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 Adf
Tag Archives: #CPI
No Aberration
In Europe and in the US
The central banks have made a mess
The latter’s seen prices
Rise up to a crisis
The former is still in distress
But one thing the two of them share
Is neither believes in the scare
That higher inflation
Is no aberration
And tapering they’ll soon declare
We have seen another day of modest overnight activity as market participants across asset classes wait for the next key data inputs. At this point, the three biggest things on the horizon are Thursday’s ECB meeting and US CPI print and then next Wednesday’s FOMC meeting. Until those data points are known, tight ranges and lack of trading liquidity are likely to be the hallmarks of all markets.
One of the things that has been something of a mystery is the disconnect between the performance of the US Treasury market and the ostensibly rapid rise in inflationary pressures, with the former essentially discounting the latter completely. In fact, I would argue this is the key question that must be answered in order to better understand the potential future outcomes. Arguably, it is also this situation which has allowed the Fed to remain sanguine over the recent jumps in CPI and PCE.
Consider that the bond market is generally assumed to have the greatest sensitivity to future economic activity given its very nature. After all, the meaning of fixed income is that regardless of future economic performance, bondholders get a stated amount of interest. It is this feature that keeps bond investors so highly attuned to inflation and inflation expectations as these investors want to ensure the real value of their investments does not decline due to rising prices. Historically, this has certainly been the case, with bond markets selling off before inflation really took off. This is also the genesis of the term ‘bond vigilantes’, coined during the Clinton administration to describe the bond market’s unwillingness to fund hugely expansionary fiscal plans and run large government deficits. My, how the world has changed!
But back then, the Federal Reserve was not in the business of QE. In fact, while it may have been a theoretical concept, even the Japanese had not yet tried it on for size. Two plus decades later, though, the role of the Fed has clearly changed given the economic stresses suffered in both the GFC and Covid induced crisis. QE has gone from an emergency tool to address a unique situation to the go-to tool in the Fed’s (and ECB’s) toolkit. Thus, have grown the central bank balance sheets and so there has been a lid on interest rates, even if not explicitly via yield curve control.
There is, however, another key change in the world since the bond vigilante days of the late 1990’s; the regulatory requirements for large banks known as GSIBs, (Global Systemically Important Banks) imposed after the GFC. These 30 institutions are required to maintain additional capital buffers and hold them in so-called High-Quality Liquid Assets (HQLA) which, not surprisingly, include Treasury bonds as well as mortgages and excess reserves. One of the things that all of these banks do is adjust that portfolio of HQLA to maximize the available revenue, which in a world where yields are zero and negative, is very hard to achieve. While Treasury bills and IOER pay virtually nothing, Treasury securities out the curve do have positive nominal yields and are thus relatively attractive for the purpose.
This leads to a potential alternative reason for the seeming lack of concern by the Treasury market over future inflation; price insensitive demand for bonds required to be held by large banks. If these banks are buying and holding more Treasuries than they otherwise would have done in an unfettered world, the price signal from those bonds is likely to be somewhat skewed. In other words, what if the Treasury market is not telling us there is no fear of inflation, but rather telling us that there are so many price insensitive buyers of bonds, even the excess supply being issued is not enough to scare holders out of the market. In that case, we will need to get our clues about inflation elsewhere, perhaps from commodity markets. And of course, commodity prices have done nothing but rally sharply across every class for the past year. While there is no doubt that the first part of that move was to make up for the severe price dislocations seen at the beginning of the Covid crisis, it is not hard to make the case that the more recent price movement is a response to rising demand meeting inelastic supply. It is the latter that drives inflation.
The point here is that both the ECB and Fed have consistently maintained that there is no reason to worry over recent high inflation prints and that there is no reason for either of them to adjust their policy mix anytime soon. If the bond market ‘meter’ is malfunctioning, though, both of these central banks may well find themselves on the wrong side of history, yet again. Rapidly rising inflation could well come to dominate the policy discussion quite quickly in that case, and maximum employment may recede to a pleasant dream. Food for thought.
As to market activity today, as mentioned above, we have seen modest movements in both directions amid modest trading volumes. Starting with equities, Asia saw small losses across the board (Nikkei -0.2%, Hang Seng 0.0%, Shanghai -0.5%) while Europe has been very modestly firmer (DAX 0.0%, CAC +0.2%, FTSE 100 +0.3%). US futures are mixed as well with DOW (-0.15%) suffering while NASDAQ (+0.3%) are a bit higher and SPX futures are essentially unchanged. Not much new information here.
Bond markets are mostly a bit firmer this morning with Treasury yields (-1.5bps) falling furthest and European sovereigns all seeing yield declines of about 0.75bps. With 10-year Treasury yields back to 1.55%, it appears, on the surface, that there is no concern about rising inflation. But if my proposed thesis is correct, that number could be quite misleading.
Commodity prices are generally coming under pressure this morning, certainly not a sign of imminent inflation, but I would argue this is simple daily price volatility more than anything else. For example, oil (-0.9%) is leading the pack lower but we are seeing weakness in precious metals (Au -0.2%, Ag -0.5%) and base metals (Cu -0.5%, Ni -0.7%, Fe -1.9%) with only grains continuing to rally as all three major ones are higher by about 1.0% this morning.
