Tougher for Jay

The Fed once again will convey
Inflation just ain’t here to stay
But every release
That shows an increase
Makes life that much tougher for Jay

Meanwhile, Chinese comments last night
Explained everything was alright
They further suggested
That more be invested
To underscore risk appetite

As we await the FOMC meeting’s conclusion this afternoon, markets have generally remained calm, even those in China.  Apparently, 20% is the limit as to how far any government will allow equity markets to decline. After three raucous sessions in China and Hong Kong, as investors fled from those companies under attack review by the Chinese government for their alleged regulatory transgressions, the Chinese press was out in force explaining that there were no long term problems and that both the economy and stock markets were just fine and quite safe.  “Recent declines are unsustainable” claimed the Securities Daily, a state-owned financial paper.  We shall see if that is the case, especially since there is no indication that the government has finished its regulatory crackdown across different industries.

However, the carnage of the past several sessions was not evident last night as the Hang Seng (+1.5%) rebounded nicely while Shanghai (-0.6%) managed to close 1.5% above the lows seen early in the session.  It hardly seems coincidental that the Chinese reacted to the declines after a 20% fall as that seems to be the number that defines concern.  Recall, in Q4 2018, Chairman Powell, who had been adamant there were no issues and was blissfully allowing the Fed’s balance sheet to slowly shrink while simultaneously raising interest rates made a quick 180˚ turn on Boxing Day when the S&P’s decline had reached 20%.  It seems that no central banker or government is willing to allow a bear market on their watch, even those that need never face the voters.

While forecasting the future is extremely difficult, it seems likely that if President Xi turns his sights on another industry, (Real Estate anyone?) then we could easily see another wave lower across these markets.  While instability is not desired, when push comes to shove, Xi’s ideology trumps all other concerns, and if he believes it is being threatened by the growth and power of an industry, you can be certain that industry will be targeted.  Caveat investor!

As to the Fed, the universal expectation is there will be no policy changes, so interest rates will remain the same and the asset purchase program will continue at its monthly pace of $120 billion.  The real questions center around tapering (will they mention it in the statement and how will Powell address it in the press conference) and the nature of inflation.  While clearly the latter will be described as transitory, will there be some acknowledgement that it is running hotter than they ever expected?

At Powell’s Congressional testimony several weeks ago, he was clear that “substantial further progress” toward their goals of maximum employment and average inflation stably at 2.0%, had not yet been made.  Has that progress been made in the interim?  I think not.  This implies, to me at least, that there is no policy change in the offing for a long time to come.  While there are many analysts who are looking for a more hawkish turn from the Fed in response to the clearly rising price pressures, the hallmark of this (and every previous) committee is that they will stick to their narrative regardless of the situation on the ground.  I expect they will ignore the much higher than expected inflation prints and that when asked at the press conference, Powell will strongly maintain inflation is transitory and will be falling soon.  Monday, I explained my concern that CPI is likely to moderate for a short period of time before heading sharply higher again, and that Powell and the Fed will take that moderation as victory.  Nothing has changed that view, nor the view that the Fed will fall far behind the curve when it comes to fighting inflation.  But that is the future.  For now, the Fed is very likely to remain calm and stick to their story.

OK, with that out of the way, we can peruse the markets, which, as I mentioned above, have been vey quiet awaiting the FOMC.  The other key Asian market, the Nikkei (-1.4%) fell overnight after having rallied during the Chinese fireworks, as the spread of the delta variant of Covid-19 and ongoing lockdowns in Japan have started to concern investors.

Europe, on the other hand, is all green on the screen led by the CAC (+0.75%) with both the DAX (+0.2%) and FTSE 100 (+0.2%) up similar but lesser amounts.  You’re hard pressed to point to the data as a driver as the little we saw showed German Import prices rise 12.9%, the highest level since September 1981, while French Consumer Confidence fell a tick to 101.  Hardly the stuff of bullish sentiment.  US futures, currently, sit essentially unchanged as traders and investors await Powell’s pronouncements.

The bond market is mixed this morning, with Treasury yields edging higher by 1 basis point while most of Europe is seeing a very modest decline in yields, less than 1bp.  Essentially, this is the price action of positions being adjusted ahead of key data.

Commodity prices show oil rising (+0.5%) but very little movement anywhere else in the space with both metals and agricultural prices either side of unchanged on the day.

Lastly, the dollar is ever so slightly stronger vs. most G10 counterparts, with AUD (-0.25%) and NZD (-0.2%) the laggards as concern grows over the economic impact of the ongoing spread of the delta variant.  CAD (+0.25%) is the one gainer of note, seemingly following oil’s lead.  EMG currencies have had a more mixed session with KRW (-0.4%) the worst performer on the back of rising Covid cases and ongoing concerns over what is happening in China.  The only other laggard of note is HUF (-0.3%) which is still suffering from its ongoing political fight with the EU and the result that EU Covid aid has been indefinitely delayed.  On the plus side, RUB (+0.35%) is following oil while CNY (+0.2%) seems to be benefitting from the calm imposed on markets last night.  Otherwise, movement in this space has been minimal.

All eyes are on the FOMC at 2:00 this afternoon, with only very minor data releases before then.  My read is that the market is looking for a slightly hawkish tilt to the Fed as a response to the rapidly rising inflation.  However, I disagree, and feel the risk is a more dovish than expected outcome. The fact that US economic data continues to mildly disappoint will weigh on any decision.  If I am correct, I think the dollar will have the opportunity to sink a bit further, but only a bit.

