An Untimely End

Should risk appetite ever fall
The asset price rally could stall
And that could portend
An untimely end
To trust in the Fed overall

Yesterday afternoon the Fed released their annual financial stability report.  In what may well be the most unintended ironic statement of all time, on the topic of asset valuations the report stated, “However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.” [Author’s emphasis.]  Essentially, the Fed seems to be trying to imply that for some reason, having nothing to do with their policy framework, asset prices have risen and now they are in a vulnerable place.  But for the fact that this is very serious, it is extraordinary that they could make such a disingenuous statement.  The reason asset prices are elevated is SOLELY BECAUSE THE FED CONTINUES TO PURCHASE TREASURIES VIA QE AND FORCE INVESTORS OUT THE RISK CURVE TO SEEK RETURN.  This is the design of QE, it is the portfolio rebalance channel that Ben Bernanke described a decade ago, and now they have the unmitigated gall to try to describe the direct outcome of their actions as some exogenous phenomenon.  If you wondered why the Fed, and truly most central banks, are subject to so much criticism, you need look no further than this.

In Europe, a little-known voice
From Latvia outlined a choice
The ECB may
Decide on one day
In June, and then hawks will rejoice

In a bit of a surprise, this morning Latvian central bank president, and ECB Governing Council member, Martins Kazaks, explained that the ECB could decide as early as their June meeting to begin to scale back PEPP purchases.  His view was that given the strengthening rebound in the economy as well as the significant progress being made with respect to vaccinations of the European population, overall financial conditions may remain favorable enough so they can start to taper their purchases.  This would then be the third major central bank that is on the taper trail with Canada already reducing purchases and the BOE slowing the rate of weekly purchases, although maintaining, for now, the full target.

This is a sharp contrast to the Fed, where other than Dallas Fed president Kaplan, who is becoming almost frantic in his insistence that it is time for the Fed to begin discussing the tapering of asset purchases, essentially every other FOMC member is adhering to the line that the US economy needs more monetary support and any inflation will merely be transitory.  As if to reaffirm this view, erstwhile uber-hawk Loretta Mester, once again yesterday explained that any inflation was of no concern due to its likely temporary nature, and that the Fed has a long way to go to achieve its new mission of maximum employment.

A quick look at the Treasury market this morning, and over the past several sessions, shows that the 10-year yield (currently 1.577%, +0.7bps on the day) seems to have found a new equilibrium.  Essentially, it has remained between 1.54% and 1.63% for about the last month despite the fact that virtually every data release over that timespan has been better than expected.  Thus, despite a powerful growth impulse, yields are not following along.  It is almost as if the market is beginning to price in YCC, which is, of course, exactly the opposite of tapering.  Given the concerns reflected in the Financial Stability Report, maybe the only way to prevent that asset price decline would be to cap yields and let inflation fly.  History has shown bond investors tend to be pretty savvy in these situations, so do not ignore this, especially because YCC would most likely result in a sharply weaker dollar and sharply higher commodity and equity prices.

This morning the market will see
The labor report, NFP
Expecting one mill
The Fed’s likely, still,
To say they’ll continue QE

Finally, it is payroll day with the following current expectations according to Bloomberg:

Nonfarm Payrolls 1000K
Private Payrolls 938K
Manufacturing Payrolls 57K
Unemployment Rate 5.8%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%

The range of forecasts for the headline number is extremely wide, from 700K to 2.1 million, just showing how little certainty exists with respect to econometric models more than a year removed from the initial impact of Covid-induced shutdowns.  As well, remember, even if we get 1 million new jobs, based on Chairman Powell’s goal of finding 10 million, as he stated back in January, there are still another 7+ million to find, meaning the Fed seems unlikely to respond to the report in any manner other than maintaining current policy.  In fact, it seems to me the bigger risk today is a disappointing number which would encourage the Fed to double down!  We shall learn more at 8:30.

As to markets ahead of the release, Asian equities were mixed (Nikkei +0.1%, Hang Seng -0.1%, Shanghai -0.65%) although Europe is going gangbusters led by Germany’s DAX (+1.3%), with the CAC (+0.3%) and FTSE 100 (+0.8%) also having good days.  German IP data (+2.5% M/M) was released better than expected and has clearly been a catalyst for good.  At the same time, French IP (+0.8% M/M) was softer than expected, arguably weighing on the CAC.

Away from Treasuries, European sovereign bonds are all selling off as risk appetite grows, or so it seems.  Bunds (+1.0bps) and OATs (+2.8bps) are feeling pressure, although not as much as Italian BTPs (+4.8bps).  Gilts, on the other hand, are little changed on the day.

Commodity prices continue to rally sharply, at least in the metals space, with gold (+0.3%, +1.5% yesterday), silver (+0.1%, +3.5% yesterday), copper (+2.6%), aluminum (+1.0%) and nickel (+0.2%) all pushing higher.  Interestingly, oil prices are essentially unchanged on the day.

Lastly the dollar is mixed on the session, at least vs. the G10.  SEK (+0.35%) is the leading gainer on what appears to be positive risk appetite, while NZD (-0.25%) is the laggard after inflation expectations rose to a 3-year high.  The other eight are all within that range and split pretty evenly as to gainers and losers.

EMG currencies, though, are showing more positivity with only two small losers (ZAR -0.25%, PLN -0.15%) and the rest of the bloc firmer.  APAC currencies are leading (KRW +0.4%, INR +0.35%, TWD +0.3%) with all of them benefitting from much stronger than forecast Chinese data. We saw Caixin PMI Services rise to 56.3 and their trade balance expand to $42.85B amid large growth in both exports and imports.  Models now point to Chinese GDP growing at 9.0% in 2021 after these releases.

At this point, we are all in thrall to the NFP release later this morning.  The dollar response is unclear to me, although I feel like a strong number may be met with a falling dollar unless Treasury yields start to climb.  Given their recent inability to do so, I continue to believe that is the key market signal to watch.

