Tag Archives: #dollardown

Quite a Surprise

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This morning’s report on inflation
Is forecast as verification
The Fed is behind
The curve and must find
The will to cease accommodation

While last night from China we learned
The trend in inflation has turned
In quite a surprise
It fell from its highs
A positive for all concerned

Ahead of this morning’s CPI report (exp 7.0%, 5.4% ex food & energy) investors around the world have been feeling positively giddy about the current situation.  Sure, China’s growth forecasts have been cut due to omicron infection outbreaks and the Chinese response of further lockdowns, but that just means that combined with the first downtick in PPI there since February 2020 (10.3%, exp 11.3%, prev 12.9%), talk has turned to the PBOC cutting interest rates next week by between 5 and 10 basis points.  So, while many other nations are aggressively fighting inflation (Brazil, Mexico, Hungary) or at least beginning to tighten policy (UK, Sweden, Canada), the market addiction to ever increasing liquidity may now be satisfied by China.  While it is still too early to know if lower interest rates are coming from Beijing, what is clear is that the credit impulse in China (the amount of lending) seems to have bottomed and is starting to reverse higher.  That alone augers well for future global growth; so, buy Stonks!

Meanwhile, I think it is valuable to consider what we heard from Chairman Powell yesterday at his renomination hearings, as well as what the two erstwhile hawks, Esther George and Loretta Mester, had to say about things.  Mr Powell, when asked why the Fed was continuing to purchase assets with inflation well above target and unemployment near historic lows inadvertently let the cat out of the bag as to the most important thing for the Fed, that if they were to move at a more aggressive pace, it could upset markets and there could be declines in both the stock and bond markets.  Apparently, the unwritten portion of the Fed’s mandate, prevent markets from falling, remains the most important goal.  While Powell paid lip service to the idea that the Fed would seek to prevent the inflationary mindset from becoming “entrenched”, he certainly didn’t indicate any sense of urgency that the Fed’s glacial pace of change was a problem.

Perhaps more surprisingly, neither Mester nor George were particularly hawkish, with both explaining that the Dot Plot from December was a good guide and there was no reason to consider a rate hike as soon as March.  Regarding QT, neither was anxious to get that started either although both wanted to see it eventually occur.  Finally, this morning, former NY Fed President (and current Fed mouthpiece) Bill Dudley explained in a Bloomberg column that there was no hurry to reduce the size of the balance sheet and that when it begins, the impact would be “like watching paint dry.”  Now, where have we heard that before?  Oh yeah, I remember.  Then Fed Chair Yellen used those exact same words to describe the last attempt to shrink the balance sheet right up until Powell was forced to pivot after the equity market’s sharp decline in 2018.  Apparently, the dynamics of drying paint are more interesting than we have been led to believe.

For those seeking proof that investors welcomed yesterday’s comments, one need only look at market behavior in their wake.  US equity markets rallied after the testimony and never looked back all day.  Treasury bonds did very little, with the sharp trend higher in yields having hit a key resistance and unable to find the will to push through.  Finally, the dollar took it on the chin, declining vs virtually every major and emerging market currency yesterday with many of those moves continuing overnight.  Recapping: higher stocks, unchanged bonds and a weaker dollar are not a sign that the market expects much tighter policy from the Fed.

Ok, so how are things looking this morning?  Well, in the equity market, the screen is entirely green. Last night, Asia followed the US lead  with gains across the board (Nikkei +1.9%, Hang Seng +2.8%, Shanghai +0.8%), and European bourses are also higher (DAX +0.35%, CAC +0.5%, FTSE 100 +0.7%) as data from the continent showed much better than expected Eurozone IP growth (2.3% vs 0.2% exp) as well as the first indication that inflation might be peaking in Germany with PPI there “only” printing at 16.1%, down from last month’s record 16.6%.  As to US futures, they are modestly higher ahead of the data, between 0.1%-0.2%.

In the bond market, while 10-year Treasury yields have edged higher by 0.7bps at this hour, they remain just below 1.75% and have shown no inclination, thus far, of breaking out much higher.  Arguably this implies that market participants are not yet full believers in the Fed tightening policy aggressively, and after yesterday’s performances, I think that is a good bet.  Meanwhile, European sovereign bonds are all rallying with yields falling nicely (Bunds -1.8bps, OATs -1.7bps, BTPs -1.3bps) as it remains clear that there is not going to be any tightening of note by the ECB this year.

On the commodity front, we continue to see strength in energy (WTI +0.5%, NatGas +5.2%) as well as industrial metals (Cu +2.9%, Zn +2.2%) although both gold -0.2%, and silver -0.2% are consolidating after strong moves higher yesterday.

Looking at FX markets, I would say the dollar is modestly weaker overall, albeit only in a few segments.  In the G10, NOK (+0.7%) and CAD (+0.2%) are the largest movers, by far, with both benefitting from oil’s continued rise.  The rest of the bloc, quite frankly, is tantamount to unchanged this morning.  In emerging markets, the picture is a bit more mixed with both gainers and losers about evenly split.  However, only 3 currencies have shown any real movement, BRL (-0.4%), KRW (+0.4%) and CLP (+0.3%).  The real seems to be consolidating some of its massive gains from yesterday, when it rallied 1.7% on the back of central bank comments implying that though inflation would fall back in 2022, it would require continued tight policy to achieve that outcome.  On the flip side, the won benefitted from a better than expected employment report showing more than 770K jobs added in the last year and indicating better economic growth going forward.  Finally, the Chilean peso seems to be benefitting from copper’s strong rally today.

Aside from this morning’s CPI report, we also see the Fed’s Beige Book at 2:00pm which has, in the past, been able to move markets if the narrative was strong enough.  Only one Fed speaker is on the docket, Kashkari, and even he, an uber-dove, is calling for 2 rate hikes this year as per his last comments.

The Fed tightening narrative is definitely having some difficulty these days which implies to me that the market has fully priced in its expectations and those expectations are that the Fed will not be able to tighten policy very much.  If the Fed is restrained, and tighter policy continues to get pushed further out in time, the dollar will suffer much sooner than I anticipated.  For those with opex and capex needs, perhaps moving up the timetable to execute makes some sense.

Good luck and stay safe
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A New T#heme

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The news yesterday from the Fed
Was Vice-Chair Clarida has fled
While later today
Chair Jay seeks to sway
The Senate to keep him Fed head

But in the meantime, it would seem
The narrative has a new theme
It seems pretty clear
Four rate hikes this year
Have gone from the fringe to mainstream

As we walk in this morning, there seems to be a lot of movement with respect to market expectations regarding the Fed’s actions going forward and exactly how those actions are going to impact the various markets.  Today’s headline event is Chairman Powell’s renomination testimony in the Senate as everyone is waiting to see just how much effort Senator Elizabeth Warren puts into trying to derail the process.  It is widely known that the Senator does not care for Mr Powell going so far as to calling him “dangerous” in his recent semi-annual testimony to the Senate.  Yesterday, she also wrote a letter demanding to see all the personal trading records of all Fed officers which probably was part of the impetus for vice-Chair, Richard Clarida, to step down early from his post.  So, on the one hand, we will be treated(?) to the scene of some Senators trying to play gotcha with the Fed Chair today with the ever-present possibility that some comment is made with a real market impact.

