies twenty-seven 0.25% rate hikes going forward!  That’s more than four years of rate rises assuming they act at every meeting.  Ask yourself how the equity market will perform during a four-year rate hiking cycle.  My take is there would be at least a few hiccups along the way, and some probably pretty large.  Consider, too, that looking at the Fed funds futures curve, the implied Fed funds rate in January 2026 is a shade under 2.0%.  In other words, despite the fact that we saw some pretty sharp movement across the interest rate markets last week, with 10-year yields rising 25 basis points and 2-year yields rising 13 basis points, those moves would just be the beginning if there was truly belief that the Fed was going to address inflation.

Rather, the evidence at this stage indicates that the market does not believe the Fed’s tough talk, at least not that they will do “whatever it takes” to address rising inflation.  Instead, market pricing indicates that the Fed will try to show they mean business but have no appetite to allow the equity market to decline any substantial amount.  If (when) stocks do start to fall, the current belief is the Fed will come to the rescue and halt any tightening in its tracks.  As I have written previously, Powell and his committee are caught in a trap of their own design, and will need to make a decision to either allow inflation to keep running hot to try to prevent an equity meltdown, or take a real stand on inflation and let the (blue) chips fall where they may.  The similarities between Jay Powell and Paul Volcker, the last Fed chair willing to take the latter stand, stop at the fact neither man had an economics PhD.  But Jay Powell is no Paul Volcker, and it seems incredibly unlikely that he will have the fortitude to continue the inflation fight in the face of sharply declining asset markets.

What does this mean for markets going forward?  As we remain in the early stages (after all, the Fed is still executing QE purchases, albeit fewer than they had been doing previously) tough talk and modest policy changes are likely to continue for now.  Equity markets are likely to continue their performance from the year’s first week and continue to slide, and I would expect that bond markets will remain under pressure as well.  And with the Fed leading the way vis-à-vis the ECB and BOJ, I expect the dollar should continue to perform fairly well against those currencies.

However, there will come a point when investors begin to grow wary of the short- and medium-term outlooks for risk assets amid a rising rate environment.  This will be highlighted by the fact that inflation will remain well above the interest rate levels, and in order to contain the psychology of inflation, the Fed will need to continue its tough talk.  Already, when looking at the S&P 500, despite being just 3% below its all-time highs, more that 50% of its components are trading below their 50-day moving averages (i.e. are in a down-trend) which tells you just how crucial the FAANG stocks are.  And none of those mega cap stocks will benefit from higher interest rates.  In the end, there is significant room for equity (and all risk asset) declines if the Fed toes the tightening line.

Looking at markets this morning shows that no new decisions have been taken as both equity and bond markets are little changed since Friday.  Perhaps investors are awaiting Wednesday’s CPI data to determine the likely path going forward.  Or perhaps they are awaiting the comments from both Powell and Brainerd, both of whom will be facing the Senate this week for confirmation hearings for their new terms.  However, we do continue to hear hawkish comments with Richmond Fed President Barkin explaining that a March rate hike would suit him, and ex-Fed member Bill Dudley explaining that there is MUCH more work to be done raising rates.

So, after Friday’s late sell-off in the US, equities in Asia rebounded a bit (Hang Seng +1.1%, Shanghai +0.4%, Nikkei closed) although European bourses are all modestly in the red (DAX -0.3%, CAC -0.4%, FTSE 100 -0.1%). US futures are also turning red with NASDAQ futures (-0.35%) leading the way down.

Meanwhile, bond markets are mixed this morning with Treasury yields edging higher by just 0.4bps as I type, albeit remaining at its highest levels since before the pandemic, while we are seeing modest yield declines in Europe (Bunds -1.0bps, OATS -1.5bps, Gilts -0.3bps).  The biggest mover though are Italian BTPs (-5.3bps) as they retrace some of their past two-week underperformance.

On the commodity front, oil (-0.2%) has edged back down a few cents although remains much closer to recent highs than lows, while NatGas (+4.4%) has jumped on the back of much colder weather forecasts in the US Northeast and Midwest areas.  Gold (+0.3%) continues to trade either side of $1800/oz, although copper (-0.2%) is under a bit of pressure this morning.

As to the dollar, it is mixed today with SEK (-0.4%), CHF (-0.35%) and EUR (-0.3%) all under pressure while JPY (+0.25%) is showing its haven bona fides.  This definitely feels like a risk move as there was virtually no data or commentary out overnight.  In the EMG space, RUB (+0.9%) is the leading gainer as traders continue to look for further tightening by the central bank despite the fact that real rates there are actually back to positive already.  INR (+0.35%) and IDR (+0.35%) also gained with the rupee benefitting from equity market inflows while the rupiah responded to word that the government would soon lift the coal export ban.  On the downside, the CE4 are in the worst shape, but those are merely following the euro’s decline.

There is a decent amount of data coming up this week as follows:

Tuesday NFIB Small Biz Optimism 98.5
Wednesday CPI 0.4% (7.0% Y/Y)
-ex food & energy 0.5% (5.4% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 200K
Continuing Claims 1760K
PPI 0.4% (9.8% Y/Y)
-ex food & energy 0.5% (8.0% Y/Y)
Friday Retail Sales -0.1%
-ex autos 0.2%
IP 0.2%
Capacity Utilization 77.0%
Michigan Sentiment 70.0

Source: Bloomberg

In addition to the data, we hear from seven Fed speakers and have the nomination hearings for Powell (Tuesday) and Brainerd (Thursday), so plenty of opportunity for more hawk-talk.

For now, I continue to like the dollar for as long as the Fed maintains the hawkish vibe.  However, I also expect that if risk assets start to really underperform, that talk will soften in a hurry.