Turning to FX, it should be no surprise that there is really no story here this morning either. The dollar is probably marginally higher overall, but really mostly mixed with small movements in virtually all currencies. In the G10, NZD (-0.3%) is the biggest mover, but this move has simply taken it back to the middle of its trading range. And the rest of the bloc has moved far less. In emerging markets, we have seen two movements of some note with HUF (-0.4%) declining after weaker than expected IP data was released, putting a dent in the idea the central bank may tighten policy, while RUB (+0.4%) rose after yesterday’s higher than expected CPI print has traders believing the central bank is likely to raise rates further. However, beyond those two moves, there is very little to discuss.
On the data front, the NFIB Small Business Optimism index was released at a disappointing 99.6, below expectations of 101.0 and actually below last month’s reading as well. That seems to be a result of the difficulty small firms are having in hiring staff. We also see the Trade Balance (exp -$68.7B) and then the JOLTS Job Openings report (8.2M) later this morning. But as mentioned at the top, I don’t think anything will matter until Thursday, so look for more range trading until then.
Good luck and stay safe
Adf
Don’t Get Carried Away
The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away
But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned
Wow! That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected. To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase. Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%. To give some context, the core 0.9% gain was the highest print since 1981. It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.
The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible. His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out. As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month. That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.
House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down. The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live. The statistics show that there is the smallest inventory of homes available in decades. As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material. And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace. A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know. As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining. However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI. That, my friends, will be harder to pass off as transitory.
The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates. However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control. While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.
The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money. Rising inflation is the last thing equity markets can abide, so these declines can not be surprising. The question, of course, is will they continue? A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story. It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels. A loss of confidence that the past is prologue could well see a very sharp correction.
Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session. It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move. While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between. Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.
Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months. The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.
Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative. We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%). At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.
This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy). Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday. In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory. I guess they hope if they say it often enough, people may begin to believe them. But that is hard to do when the prices you pay for stuff continues to rise.
Treasuries remain the key. If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher. If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.
Good luck and stay safe
Adf
Far From our Goals
Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls
There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel. In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come. On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’. I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future. After all, the Fed’s forecasting record is unparalleled…in its futility.
However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.
The problem with this attitude is that it seems to ignore the reality on the ground. Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014. In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump. But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least. At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.
It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020. Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation. The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited. There is a growing belief that we are embarking on a so-called commodity super-cycle. This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.
This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise. Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y. The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand. As such, the market seems entirely prepared for a very large number. From my vantage point, the Y/Y number is not so important today, but the M/M number is. Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.
We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy. We continue to hear them explain that any inflation readings will be transitory. And maybe they are correct. However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply. Talk about a Hobson’s Choice!
Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%). US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).
Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level. There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case. European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts). Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.
Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%). The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.
The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own. NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought. However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected). EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst. KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data. Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.
Other than the CPI data and the Treasury auction, there is no other news or data. Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately. The one thing we know is that they are unlikely to change their tune.
Which brings us back to the 10-year Treasury. It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa. I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact. My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late. In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar. Just beware.
Good luck and stay safe
Adf
Devil-May-Care
It wasn’t all that long ago
When Powell and friends let us know
That prices might rise
But that in their eyes
T’was something we soon would outgrow
And lately it seems they were right
As chains of supply get more tight
But so far, they’re clear
The Fed has no fear
Inflation could rise overnight
Investors, though, don’t seem to share
That attitude, devil-may-care
Instead they’re rebelling
And stocks they are selling
While bond markets, too, they forswear
Perhaps as a prelude to tomorrow’s CPI data here in the US, last night we saw Chinese inflation data. Chinese data, though, has a very different meaning than US data. From China, markets care far more about PPI than about CPI, as China continues to be the world’s factory floor. So, a rising PPI in China may presage rising retail prices elsewhere in the world. Consider this when looking at the Chinese data, where PPI rose a more than expected 6.8%, it’s highest print since October 2017, while CPI there rose only 0.9%, a tick less than forecast. The proximate cause of the sharp rise in PPI has been the ongoing explosion higher in commodity prices. All their input costs are rising (iron ore, steel, copper, energy, etc.) thus producers are forced to raise their prices. While retailers have not yet passed through all the cost increases in China, manufacturers and retailers elsewhere in the world have not been so sanguine on the issue. Instead, the combination of rising commodity prices and shortages in key intermediate goods, like semiconductors, has been more than sufficient to push up prices.
It should be no surprise that markets, in general, are not applauding this outcome, and in fact, are concerned that this is just the beginning of the move in prices. On the one hand, we continue to hear from both the Fed and the ECB that there is no reason to consider tightening policy at this time as neither bank has achieved their policy aims. On the other, there is no sign that the supply side damage that was caused by the pandemic is anywhere close to being repaired. Reduced supply meeting ongoing artificially high demand is guaranteed to raise prices. I guess the Fed and ECB will soon be quite pleased with themselves for having created inflation. The rest of us? Not so much.