Good luck, good weekend and stay safe
Adf

A Kettle of Hawks

There once was a kettle of hawks
Who regularly gave earnest talks
When prices would rise
They would then surmise
T’was time to forget Goldilocks

But now they’re a bevy of doves
The type every borrower loves
Who, if prices rose
Would never propose
That they would give rates, up, a shove

While today’s activity roster includes the Bank of England rate decision (no change) and QE target (possible change), I want to review yesterday’s Fedspeak as I believe it is crucial to continue our understanding of the policy evolution.

Three Fed regional presidents spoke; Chicago’s Mike Evans, a known dove; Boston’s Eric Rosengren, historically slightly more hawkish than centrist; and Cleveland’s Loretta Mester, historically one of the most hawkish Fed members.  All three made clear that they are unconcerned over the almost certain rise in inflation in the short-term, with all three convinced this is a ‘transitory’ phenomenon that will work itself out by the end of 2022.  Rosengren was particularly colorful in his description as he compared his view of general price increases upcoming to the situation right at the beginning of the pandemic shutdowns regarding toilet paper.  “My view is that this acceleration in the rate of price increases is likely to prove temporary,” he said.  He continued, “Toilet paper and Clorox were in short supply at the outset of the pandemic, but manufacturers eventually increased supply, and those items are no longer scarce.  Many of the factors raising prices this spring are also likely to be similarly short-lived.”

Now, I don’t know about you, but I would beg to differ with his assessment, specifically on the two items he mentioned, toilet paper and Clorox.  While there is no question that both items are readily available today as opposed to the situation twelve months ago, it is also very clear that the prices of both items have risen substantially.  In fact, my anecdotal evidence from the local Shop-Rite is that prices of these two items have risen at least 35% in the past twelve months, and there is no evidence that these prices are going to decline anytime soon.  After all, as a manufacturer, why would you reduce prices if customers are still buying your product?  So, while supply has improved, it has done so at the expense of higher prices.  In my book, this is the very definition of inflation.

Regarding the topic of tapering, Evans was dismissive of the idea at all and surprisingly, Mester showed no interest in the discussion in the near term.  Rosengren, however, did indicate that it was possible the situation by the end of this year could warrant a discussion, although he would sooner halt purchases of mortgage bonds than Treasuries as he mentioned the possibility that housing prices could get ‘frothy’.  Ya think?  A quick look at the recent Case Shiller House Price Index shows it has risen by nearly 12% in the past year nationwide, the fastest level since March 2006, right in the middle of the housing bubble whose bursting caused the GFC.  Perhaps this is what is meant by “frothy” in Chairman Powell’s eyes.

From London, the market’s awaiting
The Old Lady’s econ re-rating
While wondering if
She’ll offer a sniff
Of when QE might start abating

The UK’s post-pandemic growth trajectory has been far closer to the US than of the EU as PM Johnson’s government has done an excellent job of getting a large proportion of its population inoculated allowing for a reopening of the economy.  Recent data has been strong and as more restrictions are eased; prospects continue to be relatively bright.  Not dissimilar to the Fed’s situation, the Bank of England will find themselves raising their GDP growth forecasts while maintaining their ongoing monetary policy support.  Or will they?  There is talk in the market that the BOE may well discuss the initial timing of tapering purchases while they upgrade their forecasts.  Precedent was set last week when the Bank of Canada did just that, not merely discussing tapering, but actually cutting the amount of purchases by 25%.  Will the BOE follow suit?

Analyst expectations are that they will not change policy at all and explain it in the same manner as the Fed, that while inflation in the near-term may rise above their 2.0% target, this will be a temporary phenomenon and is no cause for concern.  However, any hint that tapering may be coming sooner than the current program’s target end date later this year is likely to be quite supportive of the pound, so keep that in mind.  That said, ahead of the meeting, the pound is essentially unchanged on the day at 1.3900.

Stronger growth forecasts, as well as strong earnings numbers, continue to support equity markets, although while they are not falling, rallies have been modest at best.  In fact, there is growing concern that the tech sector, which has clearly been the leader in the post pandemic equity rally, is starting to falter more seriously.  Last night saw gains in the Nikkei (+1.8%) and Hang Seng (+0.8%) but a modest decline in Shanghai (-0.2%) on its return from Golden Week.  Europe, despite strong German Factory Orders (+3.0%) and Eurozone Retail Sales (+2.7%) has been unable to make any real headway (DAX 0.0%, CAC 0.0%, FTSE 100 +0.2%).  US futures are similarly lackluster, with all three major indices higher by 0.1% at this hour.  Could it be that economic and earnings strength is fully priced in at these levels?

**BOE leaves policy unchanged, as expected**

Bond markets, on the other hand, are holding their own overall.  While Treasury yields are unchanged on the day, they slid 2.5bps yesterday and are now closer to their recent lows than highs.  In Europe, sovereigns are showing the smallest of rallies with yields in both Bunds and OATs lower by 0.5bps while Gilt yields are unchanged.  At this point, it appears that bond traders and investors are starting to believe the central banks regarding the idea of transitory inflation.  While that would be a wonderful outcome, I fear that there is far more permanent inflation scenario unfolding.

Commodity prices are mixed this morning with oil (-0.75%) soft but metals, both base and precious firmer.  In fact, iron ore has reached record high levels, rising 6.5% this week, and approaching $200/ton.  Again, rising input prices are not disappearing.

As to the dollar, it is generally softer this morning, albeit not substantially so.  In the G10, CHF (+0.4%) is the leading gainer but the European currencies are all solidly higher, between 0.2% and 0.3%, although the pound’s move occurred just since the BOE announcement.  However, commodity currencies have underperformed here and are little changed on the day.

In the emerging markets, THB (-0.45%) was the laggard after the central bank left rates on hold amid a surge in reported Covid infections.  KRW (-0.25%) was next worst as there were a surprisingly large amount of equity outflows from the KOSPI.  On the positive side, IDR (+0.8%) was the biggest mover as Indonesia saw significant equity inflows as well as increased interest in the carry trade.  ZAR (+0.7%) is benefitting from the rise in gold (+0.25%) as well as the metals complex generally.  Otherwise, while gains have been broad-based, they have been shallow.

