Tag Archives: #dollardown

More Systemic

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The winding down of the pandemic

Has fostered a massive polemic

Will rising costs fade

As Powell’s portrayed

Or are they a bit more systemic?

The inflation debate continues to be topic number one amongst market participants as the outcome is seen, rightly, as the key to future economic activity and correspondingly future market price action.  This is true across all asset classes which is why everyone cares so much.

However, not every day brings us new and exciting news on the debate which leaves the markets to seek other catalysts for movement, sometimes really stretching to find a good narrative.  Thus far, today falls under the heading of ‘looking for something to say.’

There has been limited new information released overnight which is likely why the fact that the Bank of Korea, though leaving their policy rate unchanged at 0.50%, has been a topic of conversation as they displayed a more hawkish sentiment, raising both GDP growth and inflation forecasts for 2021, and hinted that they would be looking to end their ultra-expansive monetary policy sooner than previously thought.  Earlier expectations had been rates would not begin to rise until 2023, but now the market is pricing in two 25 basis point rate hikes in 2022.  This is the fourth (BOC, BOE and RBNZ are the others) central bank of a major country that is discussing the beginning of the end of easy money.  Granted, the combined GDP of these four nations, at a touch over $7 trillion, is less than one-third that of the US, but three of them are amongst the ten largest economies in the world and the fourth, New Zealand, has a history of leading the way in monetary policy on a global basis, at least since 1988 when they ‘invented’ the inflation targeting mantra that is prevalent today.

This sentiment of considering when to end easy money is making its way more clearly into the Fed’s talking points as well.  Yesterday, Fed Vice-Chair Quarles remarked, “If my expectations about economic growth, employment and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.”  He is at least the fourth Fed speaker this week to talk about talking about tapering asset purchases which tells us that the discussion is actively ongoing at the Marriner Eccles Building in Washington.  

Perhaps what is even more interesting is the fact that the Treasury market is so nonplussed by the fact that the Fed is clearly considering the timing of a reduction in purchases at the same time we are printing the highest inflation numbers in years and the Federal government is sending out more stimulus checks and spending money like crazy.  You may disagree with Chairman Powell’s policy actions, but you cannot deny the effectiveness of his recent communication policy.  Based on price action in both bond and inflation markets, Powell’s story of transitory inflation has become the accepted truth.  I sure hope he’s right, but my personal, anecdotal observations don’t agree with his thesis.  Whether I’m looking at my cost of living or take a more monetarist view and look at the expansion of the monetary base, both point to a steady rise in prices with no end in sight.  The market, however, cares little about the FX poet’s circumstances and a great deal about Chairman Powell’s pronouncements so until he is proven wrong, it has become clear the market has accepted the transitory story.

With this in mind, a survey of market activity shows pretty limited movement in every asset class.  Equity markets had a mixed session in Asia (Nikkei -0.3%, Hang Seng -0.2%, Shanghai +0.4%) and are having a similiarly mixed session in Europe (DAX -0.3%, CAC +0.5%, FTSE 100 -0.1%).  In other words, there is no theme of note on the risk side.  Meanwhile, US futures are pointing slightly lower on the open, with the worst performer NASDAQ at -0.4% and the others with lesser declines.  None of this points to a major risk theme.

Bond prices are generally a touch softer this morning with Treasury yields higher by 1.2 basis points while Bunds (+1.0bps), OATs (+0.5bps) and Gilts (+1.7bps) have all sold off slightly.  However, in the bigger picture, all of these key bond markets are currently trading with yields right in the middle of their past three month’s activity.  Again, it is hard to define a theme from today’s price action.

Commodity prices add to the mixed view with oil (WTI -0.8%) slightly softer as it consolidates after last month’s powerful rally.  In the metals markets, precious metals are essentially unchanged this morning while industrial metals continue with the mixed theme as Cu (+0.5%) and Zn (+0.3%) are firmer while Al (-0.4%) and Sn (-0.3%) are softer. Ags have seen similar price action with Soybeans softer while both Wheat and Corn are firmer.  One of the stories here has been the recent consolidation across most commodities which has been attributed to China’s efforts to prevent inflation and the expansion of bubbles in property and housing markets.

The dollar, however, is the one thing which has shown some consistency this morning, falling almost across the board.  In fact, in G10, the dollar has fallen against all its counterparts with GBP (+0.4%) the firmest currency, but solid gains in NZD (+0.35%) and CAD (+0.3%) as well.  The pound’s jump has been in the past few minutes responding to the BOE’s Gertjan Vlieghe’s comments that rate hikes are likely to begin in 2022, again, earlier than the market had been figuring.  

EMG currencies are also gaining this morning led by the CE4 (HUF +0.65%, PLN +0.5%) as well as ZAR (+0.4%).  APAC currencies performed well overnight with CNY (+0.25%) rising for the 12th session in the 15 so far this month.  It has become abundantly clear that the PBOC is willing to allow CNY to continue to strengthen despite the potential impact on exports.  This seems to be driven by their desire to cap inflation, especially in commodity prices, as well as the fact that the inflation narrative elsewhere in the world has shown that export clients have been able to absorb some level of price rises.  To achieve both these aims, a modestly stronger renminbi is an excellent help.

On the data front, this morning brings Initial Claims (exp 425K), Continuing Claims (3.68M), the second look at Q1 GDP (6.5%) and Durable Goods (0.8%, 0.7% ex transport).  However, while this is the biggest tranche of data so far this week, tomorrow’s core PCE release remains the most important number of the week in my view as excessive strength there seems to be the only thing that could give the Fed pause in their current views.  Interestingly, we do not hear from another Fed speaker, at least in a scheduled appearance, until next Tuesday, so the data will be our best indication of what is happening.  

Looking at the dollar’s recent price action, we have seen weakness but it has run into pretty strong support.  The link between Treasury yields and the dollar remains strong, and I expect that to be the case until at least the Fed’s June meeting.  In truth, the dollar’s weakness today feels a bit overdone so I anticipate no further declines and potentially, a little rebound.