On the other hand, the tightening train has not merely pulled away from the station but is starting to gather serious speed.  Earlier this morning, Atlanta Fed President Bostic commented that he sees 3 rate hikes this year and that the Fed “will act to ensure inflation doesn’t run away from us.”  Futures markets are now pricing in a more than 60% probability of a fourth rate hike in 2022 with an increasing number of Fed speakers explaining a rate hike in March would be appropriate.  We are also hearing the 4-hike scenario from an increasing number of pundits with Goldman Sachs economists publishing that view yesterday while JPMorgan Chairman Jamie Dimon explained that “four rate hikes of 0.25% each would not have an enormous effect on the economy.”  And that is likely correct, a Fed Funds rate of 1.0% doesn’t seem that onerous for businesses.  Of course, what impact would four interest rate hikes have on financial asset prices, especially if they were joined with a reduction in the size of the Fed’s balance sheet?  And it is this latter question that seems likely to be the key as we continue to hear from more and more Fed speakers that the idea of allowing the balance sheet to ‘run-off’ is appropriate.

For those of you with shorter memories, the last time the Fed tried to reduce the size of its balance sheet, from 2017-2018, they were also raising interest rates, albeit far more slowly.  Of course, CPI had peaked below 3.0% in that cycle, GDP was running at 2.4% and wages were growing at 2.5% while the balance sheet was less than half its current size.  The point is conditions were clearly very different.  However, not only did the equity market’s 20% decline inspire the Powell Pivot on Boxing Day 2018, but nine months later, the repo market blew up forcing the Fed to take dramatic action to ensure that sufficient liquidity was made available to the banking system.  I assure you, neither of those outcomes were part of the carefully described plans the Fed had made to ‘normalize’ monetary policy.

Will this time be different?  While starting conditions certainly are different, the one thing of which we can be sure is that the complexities of the international money markets remain opaque even to the central banks charged with their oversight.  While there is no way to anticipate exactly what will happen to derail the current plans, one can almost be certain that things will not work out the way they are currently planned.  Personally, I remain convinced that markets will have a very difficult time handling any reductions in the excess liquidity that has been the dominant feature of the post Covid-19 global financial markets, and that despite a lot of tough talk now, the Fed, at least, will be walking back that hawkishness before too long.

And perhaps, markets are beginning to agree with me.  After all, hawkish monetary policy is rarely the backdrop for a risk-on attitude.  Yet that is a pretty fair description of today’s price action.  Equities are rebounding along with commodities; bonds are benign, and the dollar is softening.

While yesterday saw US equity markets in the red most of the day, the NASDAQ staged a furious late day rally to close flat although market breadth was awful (1205 gainers vs. 2201 losers).  And while Asia was still under pressure (Nikkei -0.9%, Hang Seng 0.05, Shanghai -0.7%), Europe has taken heart from something as we are seeing solid gains across the board there (DAX +1.15%, CAC +1.35%, FTSE 100 +0.7%) despite a complete lack of news.  US futures, too, have turned green with all three main indices up about 0.3% at this hour.

The Treasury rout is on hold with yields essentially unchanged this morning and the 10-year right at the key level of 1.75%.  In Europe, Bunds (-0.9bps) and Gilts (-2.3bps) are both trading well while the rest of the sovereign market is virtually unchanged.  Again, there has been essentially no news of note.

Oil prices are rallying (WTI +1.4%) while NatGas (-0.9%) has consolidated some of yesterday’s gains despite the fact it is 14 degrees here in NJ this morning.  Gold (+0.3%) and silver (+0.6%) are both firmer, as are industrial metals (Cu +0.6%, Al +0.1%, Zn +2.4%) and the ags are strong as well.

Finally, the dollar is under modest pressure with NOK (+0.4%) leading the G10 revival on the strength of oil’s rally, while CAD (+0.3%) follows closely behind.  JPY (-0.25%) is the only laggard here, again pointing to the risk characteristics in today’s price action.  EMG markets have seen similar price action with THB (+0.6%) the leading gainer followed by HUF (+0.4%) and KRW (+0.35%), all benefitting from the pause in the US yield rally and generally better risk appetite.

Today’s only data point has been released, NFIB Small Business Optimism (98.9, slightly better than 98.7 expected) and has had virtually no impact on the market.  This brings us back to the Fed as today’s most likely catalyst, as not only will we hear from Chair Powell starting at 10:00, but also from two of the most hawkish regional bank presidents, Mester and George between 9:00 and 9:30.

With risk in vogue for the session, I expect the dollar will have difficulty gaining any ground, but nothing has changed my short-term view that the Fed’s hawkishness is going to be the key driver of a stronger dollar…right up until they reverse course!

Good luck and stay safe
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A Wrong Turn

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

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

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

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

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

Nonfarm Payrolls 447K
Private Payrolls 405K
Manufacturing Payrolls 35K
Unemployment Rate 4.1%
Average Hourly Earnings 0.4% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.9%

Source: Bloomberg

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
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On the Brink

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Most pundits worldwide seem to think
The Fed is now right on the brink
Of both raising rates
And having debates
On how soon the BS should shrink

And so, today’s Minutes are key
To see if the FOMC
Has made up its mind
That they’re now behind
The curve, and need hurry QT

I am old enough to remember the last time the Fed decided that they wanted to shrink their balance sheet and normalize policy, way back in 2018.  As I recall, when first mooted, then Fed Chair Janet Yellen (she of Treasury Secretary fame) described the process of the gradual reduction as ‘like watching paint dry.’  Who knew drying paint was so exciting!  Of course, she couldn’t bring herself to even start the process.  Ultimately, the combination of slowly raising the Fed Funds rate and simultaneously reducing the size of the balance sheet (which all occurred on Powell’s watch) led to a declining stock market throughout Q4 2018 with the largest Christmas Eve sell-off ever seen in stocks as the culmination of the events.  Two days later, Chairman Powell explained he was just kidding, and tighter monetary policy was a thing of the past.

But that was then.  It’s different this time!