However, this policy mistake action in the face of the current conditions is what is driving market prices, which today are wholly in the red, and in substantial size. Equity markets worldwide (Nikkei -3.1%, Hang Seng -2.1%, DAX -2.2%, CAC -2.0%, FTSE 100 -2.2%) have been under severe pressure ever since yesterday’s US tech slump, but bond markets, too, are seeing significant selling pressure, with Bunds, OATs and Gilts all seeing yields climb by 4 basis points this morning. In other words, investors are explaining they don’t want to hold financial assets in an inflationary environment. In fact, there is a great deal of buzz in the markets about some of the large interest rate bets that are being made in both Eurodollar and Euribor futures markets, where very large size option trades are being executed with the aggressor buying put options as part of large risk reversals. It seems there is very little concern over interest rates declining from current levels, and rightly so, but expectations for higher rates well before either the Fed or ECB has indicated they are considering changing tack are the new normal.
What, you may ask, has this done for the dollar? That is a much tougher question to answer as the outcome has been far less clear. I have been adamant that the 10-year Treasury yield has been the key driver of the dollar’s value for virtually all of 2021, and despite the sell-off in European sovereigns this morning, Treasury yields are unchanged at 1.60%. Heading into tomorrow’s CPI data, as well as another round of Treasury refunding starting with today’s 3-year auction of $40 billion (a total of $108 billion will be auctioned this week), it appears that investors and traders are not certain what to do. Despite economic data that points to quickening growth, we continue to hear from Fed speaker after Fed speaker that they are not even close to considering tapering QE, let alone raising interest rates. Well, except for the lone(ly) hawk, Dallas Fed President Robert Kaplan. But yesterday, both Chicago’s Mike Evans and SF’s Mary Daly were clear it is far too early to consider tapering QE. Today brings six more Fed speakers, none of whom have a history of hawkishness.
In the end, if inflation continues to rise while Treasury yields remain rangebound due to QE, as real yields decline, look for the dollar to follow. Breakeven inflation rates continue to trade at multi-year highs (5-year 2.73%, 10-year 2.53%) and are indicating a strong belief that inflation is picking up pace. While the Fed continues to tell us they “have the tools” necessary to combat any potential inflation, the only thing of which we can be sure is they not only “have the tools” required to support markets (and the economy by extension), but that they will use those tools. When it comes to fighting the inflation battle, though, not a single current FOMC member is battle tested. Given this asymmetry, it is not surprising that we are seeing an increase in market bets on higher interest rates.
Back to the dollar, which is actually under a bit of pressure this morning, along with all those other assets. In the G10, only CHF (-0.1%) is softer as we are seeing gains from the European bloc (NOK, SEK +0.4%, EUR +0.3%) leading the way. Arguably, this is on the back of the much better than expected German ZEW expectations index, which printed at its highest level in more than 10 years. Meanwhile, the pound (+0.1%) and commodity bloc here are having a much less interesting session.
In the emerging markets, Asian currencies felt pressure overnight on the tech stock decline with KRW (-0.5%), TWD (-0.4%) and MYR (-0.3%). On the other hand, the CE4 have all followed the euro higher and we are seeing strength in ZAR (+0.5%), RUB (+0.6%) and MXN (+0.5%), despite oil’s small slide (-0.8%).
All in all, today is shaping up as another one that will be driven by the yield story. In order for the dollar to really turn around its recent weakness, we will need to see a very significant risk-off event, with Treasuries rallying and fear abundant. But so far, the current equity decline has not been sufficient to get those juices flowing. As such, I still would err on the side of a weaker dollar.
Good luck and stay safe
Adf
To Make Jay Concerned
On Friday the payroll report
Surprised folks by coming up short
Is growth really slowing?
Or else, is this showing
A government data distort?
This morning, though, all eyes have turned
To metals and stuff that is burned
As those prices soar
They seem to have more
Potential to make Jay concerned
With all that anticipation leading up to the payroll report on Friday, it sure turned out differently than expected. You may recall that the median forecast for the headline number was a cool million new jobs, with a survey range from 700K to 2.1 million. The result, 266K plus a reduction of 140K from the previous month was, in a word, awful. In fact, it was the largest statistical miss since the data began. Now, the analyst community is busy trying to figure out what went wrong.
There are a couple of possible answers, each with its own implications. The simplest explanation is that the combination of exiting from an unprecedented, government-imposed economic shutdown is not easily modeled and when combined with the vagaries of seasonal adjustments to the data, analysts’ models were simply wrong. It is important to remember that the seasonal adjustments in this data stream are quite large relative to the reported data, so this is quite a viable explanation.
A second possible explanation, and one favored by the current administration, is that the data shows the economy needs more government support as too many people are falling through the cracks. On the other hand, the business community continues to complain how difficult it is to hire qualified employees, especially in the service sector, as the ongoing government unemployment largesse is paying more than many low paying service sector jobs. (The story of the entire workforce of a Dollar General store upping and quitting en masse is the quintessential symbol of this concept.) Another facet of this argument is the skills mismatches that exist as, for example, erstwhile airline staff may not be able to analyze data for an IT firm, effectively resulting in a hiring need and unemployed worker at the same time.