This morning’s data brings Initial Claims (exp 538K), Continuing Claims (3.62M), Nonfarm Productivity (4.3%) and Unit Labor Costs (-1.0%).  However, all eyes are turned to tomorrow’s NFP report, which despite a slightly softer than expected ADP Employment number yesterday (742K, exp 850K), has seen the forecast rise to essentially 1.0 million.

Treasury bond yields have lost their mojo for now and have been able to ignore any signs of imminent inflation.  It seems that the Fed chorus of transitory inflation is having the desired impact and preventing yields from running away higher.  As long as Treasury yields remain under control, especially if they drift lower, then the dollar will remain under modest pressure.  So far, nothing has occurred to change that equation.

Good luck and stay safe
Adf

Rates May Have to Rise

Said Janet, “rates may have to rise”
Which really should be no surprise
The money we’ve spent
Has markets hell bent
On constantly making new highs

But right after this bit of diction
The market ran into some friction
So quick as a wink
She had a rethink
And said “this is not a prediction”

Just kidding!  What was amply demonstrated yesterday is that the Fed, and by extension the US government, has completely lost control of the narrative.  The ongoing financialization of the US economy has resulted in the single most powerful force being the stock market.  Policymakers are now in the position of doing whatever it takes, to steal a phrase, to prevent a decline of any severity.  This includes actual policy decisions as well as comments about potential future decisions.

A brief recap of yesterday’s events shows that Treasury Secretary Yellen, at a virtual event on the economy said, “rates may have to rise to stop the economy from overheating.”  Now, on its surface, this doesn’t seem like an outrageous statement as it hews directly to macroeconomic theory and is widely accepted as a reasonable idea. However, Janet Yellen is no longer a paid consultant for BlackRock, but US Treasury Secretary.  And the only market fundamental that matters currently is the idea that the Fed is not going to raise interest rates for at least another two years.  Thus, when a senior administration financial official (has a Freudian slip and) talks about rates needing to rise, investors take notice.

So, in a scene we have observed numerous times in the past, immediately after the comments equity markets started to sell off even more sharply than their early declines and the market discussion started to turn to when rates may be raised.  But a declining stock market is unacceptable, so in a later WSJ interview, Yellen recanted clarified those remarks explaining that she was neither predicting nor recommending rate hikes.  It was merely an observation.

However, what was made clear was just how few degrees of freedom the Fed has to implement the policy they see fit.  It is for this reason that every time an official explains the Fed ‘has the tools’ necessary to fight inflation should it arise, there is a great deal of eye-rolling.  The first tool in fighting inflation is raising interest rates, and that will not go down well in the equity world, regardless of the level of inflation.  And what we know is that the Fed clearly doesn’t have the stomach to watch stocks decline by 10% or 20%, let alone more, in the wake of their policy decisions to raise interest rates.  We know this because in Q4 2018, when they were attempting to normalize policy, raising rates and shrinking the balance sheet simultaneously, the stock market fell 20% and was starting to gain serious downside momentum.  This begat the Powell Shift on Boxing Day, which saw the Fed stop tightening and stocks stop falling.

It is with this in mind that we view the comments of other Fed speakers.  Most are hewing to the party line, with NY’s Williams and SF’s Daly both right on script explaining that while growth will be strong this year, there is still a great deal of slack in the economy and supportive (read easy) monetary policy is still critical in achieving their goals.  It is also why Dallas Fed president Kaplan is roundly ignored when he explains that tapering purchases later this year may be sensible given the strength of the economy.  But Kaplan isn’t a voter nor will he be one until 2023, so no matter how passionate his pleas are in the FOMC meeting room, it will never be known as he cannot even dissent on a policy choice.

In summary, yesterday’s Yellen comments and corrections simply reinforce the idea that the Fed is not going to raise rates for at least another two years and that tapering of asset purchases is not on Powell’s mind, nor that of most of his FOMC colleagues.  So…party on!

And that is exactly what we are seeing today in markets.  While the Hang Seng had a poor showing (-0.5%) which followed yesterday’s tech heavy selloff in the US, Europe, which of course lacks any tech sector to speak of, is sharply higher this morning (DAX +1.35%, CAC +0.9%, FTSE 100 +1.1%) as a combination of Services PMI data strength and optimism about the ending of lockdowns has investors expecting superior profit growth going forward.  US futures are also pointing higher (DOW +0.3%, SPX +0.4%, NASDAQ +0.5%) as confirmation that rates will remain low added to rising growth forecasts continue to underpin the equity case.  As an example of the growth optimism, the Atlanta Fed’s GDPNow forecast tool has risen to 13.567% as of yesterday, up from just 7.869% a week earlier!  Now, as more data is released, that will fluctuate, but if that data continues to be as strong as recent outcomes, do not be surprised to see Q2 GDP forecasts move a lot higher everywhere.

Turning to the bond markets, Treasury yields this morning are higher by 1.3 basis points, although that is after having slipped 3 bps on Monday and ultimately remaining unchanged yesterday.  But in this risk-on meme, bonds do lose their appeal.  European sovereigns are also generally lower with Bunds (+1.9bps), OATs (+2.3bps) and Gilts (+3.0bps), all seeing sellers converting their haven money into stock purchases.

Risk appetite in commodities remains robust this morning as oil prices continue to escalate (+1.1%) and are pushing back near their recent highs above $67/bbl.  While precious metals continue to lack traction, the base metal space is back in high gear this morning (Cu +0.5%, Al +0.65%, Sn +1.1%).  Agriculturals?  Wheat +0.3%, Soybeans +1.0%, Corn +0.85%.  It’s a good thing the price of what we eat has nothing to do with inflation!  As an example, Corn is currently $7.50/bushel, a price which has only been exceeded once in the data set going back to 1912, when it touched $8.00 in July 2012.  And looking at the chart, there is no indication that it is running out of steam.