Actually, it’s not.  In fact, what we have learned from observing markets for many years is that it is never different.  While the catalysts may change, market responses remain pretty much the same time and again.  So, here we are three years later with the Fed’s balance sheet having more than doubled in the intervening period, equity markets having made 70 record highs in the past twelve months and the 10-year bond yielding half what it was back then. Inflation is raging, as opposed to the situation back then, and GDP, while higher than back then, has clearly peaked and is reversing some of the pandemic-induced policy giddiness.  But human nature is still the same.  Greed and fear remain the constants and investor and trader responses to policy decisions are pretty cut and dried.  You can be confident that if longer date interest rates rise, whether in a steepening or flattening yield curve, the rationale for the mega cap stocks to maintain their value is going to diminish quickly.  And as they are the ‘generals’ of the equity market rally, when they start to fall, so will everything else, including the indices.  Ask yourself how long the Fed, whose members are virtually all multi-millionaires and hold large equity portfolios, are going to sit by and allow the stock market to correct just because some Austrian school monetary hawks believe in sound money.  Exactly.

However, we have not yet reached the point where the markets have started to decline substantially, as, of course, the Fed has not yet started to even raise interest rates, let alone shrink the balance sheet.  But that is the growing consensus view amongst the punditry, that today’s FOMC Minutes from the December meeting are going to reveal the level of interest to begin that part of policy normalization.  Many analysts continue to highlight the fact that inflation is becoming such a problem that the Fed will be forced to stay the course this time.  I wish it were so, but strongly believe that history has shown they will not.  Rather, they will change the inflation calculations and continue to explain that the alternative is worse.

Yesterday, Minneapolis Fed President Neel Kashkari, the most dovish of all FOMC members, explained that he believes the Fed Funds rate needs to rise 0.50% this year as, “…inflation has been higher and more persistent than I had expected.”   It is comments such as this that have the analyst community convinced the Fed is really going to tighten this time.  But we have heard these before as well.  This is not to say that the Minutes won’t hint at QT, they very well could do so.  However, when the rubber meets the road and risk assets are falling sharply in price, the Fed will exhibit its underlying Blepharospasm, and tighter policy will be a thing of the past (as will a stronger dollar!)

Now, leading up to the Minutes, let’s take a look at what happened last night.  In the wake of a bit of equity market schizophrenia in the US, we have seen a mixed picture.  Yesterday saw the NASDAQ fall sharply (there’s that concern over higher rates) while the Dow managed to rally.  Overnight saw the Nikkei (+0.1%) bide its time but the Hang Seng (-1.6%) and Shangahi (-1.0%) both suffer on a combination of the ongoing property sector problems as well as more lockdowns in country.  Europe, on the other hand, has managed to stay in the green (DAX +0.6%, CAC +0.5%, FTSE 100 +0.2%) after PMI Services data was released a little bit softer than forecast, but still seen as quite positive.  In a way, this was a ‘bad news is good’ idea as softening growth means the ECB doesn’t need to respond to Europe’s very high inflation readings so dramatically.  Alas, US futures are flat except for NASDAQ futures, which are lower by -0.4%.

In the bond market, while yesterday saw an early sell off in Treasuries, it was mostly unwound by the end of the day and this morning yields are little changed at 1.645%.  As to Europe, yesterday also saw Gilt yields rally sharply, 12.5 bps, but they have consolidated today, falling 1bp while the rest of the continent has seen much less movement.  Clearly, there is far less concern over ECB activity than either Fed or BOE.

As to the commodity space, oil (+0.3%) is edging higher and NatGas (+2.3%) is firming on the cold weather in the Northeast.  (Of course, compared to what happened in Kazakhastan, where the government was kicked out by the president because of high energy prices, this seems rather tame!)  Metals prices are mixed with gold (+0.2%) still hanging around $1800, while copper (-0.6%) is clearly less enamored of the current economic situation.

Finally, the dollar is under modest pressure this morning, with SEK (+0.5%) the leading G10 gainer after printing the strongest PMI data around, while JPY (+0.4%) has simply rebounded from its very sharp decline yesterday, although it remains in a very clear downtrend for now.  the rest of the G10 is modestly firmer vs. the dollar at this hour, but nothing to write home about.

In the EMG space, ZAR (+0.9%) is the leader, also seeming to benefit on the back of last week’s liquidity induced decline and seeing a rebound.  We are also seeing strength in PHP (+0.7%) and CZK (+0.6%) with the latter benefitting from expectations for further rate hikes while the former benefitted from a much lower than expected CPI print of just 3.6%.  Meanwhile, on the downside, IDR (-0.4%) was the worst performer as the infection rate rose sharply and KRW (-0.25%) fell after North Korea launched another ballistic missile and rejected further talks with the US.

On the data front, ADP Employment (exp 410K) leads this morning and then the Minutes are released at 2:00pm.  Aside from the Minutes, there are no speakers scheduled, so the dollar will need to take its cues from other markets.  Keep an eye on the 10-year as a continued rally in yields should see further dollar strength.

Good luck and stay safe
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A Visit from Chair Jay

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With Apologies to Clement Clarke Moore

Tis the first day of trading in Aught Twenty-Two
And everyone’s asking just what will come true
Will Jay and his brethren, the taper, complete?
Or when stocks start falling, will they beat retreat?
Will Omicron’s spread lead to waves of despair?
Or will people choose to live life and not care?
And what of stock markets, will their recent rise
Have legs? Or will problems lead to their demise?
To these and more questions I’ll try to respond
With forecasts for currencies, stocks and the bond

To start, let’s consider, with brush strokes quite broad
How policymakers’ decisions are flawed
Consider inflation and how it is tracked
To most it is real but to Jay, just abstract
This led to the idea of average inflation
A policy blunder condemned to damnation
So, late to the party, the Fed shall arrive
Thus, CPI next year will still be ‘bove Five

While interest rates then ought most certainly rise
Jay can’t let that happen, and so we surmise
Despite all the talk of the taper to come
By Christmas this year they’ll have grown QE’s sum
And so, ten-year yields, when this year’s finally done
Will print on your screen at percentage of One

And what about stocks after last year’s huge gains
Are more in the future?  Or will we feel pains?
Alas, what I fear is though real rates will sink
So too, GDP, will not grow, though not shrink
Instead, when the history’s written next year
A stagnant economy will bring no cheer
Thus, stocks will deflate, though I don’t think crash land
But don’t be surprised if we fall ‘neath Four Grand

Let’s turn now to things you can see and can feel
Commodities, which unlike stocks, are quite real
For oil the first thing to note is the lack
Of funding, which has caused a drilling cutback
The thing is demand has not fallen in sync
Thus, causing the policymakers to blink
And rather than forcing the drillers to freeze
Instead, are now begging, drill more pretty please
But in the meantime, ere those new wells are sunk
One Hundred per barrel is near a slam-dunk

The barbarous relic we also must view
As many believe it contains value, true
Though there’s now a camp that claims it’s been replaced
By Bitcoin and Ether and feel gold’s a waste
But whether a hodler or gold bug are you
Their trends will diverge throughout Aught Twenty-Two
In gold’s case there will be strong growth in demand
And at year’s end it will have flown ‘bove Two Grand
But Bitcoin has shown with stonks it’s correlated
As they fall, so too, will Bitcoin be deflated
Come Christmas next do not be very surprised
If Bitcoin, to $30K, has been revised