Good luck and stay safe
Adf

A Small Crisis Grows

Investors are starting to feel
That China has lost its appeal
So, capital flees
From all stocks, Chinese
As Xi brings exploiters to heel

While, thus far the impact’s been small
On markets elsewhere, please recall
That history shows
A small crisis grows
Quite quickly with each margin call

Giving credit where it is due, the Chinese have successfully distracted almost every market participant from tomorrow’s FOMC meeting.  The ongoing rout in Chinese equity markets (Shanghai -2.5%, Hang Seng -4.2%) has been fueled by the government’s hardline stance against several different industries that had become investor favorites.  If you think of the progression of events, it began with private financial firms (remember the Ant IPO that was squashed when Jack Ma was disappeared for a while?) and has continued as the evolution of the DC/EP (China’s digital yuan or CBDC) has forced the two big private payment firms, Alipay and WeChat Pay to fall into line and restrict their offerings going forward.

We have also seen the government address concerns over other tech companies and their capitalist intentions and actions, which has taken the form of questions over data security in Didi Global, the ride hailing app, and Meituan, the food service company.  After all, both of these companies are clarion calls for people to be independent, choosing their work schedule and effort, as opposed to toiling for a proper, state-owned firm.  Naturally, this is anathema to President Xi as he continues to remold the nation into his preferred view.

The latest attack has been on the private education industry, which while nominally teaching the approved curriculum, were clearly seen as an impediment to government control, and more importantly, the appropriate spread of communism.  Remember, the CCP rules the roost in China and President Xi is General Secretary of the Chinese Communist Party.  It was certainly dichotomous that an area of such immense social importance, that preached communism, would be offered by capitalist firms.

The takeaway here, though, is not that things are getting tougher for investors in China, but that history has shown that most financial crises start small and gather momentum.  While many of you may not remember the Asia crisis of 1997, it started as an issue solely confined to Thailand and the Thai baht.  Questions over the country’s ability to repay its creditors, especially as its USD reserves had shrunk and the dollar’s rally was becoming a major problem locally.  But Thailand is not a very large country from an economic perspective, and so it was initially thought this would amount to very little.  Within a month or two of the initial concerns, however, the entire region was in turmoil as it turned out virtually none of the countries there had sufficient USD reserves, and all had borrowed heavily in dollars and were having difficulty repaying those loans.  There was a huge swoon in markets, which ultimately led to Russia defaulting on its debt while Long Term Capital, a famed hedge fund of the time, wound up on the brink and was only saved by the Fed forcing the entire Wall Street community to put up money to save it.  (Ironically, Bear Stearns is the one bank that wouldn’t participate in that rescue and we know what happened to them 10 years later!)

Speaking of the GFC, this too, was seen as a minor problem at the start.  As the housing bubble inflated, the working assumption was that the entire national housing market could never fall all at once, so all of those mortgage-backed derivatives were created and sold as low risk, high return investments throughout the world.  When the first concerns were raised, none other than Fed Chair Bernanke explained that “…the troubles in the subprime sector on the broader housing market will likely be limited.”  We know how that worked out and of course, the problems quickly became global in nature and forced the first invocation of a new emergency program known as QE.

One last example of the ability of seemingly distant events to impact the entire global financial structure comes from China in 2015.  That summer, just 6 years ago, the PBOC surprised markets with a mini-devaluation of the yuan, about 2%, as a relief valve for an equity market that had started to come under pressure several months previously.  But once the PBOC acted, risk appetite disappeared and we saw a severe contraction in global equity markets, a huge bond rally and strength in the dollar as the haven of choice.

The point is that while you may consider the fact that the Chinese government is cracking down on companies that it considers to be ideologically impure, and that it will have nothing to do with your investments in the FANGMAN group of stocks, there is every chance that this action serves as the catalyst for, at the very least, a short-term price adjustment in equity indices around the world. After all, China’s growth has been a key pillar of the global growth scenario.  If that is slipping, there are likely to be problems everywhere.  Be warned and wary.

OK, on to today’s activity where the Chinese rout continues to be ignored by Japan (Nikkei +0.5%), but continues to pressure European indices lower (DAX -0.4%, CAC -0.3%, FTSE 100 -0.4%) as well as US futures, all of which are down around -0.2% at this hour.

Bond markets are a bit more uniform this morning, led by Treasury yields (-2.9bps) although European sovereigns have not rallied as much, with most seeing yield declines of roughly 1 basis point.  (As an aside, yesterday’s price action, which saw US equity markets ultimately rebound, saw Treasuries give up their early gains and close with slightly higher yields on the day.)

In the commodity space, oil is essentially unchanged on the day, as is gold, with neither moving even 0.1%.  Copper is the biggest mover, falling 1.0%, although there is lesser weakness in other base metals.  Agricultural products are mixed with both Soybean and Corn higher by 1.0% while Wheat has slipped 0.4%.

As to the dollar, on this broadly risk-off day, it is broadly higher.  In the G10 bloc, the commodity currencies are the worst performers (NZD -0.7%, NOK -0.5%, AUD -0.4%) while the rest of the bloc has seen less pressure.  Naturally, JPY (+0.25%) is bucking the dollar trend in this type of session.  In the emerging markets, ZAR (-0.7%) is the laggard as traders digest the post-riot relief act from the government and give it two thumbs down.  The next biggest loser is CNY (-0.35%), although at this point, I’ve already described the reasons capital is leaving the country.  Otherwise, most of these currencies are lower, but the movement has been on the order of -0.1% to -0.2%, so not very dramatic.  There is one outlier on the plus side, KRW (+0.4%) which seems to have been on the back of exporters selling dollars after yesterday’s won decline to its lowest level in almost a year.  However, if CNY continues to weaken, I believe KRW will ultimately follow it.