While skills mismatches certainly exist, they always have, arguably one way for businesses to obtain staffing is to pay more for the roles in question. The risk in that strategy is, especially for small businesses, increased labor costs will force companies to raise prices at the risk of losing business. Based on Friday’s report, this is clearly not yet the default choice of the small business owner. Odds are, though, especially as demand for all products and services increases with the reopening of the economy more generally, that this is going to be the outcome. Higher wages to get workers and higher prices for goods and services.
Occam’s Razor suggests that the first explanation, data uncertainty, is the most likely cause for Friday’s massive statistical miss. However, don’t expect the other two arguments to disappear as they are each very compelling for the currently competing political narratives. Ultimately, we will find out more through the data for the rest of this month and get to do this all over again in June.
On the topic of rising prices, though, this morning has much more to offer, specifically in the commodity space. The big weekend news has been about a cyberattack on Colonial Pipeline, which happens to be the largest pipeline for oil products like gasoline and diesel, to the East Coast. With the pipeline shut, (apparently the pipeline can still carry the products, but the company cannot track how much fuel is being consumed, and thus charge accordingly), gasoline and product prices are rising, dragging up oil prices as well (WTI +0.5%). But of more interest is the metals sector where prices are exploding higher. Not only are precious metals (Au +0.45%, AG +1.25%) higher, but industrial base metals are really rocking (Fe +5.1%, Cu +2.6%, Al +1.9%, Ni +0.8%). This is, of course, one of the key features of the inflation is coming narrative, sharply rising commodity prices will work their way into the price of stuff. But inflation is a measure of the ongoing change in prices over time. The Fed’s argument is that these prices will have an impact in the short run, but unless commodity prices continue rise year after year, the effect will be ‘transitory’.
The counter to the Fed’s argument is that we are currently embarking on the beginning of a commodity super-cycle, a price phenomenon where prices trend in one direction for many years on end, often 10-15 years. If this argument is correct, and the prices of copper and iron ore are just beginning their climb, then the Fed is going to find themselves with a whole lot of trouble in the future. But right now, it is merely dueling forecasts and narratives, so nothing is clear.
With all the excitement in commodities, things are pretty quiet in the financial markets. Equity markets in Asia were a bit higher (Nikkei +0.55%, Hang Seng 0.0%, Shanghai +0.25%) while European bourses are mixed (DAX -0.25%, CAC -0.2%, FTSE 100 +0.15%). US futures are also mixed with Dow (+0.3%) continuing last week’s rally while NASDAQ (-0.25%) continues to feel pain from the ongoing rotation out of tech.
Bond markets are not buying the inflation narrative at this point with Treasuries (-0.5bps) seeing slightly lower yields while Bunds and OATs are essentially unchanged on the day. The only real mover is the Gilt market (+1.7bps) which has rallied after weekend elections failed to give the Scottish National Party a majority in the Scottish Parliament and thus the prospect of a referendum to allow Scotland to leave the UK seems to be pushed back.
The outcome of the Scottish vote helped the pound as well, with GBP rallying 0.9% this morning, far and away the best performer in the FX markets. Amid broad-based dollar weakness, the pound’s performance still stands out. Next in line, in the G10, is AUD (+0.5%) which is a clear beneficiary of the rise in commodity prices. In fact, iron ore is Australia’s largest commodity export. NZD and CAD (both +0.2%) are lesser beneficiaries and the rest of the block, save JPY (-0.2%) is slightly firmer. The yen seems to be suffering from the latest poll showing PM Suga’s popularity continuing to slide and bringing some uncertainty to the situation there with an election due by the end of the year.
Asian currencies were the big beneficiary in the EMG space led by KRW (+0.7%), IDR (+0.6%) and CNY (+0.3%). The story there continues to be the anticipated strong growth rebound combined with the dollar’s weakness. Remember, Chairman Powell has essentially promised that US rates are going to remain at zero regardless of what happens for at least another year. As it happens, TWD (+0.3%) has traded to its strongest level since 1997, as the robust economic situation, plus the huge demand for semiconductors has more than offset any geopolitical concerns.
Data this week is back-loaded as follows:
| Tuesday | NFIB Small Biz Optimism | 100.8 |
| JOLTs Job Openings | 7.5M | |
| Wednesday | CPI | 0.2% (3.6% Y/Y) |
| -ex food & energy | 0.3% (2.3% Y/Y) | |
| Thursday | Initial Claims | 495K |
| Continuing Claims | 3.64M | |
| PPI | 0.3% (5.8% Y/Y) | |
| -ex food & energy | 0.4% (3.7% Y/Y) | |
| Friday | Retail Sales | 1.0% |
| -ex autos | 0.9% | |
| IP | 1.0% | |
| Capacity Utilization | 75.1% | |
| Michigan Sentiment | 90.1 |
Source: Bloomberg
Obviously, CPI will be very interesting, as will Retail Sales. We also hear from 13 more Fed speakers this week, all of whom are certain to repeat the mantra that the economy needs more support and they will not be changing policy anytime soon. Remember, inflation is transitory…until it’s not.