And finally, let ‘s turn to foreign exchange
Where this year I think we shall see quite a range
At first while belief remains Jay is a hawk
More strength in the dollar is likely a lock
But as things progress and the ‘conomy slows
Then Jay will be forced to adjust the Fed’s prose
From hawkish to dovish is what we will get
And H2 next year will, the dollar, beset

The euro, at first, will, new lows, likely test
But when it comes clear that QT’s not progressed
As well as the fact that Lagarde’s ECB
Has quietly lessened their rampant QE
Investors will find that when euros are sought
At year’s end, One-Thirty is where they’ll be bought

A similar story in England abounds
Where tightening money will strengthen their pounds
The Old Lady, sited on Threadneedle Street
Will not, on inflation, decide to retreat
Instead, rates will rise there four times through this year
And Sterling, One-Sixty, on screens will appear

From here let’s head east to the nation whose Wall
Was built in an effort, the Huns, to forestall
In modern times, though, their economy’s grown
With output that spans T-shirts to the iPhone
With exports remaining the key to success
A weaker renminbi will help reduce stress
The thing is the goal of the President, Xi
Is not really growth but a strong currency
The upshot is when this year comes to an end
Five-Ninety renminbi we’ll all comprehend

A bit further east lies a nation of isles
Which taught us that Zen leads to healthy lifestyles
This nation, despite lacking metals or oil
Grew rich on the sheer dint of well-designed toil
Its yen has developed a clear reputation
For safety since the GFC dislocation
So, this year when growth disappoints round the earth
One Hundred and Five yen the buck will be worth

Our eastward excursion is not yet complete
As Canada’s Loonie moves to the front seat
Up north they have already started the shift
From policy ease to a much tighter drift
Responding to prices that have been on fire
And trying to stop them from going still higher
Thus, don’t be surprised when the CAD follows rates
And reaches One-Ten come the year’s final dates

And lastly let’s make a right turn and head toward
The nation where all that tequila is poured
Already, Banxico is fighting the fight
To hold back inflation with all of its might
The problem for them is inflation’s a bear
And so hard to halt when it’s rampant elsewhere
So, this year despite all the central bank’s drive
To Twenty-Two look for the peso to dive.

Now let’s turn to something of greater import
How much I appreciate all your support
As we begin yet one more year in this game
There’s one thing I must very clearly exclaim
May Twenty-Two be a year of, tidings, glad
With happiness, health and no cause to be sad

Have a very happy and healthy Twenty Twenty-Two!

Til ‘flation Responds

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Apparently, Powell has learned
Why everyone’s been so concerned
With prices exploding
The sense of foreboding
‘Bout ‘flation seemed very well earned

So, Jay and his friends at the Fed
Said by March, that they would stop dead
The buying of bonds
Til ‘flation responds
(Or til stocks fall deep in the red)

By now you are all aware that the FOMC will be reducing QE twice as rapidly as their earlier pace, meaning that by March 2022, QE should have ended.  Chairman Powell was clear that inflation has not only been more persistent than they had reason to believe last year but has also moved much higher than they thought possible, and so they are now forced to respond.  Interestingly, when asked during the press conference why they will take even as long as they are to taper policy rather than simply stop buying more assets now if that is the appropriate policy, Powell let slip what I, and many others, have been saying all along; by reducing QE gradually, it will have a lesser impact on markets.  In other words, the Fed is more concerned with Wall Street (i.e. the stock market) than it is with Main Street.  Arguably, despite a more hawkish dot plot than had been anticipated, with the median expectation of 3 rate hikes in 2022 and 3 more in 2023, the stock market rallied sharply in the wake of the press conference.  If one is seeking an explanation, I would offer that Chairman Powell has just confirmed that the Fed put remains alive and well and is likely struck far closer to the market than had previously been imagined, maybe just 10% away.

One other thing of note was that Powell referred to the speed with which this economic cycle has been unfolding, much more rapidly than the post-GFC cycle, and also hinted that the Fed would consider reducing the size of its balance sheet as well going forward.  Recall, however, what happened last time, when the Fed was both raising the Fed funds rate and allowing the balance sheet to run off by $50 billion/month back in 2018; stocks fell 20% in Q4 and the Powell Pivot was born.  FWIW my sense is that the Fed will not be able to raise rates as much as the dot plot forecasts.  Rather, the terminal rate will be, at most, 2.00% (last time it was 2.50%), and that any shrinkage of the balance sheet will be minimal.  The last decade of monetary policy has permanently changed the role of central banks and defined their behavior in a new manner.  While not described as such by those “independent” central banks, debt monetization (buying government bonds) is now a critical role required to keep most economies functioning as debt/GDP ratios continue to climb.  In other words, MMT is the reality and it will require a much more dramatic, and long-lasting, negative shock for that to change.

One last thing on this; the bond market has heard what Powell said and immediately rallied.  The charitable explanation is that bond investors are now comforted by the Fed’s recognition that inflation is a problem and will be addressed.  Powell’s explanation about foreign demand seems unlikely, at least according to the statistics showing foreign net sales of bonds.  Of more concern would be the explanation that bond investors are concerned about a policy mistake here, where the Fed is tightening too late and will drive the economy into a recession, as they always have done when they tighten policy.

With Jay and the Fed finally past
The market will get to contrast
The Fed’s hawkish sounds
With Europe’s shutdowns
And watch Christine hold rates steadfast

But beyond the Fed, this has been central bank policy week with so many other central bank decisions today.  Last night the Philippines left policy on hold at 1.50%, as did Indonesia at 3.50%, both as expected.  Then, this morning the Swiss National Bank (-0.75%) left rates on hold and explained the franc remains “highly valued”.  Hungary raised their Deposit rate by 0.30% as expected and Norges Bank raised by 0.25%, also as expected, while promising another 0.25% in March.  Taiwan left rates unchanged at 1.125%, as expected and Turkey continue their unique inflation fighting policy by cutting the one-week repo rate by 1.00%, down to 14.00% although did indicate they may be done cutting for now.  As to the Turkish lira, if you were wondering, it has fallen another 3.8% as I type and is now well through 15.00 to the dollar.  YTD, TRY has fallen more than 51% vs. the dollar and quite frankly, given the more hawkish turn at the Fed, seems like it has further to go!