Finally, the dollar has evolved from a mixed session to one where it is now largely under pressure.  This fits with the risk-on theme so should be no surprise.  NZD (+0.65%) leads the way higher but the commodity bloc is all firmer (AUD +0.4%, NOK +0.35%, CAD +0.3%) on the back of the commodity rally.  The rest of the G10, though, is little changed overall.  In the EMG space, PLN (-0.4%) is the outlier, falling ahead of the central bank’s rate announcement, although there is no expectation for a rate move, there is concern over a change in the dovish tone.  As well, the Swiss franc mortgage issue continues to weigh on the nation as a decision is due to be released next week and could result in significant bank losses and concerns over the financial system there.  But away from the zloty, there are a handful of currencies that are ever so slightly weaker, and the gainers are unimpressive as well (ZAR +0.35%, RUB +0.2%), both of which are commodity driven.

Two data points this morning show ADP Employment (exp 850K) and ISM Services (64.1) with more attention to be paid to the former than the latter.  We also have three more Fed speakers, Evans, Rosengren and Mester, with the previously hawkish Mester being the one most likely to discuss things like tapering being appropriate.  But in the end, there remains a very clear majority on the FOMC that there is no reason to change policy for a long time to come.

It is difficult to develop a new narrative on the dollar at this stage.  Rising Treasury yields on the back of rising inflation expectations are likely to offer short term support for the buck but can undermine it over time.  For today, however, it seems that the traditional risk-on theme is pushing back on its modest gains from yesterday.

Good luck and stay safe
Adf

The Seeds of Inflation

Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory

But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone

Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation.  It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip.  The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives.  But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed.  (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)

For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%.  While both those results were exactly as forecast, the trend for both remains sharply higher.  The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation?  After all, it is not as though the data comes with a disclaimer.  Ultimately, a decision is going to have to be made that rising prices are becoming a problem.  Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.

For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession.  The June data will be the first test as that monthly CPI print last year was a robust 0.5%.  Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities.  But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand.  In fact, it is this uncertainty that is the primary rationale for corporate hedging.  There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results.  FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.

This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing.  Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%.  Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector.  In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday.  The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency.  Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.

Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds.  So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged.  Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets.  Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.

Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%).  The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs.  Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.

It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher.  Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today.  Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength.  There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.

As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.

Today ISM Manufacturing 65.0
ISM Prices Paid 86.1
Construction Spending 1.7%
Tuesday Trade Balance -$74.3B
Factory Orders 1.3%
-ex transport 1.8%
Wednesday ADP Employment 875K
ISM Services 64.1
Thursday Initial Claims 540K
Continuing Claims 3.62M
Nonfarm Productivity 4..2%
Unit Labor Costs -1.0%
Friday Nonfarm Payrolls 978K
Private Payrolls 900K
Manufacturing Payrolls 60K
Unemployment Rate 5.7%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%
Consumer Credit $20.0B

Source: Bloomberg

As well, we hear from five Fed speakers, including Chairman Powell this afternoon.  Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.

Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future.  Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact.  Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar.  We shall see.  As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast.  While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.

Good luck and stay safe
Adf

Filled With Froth

Said Jay, markets seem filled with froth
But let me tell you, we are loth
To even discuss
The tapering fuss.
To ZIRP and QE we are troth

Now, ask yourself what markets heard
Jay cooed like his favorite white bird
So, dollars were sold
Investors bought gold
With equity bulls undeterred

The Chairman was very clear yesterday afternoon in his press conference, the Fed is not anywhere near thinking about changing their current policy mix.  While paying lip service to the idea that if inflation turns out not to be ‘transitory’ they have the tools to address it, the overwhelming belief in the Mariner Eccles Building appears to be that by autumn, inflation will be a thing of the past and the Fed will still have their foot on the proverbial accelerator.

This does raise the question that, if economic growth is rebounding so smartly, why does the Fed need to buy $120 billion of assets each month and maintain their policy rate at 0.00%?  While I am just an FX guy, it seems to me that the current policy stance is more appropriate for an apocalyptic economic crisis, something like we suffered last year or in 2008-9, rather than for an economy that is growing at 7.0% or more.  But that’s just me.  Clearly, Chairman Powell and his committee are concerned that the economy cannot continue to grow on its own, else they wouldn’t be doing what they are doing.

When it comes to the tapering of asset purchases, Powell was also explicit that it is not nearly time to consider the idea.  Yes, we had one good NFP number, but we need a string of them to convince the Fed that we are past the worst of things.  Remember, the opening two lines of the Fed statement continue to be about Covid.  “The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.  The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world.”  Until such time as that statement changes, we don’t need to hear the press conference to know that nothing is going to change.

With this in mind, let us consider the potential impact on markets.  Starting with Treasuries, it seems reasonable to assume that yields are reflective of investors collective view on inflation going forward.  The Fed has been purchasing $120 billion / month since last June and is not about to change.  At this stage, it would appear the market has factored those purchases into the current yield.  This means, future movements are far more likely to be indicative of the evolving view on inflation.  Yesterday, after the press conference, 10-year yields slipped by 4bps, but this morning, they have recouped those losses and we currently sit at 1.65%.  With commodity prices clearly still on a massive roll (WTI +1.4%, Cu +0.8%), while the Fed is convinced that any inflation will be transitory, it is not obvious that the rest of the market agrees.  Powell said the Fed would need to see a string of strong data.  Well, next week the early expectations for NFP are 888K, which would be two very strong months in a row.  Is that a string?  Certainly, it’s a line.  But I doubt it will move the needle at the Fed.  Maximum employment is still a long way off, and there will be no changes until then.  As inflation readings climb, and they will, Treasury yields will continue to climb as well.  There is nothing magical about 1.75%, the level reached at the end of March, and I expect that by the end of Q2, we will be looking at 10-year yields close to, or above 2.0%.