Good luck and stay safe

A Wrong Turn

In Europe, the reading today
For CPI led to dismay
With prices still rising
Lagarde’s now revising
The timing for QE’s decay

Then later this morning we’ll learn
If Jay has a cause for concern
Should payrolls be strong
It will not be long
Til stock markets take a “wrong” turn

There seem to be three stories of note today with varying impacts on market behavior, and in the end, they are all loosely tied together.  Starting in Europe, CPI printed at a higher than forecast 5.0% in December, rising to a historic high for the Eurozone as currently constituted.  While energy prices were the largest driver of the data, even excluding those, CPI rose 2.6%, well above the current ECB target.  Given the series of remarkable energy policy blunders that have been made by the Europeans, one has to believe that it will be many more months before energy inflation has any chance of abating.  And as long as the continent remains reliant on Russia for its natural gas supplies, it will almost certainly be held hostage across other issues.  Remember, too, the more money spent on energy, where those funds leave the continent as they don’t really produce much of their own, the less money available for things like manufacturing and consumption of other goods.

The problem for the ECB is that the specter of slowing growth conflicts with their alleged desire to reduce QE and allow policy to “normalize”.  As we see in virtually every nation, the tension between addressing inflation and stifling growth is the crux of central bank decision making.  Madame Lagarde finds herself between the proverbial rock and hard place here.  As things currently stand, I fear the Eurozone is going to find itself in a position dangerously close to stagflation as the year progresses.  Do not be surprised if there are some major electoral changes this year.  PS, none of this is actually very good for the single currency, so keep that in mind as well.  While it has seemed to have stabilized over the past two months, another leg lower feels like it is still on the cards.  What Will Christine Do? History shows that central banks almost always err on the side of higher inflation, so do not be surprised if that is the case here as well.

Turning to the States, it is payroll day with the following forecasts:

Nonfarm Payrolls 447K
Private Payrolls 405K
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

With the market and investors still absorbing what seemed to be an even more hawkish set of FOMC Minutes than anticipated, where they extensively discussed QT, this has all the trademarks of a ‘good news is bad’ set-up, such that a strong print (>600K) will result in a bond and stock market sell-off as investors flee duration assets.  Remember, too, the ADP number printed at 807K, nearly double expectations and the highest since May21.  Since that release, forecasts have risen by about 50K and whispers even more.  The point is that if US data really starts to show significantly more strength, expectations are going to grow for more rate hikes this year as well as a quicker pace of allowing the balance sheet to shrink.  And that, my friends, will not be a good look for risky assets.

There once was a firm, Evergrande
In China, that bought tons of land
In order to build
Apartment blocks filled
With people, but now must disband

The problem for China is they
Explained, when this firm went astray
Twas under control
And they would cajole
Investors, their sales, to delay

Finally, before we move on to today’s markets, I would be remiss if I didn’t point out a change of tone from China overnight, one that was not officially announced but is true nonetheless.  You may remember back in September when we first heard about China Evergrande and the fact that the second largest property developer in that country, and the most indebted, was having trouble repaying its loans.  Initially there was talk by the doomsayers that this was China’s Lehman moment, and everything would unravel quickly.  Of course, that did not happen, although what we have seen since is a slower unraveling of that company and many others in the sector.  It turns out that when your business model is premised on borrowing excessive amounts of money to build apartment blocks in ghost cities, there could be problems down the line.

At any rate, the PBOC was adamant that everything was under control and that, anyway, China Evergrande’s borrowings weren’t that big compared to China’s GDP.  (That always sounded an awful lot like Bernanke’s comments regarding subprime mortgages.)  More recently, the PBOC imposed three ‘red lines’ regarding the ability of property developers to borrow money as they were really trying to squeeze the speculation out of the property market, but without causing the bubble to actually burst, simply deflate.  These rules, though, meant that Evergrande, and the other very weak companies in the space, suddenly had no source of funding.  Well, last night it was discovered that the PBOC has actually instructed banks to lend to property companies more aggressively.  Apparently the PBOC’s red lines have as much value as Qaddafi’s or Obama’s, in other words, none.  It can be no surprise that the PBOC has reversed course given the potential problems that exist in the Chinese property sector.  Just beware as things there remain opaque and in flux, although I doubt the renminbi is set to move dramatically soon.

Ok, quickly, after yesterday’s US equity fizzle, where markets slid slightly, Asia was mostly the same although the Hang Seng (+1.8%) did manage to rally sharply after it became clear Evergrande would get more funding.  Europe has done essentially nothing, despite a generally weak mix of data (German IP -0.2%, French IP -0.4%) as investors seem to be waiting for the payroll number to assess the Fed’s actions.  US futures are little changed at this hour as well.

We are seeing similar lack of activity in the bond market as here, too, investors await the payroll numbers.  Yesterday saw essentially no change in the 10-year Treasury yield although shorter maturity bonds did see yields rise a couple of ticks as the market continues to look for rate hikes sooner rather than later.  Europe is also biding its time to see what comes from NFP, with no major markets having moved even 1 basis point from yesterday’s levels.

Oil prices continue to rise (+0.75%) with WTI now above $80/bbl for the first time in two months.  But we are seeing strength throughout this space with NatGas (+1.4%) and Uranium (+3.5%) showing all energy is bid.  In fairness, the Uranium story is squarely on the back of the uprising in Kazakhastan where some 40% of global uranium is mined.)  On the metals front, both precious (Au +0.2%, Ag +0.2%) and base (Cu +0.3%, Al +0.5%, Zn +2.7%) are all in favor with only agricultural prices under pressure today.

As to the dollar, it is somewhat softer but not universally so.  SEK (+0.4%) and NOK (+0.3%) are the leading gainers in the G10 with oil helping the latter while the former continues to benefit from perceptions of still strong economic activity despite the latest wave of omicron.  However, other than these, movement is 0.1% or less in either direction, signifying absolutely nothing.  EMG currencies, though, have definitely seen more strength with ZAR (+0.7%), RUB (+0.7%) and CLP (+0.5%) all responding positively to the commodity rally.