On the data front this morning we see Durable Goods (exp 2.2%, 0.8% ex transport) as well as Case Shiller House Prices (16.33%) and Consumer Confidence (123.8).  The real information overload starts tomorrow with the FOMC and on through the rest of the week with Q2 GDP and Core PCE.

The dollar is back in risk mode.  If equities continue to suffer, look for the dollar to remain bid.  If they rebound, the dollar is likely to soften by the end of the day.

Good luck and stay safe
Adf

Jay’s Watershed

The PMI data released
This morning show prices increased
As bottlenecks build
With orders unfilled
Inflation has shown it’s a beast

The question is, how will the Fed
Respond as they’re looking ahead
Will prices be tamed
Or else be inflamed
This may well be Jay’s watershed

Yesterday’s ECB meeting pretty much went according to plan.  There is exactly zero expectation that Lagarde and her crew will be tightening policy at any point in the remote future.  In fact, while she tried to be diplomatic over a description of when they would consider tightening policy; when they see inflation achieving their 2.0% target at the “midpoint” of their forecast horizon of two to three years, this morning Banque de France Governor Villeroy was quite explicit in saying the ECB’s projections must show inflation stable at 2.0% in 12-18 months.  In truth, it is rare for a central banker to give an explicit timeframe on anything, so this is a bit unusual.  But, in the end, the ECB essentially promised that they are not going to consider tightening policy anytime soon.  They will deal with the asset purchase programs at the next meeting, but there is no indication they are going to reduce the pace of purchases, whatever name they call the program.

One cannot be surprised that the euro fell in the wake of the ECB meeting as the market received confirmation of their previous bias that the Fed will be tightening policy before the ECB.  But will they?

Before we speak of the Fed let’s take a quick look at this morning’s PMI data out of Europe.  The most notable feature of the releases, for Germany France and the Eurozone as a whole was the rapid increase in prices.  Remember, this is a diffusion index, where the outcome is the difference between the number of companies saying they are doing something (in this case raising prices) and the number saying they are not.  In Europe, the input price index was 89, while the selling price index rose to 71.  Both of these are record high levels and both indicate that price pressures are very real in Europe despite much less robust growth than in the US.  And remember, the ECB has promised not to tighten until they see stable inflation in their forecasts 18 months ahead.  (I wonder what they will do if they see sharply rising inflation in that time frame?)

While the latest CPI reading from the Eurozone was relatively modest at 2.0%, it strikes me that price pressures of the type described by the PMI data will change those numbers pretty quickly.  Will the ECB respond if growth is still lagging?  My money is on, no, they will let prices fly, but who knows, maybe Madame Lagarde is closer in temperament to Paul Volcker than Arthur Burns.

Which brings us back to the Fed and their meeting next week.  The market discussion continues to be on the timing of any tapering of asset purchases as well as the details of how they will taper (stop buying MBS first or everything in proportion).  But I wonder if the market is missing the boat on this question.  It seems to me the question is not when will they taper but will they taper at all?  While we have not heard from any FOMC member for a week, this week’s data continues to paint a picture of an economy that has topped out and is beginning to roll over.  The most concerning number was yesterday’s Initial Claims at a much higher than expected 419K.  Not only does that break the recent downtrend, but it came in the week of the monthly survey which means there is some likelihood that the July NFP report will be quite disappointing.  Given the Fed’s hyper focus on employment, that will certainly not encourage tapering.  The other disappointing data release was the Chicago Fed National Activity Index, a number that does not get a huge amount of play, but one that is a pretty good descriptor of overall activity.  It fell sharply, to 0.09, well below both expectations and last month’s reading, again indicating slowing growth momentum.

This morning we will see the flash PMI data for the US (exp 62.0 Mfg, 64.5 Services) but of more interest will be the price components here.  Something tells me they will be in the 80’s or 90’s as prices continue to rise everywhere.  While I believe the Fed should be tapering, and raising rates too, I continue to expect them to do nothing of the sort.  History has shown that when put in these circumstances, the Fed, and most major central banks, respond far too slowly to prevent inflation getting out of hand and then ultimately are required to become very aggressive, à la Paul Volcker from 1979-82, to turn things around.  But that is a long way off in the future.

But for now, we wait for Wednesday’s FOMC statement and the following press conference.  Until then, the narrative remains the Fed is going to begin tapering sometime in 2022 and raising rates in 2023.  With that narrative, the dollar is going to remain well-bid.

Ok, on a summer Friday, it should be no surprise that markets are not very exciting.  We did see some weakness in Asia (Hang Seng -1.45%, Shanghai -0.7%, Nikkei still closed) but Europe feels good about the ECB’s promise of easy money forever with indices there all nicely higher (DAX +1.0%, CAC /-1.0%, FTSE 100 +0.8%).  US futures are higher by about 0.5% at this hour, adding to yesterday’s modest gains.

Bond markets are behaving as one would expect in a risk-on session, with yields edging higher.  Treasuries are seeing a gain of 1.3bps while Europe has seen a bit more selling pressure with yields higher by about 2bps across the board.