Good luck and stay safe

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High Tide

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The dollar continues to slide
But is risk approaching high tide?
Last night t’was the Kiwis
Who hinted that their ease
Of policy may soon subside

As well, from the Fed yesterday
Three speakers had two things to say
It soon may be time
To change paradigm
Inflation, though, ain’t here to stay

“There will come a time in upcoming meetings, we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases.”  So said, Fed Vice-Chairman Richard Clarida yesterday.  “We are talking about talking about tapering,” commented San Francisco Fed President Mary Daly in a CNBC interview yesterday.  And lastly, Chicago Fed President Charles Evans explained, “the recent increase in inflation does not appear to be the precursor of a persistent movement to undesirably high levels of inflation.  I have not seen anything yet to persuade me to change my full support of our accommodative stance for monetary policy or our forward guidance about the path for policy.”

The Fed’s onslaught of forward guidance continues at full speed as virtually every day at least two or three Fed speakers reiterate that policy is perfect for the current situation, but in a nod to the growing chorus of pundits about higher inflation, they are willing to indicate that there will come a time, at some uncertain point in the future, when it may be appropriate to consider rolling back their current policy initiatives.

But ask yourself this; if inflation is going to be transitory, that implies that the current policy settings are not a proximate cause of rising prices.  If that is the case, why discuss tapering?  After all, high growth and low inflation would seem to be exactly the outcome that a central bank wants to achieve, and according to their narrative, that is exactly what they have done.  Why change?

This is just one of the conundra that is attendant to the current Fed policy.  On the one hand, they claim that their policy is appropriate for the current circumstance and that they need to see substantial further progress toward their goals of maximum employment and average 2% inflation before considering changing that policy.  On the other hand, we have now heard from five separate FOMC members that a discussion about tapering asset purchases is coming, which implies that they are going to change their policy.  Allegedly, the Fed is not concerned with survey data, but want to see hard numbers showing they have achieved their goals before moving.  But those hard numbers aren’t here yet, so why discuss changing policy?

The cynical answer is that the Fed actually doesn’t focus on unemployment and inflation, but rather on the equity markets foremost and the bond market secondarily.  Consider, every time there has been a sharp dislocation lower in stocks, the Fed immediately cuts rates to try to support the S&P.  This has been the case since the Maestro himself, Alan Greenspan, responded to the 1987 stock market crash and has served to inflate numerous bubbles since then.

A more charitable explanation is that they have begun to realize that they are in an increasingly untenable position.  Since the GFC, the Fed has consistently been very slow to reduce policy accommodation when the opportunity arose and so the history shows that rates never regain their previous peak before the next recession comes along.  Recall, the peak in Fed funds since 2009 was just 2.50%, reached in December 2018 just before the Powell Pivot in the wake of a 20% drawdown in the S&P 500.  In fact, since 1980, every peak in Fed Funds has been lower than the previous one.  The outcome of this process is that the Fed will have very little room to cut rates to address the next recession, which is what led to QE in the first place and more importantly has served to reduce the Fed’s influence on the economy.  Arguably, then, a major reason the Fed is keen to normalize policy is to retain some importance in policymaking circles.  After all, if rates are permanently zero, what else can they do?

It is with this in mind that we turn our attention elsewhere in the world, specifically to New Zealand, where the RBNZ signaled that its Official Cash Rate (Fed funds equivalent) may begin to rise in mid-2022.  This is a full year before previous expectations and makes the RBNZ the 3rd G10 central bank to talk about tightening policy sooner than thought.  The Bank of Canada has already started to taper QE purchases and the BOE has explained they will be starting next year as well.  It should be no surprise that NZD (+1.15%) is the leading gainer in the FX market today, nor that kiwi bonds sold off sharply with 10-year yields rising 8bps.

Do not, however, mistake this for a universal change in policy paradigm, as not only is the Fed unwilling to commit to any changes, but the BOJ remains in stasis and the ECB, continues to protest against any idea that they will be tightening policy soon.  For instance, just this morning, ECB Executive Board Member and Bank of Italy President, Fabio Panetta, said, “Only a sustained increase in inflationary pressures, reflected in an upward trend in underlying inflation and bringing inflation and inflation expectations in line with our aim, could justify a reduction in our purchases.  But this is not what we projected in March.  And, since then, I have not seen changes in financing conditions or the economic outlook that would sift the inflation path upward.”

Investors and traders have been moving toward the view that the ECB would be tapering purchases before 2023 as evidenced by the rise in the euro as well as the rise in European sovereign yields.  But clearly, though there are some ECB members (Germany, the Netherlands) who would be very much in favor of that action, it is by no means a universal view.  Madame Lagarde will have her hands full trying to mediate this discussion.

For now, the situation remains that the central bank narrative is still the most important one for markets, and the fact that we are seeing a split amongst this august group is a key reason FX volatility remains under pressure.  The lack of an underlying theme to drive the dollar or any bloc of currencies in one direction or the other leaves price action beholden to short-term effects, large orders and the speculator community.  We need a new paradigm, or at least a reinvigoration of the old one to get real movement.

In the meantime, the dollar continues to drift lower as US yields continue to drift lower.  Right now, the bond market appears to have faith in the Fed narrative of transitory inflation, and as long as that is the case, then a weaker dollar and modestly higher stock prices are the likely outcome.

Today’s price action, NZD excepted, showed that to be the case, with APAC currencies performing well, but otherwise a mixed bag.  Equity markets are marginally higher and bond yields have largely fallen in Europe, although Treasuries are little changed after a 4bp decline yesterday.  Gold is actually the biggest winner lately, having traded back above $1900/oz as investors watch the slow destruction of fiat currency values.  But in the FX space, the USD-Treasury link remains the most important thing to watch.