If Treasury yields are at 2.0%, what happens to equity markets?  In this case, it is not as clear cut as one might think.  First off, this Fed clearly has a different reaction function to data than previous iterations as they have been explicit that pre-emptive tightening to prevent potential future inflation is not going to happen.  This implies that any rise in yields is not reflective of expected Fed policy changes, but rather as a response to rising inflationary pressures.  History has shown that when inflation rises but stays below 3.0%, equity markets can remain buoyant, but once that threshold has been breached, it is a different story.  Remember, especially in the tech sector, but in truth quite generally, the reason low rates boost the stock market is because any discount cash flow model, when discounting at ultra-low rates means current values should be higher.  This is why rising yields become a problem for equity prices. In fact, it is reasonable to analogize being long growth stocks to being long bond duration, so when bond prices fall and yields rise accordingly the same thing happens to those stocks.  If this relationship holds going forward, and inflationary concerns do continue to percolate in the market, it would appear equity prices could be in for a bumpy ride.

Clearly, that is not yet the case (after all, inflation hasn’t yet reared its ugly head), as evidenced by the overnight price action in the wake of Powell’s comments.  Asia was strong (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +0.5%) and most of Europe is as well (CAC +0.55%, FTSE 100 +0.7%) although the German DAX (-0.25%) is a bit of a laggard this morning as concerns over Q1 GDP rise due to the third Covid wave.  US futures, though, are all-in with Jay, rising between 0.5% (Dow) and 1.0% (NASDAQ).  That makes sense given the assurances that there will be no tapering forever the foreseeable future.

As to the dollar, there are two different narratives at odds here.  On the one hand, the fundamentalists continue to point to a weaker dollar in the future as rising inflation tends to devalue a currency, and when combined with the massive fiscal deficit policy, a dollar decline becomes the only outlet available for pressure on the economy.  On the other hand, rising yields tend to support the dollar, so as Treasury yields continue to rise, if they stay ahead of the inflation statistics, there is reason to believe that the dollar has further to gain from here.  Of course, if inflation outstrips the rise in nominal yields such that real yields decline, we could easily have a situation with higher nominal Treasury yields and a much weaker dollar.  For now, the inflation data is lagging the Treasury market, but I suspect that by the end of May, that will not be the case, meaning the long-awaited dollar decline has a much better chance to get started then.

In the meantime, the dollar has softened ever so slightly this morning.  Versus G10 currencies, only JPY (-0.25%) has declined as the rebound in Treasury yields this morning seems to be garnering interest in the Japanese investment community.  But, while the dollar is softer vs. everything else, nothing has even moved 0.2%, which implies there is no news beyond the Fed.  In the EMG space, the dollar is also largely softer, led by HUF (+0.5%), THB (+0.45%) and INR (+0.45%).  HUF continues to benefit from the relatively hawkish stance of the central bank, while the baht rallied despite a reduction in the 2021 GDP estimate to 2.3% as Covid infections increase in the nation.  Meanwhile, INR appears to be the beneficiary of the Fed’s stance as clearly, the ongoing domestic disaster regarding its response to the latest wave of Covid infections cannot be seen as a positive.

On the data front, we start with Initial Claims (exp 540K) and Continuing Claims (3.59M) but also see the first look at Q1 GDP (6.6%), with a range of estimates from 4.5% to 10.0%!  With the Fed meeting behind us, we should start to hear from FOMC members again, but today only has Governor Quarles discussing financial regulation, a much drier subject than inflation.  Tomorrow, however, we will see the latest Core PCE data, and that has the chance to move things around.

As of now, the dollar remains on its back foot given the Fed’s clear message that tapering is a long way off and easy money is here for now.  However, if Treasury yields start to rise further, especially if they get back toward the 1.75% level, I expect the dollar will rebound.  On the other hand, if Treasuries remain quiet, the dollar probably has further to fall.

Good luck and stay safe
Adf

QE Will Wane

Some pundits have come to believe
That sometime before New Year’s Eve
The Fed will explain
That QE will wane
Though others are sure they’re naïve

So, let’s listen to what the Fed
Has very consistently said
Without hard statistics,
Not simple heuristics,
The idea of tapering’s dead

As a new week begins, all eyes are turning to the central bank conclaves scheduled for the latest clues in monetary policy activity.  Recall last week, the Bank of Canada surprised almost everyone by explaining they would reduce the amount of QE by 25% (C$1 billion/week) as they see stronger growth and incipient inflationary pressures beyond the widely discussed base effects that are coming soon to a screen near you.  This has clearly inspired the punditry, as evidenced by a recent survey of economists carried out by Bloomberg, showing more than 60% of those surveyed expect the Fed to begin to taper QE before the end of this year.  When the same questions were asked in March, less than 50% of those surveyed expected a tapering this year.  Obviously, we have seen a run of very strong survey data, as well as a very strong payroll report at the beginning of this month.  In addition, the vaccine rate has increased substantially, with the combination of these things leading to significantly upgraded economic forecasts for the US this year.

And yet, everything we have heard from Chairman Powell and the rest of the FOMC has been incredibly consistent; they are not even thinking about thinking about tapering monetary policy and will not do so until substantial further progress toward their goals of maximum employment and average inflation of 2.0% are achieved.  In addition, Powell has promised to communicate very clearly, well in advance, that changes are in the offing.  While we have had two strong employment reports in a row, the combined job gains remain a fraction of the 10 million that Powell has repeatedly explained need to be regained.  Arguably, we will need to see NFP numbers north of 750K for the next 6-9 months before the Fed is even close to their target and will consider taking their foot off the proverbial accelerator.

Of course, there is one thing that could force earlier action by the Fed, inflation rising more quickly than anticipated.  As of now, the Fed remains unconcerned over price rises and have made it clear that while the data for the next several months will be rising quickly, it is a transitory impact from the now famous base effects caused by the Covid induced swoon this time last year.  Even then, given the new framework of average inflation targeting, rather than a hard numeric target, a few more months of above 2.0% core PCE will hardly dissuade them from their views as they have nearly a decade of lower than 2.0% core PCE to offset.

But what if inflation is more than a transitory event?  While the plural of anecdote is not data, it certainly must mean something when every week we hear from another major consumer brand that prices will be rising later this year.  Personal care products, food and beverages have all been tipped for higher prices this year.  The same is true with autos and many manufactured goods as the consistent rise in input prices (read commodities) is forcing the hands of manufacturers.  While it is true that, by definition, core PCE removes food & energy prices, to my knowledge, neither toothpaste nor Teslas are core purchases.