Which of course, brings us to the final two meetings today, the ECB and the BOE.  Madame Lagarde and most of her minions have been very clear that they are not about to change policy, meaning they will continue both the PEPP and APP and are right now simply considering how they are going to manage policy once the PEPP expires in March.  That is another way of saying they are trying to figure out how to continue to buy as many bonds as they are now, while losing one of their programs.  I’m not worried about them finding a way to continue QE ad infinitum, but the form that takes is the question at hand.  While European inflation pressures have certainly lagged those in the US, they are still well above their 2.0% target, and currently show no signs of abating.  If anything, the fact that electricity prices on the continent continue to skyrocket, I would expect overall prices to only go higher.  But Madame Lagarde is all-in on MMT and will drag the few monetary hawks in the Eurozone down with her.  Do not be surprised if the ECB sounds dovish today and the euro suffers accordingly.

As to the BOE, that is much tougher to discern as inflation pressures there are far more prevalent and members of the MPC have been more vocal with respect to discussing how they need to respond by beginning to raise the base rate.  But with the UK flipping out over the omicron variant and set to cancel Christmas impose more lockdowns, it is not clear the BOE will feel comfortable starting their tightening cycle into slower economic activity.  Ahead of the meeting, the futures market is pricing in just a 25% probability of a 0.15% rate hike.  My money is on nothing happening, but we shall see shortly.

Oh yeah, tonight we hear from the BOJ, but that is so anticlimactic it is remarkable.  There will be no policy shifts there and the yen will remain hostage to everything else that is ongoing.  Quite frankly, given the yen has been sliding lately, I expect Kuroda-san must be quite happy with the way things are.

And that’s really the story today.  Powell managed to pull off a hawkish turn and get markets to embrace risk, truly an impressive feat.  However, over time, I expect that equity markets will decide that tighter monetary policy, especially if central bank balance sheets begin to shrink, is not really a benefit and will start to buckle.  But right now, all screens are green and FOMO is the dominant driver.

In the near term, I think the dollar has further to run higher, but over time, especially when equity markets reverse course, I expect the dollar will fall victim to the impossible trilemma, where the Fed can only prop up stocks and bonds simultaneously, while the dollar’s decline will be the outlet valve required for the economy.  But that is many months away.  For now, buy dollars and buy stocks, I guess.

Good luck and stay safe
Adf

Somewhat Concerned

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Investors seem somewhat concerned
That risk, in all forms, has returned
Thus, stocks are backsliding
While Jay is deciding
If QE should soon be adjourned

With the FOMC beginning its two-day meeting this morning, and PPI data due at 8:30am, it is clear that investors are taking a more precautionary view of the world today.  Certainly, yesterday’s US equity market price action, where the major indices all closed on their session lows, has not helped sentiment, nor has the current market narrative of imminently tighter policy from the Fed.  As such, it should be no great surprise that risk assets across the board are under pressure while more traditional havens have found some support.

But let us ask ourselves, is this current market (not Fed) narrative realistic?  Again, I would contend the market expectations for tomorrow are that the Fed will double the pace of its QE tapering come January, which will have them finish QE by the end of March.  And it is easy to see the merits of the argument given the persistence and magnitude of price gains seen over the past twelve to fifteen months.  This is especially so given there is no obvious reason to believe prices will decline other than the economists’ mantra that supply will be created to fill the demand.  (While this is certainly true in the long run, as Keynes pointed out back in 1923, in the long run we are all dead, so timing matters here.)

However, there are counterarguments also being made that will carry weight, especially with the political bent of the current administration.  Specifically, the maximum employment piece of the Fed mandate, which Mr Powell highlighted last year when announcing the Fed’s new policy initiatives, remains an open question.  It appears that the current Fed view is that NAIRU (full employment) is reached when the Unemployment Rate reaches 3.8%.  The November NFP report showed Unemployment has declined to 4.2%, as measured, and recall that pre-pandemic, the Unemployment Rate had fallen to 3.5%, its lowest point in half a century.  Thus, the new view is that full employment will only be reached at near historic lows.  Yet, is that maximum employment in the current vernacular?

The Fed’s policy review used the terms “broad-based and inclusive” to describe maximum employment, by which they were considering not merely the statistical headline, but the makeup of the data when broken down by various subcategories, notably race.  That November report indicated that the Unemployment rate for minorities was 6.7%, considerably higher than for the white cohort which saw Unemployment of just 3.7%.  That disparity is at the heart of the question as to whether the Fed believes its employment mandate has been fulfilled.

You will not be surprised to know that there is vocal advocacy by some that the ratio that currently exists reflects bias and the Fed must do more to alleviate the problem, even at the expense of higher inflation.  Nor would you be surprised that others make the case that rising inflation is a greater burden on the lower and middle classes, so seeking those last few jobs results in a significantly worse outcome for all, especially those for whom the policies are intended to help.

The point is it is not a slam-dunk that the Fed is going to be as aggressively hawkish as the current market narrative claims.  While Chairman Powell clearly indicated that the pace of tapering would increase, do not be surprised if it rises from $15B/month to $20B or $25B/month rather than the baseline market assumption of $30B/month.  If that is the case, then another repricing in markets will be coming, with risk assets getting a reprieve while the dollar is likely to suffer.  While this is not my base case, I would ascribe at least a 30% probability to the idea that tomorrow’s FOMC is less hawkish than currently priced.  Stay on your toes.

In the meantime, here is what has been happening since you all went home last evening.  As mentioned, risk is under pressure with Asian equity markets (Nikkei -0.7%, Hang Seng -1.3%, Shanghai -0.5%) all following the US markets lower while European markets opened in a similar vein.  However, it appears that recent omicron news regarding the efficacy of current vaccinations with respect to moderating illness has begun to turn sentiment around and we now see both the DAX and CAC flat on the day while the FTSE 100 (+0.4%) has risen, embracing the new omicron news along with better than expected employment data from the UK (Unemployment fell to 4.2% with Weekly Earnings rising 4.9%).  Alas, US futures remain lower despite that Covid news, led by the NASDAQ (-0.6%).

Bond markets, which had earlier been modestly firmer (yields lower) have reversed course on the omicron news and we now see Treasury yields (+1.9bps) rising alongside the European sovereign market (Bunds +1.5bps, OATs +1.2bps, Gilts +2.3bps).  It seems market participants continue to be whipsawed between concerns over tighter policy and positive omicron news.

Commodity prices, too, have begun to reverse course as early session declines have now been erased with oil (0.0%) back to flat on the day from a nearly 1% decline a few hours ago.  While NatGas (-2.6%) in the US remains stable and under $4/mmBTU, the situation in Europe remains dire with prices rising another 3.6% as ongoing concerns over Nordstream 2 pressure the situation.  In the metals’ markets, there is mostly red with precious (Au -0.1%) softer and base (Cu -0.1%, Al -0.7%) also under pressure.  Agricultural products are falling as well today.