Good luck and stay safe
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Not Really There

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There once was a Fed Reserve Chair
Whose minions explained with fanfare
Though prices were climbing
With all the pump priming
Inflation was not really there

Investors responded with glee
And bought everything they did see
So, risk was a hit
While yields fell a bit
As money remains largely free

Brainerd, Bostic and Bullard, though sounding like a law firm, are actually three FOMC members who spoke yesterday.  In what has been a remarkably consistent performance by virtually every single member of the committee (Robert Kaplan excepted), they all said exactly the same thing: prices will rise due to bottlenecks and shortages in the near-term, but that this was a short-term impact of the pandemic response, and that soon those issues would abate and prices would quickly stabilize again.  They pointed to ‘well-anchored’ inflation expectations and reminded one and all that they have the tools necessary to combat inflation in the event their version of events does not come to pass.  You have to give Chairman Powell credit for convincing 16 ostensibly independent thinkers that his mantra is the only reality.

The market response was one of rainbows and unicorns, with rallies across all assets as risk was snapped up everywhere.  After all, it has been nearly two weeks since the CPI print was released at substantially higher levels than anticipated raising fears amongst investors that the Fed was losing control.  But two weeks of soothing words and relatively benign data has been sufficient to exorcise those inflation demons.  In the meantime, the Fed continues to purchase assets and expand its balance sheet as though the economy is teetering on the brink of destruction while they await the “substantial progress” toward their goals to be met.

One consequence of the Fed’s QE program has been that high-quality collateral for short term loans, a critical part of the financial plumbing of the US (and global) economy has been in short supply.  For the past two months, Treasury bill issues have been clearing at 0.00%, meaning the government’s cost of financing has been nil.  This is due to a combination of factors including the Treasury running down the balances in the Treasury General Account at the Fed (the government’s checking account) and the ongoing Fed QE purchases of $80 billion per month.  This has resulted in the Treasury needing to issue less T-bills while simultaneously injecting more funds into the economy.  Banks, meanwhile, wind up with lots of bank reserves on their balance sheets and no place to put them given the relative dearth of lending.  The upshot is that the Fed’s Reverse Repurchase Program (RRP) is seeing unprecedented demand with yields actually starting to dip below zero.  This is straining other securities markets as well given the bulk of activity in markets, especially derivatives activity, is done on a margin, not cash, basis.  While so far, there have not been any major problems, as the stress in this corner of the market increases, history shows that a weak link will break with broader negative market consequences.  For now, however, the Fed is able to brush off any concerns.

The result of the constant commentary from Fed speakers, with three more on the schedule for today, as well as the fading of the memories of the high CPI print has been a wholesale reengagement of the risk-on meme.  Growth continues to rebound, while zero interest rates continue to force investors out the risk curve to find a return.  What could possibly go wrong?

Today, the answer is, nothing.  Risk is back with a vengeance as evidenced by a strong equity session in Asia (Shanghai +2.4%, Hang Seng +1.75%, Nikkei +0.7%) and a solid one in Europe as well (DAX +0.8%, CAC +0.15%, FTSE 100 0.0%).  The Chinese (and Hong Kong) rally seems to be a product of the PBOC focusing their attentions on the commodity market, not equities, as the source of imbalances and a potential target of interventionist policies thus allowing speculators there to run free.  German equities are the beneficiary of better than expected ZEW data, with both the current conditions (95.7) and Expectations (102.9) indices leading the way.  While yesterday’s US equity rally faded a bit late in the day, futures this morning are all pointing higher by about 0.3%.

Arguably, the FOMC trio had a bigger impact on the bond market, where 10-year Treasury yields are now back below 1.60%, down 1 basis point this morning and at their lowest level in more than two weeks.  It is certainly hard to believe that the bond market is remotely concerned about inflation at this time.  Remember, though, Friday we see the core PCE print, which is the number the Fed truly cares about, and while it is forecast to print above the 2.0% target, (0.6% M/M, 2.9% Y/Y) we also know that the Fed strongly believes this is transitory and is no reason to panic.  Markets, however, if that print is even stronger, may not agree with that sentiment.

Commodity prices are having a less positive day as the ongoing concerns about Chinese actions to prevent price rises continues to weigh on sentiment.  Oil has slipped just a bit (-0.3%) but we are seeing declines in Cu (-0.4%), Al (-1.1%) and Fe (-3.1%), all directly in the crosshairs of the Chinese government.  Agricultural product prices are mixed today while precious metals remain little changed.

Finally, the dollar is mostly lower this morning with broad weakness seen in the EMG bloc, but less consistency in G10.  While SEK (+0.5%) leads the way higher, the rest of the bloc has been more mixed.  NOK (-0.2%) is clearly suffering from oil’s decline, while JPY (-0.2%) seems to be giving ground as havens are unloved.  EUR (+0.25%) has been helped by that German ZEW data as well as the beginnings of a perception that the Fed is going to be more aggressively dovish than the ECB for a long time to come.  In that event, the euro will certainly rise further, although it has a key resistance level at 1.2350 to overcome.

ZAR (+0.7%) leads the emerging market parade higher as concerns over inflation there abate, and South Africa continues to have amongst the highest real yields in the world.  KRW (+0.4%) is next in line as consumer sentiment in South Korea rose to its highest level in 3 years.  The other noteworthy move has been CNY (+0.2%) not so much for the size of the move as much as for the fact that it has breached the 6.40 level and the government has indicated they are going to be taking additional steps to open the FX market in China to help local companies hedge their own FX risks. The only laggard of note is TRY (-0.3%) which is suffering as President Erdogan has replaced yet another member of the central bank’s board, inviting concerns inflation will run higher with no response.

Data today shows Case Shiller Home Prices (exp +12.5%) as well as New Home Sales (950K) and Consumer Confidence (119.0), none of which are likely to change either Fed views or market opinions.   As mentioned above, three Fed speakers will regale us with their sermon on transitory inflation, and I expect that the dollar will remain under pressure for the time being.  In fact, until we see core PCE on Friday, it is hard to make a case that the dollar will turn around and only then if the number is higher than expected.