The medium-term risk appears to be that inflation runs, not only hotter than the Fed expects, but hot enough that they begin to become uncomfortable with its impact.  While the natural response would be to simply raise rates, given Jay’s effective promise not to raise rates until 2023, as well as the fact that the Treasury can ill afford higher interest rates (nor for that matter can the rest of the economy given the amount of leverage that is outstanding), the Fed may well find themselves in quite a bind later this year.  One cannot look at the price of copper (+1.9% today, 25.6% YTD), aluminum (+1.2%, 21.1%) or iron ore (+0.4%, 16.0%) without considering that those critical inputs, neither food nor energy, are going to drive price pressures higher.  And, by the way, food and energy prices have been rocketing as well (Corn +38% YTD, Wheat +13.1%, Soybeans +18.2%, WTI +26.1%).  Chairman of the Fed may not be that attractive a position by the time Powell’s term ends in February.

Turning to the markets, if I had to characterize them in a theme, it would be idle.  Equity markets are generally flat to lower with the odd exception in Asia (Nikkei +0.4%, Hang Seng -0.4%, Shanghai -1.0%) and Europe (DAX -0.2%, CAC 0.0%, FTSE 100 0.0%).  US futures are also noncommittal this morning, with the NASDAQ (-0.3%) the only one having really moved.

In the bond market, the rally we had seen over the past three weeks has stalled and is starting to cede some ground.  For instance, Treasuries (+3.7bps) are leading the way higher but we are seeing higher yields throughout Europe (Bunds +2.3bps, OATs +2.5bps, Gilts +3.0bps) and even saw gains overnight in Australia (+1.8bps) and Japan (+0.5bps).  Historically, that would have seemed to be a risk-on phenomenon, but given the lack of equity strength, this feels a lot more like an inflationary call.

While the metals space is strong today, oil is actually softer (-1.7%) as concerns over the rampant spread of Covid in India and other emerging markets undermines the vaccine news in the West.

As to the dollar, it is generally, but not universally, weaker this morning.  In the G10, AUD (+0.6%), NZD (+0.3%) and CAD (+0.3%) are the leaders, with all benefitting from the metals rally, which has been sufficient to offset weaker oil prices for the Loonie.  On the downside, NOK (-0.1%) is clearly feeling a bit of pressure from oil, although 0.1% hardly makes a statement.  EMG currencies are showing the same type of price action with TRY (+1.2%) the leading gainer as it rebounds from near-record lows amid hopes the tension with the US will be temporary.  Away from the lira, TWD (+0.5%) rallied on concerns that the Taiwanese government would be pressured by the US with respect to its currency and competition concerns.  We saw similar, but lesser pressure on KRW (+0.4%).  Meanwhile, the modest declines seen in HUF (-0.2%) and MXN (-0.1%) define the other side of the spectrum.

Clearly, the FOMC meeting is the highlight of the week, but there is other important data as well, including the BOJ tonight.

Today Durable Goods 2.5%
-ex transport 1.6%
Tuesday Case Shiller Home Prices 11.8%
Consumer Confidence 112.0
Wednesday FOMC Decision 0.00% – 0.25%
IOER 0.12%
Thursday Initial Claims 550K
Continuing Claims 3.59M
GDP Q1 6.9%
Personal Consumption 10.3%
Friday Personal Income 20.0%
Personal Spending 4.2%
Core PCE 1.8%
Chicago PMI 64.2
Michigan Sentiment 87.5

Source: Bloomberg

The end of the week is where all the action will be, assuming Chairman Powell doesn’t shake things up Wednesday afternoon.  Core PCE is forecast to print at its highest level since February 2020, but if you recall the CPI data, it was a tick higher than forecast as well.  Of course, for now, it doesn’t matter.  This is all transitory.

Nothing has changed my opinion with respect to the relationship between the dollar and the 10-year Treasury yield.  While it is not actually tick for tick, if yields do back up, I would look for the dollar to find its footing in the near term.  I know the dollar bears are back in force, but we need to see a break above the 1.2350 level in the euro to really turn the tide in my view.  Otherwise, we are simply at the bottom of the dollar’s range.

Good luck and stay safe
Adf

So Slyly

The stock market’s feeling some pains
As word is that capital gains
Will soon be taxed highly
As Biden, so slyly
Pays tribute to John Maynard Keynes

It can be no surprise that the Biden administration has begun to float trial balloons regarding higher tax rates as they were a key plank in Biden’s presidential campaign.  Given the remarkable amount of money that this administration seems to want to spend, there needs to be some additional revenue to help pay for things, although the gap between the spending plans and forecast revenue enhancements remains extremely wide.  For instance, while the mooted price tag for the American Jobs Plan, the latest proposal, is on the order of $2.3 trillion, the estimated revenues of the capital gains tax rise is somewhere in the $500 billion to $1 trillion zone.  That’s still a pretty big gap that needs to be filled.  Of course, we know that the Treasury will simply borrow the difference, and based on current form, the Fed will buy most of that.  Who knows, maybe MMT really does work, and everything will work out fine.

Investors, though, seeing the world through a slightly different prism than policymakers, may decide that while the extraordinary equity market rally has been lots of fun, it might be time to take some money off the table.  When the first headlines about a doubling of capital gains taxes hit the tape, US markets fell about 1.3% and finished lower on the day.  Now, we are still a long way from those tax laws being enacted, but do not be surprised if equity markets have more difficulty making new highs going forward.  After all, if the government is going to tax away your gains, the risk/reward equation will change for the worse.  (While on the subject of taxes, there was a rumor that the Treasury was talking about 70% marginal tax rates on Bitcoin and other cryptocurrency gains.  It should be no surprise they suffered as well.)