And that is really it for the day.  My take on the NFP data is that good news (i.e. a strong print) will be a negative for risk assets as estimates will be that the Fed needs to move that much quicker to alleviate the inflation pressures.  That means a classic risk-off scenario of stronger dollar, stronger yen and weaker equities.  Bonds, however, are likely to see curve flattening more than higher rates, as the front end will be sold aggressively while the back lags appreciably.

Good luck, good weekend and stay safe

Quite Insane

There once was a concept, inflation
That frightened the heads of each nation
As prices would rise
They could not disguise
The fact it was just like taxation

But now, though it seems quite insane
Most governments try to explain
No need for dismay
Inflation’s okay
There’s no reason you should complain

The latest example is from
The UK, where people’s income
Continues to lag
Each higher price tag
And prospects for growth are humdrum

It certainly is becoming more difficult to accept the idea that the current inflationary surge being felt around the world is going to end anytime soon.  I keep trying to imagine why any company would cut prices in the current macroeconomic environment given the amount of available funds to spend held by consumers everywhere.  So called ‘excess’ savings, the amount of savings that are available to consumers above their long-term trend, exceed $3 trillion worldwide, with more than $2 trillion of that in the US alone.  If you run a company and are being faced with higher input costs (energy, wages, raw materials, etc.) and there has been no reduction in demand for your product, the most natural response is to continue to raise prices until you find the clearing price where demand softens.  It is a pipe dream for any central bank to expect that the current situation is going to resolve itself in the near future.

And yet…the major central banks (Fed, ECB, BOE and BOJ) continue to be committed to maintaining ultra-easy monetary policy.  For instance, today’s inflation data from the UK is a perfect case in point.  CPI rose a more than expected 4.2% Y/Y, more than double the BOE’s price target.  Core CPI rose 3.4%, also more than expected and RPI (Retail Price Index, the price series that UK inflation linked bonds track), rose 6.0%, the highest level since 1991.  And yet, the BOE is seemingly no closer to raising rates.  You may recall that despite what appeared to be clear signaling by the BOE they would be raising interest rates at their meeting earlier this month, they decided against doing so, surprising the market and leading to significant volatility in UK interest rate markets.  In fact, BOE Governor Bailey fairly whined afterwards that it was not the BOE’s job to manage the economy.  (If not, what exactly is their job?)  At any rate, the growing concern in the UK is that growth is slowing more rapidly while prices continue to rise.  This has put the BOE in a tough spot and will likely force a decision as to which issue to address.  The problem is the policy prescriptions for each issue are opposite, thus the conundrum.

The bigger problem is that this conundrum exists in every major economy.  The growth statistics we have seen have clearly been supported by the massive fiscal and monetary policy expansion everywhere.  In the US, that number is greater than $10 trillion or 40% of the economy.  The fear is that organic growth, outside the stimulus led measures, is much weaker and if policy support is removed too early, economies will quickly fall back into recession.  In fact, that is the most common refrain we hear from policymakers around the world, premature tightening will be a bigger problem.  Ultimately, a decision is going to need to be made by every central bank as to which policy problem is more important to address immediately.  For the past four decades, the only policy issue considered was growth and how to support it.  But now that inflation has made a comeback, it is a much tougher choice.  We shall see which side the major central banks choose over the coming months, but in the meantime, the one thing which is abundantly clear is that prices are going to continue to rise.

A reasonable question would be, how have markets responded to the latest data and comments?  And the answer is…no change in attitude.  Risk appetite remains relatively robust as the money continues to flow from central banks, although certain risk havens, notably gold, are finding new supporters as fears of significantly faster inflation grow.

So, let’s survey today’s markets.  Equities have had a mixed session with Asia (Nikkei -0.4%, Hang Seng -0.25%, Shanghai +0.45%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 -0.3%) all, save China, remaining near all-time highs (in the case of the Nikkei they are merely 31 year highs from after the bubble there), but certainly showing no signs of backing off.  US futures are showing similar price action with very modest movement either side of flat.

Bonds, as well, are little changed and mixed on the day with Treasuries (-0.5bps) catching a modest bid after having sold off sharply over the past week.  In Europe, the price action is similar with Bunds (-0.3bps), OATs (+0.2bps) and Gilts (-0.5bps) all within a few tics of yesterday’s closing levels.  I would have expected Gilts to suffer somewhat more given the UK inflation data, but these days, it appears that inflation doesn’t have any impact on interest rates.

Commodity prices are softer this morning led by oil (-1.3%) and NatGas (-1.75%), although European NatGas is higher by more than 7.3% this morning as Russia continues to restrict flows to the continent.  (I have a feeling that the politicians who made the decision to rely on Russia for a critical source of power are going to come under increasing pressure.)  In the metals markets, industrials are mostly under pressure (Cu -1.0%, Sn -0.1%, Zn -0.8%) but we are seeing a slight rebound in aluminum (+0.6%) and precious metals are doing fine (Au +0.6%, Ag +1.1%).  It seems that inflation remains a concern there.

As to the dollar, it has outperformed a few more currencies than not, with TRY (-1.25%) the biggest loser as the central bank there has clearly made the decision that growth outweighs inflation and is expected to cut interest rates further despite inflation running at nearly 20%.  Elsewhere in the EMG bloc, the losers are less dramatic with MYR (-0.3%) and CLP (-0.3%) the next worst performers.  On the plus side, RUB (+0.8%) is the clear leader, shaking off the decline in oil prices as inflows to purchase Russian bonds have been enough to support the ruble.  Otherwise, there are a handful of currencies that have edged higher, but nothing of note.