The dollar is on its back foot this morning as positivity permeates the markets with only NOK (-0.15%) softer in the G10, still feeling the lingering pain of oil while we see CHF (+0.35%) and EUR (+0.3%) lead the way higher.  Much of this movement, I believe, is position related as there has been little data or commentary to drive things, and the broader dollar gains that we have seen over the past months are seeing some profit-taking ahead of the FOMC and ECB meetings in the event that my case above for a more dovish outcome occurs.  Remember, too, given the market’s long dollar positioning, even a hawkish Fed could see a ‘sell the news’ result.

EMG currencies are showing similar trends with TRY (-3.3%) the true outlier as the lira quickly melts on ongoing policy concerns.  But elsewhere, HUF (+0.8%) has gained as the central bank reduced its QE purchases and expectations of further rate hikes are rampant.  CZK (+0.5%) is also benefitting from hawkish central bank news as the head there explained he saw rates closer to 4.0% than 3.0% next year (current 2.75%).  After those stories, there is much less movement overall.

Data this morning showed the NFIB Small Business Optimism Index edge slightly higher to 98.4 while PPI (exp 9.2%, 7.2% ex food & energy) is due at 8:30.  If the market takes hold of the latest omicron news, I would expect the equity market to turn around, but also the dollar as less Covid worries allows the Fed to be more hawkish.  But really, all eyes are on tomorrow afternoon, so don’t look for too much movement in either direction today.

Good luck and stay safe
Adf

Not the Plan

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It turns out the internet can
Stop working, though that’s not the plan
Thus, to be succinct
The people who linked
Their lives to it found nothing ran

Under the heading, ‘It’s amusing today but could be much worse’, it seems there is a downside to all the conveniences we were promised if we just linked all the mundane features of life to the internet so the IoT could work its magic.  When the IoT stops working, so do all those mundane features, like door locks using Ring, and Roomba® vacuums and smart refrigerators and washing machines.  And so, yesterday, when Amazon Web Services crashed for upwards of 9 hours along the East Coast, many people and businesses learned just how reliant they were on a single private company (albeit a big one) for maintaining the status quo of their lives.  Do not be surprised if the question arises as to whether the ‘cloud’ has become too important for the private sector to manage by itself and needs to be regulated as a utility going forward.

With omicron somewhat less feared
The bulls feel the way has been cleared
To add to positions
Which led to conditions
Where price rises were engineered

Markets, however, were completely unconcerned with any hiccups regarding the cloud and bulled ahead with spectacular gains yesterday as the NASDAQ led the way rising more than 3.0%.  While this author’s view is risk appetite is more closely correlated to views on / concerns over the tapering of QE and tighter Fed policy, the narrative has been very focused on omicron and the news that it seems to be more widespread but far less virulent and therefore will have a lesser impact on the recovering economy.  At least, that’s what the punditry is saying this morning as an explanation for yesterday’s massive risk-on rally.

And perhaps, that is an accurate viewpoint.  Perhaps last week’s selloff was entirely due to the uncertainty over just how impactful omicron would be on the global economy.  The problem is that doesn’t pass the smell test.  Consider that if omicron was really going to result in another wave of economic closures, the central bank response would likely be adding still more liquidity to the global system, much of which would find its way into equities.  In contrast, tighter monetary policy that reduces overall liquidity would have the opposite effect.  As such, it seems to me that sharp declines are more likely on fear of less liquidity than fear of the latest virus variant.  So, while markets are still pricing rate hikes for next year, they have clearly come to grips with the current expected pace of those hikes.  Now, if inflation continues to rip higher, and we see the latest CPI print on Friday, the sanguinity over the pace of rate hikes could well disappear.  Remember that there are many ‘fingers of instability’ weaving throughout the market construct, among them massive leverage and extremely high equity valuations.  Risk is a funny thing, it often isn’t a concern until, suddenly, it is the only concern.  Risk asset markets, while continuing to ascend, are also doing so on less and less breadth.  Again, I would contend that hedging remains a critical activity for the corporate set.

Looking around markets today, yesterday’s euphoria, while evident in Asia overnight, has not made its way to Europe.  Japan’s Nikkei (+1.4%) led the way in Asia despite GDP data printing at a much lower than expected -3.6% in Q3.  It seems to me any idea that the BOJ will consider reducing its support for the economy is misplaced.  If anything, I would anticipate increased support as the nation tries to dig itself out of its latest economic hole.  As to the rest of Asia, the Hang Seng (+0.1%) lagged as its tech sector continues to be undermined by Xi’s ongoing crackdown on Chinese tech behemoths, but Shanghai (+1.1%) with far less tech exposure, did fine.

Europe, on the other hand, is under a bit of pressure this morning with the DAX (-0.6%) leading things lower followed by the CAC (-0.3%) while the FTSE 100 is little changed on the day.  The big news in Germany is that Angela Merkel is officially out as Chancellor and Olaf Scholz was sworn in as the new leader of the nation.  I don’t envy his situation as energy prices are rising sharply and Germany is entirely reliant on Russia and Vladimir Putin for the natural gas necessary to stay warm this winter, while their export-led economy is so tightly tied to China’s performance, that the ongoing slowdown there will soften growth prospects.  But then again, as a Social Democrat, maybe that is exactly the position Scholz relishes.

Finally, US markets remain in euphoria mode with futures all pointing higher by another 0.4% at this hour with the S&P 500 less than 1% from its all-time high.

The bond market, this morning, is showing no clarity whatsoever.  Treasury yields, after backing up 5bps yesterday, are actually lower by 0.8bps despite the positive look from equities.  Bunds and OATs are little changed while Gilts (-1.4bps) are showing the most strength.  Perhaps of more interest are the PIGS, where yields are rising sharply (Italy +3.2bps, Greece +4.9bps) after comments from Latvian ECB member, Martin Kazaks, that there was little reason to continue with additional QE once PEPP expires in March.  I suspect the Greeks and Italians would have a different opinion!

Last week, commodity prices were under huge pressure, led by oil, which cratered in the wake of the Thanksgiving holiday.  This morning, WTI (+0.75%) and Brent (+1.0%) are continuing their strong rebound with both grades more than 12% off their recent lows.  NatGas (+3.9%), too, is rebounding but has much further to go to reach the peaks seen in October.  Metals market, on the other hand, are having a less interesting day with gold (+0.1%) and copper (+0.1%) just edging up a bit.

Turning to the dollar, it is broadly, but not universally weaker this morning with NOK (+0.6%) leading the way on the back of oil’s rebound, although the rest of the G10 gainers are far less impressive (AUD +0.2%, CAD +0.1%).  There are some laggards as well with GBP (-0.35%) falling after news that PM Johnson is about to impose new travel restrictions in the country.  Now, if the UK combines tightening monetary policy, at which the BOE has hinted, with omicron inspired restrictions, that is clearly a recipe for slowing growth, and a weaker pound and FTSE.  In fact, the pound has fallen to its lowest level in almost exactly 12 months this morning.  In the EMG space, only TRY (-1.3%) is really falling and that story is consistent.  On the plus side, though is THB (+0.6%), RUB (+0.4%) and ZAR and MXN (both +0.35%) as the commodity sector continues to perform well while Thailand powered ahead on reduced omicron fears.  So, the UK is reacting one way while the Thai government is going in the opposite direction!