Good luck and stay safe
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Tapering Talk

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Despite all the tapering talk
The market did not walk the walk
Now sovereigns worldwide
Have seen their yields slide
While stocks are where people all flock

Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing?  That was so two days ago.  With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion.  Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion.  Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals.  In other words, tapering is still a long way in the future.

This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so.  Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals.  Do not be misled into believing the Fed is on the cusp of removing accommodation.  They are not!

A quick look at yesterday’s data highlights why they are still a long way off.  While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth.  As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever.  But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem.  Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.

Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon.  While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.

Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing.  The interesting thing is the contrast between the data from Asia and that from Europe.  It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5.  While a slight decline from the previous month, it is still well into growth territory.  However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7.  There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.

European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end.  As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength.  Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact.  While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.

Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening.  The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.

Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.

Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%).  Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there.  Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day.  US futures are all modestly higher at this point, by roughly 0.25%.

As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps.  But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads.  The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.

Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer.  However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.

Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above.  In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May).  But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4.  In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.

On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00.  Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.

Nothing has changed my view that as go 10-year yields, so goes the dollar.  If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain.  If, however, yields reverse higher, the dollar will find its footing immediately.

Good luck, good weekend and stay safe
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Retrogression

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To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression

“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”  This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity.  Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.

No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything.  So, is this really as hawkish as the commentariat would have us believe?  Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report.  Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy.  Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time.  Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).

The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis.  That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”

Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do.  The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion.  In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco.  Of that group, Chicago’s Evans and SF’s Daly are uber-dovish.  Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all.  This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months.  Do not get overexcited about the Fed tapering.

Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive.  Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released.  Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session.  In other words, it was hardly a rout based on the Minutes.  The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit.  Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.

As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%.  But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps.  This is hardly the sign of a market preparing for a Fed change of heart.  European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps).  Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.

Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%).  However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions.  The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day.  Agricultural products, though, maintain their bids with small gains across the board.

Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April.  This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.

Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes.  Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%).  Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night.  However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.

Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%).  All of these are benefitting from the broad based, but mild, dollar weakness.  The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.

Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0).  Then at 10:00 we see Leading Indicators (1.3%).  On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.

Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment.  Look for the dollar to drift lower on the day.

Good luck and stay safe
Adf

Gazumped

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While measured inflation has jumped
And stock markets, Powell has pumped
The dollar is queasy
As money this easy
Has bulls concerned they’ll get gazumped

But its not just Powell who’s saying
That QE and ZIRP will be staying
Almost to a man
The Fed’s master plan
Is printing and buying…and praying

Once again, yesterday, we heard from several FOMC members and each of them highlighted that the data has not yet come close to describing the “substantial progress” they are seeking with respect to reduced unemployment and so it is not nearly time to begin even thinking about tapering.  Well, except for the lone quasi-hawkish voice of Dallas Fed President Robert Kaplan, who did express concern that the Fed’s actions were part of the reason that asset prices are so high.  But not to worry, Mr Kaplan will not be a voter until 2023, so will not even be able to officially register his disagreement with policy for two more years.  In other words, based on everything we continue to hear, we can expect a series of 9-0 votes every six weeks to maintain current policy.

It is this ongoing messaging, which comes not only from the Fed but from the ECB and BOJ as well, that continues to drive the narrative as well as market prices.  Inflation?  Bah, it’s transitory and while 2021 may see some higher readings, it will all disappear by 2022.  Bubbles?  Bah, central banks cannot detect them and, even if they could, it is not their job to deflate them.  It has become abundantly clear that the three big central banks have jointly decided that the only thing that matters is the unemployment rate, and until that data is back at record low levels, regardless of what else is happening in the economy, the current state of QE and ZIRP/NIRP is going to remain in place.

Thus, it cannot be that surprising this morning that the dollar has begun to slide a bit more in earnest, while risk appetite, as measured by equity prices remains robust.  A very large segment of the punditry continue to harp on concerns over rising inflation and how the Fed and other central banks will be forced to adjust their policy to prevent it from getting out of hand.  But simply listening to virtually every central banker tells us that nothing is going to change.

“Through that April employment report, we have not made substantial further progress,” said Fed Vice-Chair Richard Clarida yesterday.  Meanwhile, from the ECB, Francois Villeroy de Galhau explained this morning, “Today there’s no risk of a return of lasting inflation in the euro area, and so there’s no doubt that the ECB’s monetary policy will remain very accommodative for a long time.  I want to say that very clearly.”  I don’t know about you, but it seems pretty clear that the concept of tapering QE purchases, let alone raising interest rates, is not even on the table.

Now, smaller central banks have changed their tune, notably the Bank of Canada and Sweden’s Riksbank, with the former actually reducing QE purchases while the latter has promised to do so shortly.  As well, the Bank of England has begun the discussion about reducing policy support as the economy there continues to open rapidly, and growth picks up.  As such, it should not be that surprising that those three currencies (GBP +2.75%, CAD +2.1%, SEK +1.9%) are the leading gainers vs. the dollar so far this month.

Perhaps what is also interesting is that the euro is strengthening so clearly vs. the dollar despite the strong words by ECB members regarding the maintenance of easy money.  It appears that the market has a stronger belief in the Fed’s willingness to ignore the repercussions of their policy choices than that of the ECB.  Remember, in the end, Europe remains reliant on Germany as its engine of growth and largest economy, and German DNA, ever since the Weimar hyperinflation in the 1920’s favors tighter policy, not looser.  Madame Lagarde will have a tougher battle to maintain easy policy if the data starts to point higher than will Chairman Powell.  Right now, however, that is all theoretical regarding both banks.  Easy money is here for the foreseeable future, which means that risk appetite is likely to remain strong, driving up stock and commodity prices while the dollar sinks.