In the G10, the picture is also of a few more losers than gainers but no very large moves at all.  surprisingly, GBP (+0.1%) has done very little in the wake of the CPI data and actually SEK (+0.35%) is the best performer on the day.  However, given the krona’s recent performance, where it has fallen more than 4% in the past week, a modest rebound should not be much of a surprise.  Overall, the dollar has retained its bid as evidenced by the euro (-2.8%) and the yen (-2.0%) declining during the past week with virtually no rebound.  It appears that the market continues to believe the Fed is going to be the major central bank that tightens policy fastest and the dollar is benefitting accordingly.

This morning’s data brings Housing Starts (exp 1579K) and Building Permits (1630K), neither of which seem likely to move markets.  Yesterday’s Retail Sales and IP data were much stronger than expected, which clearly weighed on bond markets a bit, and supported the dollar, but had little impact elsewhere.  We hear from seven! Fed speakers today, as they continue to mostly double down on the message that they expect inflation to subside on its own and so it would be a mistake to act prematurely.  There is a growing divide between what the market believes the Fed is going to do and what the Fed says they are going to do.  When that resolves, it will have a large market impact, we just don’t know when that will be.

For now, you cannot fight the dollar rally, but I will say it is getting a bit long in the tooth and a modest correction seems in order during the next several sessions.  Payables hedgers should be picking spots and layering into hedges because the longer-term situation for the dollar remains far more tenuous.

Good luck and stay safe


The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked

Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?

I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory.  Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles.  However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass.  In fact, back in the day, the Fed was still concerned about deflation.

Well Jay, how about now?  Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows.  And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years.  One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship.  The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.

And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond.  Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.

As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September.  While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement.  In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.

The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions.  While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act.  Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10.  Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.

So, how are markets digesting this news?  Not terribly well.  At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared.  However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit.  US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices.  Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.

Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps.  Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day.  But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out.  This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour.  But the rest of Europe is not so lucky, especially with the PIGS still under pressure.  I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.

Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs.  This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates.  NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October.  It seems that some of those fears have abated.  Gold, however, continues to rally, up another 0.4% today and about 4% in the past week.  Perhaps it has not entirely lost its inflationary magic.

And finally, the dollar continues to perform very well after a remarkable performance yesterday.  For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%.  ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse.  But don’t discount the euro having taken out every level of technical support around and falling 1%.  This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun.  In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements.  The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age.  The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.

With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly.  There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk.  In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term.  Later on?  Perhaps a very different story.

Good luck and stay safe

Prices Rise in a Trice#CPI, #inflationexpectations

There once was a world where the price
Of stuff stayed the same…paradise
But then central banks
Were born, and now thanks
To them prices rise in a trice

Now, worldwide the story’s the same
As these banks, inflation, can’t tame
They’re all terrified
That stocks might just slide
And they would come in for the blame

“I’d expect price increases to level off, and we’ll go back to inflation that’s closer to the 2% that we consider normal.  In the 70’s and 80’s inflation expectations became embedded in the American psyche.  That isn’t happening now.”  So said Treasury Secretary Yellen yesterday in an interview on NPR.  One has to wonder on what she bases these expectations.  Certainly not on any of the evidence as per the most recent data releases.

For instance, the NY Fed’s latest Inflation expectation survey was released yesterday with 1-year (5.7%) and 3-year (4.2%) both at the highest level in the series’ history since it began in 2013.  She cannot be looking at yesterday’s PPI data (8.6%, 6.8% core) as an indicator given both of these are at their highest level on a final demand basis since PPI started being measured in this manner in 2011.  However, a look a little deeper at the intermediate levels, earlier in the supply chain, show inflation running at levels between 11.8% and 27.8% Y/Y.  While all of these costs are not likely to flow into the price of finished goods, you can be sure that the pressure to raise prices throughout the chain for both goods and services remains great.  And of course, later this morning we will see the CPI data (exp 5.9% Y/Y, 4.3% ex food & energy) with both indicators forecast to show substantial increases from last month.  Secretary Yellen continues to try to sell the transitory story and twelve months of increasing prices later, it is wearing thin.

The US, though, is not the only place with this problem, it is a global issue.  Last night China released its inflation readings with PPI (13.5%) rising far more than expected and touching levels not seen since 1995.  CPI there rose to 1.5%, a tick higher than expected which indicates that either there is a serious lack of final demand in the country or they are simply manipulating the data to demonstrate that the government is in control.  (In fact, it is always remarkable to me when a Chinese data point is released that is not exactly as expected given the control the government exerts on every aspect of the process.)  Regardless, the fact is that price pressures continue to rise in China on the back of rising energy costs and shortages of available energy, and ultimately, given China’s status as the world’s largest exporter, those costs are going to feed into other nations’ import prices.

How about Europe?  Well, German CPI rose 4.5% Y/Y in October, the highest level since September 1993 in the wake of the German reunification which dramatically shook up the economy there.  Remember, too, the German’s have a severe phobia over inflation given the history of the Weimar Hyperinflation, so discontent with the ECB’s performance is growing apace in the country.

Essentially, it is abundantly clear that rising prices have become the norm, and that any idea that we are going to ease back to moderate inflation in the near-term are fantasy.  Naturally, with inflationary pressures abundant, one might expect that central banks would be out to address them by tightening policy.  And yet, while peripheral nations have already done so, the biggest countries remain extremely reluctant to tighten as concern over economic output and employment growth continue to dominate their thoughts.