On the data front, yesterday’s productivity and labor cost data were even more awful than forecast and Consumer Credit rose far less than anticipated and barely 56% as quickly as September.  This morning brings only the JOLTs report (exp 10469K) which means that with the lack of Fed speakers, the FX market will look elsewhere for drivers. As long as risk remains in vogue, I expect the dollar to remain under some pressure, but if the European equity impulse comes here, look for the dollar to recoup its losses before the day is over.

Good luck and stay safe
Adf

No Longer Taboo

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The omicron variant seems
No longer to haunt people’s dreams
Thus, stocks are advancing
And markets financing
The craziest, wildest schemes

So, risk is no longer taboo
As narrative changes ensue
Chair Powell’s regained
Control, and contained
The fallout from his last miscue

Risk appetite is remarkably resilient these days as evidenced not only by yesterday’s US equity rally, but by the follow-on price action in Asia last night as well as Europe this morning.  In fact, it seems the rare market that has not rallied at least 2% this morning.  Naturally, this raises the question as to what is driving this sudden return to bullishness?  Is it a widening view that the omicron variant is not going to result in more draconian government lockdowns?  Well, based on the news that NYC has imposed new restrictions on people, requiring vaccinations for everyone aged 5 and older to enter any public building, that may not be the case.  Perhaps the news that Austria has established fines of €600 for the first time someone is found not to be vaccinated with an increasing scale and jail time in that person’s future if they do not correct the situation, is what is easing concern.

At this point, arguably, it is too early to truly understand the nature of the omicron variant and its level of virulence, although it is clearly highly transmissible.  Early indications are that it is not as deadly but also that none of the currently approved vaccines does much with respect to preventing either infection or transmission of this variant.  However, global equity investors have clearly spoken and decided that any potential issues are either likely to be extremely short-term or extremely mild.

Perhaps this renewed risk appetite has been whetted by the idea that the Fed’s tapering will be a net positive for the market.  On the surface, of course, that doesn’t seem to accord with the idea that it has been the Fed’s (and ECB’s) largesse of adding constant liquidity to the system that has been the major support for the equity rally.  I’m sure you all have seen the graph that shows the growth in the Fed’s balance sheet overlain on the price action in the S&P 500, where the two lines are essentially the same.  So, if more central bank liquidity has been the key driver of higher stock prices, how can reduced liquidity and threats(?) or indications of higher interest rates coming sooner help support stocks.  That seems to run contra to both that thesis as well as the idea that inflation is good for stocks, with the second idea suffering from the concept that tighter monetary policy is designed to fight inflation.

But maybe, that is the key.  For the cognitive dissonant equity bull, loose policy and high inflation are good for equity markets because loose policy will keep the economy growing faster than inflation can reduce real returns.  On the other hand, tighter policy will fight inflation thus allowing lower nominal returns to remain competitive on a real basis.  Or something like that.  Frankly, it has become extremely difficult to understand the ever-changing rationales of equity bulls.  But that doesn’t mean they haven’t been right for a long time now, despite changes in underlying macroeconomic trends.

From its peak on November 22, to its bottom Friday, the S&P 500 fell about 5.25%, not even a correction, as defined in the current vernacular.  That requires a 10% pullback.  So, for all intents and purposes, this bull market has done nothing more than pause for a few days and is apparently trying to regain all its lost ground as quickly as possible.  Remember this, though, trees do not grow to the sky, nor do markets rally forever.  There continue to be numerous red flags as to the performance of equities; notably potentially tighter monetary policy, extremely high valuations, narrowing breadth of index performance and questions over future earnings growth amongst others.  And any of these, as well as the many potential issues that are not even currently considered, can be a catalyst for a more significant risk-off event.  In fact, the situation in the Treasury market, the curve is flattening quite rapidly, seems to be one clear warning that the future may not be as rosy as currently priced by the stock market.  Do not take for granted that risk appetite will remain this robust indefinitely and plan accordingly.

But today that is not a concern!  Risk is ON and in a big way.  After yesterday’s US rally, we saw all green in Asia (Nikkei +1.9%, Hang Seng +2.7%, Shanghai +0.2%) and Europe (DAX +2.1%, CAC +2.2%, FTSE 100 +1.2%) with US futures all higher between 1.0% (DOW) and 1.8% (NASDAQ).  In other words, all is right with the world!  Interestingly, one of the stories making the rounds today is about yesterday’s Chinese reduction in the RRR, but that was literally yesterday’s news, well known throughout the entire session.  I feel like there is something else driving things.

As to the bond market, while prices have fallen slightly, the movement is a lot less than would be expected given the strength of the equity rally.  Treasury yields are higher by just 0.2bps while Bunds (+1.5bps), OATs (+0.9bps) and Gilts (+2.4bps) are all responding a little more in line with what would normally be expected.  Data from Europe was slightly better than forecast with German IP (2.8%) and ZEW Expectations (29.9) both showing the economy there holding up better despite the ongoing lockdowns.  Asian bonds also saw yields climb a bit making the process nearly universal.

Commodity prices are following the risk narrative with oil (+2.8%) rallying sharply for the second consecutive day and now trading nearly 15% off the lows seen Thursday!  NatGas (+2.2%) is rebounding but still well below its highs seen in early October, while metals prices are all higher as well led by Cu (+0.7%) and Al (+1.2%) although both gold (+0.25%) and silver (+0.3%) are a bit firmer as well.

It will come as no surprise that the dollar is somewhat softer this morning given the environment as we see AUD (+0.7%), CAD (+0.5%) and NOK (+0.4%) all benefit from firmer commodity prices while the euro (-0.25%) is actually the laggard on the day, despite the rally in equities there.  Perhaps the single currency is gaining some haven characteristics.  In the emerging markets, TRY (+0.7%) is the leading gainer followed by THB (+0.6%) and BRL (+0.5%).  One can simply recognize the extreme volatility in the lira given the ongoing policy missteps, so a periodic rally should be no surprise.  As to the baht, it seems buyers are looking for China’s RRR cut to support the Chinese economy and by extension the Thai economy as well.  Brazil is a more straightforward commodity story I believe.  On the downside, CZK (-0.4%) and HUF (-0.3%) are the laggards as traders express mild concern that the central banks there may not keep up with rising inflation when they meet this week and next.

On the US data front, Nonfarm Productivity (exp -4.9%) and Unit Labor Costs (+8.3%) lead along with the Trade Balance (-$66.8B) at 8:30.  One cannot help but look at the productivity and labor cost data and wonder how equity markets can continue to rally.  Those seem to point to the worst of all worlds.  As to the Fed, they are in their quiet period ahead of next Wednesday’s meeting, so nothing to report there.