The dollar is starting the week off on the back foot. If we continue to hear Fed speakers insist that policy is not going to change, and we continue to see inflationary consequences rise, the dollar will weaken further. In the end, 10-year Treasury yields remain the key number to watch. As long as they remain within the recent range, the dollar is likely to remain soft. If they should break higher, though, watch out.
Good luck and stay safe
Adf
Not If But When
Eight years ago, when Chairman Ben
Suggested t’was not if but when
The Fed would reduce
Its purchase, profuse,
Of bonds, traders sold bonds, bought yen
But these days when taper’s discussed
The bond market doesn’t seem fussed
The reason could be
There’s now nobody
The market invests with its trust
Yesterday’s CPI data printed a tick higher than forecast indicating that, yes, prices are rising relative to last year. The headline print of 2.6% was the beneficiary of a substantial rise in energy prices compared to last year, but the core price index indicated that both goods and services prices are rising in price. One data point is not enough to make any claims in either direction, but it will certainly keep the discussion going for a while. The market response was somewhat counterintuitive as by the end of the day, 10-year Treasury yields had fallen 6 basis points and the dollar was softer amid modestly firmer equity prices. While the link between the dollar and Treasuries remains intact, the question is why would bonds rally (yields decline) if inflation was rising?
One possible answer is that the market had gotten far ahead of itself with respect to pricing in rising inflation. Historically, inflation takes time to manifest itself as prices on many things are sticky, meaning they remain stable for a time amid broad pressures and then shift in a relatively large step, rather than a gradual daily or weekly increase. We are all familiar with the situation when an item regularly purchased suddenly rises in price to catch up to the broad underlying price pressures. But when taken over the totality of all goods purchased, while any given good or service may see prices rise in discrete steps, the index moves up in a relatively smooth manner. This fact is why yesterday’s data are interesting, because the headline jump of 0.6% M/M certainly tests the definition of smooth. Consider that a monthly increase of 0.6% would result in annual inflation of 7.4%, a level that even the Fed would consider too hot. FYI, yesterday’s core print, which was actually 0.34%, would represent 4.2% core CPI over a year. So, yes, the base effects were instrumental in the much higher Y/Y data, but the monthly increases were pretty high in any accounting.
And yet, the bond market ultimately rallied all day, having touched 1.7% in early European trading and closing the session at 1.615%. If this wasn’t a classic case of buy the rumor, sell the news, I don’t know what is. And, as we have seen consistently all year, the dollar dutifully followed yields lower while equity markets ultimately rallied, although the euphoria over the value trade seems to be waning.
Perhaps of more interest is the fact that we have now had 3 key central bankers, two from the ECB, Knot and Villeroy, and the Fed’s Bullard all start to discuss the idea of tapering bond purchases. This seems incongruous given the adamant claims on both sides of the pond that current monetary policy is necessary and appropriate to ensure the respective economies return to form. And yet each of these discussed how tapering of QE could begin before the year is out. You may recall that Bullard wanted to tie the idea of tapering to the level of vaccinations in the economy, indicating that when 75% of the population is vaccinated, it could be time to start slowing purchases with the implication being the economy would then be able to stand on its own two feet.
This morning, Banque de France Governor Villeroy de Galhau explained that there could be an evolution in monetary policy at the ECB, which while remaining accommodative would shift the burden back to the APP (the original QE plan) from PEPP, which will ostensibly run its course in March 2022. Last week, Knot, the Dutch Central Bank president expressed his view that the current expectations of robust growth in the second half of the year could be a signal to begin tapering asset purchases. Now, understand that there were members from both central bank committees pushing back on the idea, but the fact remains that there is some consideration of tapering. Today, we hear from Chairman Powell again, but we will not hear from Madame Lagarde until her press conference after the ECB meeting next week.
Adding up the disparate facts is quite difficult. On the one hand, we have the first trial balloons floated regarding tapering of asset purchases as a response to the forecasts for extremely robust growth this year. On the other hand, the market appears to have indicated that, at least for now, the idea of much faster growth leading to much higher inflation has run its course. It strikes me that the market is unlikely to worry too much about these trial balloons until they hear from Powell and/or Lagarde. Until then, it appears that a short period of higher inflation readings is on the cards and unless they really start to spike, that is unlikely to have a big impact on either equities or bonds.
Speaking of equities, yesterday saw the S&P 500 close at yet another new all-time high with the NASDAQ pushing back to within 1% of its February record. Clearly, there is no inflation scare there. Rather, all eyes are turning to the first earnings releases due today. Overnight saw the Nikkei slide (-0.4%) but elsewhere in Asia equities rallied (Hang Seng +1.4%, Shanghai +0.5%). European markets are mixed with the DAX (-0.1%) lagging while both the CAC (+0.4%) and FTSE 100 (+0.3%) continue to grind higher. Apparently, Villeroy’s comments about tapering have not been seen as a danger. US futures are modestly higher at this point, just 0.2% or so as the market bides its time ahead of Powell’s comments at noon.