Commodity price are broadly higher this morning with oil (+0.1%) consolidating its recent rebound but base metals (Cu +0.4%, Al +0.7% and Sn +1.1%) all performing well.  All that manufacturing activity is driving those metals higher.  Precious metals, meanwhile, are under pressure (Au -0.5%. Ag -1.1%).

Finally, the dollar is doing well this morning despite the positive risk attitude.  In the G10, JPY (-0.3%) is the laggard as Covid infections spread, notably in the Olympic village, and concerns over the situation grow.  But both GBP (-0.25%) and CHF (-0.25%) are also under pressure, largely for the same reasons as Covid infections continue to mount.  The only gainer of note is NZD (+0.2%) which is the beneficiary of short covering going into the weekend.

In the emerging markets, ZAR (-0.55%) is the worst performer, falling as concerns grow that the SARB will remain too dovish as inflation rises there.  Recall, they just saw a higher than expected CPI print, but there is no indication that policy tightening is on the way.  HUF (-0.5%) is the other noteworthy laggard as the ongoing philosophical differences between President Orban and the EU have resulted in delays for Hungary to receive further Covid related aid that is clearly needed in the country.  The forint remains weak despite a much more hawkish tone from the central bank as well.

Other than the PMI data, there is nothing else to be released and we remain in the Fed’s quiet period, so no comments either.  Right now, the market is accumulating dollars on the basis of the idea the Fed will begin tapering soon.  If equities continue to rally, this goldilocks narrative could well help the dollar into the weekend.

Good luck, good weekend and stay safe
Adf

Bears’ Great Delight

As Covid renews its broad spread
Investors have started to shed
Their risk appetite,
To bears’ great delight,
And snap up more havens instead

Risk is off this morning on a global basis.  Equity markets worldwide have fallen, many quite sharply, while haven assets, like bonds, the yen and the dollar, are performing quite well.  It seems that the ongoing increase in Covid infections, not only throughout emerging markets, but in many developed ones as well, has investors rethinking the strength of the economic recovery.

The latest mutation of Covid, referred to as the delta variant, is apparently significantly more virulent than the original.  This has led to a quickening of the pace of infections around the world.  Governments are responding in exactly the manner we have come to expect, imposing lockdowns and curfews and restricting mobility.  Depending on the nation, this has taken various forms, but in the end, it is clearly an impediment to near-term growth.  Recent examples of government edicts include France, where they are now imposing fines on anyone who goes to a restaurant without a vaccine ‘passport’ as well as on the restaurants that allow those people in.  Japan has had calls to cancel the Olympics, as not only will there be no spectators, but an increasing number of athletes are testing positive for the virus and being ruled out of competition.

A quick look at hugely imperfect data from Worldometer shows that 8 of the 10 nations with the most reported new cases yesterday are emerging markets, led by Indonesia and India.  But perhaps of more interest is that the largest number of new cases reported was from the UK.  Today is ‘Freedom Day’ in the UK, where the lockdowns have ended, and people were to be able to resume their pre-Covid lives.  However, one has to wonder if the number of infections continues to rise at this pace, how long it will be before further restrictions are imposed.  Clearly, market participants are concerned as evidenced by the >2.0% decline in the FTSE 100 as well as the 0.45% decline in the pound.

While this story is not the only driver of markets, it is clearly having the most impact.  It has dwarfed the impact of the OPEC+ agreement to raise output thus easing supply concerns for the time being.  Oil (WTI – 2.75%) is reacting as would be expected given the large amount of marginal supply that will be entering the market, but arguably, lower oil prices should be a positive for risk appetite.  As I indicated, today is a Covid day.  The other strong theme is in agricultural products where prices are rising in all the major grains (Soybeans +0.6%, Wheat +1.4%, Corn +1.7%) as the weather is having a detrimental impact on projected crop sizes.  The ongoing drought and extreme heat in the Western US have served to reduce estimates of plantings and heavy rains have impacted crops toward the middle of the country.

With all that ‘good’ news in mind, it cannot be surprising that risk assets have suffered substantially, and havens are in demand.  For instance, Asian equity markets were almost universally in the red (Nikkei -1.25%, Hang Seng -1.85%, Shanghai 0.0%), while European markets are performing far worse (DAX -2.0%, CAC -2.0%, FTSE MIB (Italy) -2.9%).  US futures are all pointing lower with the Dow (-1.0%) leading the way but the others down sharply as well.

Bonds, on the other hand, are swimming in it this morning, with demand strong almost everywhere.  Treasuries are leading the way, with yields down 4.7bps to 1.244%, their lowest level since February, and despite all the inflation indications around, sure look like they are headed lower.  But we are seeing demand throughout Europe as well with Bunds (-2.4bps, OATs -2.0bps and Gilts -3.6bps) all well bid.  The laggards here are the PIGS, which are essentially unchanged at this hour, but had actually seen higher yields earlier in the session.  After all, who would consider Greek bonds, where debt/GDP is 179% amid a failing economy, as a haven asset.

We’ve already discussed commodities except for the metals markets which are all lower.  Gold (-0.35%) is not performing its haven function, and the base metals (Cu -1.7%, Al -0.1%, sn -0.7%) are all responding to slowing growth concerns.