Historically, central bank decision making always required balancing the two competing goals of pumping up supporting the economy while preventing prices from running away.  Between the GFC and the pandemic, though, there was no need to worry as measured inflation never reared its ugly head, so easy money supported growth with no inflationary consequences.  But post-pandemic fiscal largess has changed the equation and now central banks have to make a decision, with significant political blowback to either choice.  Yet the biggest risk is the lack of a decisiveness may well lead to the worst of all worlds, rising prices and slowing growth, i.e. stagflation.  I promise you a stagflationary environment will be devastating to financial assets all over.

Now, as we await the CPI data, let’s take a look around the markets to see how traders and investors are responding to all the latest news and data.

Equity markets are mostly following the US lead from yesterday with declines throughout most of Asia (Nikkei -0.6%, Hang Seng +0.7%, Shanghai -0.4%) and most of Europe (DAX -0.2%, CAC -0.3%, FTSE 100 +0.4%).  US futures are all pointing lower at this hour as well (DOW -0.3%, SPX -0.3%, NASDAQ -0.5%) so there is little in the way of joy at the current moment.  Risk is definitely under pressure.

What’s interesting is that bonds are not seen as a viable replacement despite declining stock prices as yields in Treasuries (+2.7bps) and throughout Europe (Bunds +0.8bps, OATs +2.1bps, Gilts +3.4bps) are higher.  So, stocks are lower and bonds are lower.  Did I mention that stagflation would be negative for financial assets?

On this very negative day, commodity prices, too, are under pressure with oil (-0.6%), NatGas (-1.8%), gold (-0.35%), copper (-0.3%) and tin (-1.1%) all suffering.  In fact, throughout the entire commodity complex, only aluminum (+2.0%) and corn (+0.5%) are showing gains.  At this point, oil remains in a strong uptrend, so any pullback is likely technical in nature.  NatGas continues to respond to the glorious weather in the northeast and Midwest with reduced near-term demand.  Even in Europe, Gazprom has finally started to let some more gas flow hence reducing price pressures there although it remains multiples of the US price.

Turning to the dollar, it is today’s clear winner, gaining against 9 of its G10 brethren, with CAD (flat) the only currency holding its own.  SEK (-0.6%) and NOK (-0.5%) lead the way lower with the latter tracking oil’s declines while the former is simply showing off its high beta characteristics with respect to dollar movement.  In the EMG bloc, TRY (-1.1%) is the laggard as traders anticipate another interest rate cut, despite high inflation, and there is concern over the fiscal situation given significant foreign debt payments are due next week.  ZAR (-0.9%) is slumping on the commodity story as well as concerns that the budget policy may sacrifice the currency on the altar of domestic needs.  But the weakness extends throughout the space with APAC currencies under pressure as well as LATAM currencies.  This is a dollar story today, with very little holding up to the perceived stability of the buck.

As well as the CPI data, given tomorrow’s holiday, we see Initial (exp 260K) and Continuing (2050K) Claims at 8:30.  There are actually no further Fed speakers today with Bullard yesterday remarking that two rate hikes were likely in 2022.  We shall see.

With the inflation narrative so strong, this morning’s data will be key to determining the short-term direction of markets.  A higher than expected print is likely to see further declines in both stocks and bonds with the dollar benefitting.  A weaker outcome seems likely to unleash yet another bout of risk acquisition with the opposite effects.