What about bonds, you may ask?  Haven’t they been the key driver?  The answer is that they have been the key driver,  but a close look at statistics like inflation breakevens, and more importantly, the shape of the breakeven curve, offer indications that even though near-term expectations are for much higher inflation, more and more investors are buying the transitory story.  If that is, in fact, the case, then there is ample room for bonds to rally as well, which would be quite the shock to all the inflationistas out there.

This morning is exhibit A regarding the impact of increased risk appetite.  Equity markets around the world are higher with Asia (Nikkei +2.1%, Hang Seng +1.4%, Shanghai +0.3%) putting in some very strong performances while Europe (DAX +0.25%, CAC +0.2%, FTSE 100 +0.4%) are all green, but have come off their best levels of the morning.  US futures are also pointing higher, with gains ranging from 0.2% (Dow) to 0.7% (Nasdaq).

The bond market, meanwhile, is directionless, with yields for Treasuries (-0.5bps) and European sovereigns (Bunds 0.0bps, OATs -0.7bps, Gilts +0.7bps) all trading in narrow ranges.  If you consider that given the increase in risk appetite as evidence by stocks, commodities and the dollar, the very fact that bonds are not selling off is actually a bullish sign.

Speaking of commodities, Brent crude (+0.6%) traded above $70/bbl for the first time since November 2018 this morning and WTI is firmer by a similar amount.  Metals prices continue to rally (Au 0.0%, Ag +0.8%, Cu +1.0%, Al +0.7%), as do foodstuffs (Soybeans +0.6%, Wheat +0.75%, Corn +1.7%).  While it is not clear how much longer commodity prices will rally, it seems abundantly clear, based on their price action, that the rally has more legs.

And finally, the dollar, which as mentioned above is under pressure, is having a really bad day.  Versus its G10 counterparts, the dollar is softer across the board with NZD (+0.7%), NOK (+0.6%) and CHF (+0.55%) leading the way.  But the euro (+0.45%) is also much firmer and now trading above 1.22 for the first time since early February.  If you recall, 1.2350 was the high seen the first week of January, and in order to truly change opinions, the euro will have to trade through that level.  With the dollar so weak, it certainly seems like there is a good chance to get there soon.

EMG markets are also seeing pretty uniform gains with ZAR (+0.7%), HUF (+0.65%) and PLN (+0.6%) leading the way, the former on the back of commodity price strength while the two CE4 currencies are benefitting from the belief that both central banks may be tightening policy shortly as well as the euro’s strength.  But we saw strength overnight in the APAC currencies as well (KRW +0.4%, SGD +0.4%, TWD +0.35%) as they all are responding to the broad-based dollar weakness.

On the data front, today brings Housing Starts (exp 1702K) and Building Permits (1770K), with both simply showing that the housing market remains on fire.  Meanwhile, only Robert Kaplan is scheduled to speak, but we already know what he thinks (tapering needs to start soon) and we also know his is a lone voice in the wilderness.  It would not surprise me if we had a surprise series of comments from another FOMC member just to counter his views.

Looking ahead to the session, there is no reason to believe that the dollar’s weakness is going to change anytime soon.  Unless Treasury yields start to back up smartly, risk appetite is the dominant story today, and that bodes ill for the dollar.

Good luck and stay safe
Adf

To ZIRP They’ll Adhere

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The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt

In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere

It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions.  For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm.  Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year.  Which means that the entire argument is based on dueling forecasts of the future beyond that.  In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.

What is transitory?  Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now.  According to Merriam-Webster, it describes something of brief duration or temporary.  Which begs the question, what is brief?  Is 3 months brief?  6 months?  Longer?  Arguably, brief depends on the context involved.  For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.

There continue to be strong arguments in favor of both sides of the argument.  On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years.  No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices.  As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items.  Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral.  In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.

Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains.  In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices.  We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation.  Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support.  As they are wont to say, the Fed can’t print copper or corn.  The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?

Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets.  By now, you are all aware I remain in the inflationist camp and have been for a while.  I cannot ignore the rising prices I see every time I go into a store.  But the deflationists make excellent points.  This argument discussion will rage for at least another two months and the July CPI release.  Until then, the one thing that seems clear is that market volatility is likely to remain significant.

As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed.  At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well.  US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.

Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively.  Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.

Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).

Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs.  Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%).  Much of this movement seems to be on the back of positioning rather than fundamental news.  On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.

EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region.  CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line.  On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.

Not a ton of data this week, but here is what we see:

Today Empire Manufacturing 23.9
Tuesday Housing Starts 1705K
Building Permits 1770K
Wednesday FOMC Minutes
Thursday Initial Claims 455K
Continuing Claims 3.64M
Philly Fed 41.9
Friday Existing Home Sales 6.08M

Source: Bloomberg

The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total.  Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.

With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck.  This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along.  If you are in the deflationist camp, it’s the opposite.  But remember, at a point in time, inflation will undermine the dollar’s value.  Just not right away.

Good luck and stay safe
Adf

They Haven’t the Nerve

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It’s not just the Federal Reserve
Who thinks that inflation’s steep curve
Is likely short-term
And so reconfirm
For rate hikes, they haven’t the nerve

In Mexico, Chile, Peru
Each central bank chose to eschew
The chance to raise rates
For like in the States
They pray that inflation’s not true

Inflation remains the key talking point in every market these days.  This means not just equity, bond and commodity markets, but also geographically, not just the US, but literally every country in the world.  And in every one of these situations the two camps remain strongly at odds over the likely permanence of rising prices.  In the US, of the 16 current members of the FOMC, only one, Dallas’s Richard Kaplan, is concerned that inflation may be more than transitory.  Meanwhile the Bank of Canada has already made their move to begin tapering QE over concerns that rising inflation may become a bigger problem in the future.

Of course, inflation is not just a G10 phenomenon, it is a global one, arguably more so an issue in emerging markets than in developed ones.  Given the timing of recent central bank actions, I thought it would be interesting to take a quick look at Latin America for a sense of how other nations are dealing with rising prices.