Ahh, but to find a market where something is higher, one need only look at the dollar, which is firmer against every currency except the yen, the other great haven.  CAD (-1.2%) is the laggard today, falling on the back of the sharp decline in oil and metals prices.  NOK (-0.9%) is next in line, for obvious reasons, and then AUD (-0.7%, and NZD (-0.7%) as commodity weakness drags them lower.  The euro (-0.25%) is performing relatively well despite the uptick in reported infections, as market participants start to look ahead to the ECB meeting on Thursday and wonder if anything of note will appear beyond what has already been said about their new framework.  In addition, consider that weakness in commodities actually helps the Eurozone, a large net importer.

In the EMG space, it is entirely red, with RUB (-0.75%) leading the way lower, but weakness in all regions.  TRY (-0.7%), KRW (-0.7%), CZK (-0.55%) and MXN (-0.5%) are all suffering on the same story, weaker growth, increased Covid infections and a run to safety and away from high yielding EMG currencies.

Data this week is quite sparse, with housing the main theme

Tuesday Housing Starts 1590K
Building Permits 1700K
Thursday Initial Claims 350K
Continuing Claims 3.05M
Leading Indicators 0.8%
Existing Home Sales 5.90M
Friday Flash PMI Mfg 62.0
Flash PMI Services 64.5

Source: Bloomberg

The Fed is now in their quiet period, so no speakers until the meeting on the 28th.  Thursday, we hear from the ECB, where no policy changes are expected, although further discussion of PEPP and the original QE, APP, are anticipated.  So, until Thursday, it appears that the FX markets will be beholden to both exogenous risks, like more Covid stories, and risk sentiment.  If the equity market remains under pressure, you can expect the dollar to maintain its bid tone.  If something happens to turn equities around (and right now, that is hard to see) then the dollar will likely retreat in a hurry.

Good luck and stay safe
Adf

Progress, Substantial

To everyone who thought the Fed
Was ready to taper, Jay said
‘Til progress, substantial,
Is made, no financial
Adjustments are reckoned ahead

If, prior to yesterday, you were worried that the Fed was getting prepared to taper its asset purchases, stop worrying.  It doesn’t matter what Dallas Fed President Kaplan, or even SF Fed President Daly says about the timing of tapering.  The only ones who matter are Powell, Clarida, Williams and Brainerd, and as the Chairman made clear once again yesterday, they ain’t going to taper anytime soon.

In testimony to the House Financial Services Committee Chairman Jay sent a clear message; nothing is changing until the Fed (read the above-mentioned four) sees “substantial further progress” on their twin goals of maximum employment and an average inflation rate of 2.0%.  Obviously, they have moved a lot closer on the inflation front, with many pundits (present company included) saying that they have clearly exceeded their goal and need to address that issue.  But for as much vitriol as is reserved for our previous president, both the Fed and Congress are clearly all-in on the idea that the 3.5% Unemployment Rate achieved during his term just before the pandemic emerged, which was the lowest in 50 years, is actually the appropriate level of NAIRU.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment and is the economic acronym for the unemployment rate deemed to be the lowest possible without causing increased wage pressures leading to rising inflation.  For the longest time, this rate was thought to be somewhere in the 4.5%-5.5% area, but in the decade following the GFC, as policymakers pushed to run the economy as hot as possible, the lack of measured consumerinflation, despite record low unemployment, forced economists to rethink their models.  Arguably, it is this change in view that has led to the fascination with MMT and the willingness of the current Fed to continue QE despite the evident froth in the asset markets.  Of course, now those asset markets are not just paper ones like stocks and bonds, but also housing and commodities.

But that is the situation today, despite what appears to be very clear evidence that inflationary pressures are not just high, but longer lasting as well, the Fed has their story and they are sticking to it.  They made this clear to everyone last year with the new policy framework that specifically explains they will remain behind the curve on inflation because they will not adjust policy until they see real data, not surveys, that demonstrate growth is overheating.  Yet, given the Fed’s history, where they have often tightened policy in anticipation of higher inflation and thereby reduced growth, or even caused recessions, the market has learned to expect that type of response.  While I personally believe prudent policy would be to tighten at this time, I take Mr Powell at his word, they are not going to change anytime soon.  I assure you that of the dots in the last dot plot, Jay Powell’s was not one of the ones expecting interest rates to be 0.50% by the end of 2023.

One of the things that makes this so interesting is the difference of this policy with that of an increasing number of other central banks, where recognition of rising inflation is forcing them to rethink their commitment to ZIRP.  Earlier this week, the RBNZ abruptly ended QE and explained rates may rise before the summer is over.  Yesterday, the Bank of Canada reduced its QE purchases by another C$1 billion/week, furthering the progress they started in June, and Governor Macklem made clear that if inflation did persist, they would react appropriately.  Last night it was the Bank of Korea’s turn to explain that economic activity was picking up quickly and inflationary pressures alongside that which would make them consider raising the base rate at their next meeting.  Finally, all eyes are turning toward the BOE as this morning’s employment report showed that the recovery is still picking up pace and that wage growth, at a 7.3% Q/Q rise, is really starting to take off.  Market talk is now focused on whether the Old Lady will be the next to start to tighten.

In truth, the only three central banks that have made clear they are not ready to do so are the big 3, the Fed, ECB and BOJ.  The BOJ meets tonight with no changes to policy expected as they seem to be focused on what they can do to address climate change (my sense is they can have the same success on climate change as they have had on raising inflation, i.e. none).  Next week the ECB will unveil their new framework which seems likely to include the successor to the PEPP as well as their already telegraphed new symmetrical inflation target of 2.0%.  And then the Fed meets the following week, at which point they will work very hard to play down inflation in the statement but will not alter policy regardless.