Good luck and stay safe

Growing Disdain

There is now a silver haired queen
Whose role since she came on the scene
Has been to explain,
With growing disdain,
Inflation is still unforeseen
Her minions, as well, all campaign
To make sure the message is plain
Though prices are rising
They won’t be revising
Their plans, or so said Philip Lane
There is a growing disconnect between the ECB and the rest of the world’s central banks.  While the transitory narrative has been increasingly taken out back and shot, the ECB will not let that story die.  Just today, ECB Chief Economist Philip Lane defended the ECB stance, explaining, “If we look at the situation over the medium term, the inflation rate is still too low, below our 2% target.  This period of inflation is very unusual and temporary, and not a sign of a chronic situation.  The situation we are in now is very different from the 1970’s and 1980’s.”  [author’s emphasis]  In other words, in case Madame Lagarde’s comments from last week that the ECB is “very unlikely” to raise rates next year, were not clear, the ECB is telling us that their mind is made up and there will be no policy tightening in the foreseeable future.
In fairness, raising interest rates will not convince Russia to pump more natural gas through the pipelines to help mitigate the dramatic rise in prices there.  Nor will it help build new semiconductor fabs to alleviate that shortage.  However, what it might do is reduce demand for many things thus easing supply constraints and perhaps encouraging prices to fall.  After all, that is exactly what tighter monetary policy is supposed to do.  The problem with that logic, though, is that there isn’t a central banker on the continent that is willing to risk slowing down growth in order to address rapidly rising prices.  The politics of that move would likely bring more rioters into the streets.  Once again, central banks’ vaunted independence is shown to be a sham.  They are completely political and beholden to the government in charge at any given time.
And so, we are left with a situation where prices continue to rise throughout the world while the two largest economic areas, the US and Eurozone, maintain the easiest monetary policy in history.  Yes, I know the Fed said it would begin to reduce its QE purchases, but even if they do reduce purchases by $15 billion / month, they are still going to expand their balance sheet by a further $420 billion and interest rates are still at zero.  There remains virtually zero chance that inflation is going to fade as long as the current incentive structure remains in place. 
Speaking of the Fed, Friday’s NFP data was substantially better than expected with job growth rising 531K and revisions higher for the previous two months of an additional 235K.  The Unemployment Rate fell to 4.6% and wages continue to climb smartly, +4.9% Y/Y.  (Of course, on a real basis, that is still negative given the current 5.4% CPI with expectations that on Wednesday, the latest release will jump to 5.9%.)  However, Chairman Powell has indicated that the Fed believes there is still a great deal of slack in the labor market, based on the Participation Rate remaining well below pre-pandemic levels, and so raising rates prematurely would be a mistake.  Summing it all up, there is no reason to believe that either US or ECB monetary policy is going to be changing anytime soon, regardless of the data.
The question at hand, then, is what will this mean for markets in general and the dollar in particular?  As long as new, excess liquidity continues to flood the markets, there is little reason to believe that the ongoing bull market in equities, commodities, real estate, and bonds is going to end.  While history has shown that rising inflation will eventually hurt both bonds and stocks, we are not yet at that point, and quite frankly don’t appear to be approaching it that rapidly.  Though there remains a small cadre of old-timers (present company included) who have a difficult time accepting current valuations as normal and who have actually lived through inflationary times, the bulk of the market participants do not carry that baggage and so are unencumbered by negative thoughts of that nature.  But, as an example of how inflation can degrade equity markets, from Q4 1968 through Q1 1980, the S&P 500 fell 1% in nominal terms while inflation averaged 7.1% per year with a high print of 14.8%.  The point is that the last time we had an inflation situation of the current magnitude, holding equities did not solve the problem.  As George Santayana famously told us back in 1905, “Those who cannot remember the past are condemned to repeat it.”
With this in mind, let us take a look at markets and the week ahead.  Aside from the ECB comments this morning, arguably the most impactful news from the weekend was the story that Elon Musk is planning to sell $20 billion worth of stock in order to pay his upcoming tax bill.  Not surprisingly Tesla’s stock is lower by nearly 6% on the news and it seems to have put a damper on all equity activity.  After all, if Tesla isn’t going higher, certainly nothing else can have value!
Looking at equity markets, Asia (Nikkei -0.35%, Hang Seng -0.4%, Shanghai +0.2%) were mixed but leaning weaker.  That is an apt description of Europe as well (DAX -0.2%, CAC +0.2%, FTSE 100 -0.1%) although overall, the movement has not been that significant.  US futures, meanwhile, are little changed although NASDAQ futures are slightly lower while the other two major indices are edging higher.
Bonds, on the other hand, are all under pressure with Treasuries (+2.8bps) leading the way although this was after a major rally on Friday that saw the 10-year yield fall 7bps and a total of 15bps since the FOMC last Wednesday.  But European sovereigns, too, are all lower with yields rising (Bunds +2.0bps, OATs +2.1bps, Gilts +2.9bps).  Perhaps bond investors are beginning to register their concern over the inflation story.
On that front, commodity prices are rebounding off the lows seen last week led by energy with oil (+1.25% and back over $82/bbl) and NatGas (+1.1%) both having good days.  The rest of the space, though, is more mixed with copper (+0.2%) and tin (+0.4%) both firmer this morning, while aluminum (-0.2%) and iron ore (-3.25%) are both suffering.  Precious metals are little changed although Friday saw a sharp rally in the barbarous relic.  And yes, the cryptocurrency space is rocking today as well.
As to the dollar, it has had a mixed performance this morning with both gainers and losers across the G10 and EMG spaces.  In the G10, NZD (+0.6%) is the clear leader as the government is talking of ending the draconian lockdown measures by the end of the month.  In fact, we saw similar behavior in the EMG currencies as THB (+0.8%) and IDR (+0.5%) rallied on similar news.  On the flip side, BRL (-0.8%) continues to decline despite the central bank being one of the most aggressive in its rate hike path having raised the SELIC rate from 2% in March to 7.75% last month with expectations growing for yet another hike in December.  Of course, inflation is running at 10.25% there, so real yields remain firmly negative.
On the data front, this is inflation week with both the PPI and CPI on the docket.


NFIB Small Biz Optimism




0.6% (8.6% Y/Y)


-ex food & energy

0.5 (6.8% Y/Y)


Initial Claims



Continuing Claims




0.6% (5.9% Y/Y)


-ex food & energy

0.4% (4.3% Y/Y)


JOLTS Job Openings



Michigan Sentiment


Source: Bloomberg
Of course, the Fed doesn’t care about CPI as its models work better with core PCE, which also happens to be designed to be permanently lower.  The rest of us, however, know better and recognize the pain.  We have a number of Fed speakers on the calendar this week as well, with Chairman Powell headlining 9 planned appearances.  My sense is that there will be a strenuous effort to press the storyline that inflation may take a little longer to fall back, but don’t worry, it will fall again.
If pressed, I would say the dollar is far more likely to continue to grind higher, but that any movement will be slow.  While Treasury yields are not supportive right now, the reality is that amid major currency bonds, Treasuries continue to offer the best combination of yield and liquidity so remain in demand.  I think that along with the need for other economies to buy dollars to buy energy will maintain the bid in the buck.
Good luck and stay safe

Somewhat Misleading

The latest inflation’ry reading
Showed price rises kept on proceeding
But bond markets jumped
While dollars were dumped
This movement seems somewhat misleading

The two market drivers yesterday were exactly as expected, the CPI report and the FOMC Minutes.  The funny thing is it appears the market’s response to the information was contrary to what would have been expected heading into the session.

Starting with CPI, by now you are all aware that it continues to run at a much hotter pace than the Fed’s average 2.0% target.  Yesterday’s results showed the M/M headline number was a tick higher than forecast at 0.4%, as was the 5.4% Y/Y number.  Ex food & energy, the results were right on expectations at 4.0%, but that is cold comfort.  Here’s a bit of bad news though, going forward for the next 5 months, the monthly comps are extremely low, so the base effects (you remember those from last year, right?) are telling us that CPI is going to go up from here.  Headline CPI is almost certain to remain above 5.0% through at least Q1 22 and I fear beyond, especially if energy prices continue to rise.  The Social Security Administration announced that benefits would be increased by 5.9% next year, the largest increase in 20 years, but so too will FICA taxes increase accordingly.