In the bond market, after a big rally yesterday, the 10-year has seen yields back up slightly, by 1.1 bps, although European bonds are all looking at modest yield declines (Bunds -1.0bps, OATs -1.2bps, Gilts -0.3bps). It has become pretty clear that the rush higher in yields has stalled for now, with important implications for all the other markets, especially the dollar.
Oil prices are continuing their recent rebound, with WTI +1.6%, although the price action in the metals markets remains confusing. Precious metals rallied sharply yesterday but are little changed this morning. Base metals continue to trade both ways with Cu (+1.1%) leading the way higher, but Al (-0.3%) lagging. It all seems very much like a consolidation period ahead of the next leg higher.
As to the dollar, after sliding all day yesterday alongside Treasury yields, it is continuing lower this morning. The leading gainer is NZD (+0.8%) which has rallied based on the market’s interpretation that standing pat by the RBNZ last night was actually hawkish, which has helped drag AUD (+0.65%) higher as well. Oil is supporting NOK (+0.45%) but the rest of the moves are far less significant. EMG currencies are also performing well this morning, led by KRW (+0.85%) and TRY (+0.5%). The won was a beneficiary of the generally falling dollar as well as foreign inflows into the KOSPI. TRY, on the other hand, simply offers yields that are too high to resist for certain investors, despite rising inflation there.
The only data today is the Fed’s Beige Book, to be released at 2:00, but aside from Powell at noon, we hear from four other Fed speakers including vice-chairman Clarida at 3:45 this afternoon. Come Friday, the Fed will enter their quiet period ahead of the next FOMC meeting, so it seems everyone wants to get their thoughts aired ahead of that.
In the end, the dollar remains beholden to 10-year Treasury yields, so we could be in for a period of very limited movement, if Treasuries have found a new home. Unless we hear something new from the Chairman today, I expect we are looking at a period of quiet for the next two weeks. The calm before the storm.
Good luck and stay safe
Adf
A Simple Statistic
There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic
But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided
The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning. At that time, CPI will be released with the following median forecasts according to Bloomberg:
| CPI MoM | 0.5% |
| -ex food & energy MoM | 0.2% |
| CPI YoY | 2.5% |
| -ex food & energy YoY | 1.5% |
The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018. As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high. After all, last month CPI YoY printed at 1.7%, so this is a big jump. We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs. Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.
Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA. My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data. What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation. And I can’t help but notice how the price of things that I buy seem to continue to rise as well. While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning. Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price. Certainly not gasoline, and even tech items cost more. If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.
Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future. In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all. If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.
Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices. We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities. Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance. Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year. The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions. Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low. However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.
Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon. This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality. In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.
As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus. So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.
Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets. The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder. We also saw yields rise in Australia overnight.
Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains. Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way. In other words, pretty much every market is waiting for CPI to take their cues.
FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data. This is especially odd given oil’s gains in the session. But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number. EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.
The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week. Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option. While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.
At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver. If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck. These days, it is truly binary.
Good luck and stay safe
Adf
Prices Are Rising
While Jay and the Fed are persuaded
Inflation won’t soon be upgraded
The press keeps advising
That prices are rising
How long can rate hikes be evaded?
Chairman Powell gave yet another interview this weekend, this time to a national audience on 60 Minutes last night. A cynic might believe that the Chairman is concerned the Fed’s message, inflation is still quite low and will not present any problems, is not getting across to the general public. While those of us in the financial markets are well aware of everything he utters, his fame amongst the general populace is far less significant. (After all, I’m pretty certain he doesn’t have either an Instagram or TikTok presence!) The problem for the Fed if they are unable to get their message across is that people might start to believe their own eyes what they read in the papers and lately, that is not synching well with the Fed’s message. The number of stories on inflation has been inflating along with a clearly growing interest by the general population, at least as evidenced by the number of Google searches on the subject. The fear here is that all of this talk of rising prices might result in a change in inflation expectations by the general population, and according to the Fed’s models, that is when inflation starts to rise.
The Fed is not the only central bank in this position as evidenced by comments this morning from Banca’d’Italia, and ECB Executive Board Member, Fabio Panetta’s comments, “We cannot be satisfied with inflation at 1.2% in 2022 and 1.4% in 2023.” Here, too, the concern is over too low inflation although, in fairness, the inflationary impulse on the Continent is far less consistent than in the US.
One need not look too deep beneath the surface to find a viable explanation for this lack of concern over rising prices. Clearly the ongoing need for central banks to continue to monetize purchase government debt issuance in order to support the government in power economy is the catalyst. And there is no better rationale for a central bank to continue QE than a strong belief that inflation is too low along with a commitment to raise it.