As you consider the policy changes afoot, as well as the trajectory of inflation, and combine that with your finance 101 models that show inflation undermines the value of a currency in the FX markets, it would lead you to believe that the dollar has real downside opportunity vs. many currencies, just not the euro or the yen.  But markets are fickle, so don’t put all your eggs in that basket.

Turning to today’s activities, while Chinese equity markets performed well (Hang Seng +0.75%, Shanghai +1.0%) after Chinese GDP data was released at 7.9% for Q2, just a tick lower than forecast, and the rest of the data, Retail Sales and Fixed Asset Investment all beat expectations, the rest of the world has been much less exuberant.  For instance, the Nikkei (-1.15%) stumbled along with Australian and New Zealand indices, although the rest of SE Asia actually followed China higher.  Europe has been under pressure from the start this morning led by the DAX (-0.9
%) although the CAC (-0.75%) and FTSE 100 (-0.7%) are nothing to write home about.  US futures are also under pressure (Dow -0.5%, SPX -0.3%) although the NASDAQ continues to power ahead (+0.2%).

In this broadly risk-off session, it is no surprise that bond markets are rallying.  Treasuries, after seeing yields decline 7bps after Powell’s testimony, are down another 2bps this morning.  Similarly, we are seeing strength in Bunds (-1.4bps) and OATs (-1.1bps) although Gilts (+1.4bps) seem to be concerned about potential BOE policy changes.

On the commodity front, oil fell sharply after the Powell testimony and has continued its downward move, falling 1.8% this morning.  Gold, which had been higher earlier in the session is now down 0.15%, although copper (+0.6%) remains in positive territory.  At this point, risk has come under pressure across markets although there is no obvious catalyst.

It should not be surprising that as risk is jettisoned, the dollar is rebounding.  From what had been a mixed session earlier in the day, the dollar is now firmer against 9 of the G10 with NOK (-0.5%) the laggard although the entire commodity bloc is suffering.  The only gainer is the pound (+0.1%) which seems to be on the back of the idea the BOE may begin to tighten sooner than previously expected.

EMG currencies that are currently trading are all falling, led by ZAR (-0.7%), PLN (-0.5%) and HUF (-0.5%).  The rand is very obviously suffering alongside the commodity story, while HUF and PLN are under pressure as a story about both nations losing access to some EU funds because of their stance on issues of judicial and immigration policies is seen as a negative for their fiscal balances.  Overnight we did see strength in KRW (+0.6%) and TWD (+0.4%) with the former benefitting from the BOK’s comments on tightening policy while the latter saw substantial equity market inflows driving the currency higher.

Data today includes Initial (exp 350K) and Continuing (3.3M) Claims as well as Empire Mfg (18.0), Philly Fed (28.0), IP (0.6%) and Capacity Utilization (75.6%).  Yesterday’s PPI was also much higher than forecast, but that can be no surprise given the CPI data on Tuesday.  In addition, Chairman Powell testifies before the Senate Banking Panel today, with the same prepared testimony but a whole new set of questions.  (I did reach out to my Senator, Menendez, to ask why Chairman Powell thinks forcing prices higher is helping his constituents, but I’m guessing it won’t make the cut!)

And that’s the day.  Right now, with risk under pressure, the dollar has a firm tone.  But the background of numerous other central banks starting to tighten as they recognize rising inflation and the Fed ignoring it all does not bode well for the dollar in the medium term.

Good luck and stay safe
Adf

Like Tides in the Sea

Though Jay and the FOMC
Refuse to accept it can be
Most prices worldwide
Can be certified
As rising like tides in the sea

Back in 2011, wedged between the GFC and the European debt crisis, the world witnessed the Arab Spring.  This was a series of populist protests throughout the Middle East and North Africa that were triggered by a confluence of events including a desire for more freedom and democracy by a group of populations that had been oppressed by kleptocratic and authoritarian rulers.  But one of the key issues that was apparent in each of the nations involved was the fact that inflation, specifically food prices, were rising rapidly and the impoverished citizenry of many of these nations could no longer afford to feed themselves or their families.  Ultimately, while there was much angst at the time about changes in ruling regimes and much hope that the siren song of freedom would be heard in heretofore brutal dictatorships, very little changed except the name of the authoritarian and kleptocratic leader.

From our perspective in the markets, the importance of this lesson is the potential impact that sharply rising food prices can have on both financial markets and political outcomes.  This appears topical given the rioting that has begun in two very different countries, Cuba and South Africa.  In Cuba, the list of complaints could have been written in Tunisia in 2011, as the people there are growing tired of the conditions under which they are forced to live by Raul Castro and Miguel Diaz-Canel, the heirs to the Fidel Castro regime.  The economy is in tatters and food shortages are rampant with little hope of change as long as the government remains in place.  South Africa, meanwhile, has had a different catalyst, the imprisonment of former president Jacob Zuma, but the conditions on the ground, where inflation is rising sharply, and growth has been lagging are not dissimilar to what precedes this behavior anywhere.