Mexico – Banco de Mexico left its overnight rate at 4.00% for the third consecutive month yesterday despite the fact that CPI is running at 6.08% and they are currently focused on targeting 3.0% inflation.  Clearly, those numbers don’t seem to go together well, but the explanation is that the disappointingly slow rebound in the economy after last year’s Covid induced disaster has the central bank determined to help support economic growth at the risk of allowing higher inflation to become entrenched.  Not only that, they have committed to maintaining policy rates here until growth picks up further.  Look for higher inflation going forward.

Chile – Banco Central de Chile left its overnight rate at a record low of 0.50% yesterday for the 13th consecutive month despite the fact that inflation is running at 3.3%, above its 3.0% target, and trending sharply higher.  While the rise in copper prices has been an extraordinary boon to the country, given its reliance on the metal for so much of its export earnings (nearly 30%), the economy is still recovering from last year and the central bank deemed economic support, especially in this time of political uncertainty, more important than price stability.

Peru – Banco Central de Reserva del Peru left its rate at 0.25%, also a record low, for the 13th consecutive month despite the fact that inflation is running at 2.4% vs. BCRP’s 2.0% target.  Here, too, political considerations are in the mix given the upcoming second round of presidential elections and the concern that a little known left-wing school teacher may become president next month.  Here, too, the board explained that policy was appropriate for the current situation despite higher than desired inflation.

These moves contrast with Brazil, which raised rates last week by 0.75%, to 3.50%, for the second consecutive meeting and are set to do so again in June.  Of course, CPI in Brazil, which is targeted at 3.0%, is currently running at 6.76% and climbing quickly.  If it weren’t for Argentina (CPI 46.3%) Brazil would be suffering the worst inflation in Latin America.  (I exclude Venezuela here as it is impossible to measure the inflation rate given the utter collapse of the economy and monetary system.)

It seems that the central banking community is filled with a great number of people who are either innumerate or highly political.  Neither of these characteristics make for an effective and independent central bank, and given the plethora of central bankers worldwide who exhibit these tendencies, it is a fair bet that rising prices are going to be a feature of our lives, no matter where we live, for a long time to come.  The point is, it is not just the Fed that is willfully blind to the evidence of rising prices, it is a widely held viewpoint.

Today, however, the markets have decided to agree with the predominant central bank view that inflation is a transitory phenomenon as evidenced by the fact that risk appetite is back in vogue.  It starts with the bond market, where Treasury yields are falling (-1.9bps) and now 6 basis points below the levels reached after Wednesday’s CPI data.  Yesterday’s PPI data, though also higher than expected, had virtually no impact on markets.  In Europe, Gilts (-3.1bps) are also rallying along with Bunds (-0.8bps) although French OATs are flat on the day.

This renewed confidence in a lack of inflation scare has had a much bigger impact on the equity markets, where once again, buying the dip seemed to be the correct move.  Asia saw robust gains (Nikkei +2.3%, Hang Seng +1.1%, Shanghai +1.8%) and Europe is having a solid day as well (DAX +0.7%, CAC +0.7%, FTSE 100 +0.7%).  US futures are pointing to a continuation of yesterday’s rally with NASDAQ (+1.0%) leading the way, but all three indices higher by at least 0.5%.

Commodity prices are rising led by oil (+1.25%) and precious metals (Au +0.5%, Ag +0.7%) although the base metals are a bit more mixed (Cu -0.8%, Fe -5.2%) after China instituted price restrictions against steel producers in order to try to quash the recent explosion higher in steel prices.

As to the dollar, it should be no surprise that it is broadly softer this morning against both its G10 and EMG counterparts.  NOK (+1.1%) leads the way higher on the back of oil’s rally but we are seeing solid gains in NZD (+0.6%) and SEK (+0.5%) on the back of broadly positive risk appetite.  In the EMG bloc, only TWD (-0.03%) managed to lose any ground after another day of significant foreign equity outflows and an uptick in Covid cases.  Otherwise it is all green led by TRY (+0.85%), HUF (+0.6%) and MXN (+0.45%).  Turkey’s lira, which is approaching all time lows appears to be seeing a simple trading bounce as there is no news to drive things.  Mexico is clearly benefitting from the oil rally while Hungary’s forint is the beneficiary of a growing belief that the central bank there is going to raise rates to fight rising inflation.  As I said, there are several central banks that still try to focus on reality rather than wishful thinking, but they seem to be few and far between.

This morning brings Retail Sales (exp 1.0%, 0.6% ex autos) as well as IP (0.9%), Capacity Utilization (75.0%) and Michigan Sentiment (90.0).  On the central bank front, only Richard Kaplan, the lone hawk standing, speaks today, so look for more discussion about the need to think about tapering QE.  The thing is, the market is fully aware that he has no support in this stance and so it will not likely have any impact.

With the inflation scare behind us for at least another two weeks (Core PCE will be released at the end of the month), it seems the way is open for more risk-on sentiment.  This means bond yields are unlikely to rise very much and the dollar will therefore remain under pressure.

Good luck, good weekend and stay safe
Adf

Devil-May-Care

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It wasn’t all that long ago
When Powell and friends let us know
That prices might rise
But that in their eyes
T’was something we soon would outgrow

And lately it seems they were right
As chains of supply get more tight
But so far, they’re clear
The Fed has no fear
Inflation could rise overnight

Investors, though, don’t seem to share
That attitude, devil-may-care
Instead they’re rebelling
And stocks they are selling
While bond markets, too, they forswear

Perhaps as a prelude to tomorrow’s CPI data here in the US, last night we saw Chinese inflation data.  Chinese data, though, has a very different meaning than US data.  From China, markets care far more about PPI than about CPI, as China continues to be the world’s factory floor.  So, a rising PPI in China may presage rising retail prices elsewhere in the world.  Consider this when looking at the Chinese data, where PPI rose a more than expected 6.8%, it’s highest print since October 2017, while CPI there rose only 0.9%, a tick less than forecast.  The proximate cause of the sharp rise in PPI has been the ongoing explosion higher in commodity prices.  All their input costs are rising (iron ore, steel, copper, energy, etc.) thus producers are forced to raise their prices.  While retailers have not yet passed through all the cost increases in China, manufacturers and retailers elsewhere in the world have not been so sanguine on the issue.  Instead, the combination of rising commodity prices and shortages in key intermediate goods, like semiconductors, has been more than sufficient to push up prices.