That cynic might also question the timing of this 60 Minutes interview as it was aired just two days before the CPI data is to be released. We are all aware that CPI prints for the next several months will be quite a bit higher than the Fed’s 2.0% target as the base effects from the initial impacts of the Covid-inspired lockdowns are now the comparison. The month-on-month rate of CPI in March 2020 was -0.4% with it declining to -0.8% in April 2020. Given the very real increases in price pressures we have observed in the past months, you can be sure that CPI tomorrow, currently expected at 0.5% M/M, 2.5% Y/Y will be quite high. All told, Powell and the Fed will have to work overtime in order to ensure their message on inflation gets across, because if the general population starts to anticipate rising prices, even though the Fed ‘has tools’ to combat inflation, given the fragility of the economy, their ability to use those tools is highly suspect. Inflation, once it gets rolling, has a history of being more persistent than desired, and as much as the Fed claimed to fear deflation, I’m pretty sure they are not looking forward to having to fight inflation either. Especially as that would require actions that will slow the economy down, meaning they will be an easy political target for both sides of the aisle.
But CPI is tomorrow’s release, despite the fact that there are no less than ten stories on major media sites on the subject today. In the meantime, markets are starting the week generally on their back foot, with risk definitely under some pressure today. Equity markets in Asia, for instance, were all red (Nikkei -0.8%, Hang Seng -0.9%, Shanghai -1.1%) while European markets have been more mixed, but the mix is flat to down (DAX +0.1%, CAC 0.0%, FTSE 100 -0.4%). US futures markets are also pointing slightly lower, with all three major indices off by about 0.15% as I type.
Bond market activity has been fairly quiet, with the 10-year Treasury yield unchanged on the day, although we are seeing very modest gains (yield declines) in most of Europe (Bunds -1.3bps, OATs -1.5bps). Gilts are the lone exception here, with yields rising 1.0 basis point as the UK economy, despite a surprise spring snowstorm, welcomes the reopening of pubs for outdoor drinking/dining. As the UK economy reopens, there is a great deal of focus on the £150 billion of savings that have accrued during the lockdown and how much of that will be quickly spent. After all, that represents nearly 7% of GDP in the UK, and obviously, if spent would have a remarkable impact on growth there.
Commodity prices show oil rebounding from its recent lows (WTI +1.1%) as it pushes back to $60/bbl. Metals prices, however, have been far more mixed with precious largely unchanged, and base metals showing both gains and losses (Cu -0.4%, Al +0.2%).
Finally, the dollar is edging lower this morning in general, but by no means universally. G10 markets are led by GBP (+0.4%) on the economy reopening news and corresponding growth in confidence there, as well as JPY (+0.4%) which some will attribute to haven demand as equity markets suffered in Asia overnight, but I might attribute to Hideki Matsuyama’s fantastic win at the Masters yesterday. On the downside, SEK (-0.25%) is the weakest of the bunch, which looks more like position trading than fundamentally driven activity.
EMG currencies are also mixed this morning, but most of the movement remains modest at best. HUF (+0.6%) is the leading gainer followed by RUB (+0.3%) and PLN (+0.3%). The HUF seems to be rallying on the news that the central bank will be buying the soon to be issued government green bonds as part of their QE exercise, helping to add demand there. As to the other two, given the euro’s modest climb, it is no surprise to see EEMEA currencies rise. On the downside, it is all APAC currencies that fell last night, led by INR (-0.4%) and KRW (-0.35%), which were victims of local equity market disposals by international investors.
Data wise, there is important information beyond tomorrow’s CPI as follows:
| Today | Monthly Budget Statement | -$658B |
| Tuesday | CPI | 0.5% (2.5% Y/Y) |
| -ex food & energy | 0.2% (1.5% Y/Y) | |
| Wednesday | Fed Beige Book | |
| Thursday | Initial Claims | 700K |
| Continuing Claims | 3700K | |
| Retail Sales | 5.5% | |
| -ex autos | 4.8% | |
| Empire Manufacturing | 18.8 | |
| Philly Fed | 40.0 | |
| IP | 2.5% | |
| Capacity Utilization | 75.6% | |
| Business Inventories | 0.5% | |
| Friday | Housing Starts | 1600K |
| Building Permits | 1750K | |
| Michigan Sentiment | 89.0 |
Source: Bloomberg
So, there is much to learn this week, especially on Thursday, although if the CPI data is large enough, it is likely to dominate conversation for a while. The FOMC is back on tour this week with ten more speakers, including Chairman Powell on Wednesday, across at least 15 different venues. I expect there will be a great deal of effort downplaying any thoughts that inflation is making a permanent comeback and that current policy is perfect for right now.
In the end, though, the dollar remains beholden to the Treasury bond, as do most markets, and so all eyes will continue to be on its movement going forward. Strong data that pushes it to its recent high yield at 1.75% or beyond will result in the dollar rallying. On the other hand, if the data goes the other way, look for the dollar to retreat a bit further.