While two countries don’t yet make a trend, it will be important to pay close attention to other EMG nations who are experiencing the same types of pressures.  Remember, just because the Fed, ECB and BOJ are not ready to raise rates as they studiously ignore rising inflation, the same has not been true in a number of emerging markets like Brazil, Hungary and Mexico, whose central banks are responding to the obvious rise in price pressures by raising their policy rates.  Inflation is insidious as it impacts all that we do and eventually weighs on how we approach our everyday tasks.  Yesterday, the NY Fed released its monthly survey of inflation expectations and it jumped to 4.8% in the one-year category, the highest level since the survey began.  While inflation is frequently described as a monetary phenomenon, it is also a psychological one.  When you expect prices to rise, you tend to err on the side of buying things sooner rather than waiting.  And that behavior drives prices as well.  As the evidence of more persistent price rises continues to increase, there will come a denouement between the Fed and reality.  It is at that point that we could see some cracks in the current narrative of “stonks to the moon!”  Remember, being hedged ahead of a significant policy change makes a great deal of sense, so don’t wait until it’s too late.

Meanwhile, the market story today is one of a modest continuation of recent trends with no substantial outliers.  It appears investors are waiting for more information from the ECB on their new policy framework next week, as well as this morning’s testimony by Chairman Powell at the House of Representatives.

After yesterday’s late day rally in the US, Asian equity markets were all in the green (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.3%) with the big data release Chinese trade numbers showing their exports climbed more than forecasts, clearly a positive sign for both China and global growth.  Europe has been a bit more mixed with extremely modest movement either side of unchanged and no story or data to discuss while US futures show the NASDAQ (+0.35%) continuing to power ahead although the other two main indices have done nothing.

Bond markets are rallying ever so slightly with Treasury yields lower by 0.8bps and similar declines throughout Europe (Bunds -0.7bps, OATs -1.5bps, Gilts -1.1bps).  As to commodity markets, they are mixed this morning with oil (+0.1%) marginally higher along with gold (+0.1%), while copper (-1.1%) is lagging.  The long-term trend for most commodities remains higher, although we continue to see short-term consolidation.

In the FX market, the most notable mover has been ZAR (-1.35%) which is continuing to suffer on the back of the rioting in the country and the likely negative impact it will have on the economy.  Other laggards in the EMG bloc are HUF (-0.5%), PLN (-0.5%) and MXN (-0.4%), as traders respond to differing issues in each nation.  Poland’s central bank has hinted that they will extend QE at a moment’s notice in the event the delta variant of Covid becomes a bigger problem, while Hungary seems to be suffering for its unwillingness to agree to a global corporate tax rate.  As to Mexico, the nominee for central bank governor, Arturo Herrera, explained he would not expect Banxico to begin a tightening cycle, despite the fact they have already raised rates once.  On the plus side, RUB (+0.4%) leads the way as traders anticipate future gains in the oil price.

In the G10 space, while the dollar is broadly firmer, the biggest movers have been GBP (-0.3%) and NOK (-0.3%), hardly the stuff of excitement.  Arguably, what we continue to see is short USD covering as positions remain overly short, albeit somewhat reduced from where things stood at the beginning of the quarter.

This morning, in addition to the Powell testimony, we see CPI (exp 4.9%, 4.0% ex food & energy), which ought to be quite interesting.  If the forecast is correct, it would be the first time that the Y/Y data fell since last November.  As well, if this is the case, Chair Powell will almost certainly point to the outcome in his comments today as a strong sign the Fed’s transitory inflation story playing out exactly as they anticipate.  Of course, a higher than expected print will require a bit more tap dancing on Powell’s part.

The FX market continues to consolidate with no large trend driving things currently.  Now that the relationship between the dollar and Treasuries has seemingly broken, traders are looking for new short-term drivers and waiting for clarification as to how the next trend will derive.  In other words, we are likely to continue to see somewhat choppy and directionless trading for the next several weeks unless we get something of real note.  So, paraphrasing Samuel Beckett, it appears we are ‘Waiting for Powell.”

Good luck and stay safe
Adf

Capitalism is Spurned

When looking through history’s pages

It seems there are only two stages

At times capital

Has markets in thrall

At others, it’s all about wages

Four decades past Maggie and Ron

Convinced us, for things to move on

T’was capital needed

For growth unimpeded

But seemingly those days are gone

Instead, now the cycle has turned

As two generations have learned

That labor should take

The bulk of the cake

While capitalism is spurned

The upshot is that now inflation

Will percolate throughout the nation

While central banks claim

That prices are tame

Your costs will increase sans cessation

With markets fairly quiet this morning I thought it would be an interesting idea to step back to a more macro view of the current financial and economic framework as I strongly believe it is important to understand the very big picture in order to understand short term market activities.

A number of prominent historians and economists contend that both history and the economy are cyclical in nature although long-term trends underlie the process.  One might envision a sine wave overlaying an upward sloping line as a description.  Now the period and amplitude of the sine wave are open to question, but I would offer that a full cycle occurs in the timeframe of 80-100 years.  As per Neil Howe’s excellent book, The Fourth Turning, this encompasses four generations over which time each generation’s response to their upbringing and the events that occurred during those formative years result in fairly similar outcomes every fourth generation.

Ultimately, I believe it is valid to consider the cyclical nature in terms of the importance of the two key inputs to economic activity; capital and labor.  It is the combination of these two inputs that creates all the economic wealth that exists.  However, depending on the government regulatory situation and the societal zeitgeist, one will always dominate the other.

If we look back 100 years to the Roaring Twenties, it was clear capital had the upper hand as the administrations of Warren Harding and Calvin Coolidge maintained a very laissez faire attitude to the economy and watched as large companies grew to dominate the economy.  Of course, the Great Depression ended that theme and resulted in FDR’s New Deal and ultimately the ensuing 40 years of government intervention in the economy alongside labor’s growing power.  Forty years on from the Depression saw the height of government interventionism with the ‘guns and butter’ strategy of LBJ, the Vietnam War, the Great Society and also, the seeds of the next change, the Summer of Love.  At that point, the economic effects of the government’s heavy hand were starting to have a negative impact, restricting growth and driving inflation higher.