It should be no surprise that markets, in general, are not applauding this outcome, and in fact, are concerned that this is just the beginning of the move in prices.  On the one hand, we continue to hear from both the Fed and the ECB that there is no reason to consider tightening policy at this time as neither bank has achieved their policy aims.  On the other, there is no sign that the supply side damage that was caused by the pandemic is anywhere close to being repaired.  Reduced supply meeting ongoing artificially high demand is guaranteed to raise prices.  I guess the Fed and ECB will soon be quite pleased with themselves for having created inflation.  The rest of us?  Not so much.

However, this policy mistake action in the face of the current conditions is what is driving market prices, which today are wholly in the red, and in substantial size.  Equity markets worldwide (Nikkei -3.1%, Hang Seng -2.1%, DAX -2.2%, CAC -2.0%, FTSE 100 -2.2%) have been under severe pressure ever since yesterday’s US tech slump, but bond markets, too, are seeing significant selling pressure, with Bunds, OATs and Gilts all seeing yields climb by 4 basis points this morning.  In other words, investors are explaining they don’t want to hold financial assets in an inflationary environment.  In fact, there is a great deal of buzz in the markets about some of the large interest rate bets that are being made in both Eurodollar and Euribor futures markets, where very large size option trades are being executed with the aggressor buying put options as part of large risk reversals.  It seems there is very little concern over interest rates declining from current levels, and rightly so, but expectations for higher rates well before either the Fed or ECB has indicated they are considering changing tack are the new normal.

What, you may ask, has this done for the dollar?  That is a much tougher question to answer as the outcome has been far less clear.  I have been adamant that the 10-year Treasury yield has been the key driver of the dollar’s value for virtually all of 2021, and despite the sell-off in European sovereigns this morning, Treasury yields are unchanged at 1.60%.  Heading into tomorrow’s CPI data, as well as another round of Treasury refunding starting with today’s 3-year auction of $40 billion (a total of $108 billion will be auctioned this week), it appears that investors and traders are not certain what to do.  Despite economic data that points to quickening growth, we continue to hear from Fed speaker after Fed speaker that they are not even close to considering tapering QE, let alone raising interest rates.  Well, except for the lone(ly) hawk, Dallas Fed President Robert Kaplan.  But yesterday, both Chicago’s Mike Evans and SF’s Mary Daly were clear it is far too early to consider tapering QE.  Today brings six more Fed speakers, none of whom have a history of hawkishness.

In the end, if inflation continues to rise while Treasury yields remain rangebound due to QE, as real yields decline, look for the dollar to follow.  Breakeven inflation rates continue to trade at multi-year highs (5-year 2.73%, 10-year 2.53%) and are indicating a strong belief that inflation is picking up pace. While the Fed continues to tell us they “have the tools” necessary to combat any potential inflation, the only thing of which we can be sure is they not only “have the tools” required to support markets (and the economy by extension), but that they will use those tools. When it comes to fighting the inflation battle, though, not a single current FOMC member is battle tested.  Given this asymmetry, it is not surprising that we are seeing an increase in market bets on higher interest rates.

Back to the dollar, which is actually under a bit of pressure this morning, along with all those other assets. In the G10, only CHF (-0.1%) is softer as we are seeing gains from the European bloc (NOK, SEK +0.4%, EUR +0.3%) leading the way.  Arguably, this is on the back of the much better than expected German ZEW expectations index, which printed at its highest level in more than 10 years.  Meanwhile, the pound (+0.1%) and commodity bloc here are having a much less interesting session.

In the emerging markets, Asian currencies felt pressure overnight on the tech stock decline with KRW (-0.5%), TWD (-0.4%) and MYR (-0.3%).  On the other hand, the CE4 have all followed the euro higher and we are seeing strength in ZAR (+0.5%), RUB (+0.6%) and MXN (+0.5%), despite oil’s small slide (-0.8%).

All in all, today is shaping up as another one that will be driven by the yield story.  In order for the dollar to really turn around its recent weakness, we will need to see a very significant risk-off event, with Treasuries rallying and fear abundant.  But so far, the current equity decline has not been sufficient to get those juices flowing.  As such, I still would err on the side of a weaker dollar.

Good luck and stay safe
Adf

To Make Jay Concerned

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On Friday the payroll report
Surprised folks by coming up short
Is growth really slowing?
Or else, is this showing
A government data distort?

This morning, though, all eyes have turned
To metals and stuff that is burned
As those prices soar
They seem to have more
Potential to make Jay concerned

With all that anticipation leading up to the payroll report on Friday, it sure turned out differently than expected.  You may recall that the median forecast for the headline number was a cool million new jobs, with a survey range from 700K to 2.1 million.  The result, 266K plus a reduction of 140K from the previous month was, in a word, awful.  In fact, it was the largest statistical miss since the data began.  Now, the analyst community is busy trying to figure out what went wrong.

There are a couple of possible answers, each with its own implications.  The simplest explanation is that the combination of exiting from an unprecedented, government-imposed economic shutdown is not easily modeled and when combined with the vagaries of seasonal adjustments to the data, analysts’ models were simply wrong.  It is important to remember that the seasonal adjustments in this data stream are quite large relative to the reported data, so this is quite a viable explanation.