The initial market movement on the release was perfectly logical with the dollar bouncing off its lows while Treasury yields backed up.  Given the current correlation between those two, things made sense.  However, that price action was relatively short-lived and as the morning progressed into the afternoon, the dollar started to slip along with yields.  Thus, leading up to the Minutes’ release, the situation had already turned in an unusual direction.

The Minutes explained, come November,
Or possibly late as December
The time will have come
Where QE’s full sum
Ought fade like a lingering ember

The Minutes then confirmed what many in the market had expected which was that the taper is on, and that starting in either mid-November or mid-December the Fed would be reducing its monthly asset purchases by $15 billion ($10 billion less Treasuries, $5 billion less mortgages).  This timeline will end their QE program in the middle of next year and would then open the way for the Fed to begin to raise rates if they deemed it necessary.

Oddly enough, the bond rally really took on legs after the Minutes and the dollar extended its losses.  So, while the correlation remains intact, the direction is confusing, at least to this author.  Losing the only price insensitive bond buyer while the government has so much debt to issue did not seem a recipe for higher bond prices and lower yields.  Yet here we are.  The best explanation I can offer is that investors have assessed that less QE will result in slowing growth and reduced inflationary pressures, so much so that there is the beginning of talk about a recession in the US early next year.  Alas, while I definitely understand the case for slowing growth, and have been highlighting the Atlanta Fed’s GDPNow trajectory lower, there is nothing about the situation that I believe will result in lower inflation, at least not for quite a while yet.  Thus, a bond market rally continues to seem at odds with the likely future outcome.

Of course, there is one other possible explanation for this behavior.  What if, and humor me here for a moment, the Fed doesn’t actually follow through with a full tapering because equity prices start to fall sharply?  After all, I am not the only one to have noticed that the Fed’s reaction function seems to be entirely based on the level of the S&P 500.  Simply look back to the last time the Fed was trying to remove policy accommodation in 2018.  You may recall the gradual reduction in the size of their balance sheet as they allowed bonds to mature without replacing them while simultaneously, they were gradually raising the Fed funds rate.  However, by Christmas 2018, when the equity market had fallen 20% from its highs, Chairman Powell pivoted from tightening to easing policy thus driving a reversal higher in stocks.  Do you honestly believe that a man with a >$100 million portfolio is going to implement and maintain a policy that will make him poorer?  I don’t!  Hence, I remain of the belief that if they actually do start to taper, still not a given in my mind, it won’t last very long.  But for now, the bond market approves.

Thus, with visions of inflation dancing in our heads, let’s look at this morning’s market activity.  Equity markets are clearly of the opinion that everything is under control, except perhaps in China, as we saw the Nikkei (+1.5%) put in a strong performance and strength throughout most of Asia.  However, the Hang Seng (-1.4%) and Shanghai (-0.1%) were a bit less frothy.  Europe, though, is all in on good news with the DAX (+0.8%), CAC (+0.9%) and FTSE 100 (+0.7%) having very positive sessions.  This has carried over into the US futures market where all three major indices are higher by at least 0.6% this morning.

Bonds, meanwhile, are having a good day as well, with Treasury yields sliding 0.7bps after a nearly 5bp decline yesterday.  In Europe, given those markets were closed during much of the US bond rally, we are seeing a catch-up of sorts with Bunds (-3.7bps), OATs (-3.1bps) and Gilts (-1.6bps) all trading well as are the rest of Europe’s sovereign markets.

On the commodity front, pretty much everything is higher as oil (+1.25%), NatGas (+2.1%) and Uranium (+21.7%!) lead the energy space higher.  Metals, too, are climbing with gold (+0.4%), copper (+0.7%) and aluminum (+3.4%) all quite firm this morning.  Not to worry, your food is going up in price as well as all the major agricultural products are seeing price rises.

As to the dollar, it is almost universally lower this morning with only two currencies down on the day, TRY (-0.9%) and JPY (-0.15%).  The former is suffering as President Erdogan fired three more central bankers who refuse to cut interest rates as inflation soars in the country and the market concern grows that Turkey will soon be Argentina.  The yen, on the other hand, seems to be feeling the pressure from ongoing sales by Japanese investors as they seek to buy Treasury bonds with much higher yields than JGBs.  However, away from those two, the dollar is under solid pressure against G10 (SEK +0.9%, NOK +0.8%, CAD +0.55%) and EMG (THB +0.7%, IDR +0.7%, KRW +0.6%).  Broadly speaking, the story is much more about the dollar than about any of these particular currencies although commodity strength is obviously driving some of the movement as is positive news in Asia on the Covid front where some nations (Thailand, Indonesia) are easing restrictions on travel.

On the data front, this morning brings the weekly Initial (exp 320K) and Continuing (2.67M) Claims numbers as well as PPI (8.7%, 7.1% ex food & energy).  PPI tends to have less impact when it is released after CPI, so it seems unlikely, unless it is a big miss, to matter that much.  However, it is worth noting that Chinese PPI (10.7%) printed at its highest level since records began in 1995 while Korean import and export prices both rose to levels not seen since the Asian financial crisis in 1998.  The point is there is upward price pressure everywhere in the world and more of it is coming to a store near you.

We hear from six more Fed speakers today, but it would be quite surprising to have any change in message at this point.  To recap the message, inflation is proving a bit stickier than they originally thought but will still fade next year, they will never allow stock prices to fall, inflation expectations remain anchored and tapering will begin shortly.

While I still see more reasons for the dollar to rally than decline, I believe it will remain linked to Treasury yields, so if those decline, look for the dollar to follow and vice versa.