Attempting, us all, to assure
Lagarde said, t’would be “premature”
To taper our buying
Since we are still trying
To help the recovery endure

Yesterday’s other big story was the ECB meeting where, while policies were left unchanged as expected, there was a great deal of anticipation that Madame Lagarde might offer some hints as to the structural reforms due to be announced in June, or even give a bit more guidance on the current situation within the PEPP.  Alas, the information quotient from this meeting was pretty limited.  Lagarde insisted that increased buying in the PEPP, which was a key outcome from the March meeting, would remain in place, although the pace of purchases does not seem to have increased all that much.  Yet when asked directly about the probability of tapering those purchases, Lagarde was adamant that it was “simply premature” to discuss that subject.

What is becoming apparent at the ECB is that there is a growing divide between the hawks and doves regarding how policy should evolve.  The Frugal four are clearly seeing improved economic activity and the beginnings of rising prices while the more profligate southern countries continue to lag in both economic activity and rate of vaccinations.  It is becoming clear that a single monetary policy is no longer going to be efficient for both groups of countries simultaneously.  When Super Mario was ECB President, he simply ran roughshod over the hawks, but then he had the policy chops to do so on his own.  It remains to be seen if Madame Lagarde will have the same ability.  The upshot is that we could be looking at some more volatility in Eurozone markets if the hawks start speaking in concert and do not back Lagarde.  We shall see.

Away from those stories, though, the market this morning is ostensibly focused on the better than expected PMI data that we have seen around the world.  Starting with Australia last night, and on to Japan and most of Europe and the UK, the big gainer was Services PMI, which is back above 50 everywhere except Japan, which printed at 48.3.  But Australia, the Eurozone and the UK are all back in expansionary territory as anticipation of the great reopening takes hold.  In this regard, the Japanese data makes sense as the nation is about to impose lockdowns again for the next two weeks in Tokyo, Kyoto and two other prefectures, closing bars and restaurants and banning public gatherings.

In addition to the PMI data, UK Retail Sales was quite strong, rising 4.9% M/M ex fuel, as were Japanese Department Store Sales (+21.8%).  With all of this positive data, it can be no surprise that the dollar is under pressure this morning, but it is a bit surprising that equity markets in Europe are under pressure (DAX -0.3%, CAC -0.2%, FTSE 100 -0.4%) and sovereign bond yields are softer (Bunds -1.3bps, OATs -1.2bps, Gilts -0.7bps).  While buy the rumor, sell the news is always a viable thought process, it strikes me that there were no rumors of this type of economic strength.

Finishing the market recap, commodities are firmer (WTI +0.5%, Au +0.1%, Cu +0.8%), which syncs well with the dollar’s weakness.  In the G10 space, the dollar is softer versus the entire spectrum of currencies, with EUR (+0.3%) and GBP (+0.3%) leading the way while JPY (+0.1%) is the laggard today.  In the EMG space, RUB (+0.6%) is the leading gainer after the Bank of Russia raised their base rate by 0.50% to 5.00% in a surprise as only 25bps was expected.  Away from that, the CE4 are all following the euro higher and then commodity currencies are also edging higher, but by much lesser amounts (ZAR +0.2%, MXN +0.2%).  There are a few decliners here, TRY (-0.2%), INR (-0.1%) but the size of the move is indicative of the lack of general interest.  Certainly, both those nations have been suffering more significantly with Covid lately, and it would not be a surprise to see both currencies continue to lag until that situation changes.

On the data front this morning, New Home Sales (exp 885K) is the major number, although preliminary PMI data (61.0 Mfg, 61.5 Services) is also due.  In the US, though, there is far more focus on ISM than PMI.  With the Fed coming up next week, there is no Fedspeak to be had, so as we head into the weekend, it is reasonable to expect a quiet session.  Equity futures are currently slightly in the green, roughly 0.15%, so perhaps the gut reaction to the tax news has passed and won’t have an impact.  But the one thing of which we can be certain appears to be that higher taxes are on the way.  That is a double whammy for equities as higher corporate tax rates will reduce earnings while higher cap gains taxes will encourage selling before those taxes come into effect.

In the end, though, nothing has changed the underlying market driver, the 10-year Treasury.  If yields there continue to slide, the dollar will remain weak across the board.  If they reverse, look for the dollar to rebound.  Next week, after the Fed, we see Core PCE data on Friday.  Currently, that is forecast to rise 1.8%.  a high side surprise there could well shake things up with regard to views on tapering with a corresponding impact on all markets.  But until the Fed on Wednesday, it seems we are in for some slow times.

Good luck, good weekend and stay safe
Adf

We’ll Be Behind

The Chair and the Vice-Chair both said
Before we raise rates at the Fed
We’ll taper our buying
While we’re verifying
If growth can keep moving ahead

So, don’t look at forecasts ‘cause we
Care only for hard stats we see
Thus, we’ll be behind
The curve, but you’ll find
Inflation we’ll welcome with glee

The Fed has made clear they are driving the bus looking only in the rearview mirror.  This is a pretty dramatic change in their modus operandi.  Historically, given the widespread understanding that monetary policy works with a lag of anywhere from 6 months to 1 year, the Fed would base policy actions on their forecasts of future activity.  This process was designed to prevent inflation from rising too high or allowing growth to lag too far from trend.  One of the problems they encountered, though, was that they were terrible forecasters, with their models often significantly understating or overstating expectations of future outcomes.

So, kudos to Chairman Powell for recognizing they have no special insight into the future of the economy.  It is always difficult for an institution, especially one as hidebound as the Federal Reserve, to recognize its shortcomings.  This does beg the question, though, if they are going to mechanically respond to data with policy moves, why do they even need to be involved at all?  Certainly, an algorithm can be programmed to make those decisions without the added risk of making policy errors. Instead, the Fed could concentrate on its role as banking supervisor, an area in which they have clearly fallen behind.  But I digress.

Back in the real world, this change, which they have been discussing for some time, is truly important.  It seems to be premised on the idea that measured inflation remains far below their target, so running the economy ‘hot’ is a desirable way to achieve that target.  And running the economy hot has the added benefit of helping to encourage maximum employment in the economy, their restated goal on that half of the mandate.  It also appears to assume that they have both the tools, and the wherewithal to use them, in case inflation gets hotter than currently expected.  It is this last assumption that I fear will come back to haunt them.  But for now, this week’s CPI data did nothing to scare anybody and they are feeling pretty good.