A second possible explanation, and one favored by the current administration, is that the data shows the economy needs more government support as too many people are falling through the cracks.  On the other hand, the business community continues to complain how difficult it is to hire qualified employees, especially in the service sector, as the ongoing government unemployment largesse is paying more than many low paying service sector jobs.  (The story of the entire workforce of a Dollar General store upping and quitting en masse is the quintessential symbol of this concept.)  Another facet of this argument is the skills mismatches that exist as, for example, erstwhile airline staff may not be able to analyze data for an IT firm, effectively resulting in a hiring need and unemployed worker at the same time.

While skills mismatches certainly exist, they always have, arguably one way for businesses to obtain staffing is to pay more for the roles in question.  The risk in that strategy is, especially for small businesses, increased labor costs will force companies to raise prices at the risk of losing business.  Based on Friday’s report, this is clearly not yet the default choice of the small business owner.  Odds are, though, especially as demand for all products and services increases with the reopening of the economy more generally, that this is going to be the outcome.  Higher wages to get workers and higher prices for goods and services.

Occam’s Razor suggests that the first explanation, data uncertainty, is the most likely cause for Friday’s massive statistical miss.  However, don’t expect the other two arguments to disappear as they are each very compelling for the currently competing political narratives.  Ultimately, we will find out more through the data for the rest of this month and get to do this all over again in June.

On the topic of rising prices, though, this morning has much more to offer, specifically in the commodity space.  The big weekend news has been about a cyberattack on Colonial Pipeline, which happens to be the largest pipeline for oil products like gasoline and diesel, to the East Coast.  With the pipeline shut, (apparently the pipeline can still carry the products, but the company cannot track how much fuel is being consumed, and thus charge accordingly), gasoline and product prices are rising, dragging up oil prices as well (WTI +0.5%).  But of more interest is the metals sector where prices are exploding higher.  Not only are precious metals (Au +0.45%, AG +1.25%) higher, but industrial base metals are really rocking (Fe +5.1%, Cu +2.6%, Al +1.9%, Ni +0.8%).  This is, of course, one of the key features of the inflation is coming narrative, sharply rising commodity prices will work their way into the price of stuff.  But inflation is a measure of the ongoing change in prices over time.  The Fed’s argument is that these prices will have an impact in the short run, but unless commodity prices continue rise year after year, the effect will be ‘transitory’.

The counter to the Fed’s argument is that we are currently embarking on the beginning of a commodity super-cycle, a price phenomenon where prices trend in one direction for many years on end, often 10-15 years.  If this argument is correct, and the prices of copper and iron ore are just beginning their climb, then the Fed is going to find themselves with a whole lot of trouble in the future.  But right now, it is merely dueling forecasts and narratives, so nothing is clear.

With all the excitement in commodities, things are pretty quiet in the financial markets.  Equity markets in Asia were a bit higher (Nikkei +0.55%, Hang Seng 0.0%, Shanghai +0.25%) while European bourses are mixed (DAX -0.25%, CAC -0.2%, FTSE 100 +0.15%).  US futures are also mixed with Dow (+0.3%) continuing last week’s rally while NASDAQ (-0.25%) continues to feel pain from the ongoing rotation out of tech.

Bond markets are not buying the inflation narrative at this point with Treasuries (-0.5bps) seeing slightly lower yields while Bunds and OATs are essentially unchanged on the day.  The only real mover is the Gilt market (+1.7bps) which has rallied after weekend elections failed to give the Scottish National Party a majority in the Scottish Parliament and thus the prospect of a referendum to allow Scotland to leave the UK seems to be pushed back.

The outcome of the Scottish vote helped the pound as well, with GBP rallying 0.9% this morning, far and away the best performer in the FX markets.  Amid broad-based dollar weakness, the pound’s performance still stands out.  Next in line, in the G10, is AUD (+0.5%) which is a clear beneficiary of the rise in commodity prices.  In fact, iron ore is Australia’s largest commodity export.  NZD and CAD (both +0.2%) are lesser beneficiaries and the rest of the block, save JPY (-0.2%) is slightly firmer.  The yen seems to be suffering from the latest poll showing PM Suga’s popularity continuing to slide and bringing some uncertainty to the situation there with an election due by the end of the year.

Asian currencies were the big beneficiary in the EMG space led by KRW (+0.7%), IDR (+0.6%) and CNY (+0.3%).  The story there continues to be the anticipated strong growth rebound combined with the dollar’s weakness.  Remember, Chairman Powell has essentially promised that US rates are going to remain at zero regardless of what happens for at least another year.  As it happens, TWD (+0.3%) has traded to its strongest level since 1997, as the robust economic situation, plus the huge demand for semiconductors has more than offset any geopolitical concerns.

Data this week is back-loaded as follows:

Tuesday NFIB Small Biz Optimism 100.8
JOLTs Job Openings 7.5M
Wednesday CPI 0.2% (3.6% Y/Y)
-ex food & energy 0.3% (2.3% Y/Y)
Thursday Initial Claims 495K
Continuing Claims 3.64M
PPI 0.3% (5.8% Y/Y)
-ex food & energy 0.4% (3.7% Y/Y)
Friday Retail Sales 1.0%
-ex autos 0.9%
IP 1.0%
Capacity Utilization 75.1%
Michigan Sentiment 90.1

Source: Bloomberg

Obviously, CPI will be very interesting, as will Retail Sales.  We also hear from 13 more Fed speakers this week, all of whom are certain to repeat the mantra that the economy needs more support and they will not be changing policy anytime soon.  Remember, inflation is transitory…until it’s not.

The dollar is starting the week off on the back foot.  If we continue to hear Fed speakers insist that policy is not going to change, and we continue to see inflationary consequences rise, the dollar will weaken further.  In the end, 10-year Treasury yields remain the key number to watch.  As long as they remain within the recent range, the dollar is likely to remain soft.  If they should break higher, though, watch out.

Good luck and stay safe
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