Good luck and stay safe

Prices Will Grow

As markets await CPI
It’s funny to watch the Fed try
Explaining inflation
Will lack the duration
To send expectations sky-high

But even their own surveys show
That most people already know
Inflation is here
And well past next year
The level of prices will grow

Each month the Federal Reserve Bank of New York publishes the results of a survey of consumer expectations on inflation.  Yesterday, they published the September results and, lo and behold, the data showed that 1-year inflation expectations rose to 5.31%, by far the highest point since the survey began in 2013.  The 3-year data rose to its highest ever level of 4.19%, also well above the Fed’s 2.0% target.  And yet somehow, the authors of the report explained that inflation expectations remain well anchored.  Their claim is that if you look at the 5-year expectations, they remain near the levels seen before the pandemic, indicating that there should be no concern.  I don’t know about you, but 3 years of inflation running above 4.0% seems a lot longer than transitory.

Of course, it’s not just the analysts at the NY Fed who are unwilling to admit to the increasingly obvious situation, we continue to hear the same from other officials.  For instance, Treasury Secretary Janet Yellen, in a televised interview yesterday remarked, “I believe it’s [inflation] transitory, but I don’t mean to suggest these pressures will disappear in the next month or two.”  She then raised the specter of shortages by commenting, “There’s no reason for consumers to panic over the absence of goods they’re going to want to acquire at Christmas.”  Now, don’t you feel better?

In fairness, however, there are several Fed members who have finally admitted that the transitory emperor has no clothes.  Atlanta Fed President Raphael Bostic explained yesterday, “It is becoming increasingly clear that the feature of this episode that has animated price pressures – mainly the intense and widespread supply-chain disruptions – will not be brief.  By this definition, then, the forces are not transitory.”  As well, we heard from St Louis Fed President James Bullard, “I have to put some probability on a scenario where inflation stays high or even goes higher.”

At this point, it’s fair to ask, which is it?  Clearly there is a split at the Fed with some regional presidents recognizing that inflation has risen sharply and has all the appearances of being persistent, while Fed governors seem more likely to lean toward the transitory fable.  Perhaps what explains this split is the regional presidents have a far different constituency than do the Fed governors.  The Fed presidents are trying to address the issues extant in their respective geographies, so rising inflation matters to them.  Meanwhile, the governors, despite the claim that the Fed is apolitical, serve their masters in Congress and the White House, who believe they need to continue QE and ZIRP forever to continue spending money in unconscionable sums while not suffering from the slings and arrows of the bond market vigilantes.  But remember this too, every Fed governor votes at every meeting while only a handful of regional presidents vote (granted, Bostic is one of those right now.)  I fear we will continue to hear transitory for a while yet.

All this is a prelude to two key pieces of information today, this morning’s CPI release (exp 5.3% headline, 4.0% core) and the FOMC Minutes from the September meeting to be released at 2:00pm.  The one thing that has been very clear lately is that interest rate markets are beginning to buy into the persistence of inflation.  While Treasury yields have edged lower by 1.6bps this morning, in the past 3 weeks, those yields have risen 26 basis points.  And this is a global phenomenon with Bund yields, for instance, having risen 20 basis points over the same period despite a 4.1bp decline today.  Investors are starting to pressure the central bank community with respect to interest rates, driving them higher as fears of rising inflation abound worldwide.  While some, central banks have recognized the reality on the ground (Norway, New Zealand, numerous EMG nations) and others have paid lip service to the idea of raising rates (the UK, Canada), the two biggest players, the Fed and ECB, will not even discuss raising rates, although the Fed continues to tease us with talk of tapering.

However, I will ask again, do you believe the Fed will taper (tighten) policy if GDP growth is more clearly abating?  My view remains that they may actually start to taper, but that it will be a short-lived process as weak GDP growth will dissuade them from doing anything to worsen that side of the ledger.  While eventually, weaker GDP growth will result in demand destruction and reduced price pressures, that is likely to take a very long time.  Hence, the idea of stagflation remains very viable going forward.

Now it’s time to look at markets.  Equities have had a mixed session thus far with Asia (Nikkei -0.3%, Hang Seng -1.4%, Shanghai +0.4%) seeing both gainers and losers and Europe (DAX +0.7%, CAC +0.25%, FTSE 100 -0.1%) seeing similar mixed price action.  UK data showed August GDP was a tick lower than forecast and is clearly slowing from its previous pace, arguably weighing on the FTSE.  As to US futures, they are edging higher ahead of the data with gains in the 0.1%-0.3% range after yesterday’s modest declines.

We’ve already discussed bonds so a look at commodities shows that oil (-0.6%) is retreating for the moment as is NatGas (-1.5%), while we are seeing strength in gold (+0.7%) and copper (+1.7%).  In fact, the entire metals complex is stronger today as apparently, weaker energy prices are good for industrial activities.

As to the dollar, it is under some modest pressure today across the board.  In the G10, SEK (+0.35%) and CHF (+0.35%) lead the way with JPY (0.0%) the laggard.  However, there are no specific stories that seem to be driving things, rather this is a broad-based dollar correction from recent strength.  The same situation holds in the EMG bloc with ZAR (+0.75%) the leader followed by much lesser movement of KRW (+0.4%), CZK (+0.35%) and PLN (+0.35%).  The won has responded to comments from the central bank that it is closely watching the exchange rate and will not be afraid to step in if it becomes destabilized.  That is a euphemism for much weaker, as the currency had fallen nearly 9% in the previous four months.  As to the others, recent weakness seems to merely being consolidated with nothing new driving price action.

While the Fed may not care much about CPI, the rest of us do care.  And really, so do they, but it doesn’t tell their story very well.  At any rate, while it is entirely reasonable that we see a continued flatlining of price rises, the risks remain to the upside as at some point, housing inflation is going to show up in the data.  And that, my friends, is going to be significant and persistent!  Ahead of the number, don’t look for much.  If we see a high print, expect the dollar to regain this morning’s losses, though, as the market will become that much surer the taper is on its way.

Good luck and stay safe