One other thing they both made clear was that the timing of any rate hike was absolutely going to be after QE purchases are completed.  So, the tapering will begin at some point, and only when they stop expanding the balance sheet will they consider raising the Fed Funds rate.  Right now, the best guess is late 2023, but clearly, since they are data driven, that is subject to change.

There is a conundrum, though, in the markets.  Despite this very clear policy direction, and despite the fact that bond investors are typically quite sensitive to potential inflation, Treasury yields have seemingly peaked for the time being and continue to slide lower.  Certainly, the auctions this week, where the Treasury issued $120 billion in new debt were all well received, so concerns over a buyer’s strike were overblown.  In fact, overnight data showed that Japanese buyers soaked up nearly $16 billion in bonds, the largest amount since last November.  But, depending on how you choose to measure real interest rates, they remain somewhere between 0.0% and -1.0% based on either Core or Headline CPI vs. the 10-year.  Traditionally, headline has been the measure since it represents everything, and for a bond investor, they still need to eat and drive so those costs matter.

Summing this all up tells us 1) the Fed is 100% reactive to data now, so overshooting in their targets is a virtual given; 2) interest rates are not going to rise for at least another two years as they made clear they will begin tapering their QE purchases long before they consider raising interest rates; and 3) the opportunity for increased volatility of outcomes has grown significantly with this new policy stance since, by definition, they will always be reactive.  To my mind, this situation is one where the current market calm is very likely preceding what will be a very large storm.  If central banks handcuff themselves to waiting for data to print (and remember, hard data is, by definition, backwards looking, generally at least one month and frequently two months), trends will be able to establish themselves such that the Fed will need to respond in a MUCH greater manner to regain control.  Markets will not take kindly to that situation.  But that situation is not yet upon us, so the bulls can continue to run.

And run they have, albeit not as quickly as they have been recently.  In Asia overnight, it was actually a mixed performance with the Nikkei (+0.1%) eking out a small gain while the Hang Seng (-0.4%) and Shanghai (-0.5%) both stumbled slightly.  Europe, on the other hand, is all green with gains ranging between 0.2% and 0.4% across the major markets.  US futures are actually looking even better, with gains of 0.45%-0.6% at this hour.  Earnings season started yesterday, and the big banks all killed it in Q1, helping the overall market.

Bond yields, meanwhile, are continuing to slide, with Treasuries (-1.9bps) continuing to show the way to virtually all Western bond markets.  Bunds (-1.6bps), OATs (-2.0bps ) and Gilts (-2.7bps) are rallying as well despite the generally upbeat economic news.  There was, however, one negative release, where the German economic Institutes have cut their GDP forecast by 1.0%, to 3.7%, after the third wave and concomitant lockdowns.

Oil prices, which have had a huge runup this week, have slipped a bit, down 0.5%, but the metals markets are all in the green with Au (+0.6%), Ag (+0.6%), Cu (+1.5%) and Al (+0.25%) all in fine fettle.

It can be no surprise that with Treasury yields lower and commodity prices generally higher, the dollar is under further pressure this morning.  In the G10, the commodity bloc is leading the way with NZD (+0.25%), CAD (+0.2%) and AUD (+0.2%) all performing well.  There are a few laggards, but the movement there is so small, it is hardly a sign of anything noteworthy.  The euro, for instance, is lower by 0.1%, truly unremarkable.  In the EMG bloc, RUB (-1.2%) is the biggest mover, suffering on the news that the Biden Administration is slapping yet more sanctions on Russia for their election meddling efforts.  After that, HUF (-0.4%) has suffered as the central bank maintains its rate stance despite quickening inflation readings.  On the plus side, ZAR (+0.65%) and MXN (+0.3%) are the leading gainers, both clearly benefitting from the commodity story today.

One thing to watch here is the technical picture as despite the slow-motion decline in the dollar since the beginning of the month, it is starting to approach key technical support levels with many traders looking for a breakout should we breach those levels.  We shall see, but certainly if Treasury yields continue to slide, the dollar is likely to slide further.

We have a bunch of data today led by Initial Claims (exp 700K), Continuing Claims (3.7M), Retail Sales (+5.8%, +5.0% ex autos) and then Empire Manufacturing (20.0), Philly Fed (41.5), IP (2.5%) and Capacity Utilization (75.6%).  The Retail Sales data is based on the second stimulus check being spent, and the Claims data is assuming strength based on the NFP from last month.    We also hear from a bunch more speakers, but Powell and Clarida are done, so it would be surprising to see anything new from this group of three.

All told, nothing has changed my view that as goes the 10-year Treasury yield, so goes the dollar.  That will need to be proven wrong consistently before we seek another narrative.

Finally, I will be taking a few, very needed, days off so there will be no poetry until I return on Thursday April 22.

Good luck, good weekend 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
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Inflation Be Damned

The Minutes revealed that the Fed
Cares not about outlooks, instead
Inflation be damned
They now are programmed
To wait until growth is widespread

There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh?  Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time.  We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around.  And that’s great!  Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis.  Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive.  And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come.  A cynic might think that those central banks don’t actually believe their own forecasts.

Yesterday’s FOMC Minutes revealed this exact situation.  “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.”  In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates.  On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves.  After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”

It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations.  For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano.  I’ve been sitting on that volcano for many, many years.  It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices.  Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever.  And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.

Thus, the conundrum.  Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue.  Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy.  But every central bank has essentially promised they will be falling behind the curve to fight the current battle.

So, let’s follow this line of thought to some potential conclusions.  Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse.  Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation.  (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!)  Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money.  Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter?  This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B.  And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below).  Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.

So, with that in mind, let’s take a quick tour of the markets.  Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day.  In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher.  As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.

As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs.  European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point.  A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year!  Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget.  Imagine what would happen if yields there rose, even 100 basis points.  And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.

Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector.  And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline.  But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.

In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today.  Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week.  As described above, inflation s clearly not going to be a major policy driver in most economies for now.  But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.

On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon.  But what can the Fed tell us that we don’t already know?

As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well.  And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.

Good luck and stay safe
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