Good luck and stay safe
Adf
On Edge
Two fears have the market on edge
Inflation that many allege
Will drive bond yields higher
Thus, causing a dire
Result, pushing stocks off the ledge
But right now, the bulls rule the roost
As inflation has not been produced
So, Jay and Christine
Have no need to wean
The market from QE’s large boost
Yesterday morning’s CPI release was a touch softer than expected, thus helping to abate fears of the much-mooted inflationary surge arriving soon. (PS, it is clear that starting next month the CPI data will be much higher, given the year over year comps, with the key question being will that continue through the summer and beyond.) In the meantime, bond investors, who had clearly been concerned over the rising inflation story, relaxed a bit and bought more Treasuries. The result was that the early morning rise in yields was unwound. Of course, the other big news yesterday was the 10-year Treasury auction which was received by the market with general aplomb. While there was a 1 basis point tail, the bid-to-cover ratio at 2.37 was right in line with recent averages. One little hiccup, though, was indirect bidders (usually foreign governments) continued their declining participation, falling to 56.8%, with the implication that natural demand for Treasuries is truly sinking. This latter point is critical because, given the amount of new money the Treasury will need to borrow this year and going forward, it will increase pressure on the Fed to absorb more (i.e. increase QE), or yields will definitely climb.
However, that apparently, is a story for another day. Equity markets reveled in the low inflation print and modest bond market rally, while the dollar fell pretty much across the board, reversing all of its early gains.
Which brings us to this morning’s ECB meeting, where the question is not about a change in policy, as quite clearly no policy change is in the offing, but rather about the ECB’s utilization and reaction function of its current policy programs. While sovereign yields have stabilized for the past several sessions, the fact remains that they have not fallen back anywhere near the levels seen at the beginning of the year. The question market participants have is exactly what will constitute a tightening in financial conditions that might bring a response.
As mentioned yesterday, the ECB has been consistently underutilizing the PEPP compared to recent months, with weekly purchases falling to a net €12 billion despite the rise in yields. So, it would seem that the ECB does not believe the current yield framework is a hindrance to the economy. However, you can be sure that Madame Lagarde will field several questions on the topic at this morning’s press conference as market participants try to determine the ECB’s pain threshold. The last we heard on the topic was that they were carefully watching the market with some of the more dovish members calling for a more active stance to prevent a further climb in yields.
And remember, the ECB is not only focused on sovereign yields, but on the exchange rate as well, which is also officially a key indicator. With the US inflation story getting beaten back, and US yields slipping, the euro’s concomitant rise will not be welcome. Now, we remain well below the early January highs in the single currency, but if the euro has bottomed, and more importantly starts that long-term rise that is so widely expected, the ECB will find themselves in yet another sticky situation. These, however, are stories for a future date, as today the euro is firmly in the middle of recent ranges while sovereign yields are slipping a bit.
With two potential landmines behind us, risk appetite has been reawakened, with asset purchases across virtually all classes. For instance, overnight saw equity market strength across the board (Nikkei +0.6%, Hang Seng +1.65%, Shanghai +2.4%) although Europe’s early gains have mostly diminished and markets are little changed ahead of the ECB (DAX -0.1%, CAC +0.1%, FTSE 100 -0.35%). US futures, though, are largely booming, led by the NASDAQ (+1.9%) but seeing solid gains in the other indices as well.
On the bond front, Treasury yields are lower by 1.9 basis points, back to 1.50%, while we are seeing more modest declines in the major European bond markets, on the order of 0.5bps for all of them.
Oil prices are firmly higher (WTI +1.2%) as is the entire energy complex. Metals prices, too, are rising with both precious and base seeing a resumption of demand. Meanwhile agricultural prices are generally moving up in sync. Once again, to the extent that commodity price rises are a harbinger of future inflation, the signs are clearly pointing in that direction.
The dollar, meanwhile, which reversed yesterday’s early gains to close lower across the board, has continued in that direction with further losses this morning. CHF (+0.5%) leads the way in the G10, which given the fact it had been the biggest loser over the past month, falling more than 5.6%, should be no surprise. But the rest of the bloc is seeing gains in the commodity focused currencies with AUD (+0.45%), NZD (+0.4%) and CAD (+0.3%) next in line. Perhaps the biggest surprise is that NOK (0.0%) is not along for the ride.
EMG currencies are also broadly firmer led by BRL (+1.6%) which is following on yesterday’s 2.5% rally as the central bank has been actively intervening to stem the real’s recent weakness. Concerns remain over rising inflation, and expectations for rising policy rates are growing there, which would likely support the currency even more. But we are seeing strength in ZAR (+1.0%), CLP (+1.0%) and MXN (+0.65%) as well, clearly all benefitting from the commodity story. However, virtually the entire bloc is firmer given today’s increasing risk-on attitude.
Aside from the ECB meeting, with the statement published at 7:45 and the press conference at 8:30, we see Initial Claims (exp 725K), Continuing Claims (4.2M) and the JOLTs Job Openings survey (6.7M). Again, no Fed speakers so look for the dollar to follow risk attitude and the movement in real yields. Those are both pointing toward a lower dollar as the day progresses, and I see no reason to fight that absent comments from a surprising source. Unless Madame Lagarde fumbles the press conference, look for this little risk bounce to continue.
Good luck and stay safe
Adf
fxpoetry 