While I may not agree with its underpinnings, risk is clearly in vogue this morning and I don’t see any reason for that to change today.  In general, I would look for the dollar to continue to soften slightly, but also see limited scope for a large move.  All eyes have turned to the Fed next week and will be anxiously awaiting Chair Powell’s explanations for whatever moves they make.

Good luck and stay safe
Adf

Transitory is Dead

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Said Jay, transitory is dead
And now when we’re looking ahead
To our consternation
It seems that inflation
Has climbed up to levels we dread

The market heard this and was stunned
Thus, equities quickly were shunned
The dollar was bought
And everyone thought
They’re better off buying the Bund

Finally!  It only took Chairman Powell 9 months to accept the reality on the ground that inflation is not likely to disappear anytime soon.  He officially ‘retired’ the word transitory as a description and confessed that inflation has been more persistent than he and the Fed had forecast.  The question that was not addressed is why the Fed thought that the supply chain bottlenecks were going to be short-lived to begin with.  After all, the primary use of ultra-cheap funding by the corporate community has been capital structure rebalancing (i.e. share repurchases) as that was the most efficient way to improve company valuations.  At least their stock market valuations.  Thus, there was never any evidence that investment was flowing toward areas that were bottle(necke)d up.

Ironically, this was partly Powell’s fault as his continued confidence that inflation was transitory, and bottlenecks would ease discouraged any company from making the investments to ease those very same bottlenecks.  Consider this, why would a company spend money to increase capacity if the benefits to be gained would be so short-lived?  And so, investments were not made, capacity remained the same and the bottlenecks persisted.

But now the Fed has acknowledged that inflation is a problem and Mr Powell has indicated that the pace of tapering QE ought to be increased.  The market read this as a doubling of the pace and so QE is now set to end in March, at least according to the punditry.  We will find out more precisely come the FOMC meeting in two weeks’ time.

Ultimately, the problem for Powell and the Fed is that a more aggressive timeline to tighten policy could potentially have a fairly negative impact on both stock and bond markets.  If that is the case, and there is no reason to believe it won’t be, Mr Powell may find himself in a similar situation as Q4 2018, when comments regarding the fact that the Fed was “nowhere near neutral” interest rates, which implied further tightening, resulted in a 20% decline in the S&P 500 Index and led to the infamous Powell Pivot on Boxing Day, when the Fed stopped tightening and began to ease policy.  Can Powell withstand a 20% decline in the S&P 500 today?  I doubt it.  10%?  Even that will be tough.  In essence, Powell now finds himself caught between President Biden’s growing concerns over inflation and the market’s likely concerns over tighter policy.  If nothing else, we should finally learn the Fed’s true master as this plays out.

So, with that in mind, let’s take a look at how markets have responded overnight.  While yesterday saw an immediate rejection of risk assets, the first bargain hunters have returned and equity markets were largely in the green overnight and on into this morning.  The Nikkei (+0.4%), Hang Seng (+0.8%) and Shanghai (+0.35%) all managed to rally amid mixed data (Japan’s PMI rising to 54.5, China’s Caixin PMI falling to 49.9) and despite ongoing concerns the omicron variant would lead to further lockdowns.

European bourses (DAX +1.4%. CAC +1.3%, FTSE 100 +1.3%) are all much firmer after the PMI data there was generally better than expected.  This is despite the fact that the OECD released its latest forecasts, slightly downgrading global growth for 2021 although maintaining its 2022 global growth forecast of 4.5%.  Pointed comments about the risks of the omicron variant accompanied the release as all the work was done before that variant became known.  Perhaps investors are looking at omicron and assuming it will delay tightening further, thus support equity values.  Finally, US futures are all pointing sharply higher this morning, at least 1.0% with NASDAQ futures +1.5% at this hour.

It should be no surprise, given risk is back in vogue, that bonds are selling off again.  The one thing that has been evident is that volatility in markets has increased and shows no signs of abating until there is a more coherent story and clarity on ultimate central bank policy.  This morning, Treasury yields (+3.6bps) have jumped as have Bunds (+2.7bps), OATs (+3.1bps) and Gilts (+5.6bps).  Perhaps more surprising is that Italian BTPs (+6.5bps) have been the worst performer on the continent as during a risk-on session, these bonds tend to outperform.  Asian bond markets performed in a similar manner as yields rallied everywhere there.

Commodity prices are at least making sense today as we are seeing strength virtually across the board.  Oil (+4.5%) is leading the energy space higher, although NatGas (-3.4%) remains disconnected and is the sole outlier.  Metals are firmer as both precious (Au +0.7%, Ag +0.2%) and industrial (Cu +0.45%, Al +0.7%, Sn +0.3%) see buying interest and agricultural prices are firmer as well.

The dollar, though, has less direction today with the G10 seeing commodity currencies stronger (NZD +0.35%, AUD +0.3%, CAD +0.25%) while financials are under modest pressure (CHF -0.2%, JPY -0.15%, EUR -0.15%).  Now, in fairness, none of these moves are that large and most likely they represent position adjustment more than anything else.  In the emerging markets, TRY (+1.8%) remains the most volatile, rising sharply (more than 8.5% at its peak) after the central bank announced they were intervening due to “unhealthy price formations” in the market.  It seems those price formations have been the result of President Erdogan continuing his campaign to lower interest rates in the face of soaring inflation.  But there were other gainers of note including MXN (+0.9%) backed by oil’s rebound, KRW (+0.8%) on the strength of stronger than forecast output data and CLP (+0.7%) on the rise in copper prices.

Data this morning brings ADP Employment (exp 525K), ISM Manufacturing (61.2) and Prices Paid (85.5) and at 2:00 this afternoon, the Fed releases the Beige Book.  Chairman Powell and Secretary Yellen testify to the House Financial Services Committee starting at 10:00, and remember, that was when the fireworks started yesterday.  I doubt we will see the same type of movement but be alert.

The dollar story has lost its conviction as previously, the thought of a more aggressive Fed would have led to a much firmer dollar.  However, we are not witnessing that type of price action here.  While I still believe that will impact the currency’s near-term movement, right now it appears that many currencies are trading on their own idiosyncratic issues without the benefit of the big picture.  If the Fed does taper more quickly and begin to raise rates, I do expect the dollar will benefit and we can see 1.10 or lower in the euro as there is absolutely no indication the ECB is going to follow suit.  However, I suspect that equity market pain will become too much for the Fed to tolerate, and that any dollar strength will be somewhat short-lived.  Payables hedgers should take advantage over the next few weeks/months, but if you are a receivables hedger, I think patience may be a virtue here.

Good luck and stay safe
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