Like day follows night, this led to a change in the zeitgeist and a change in the relationship between capital and labor.  The Reagan/Thatcher revolution arose at a time when people saw only the negatives of government and led to a reduction of government control and activity (on a relative basis), as well as the beginnings of the financialization of the economy.  Arguably, that peaked in the dot com bubble in 2001, or perhaps in the GFC in 2008, but certainly, ever since the latter, we have seen a significant adjustment in the relationship of the government and the governed.

My contention is that we are entering into a new period of labor’s ascendancy versus capital and increased government involvement in every facet of life.  While this has manifest itself in numerous ways, from the perspective of markets, what this means is that the heavy hand of central banks is going to weigh even more greatly on events than it has until now. The myth of the independent central bank is no longer even discussed.  Rather, central banks and finance ministries are now working hand in hand as partners in trying to manage their respective economies.  And ultimately, what that means is that QE has become a permanent part of the financial landscape as debt monetization is required in order to fund every new government initiative.  If this thesis is correct, the idea that the Fed may begin to taper its QE purchases starting next year seems highly unlikely.  Instead, as I have written before, it seems more likely they will increase those purchases as the latest ‘sugar high’ of fiscal stimulus wanes and the economy once again slows down.

Interestingly, the most salient comments made today appear to back up this thesis.  Madame Lagarde was interviewed on Bloomberg TV this morning and explained that a new policy shift would be forthcoming in the near future from the ECB.  Recognizing that the PEPP was due to expire come March and recognizing that the Eurozone economy was not growing anywhere near its desired rate, the ECB is already preparing for the PEPP’s successor.  In other words, QE will not end at its originally appointed time.  In addition, she explained that they would be adjusting their forward guidance as the previous model clearly did not achieve their goals.  (Might I suggest, QE Forever?  It’s catchy and sums things up perfectly!)

So, to recap; the broad cycles of history are turning through an inflection point and we are very likely to see capital’s importance diminish relative to labor going forward.  This means that profit margins will shrink amid higher wages and greater regulatory burdens.  Equity returns will suffer accordingly, especially on a real basis as price pressures will continue to rise.  However, debt monetization will prevent yields from rising, so negative real yields are also likely here to stay for a while.  As to currencies, their value will depend on the relative speed with which different countries adapt to the new realities, so it is not yet clear how things will turn out.  It is also largely why currencies have range-traded for so long, the outcome is not yet clear.

With that to consider as a background, I would offer that market activity remains fairly unexciting.  For now, the ongoing themes remain in place, so, central bank liquidity continues to be broadly supportive of asset markets and arguably will continue to be so for the time being.

Turning to today’s session shows that Asian equity markets followed Friday’s US lead by rallying nicely (Nikkei +2.2%, Hang Seng and Shanghai +0.6%) as markets continue to respond to the PBOC’s modest policy ease announced last week regarding the RRR reduction.  Europe, though, is a bit less bubbly this morning (DAX -0.1%, CAC -0.3%, FTSE 100 -0.6%).  Finally, US futures are mixed with the NASDAQ continuing its run higher (+0.2%) but the other two markets less happy with modest declines.

Bond markets, after selling off Friday in what was clearly a short-term profit taking act, have rallied back a bit this morning with yields declining in Treasuries (-1.5bps), Bunds (-1.5bps), OATs (-2.0bps) and Gilts (-2.0bps).

Commodity prices are under pressure, with oil (-1.4%) leading the way lower, but weakness across both precious (Au -0.45%) and base (Cu –1.4%) metals and most ags.  In other words, the morning is shaping up as a risk-off session.

This is true in the FX market as well with the dollar broadly firmer in both the G10 and EMG blocs.  Commodity currencies are the biggest laggards (NOK -0.6%, CAD -0.45%, AUD -0.4%) but the dollar is higher universally in the G10.  As to the EMG bloc, ZAR (-1.8%) is by far the worst performer as a combination of increased Covid spread and local violence after the imprisonment of former president Jacob Zuma has seen capital flee the nation.  However, here too, the bulk of the bloc is softer with the commodity currencies (MXN -0.5%, RUB -0.45%) next worse off.

While there is no data today, this week does bring some important news, including the latest CPI reading tomorrow:

Tuesday NFIB Small Biz Optimism 99.5
CPI 0.5% (4.9% Y/Y)
-ex food & energy 0.4% (4.0% Y/Y)
Wednesday PPI 0.5% (6.7% Y/Y)
-ex food & energy 0.5% (5.0% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 350K
Continuing Claims 3.5M
Philly Fed 28.0
Empire Manufacturing 18.0
IP 0.6%
Capacity Utilization 75.6%
Friday Retail Sales -0.4%
-ex autos 0.4%
Michigan Sentiment 86.5

Source: Bloomberg

On the Fed front, the highlight will be Chairman Powell testifying before the House on Tuesday and the Senate on Wednesday, with only a few other speakers slated for the week.

At this point, the market question is; will the dollar rally that has been quite impressive for the past weeks, albeit halted on Friday, continue, or have we seen the top?  Given the breakdown in the treasury yield – dollar relationship, my gut tells me the dollar has a bit further to go.

Good luck and stay safe

Adf

Quite Unforeseen

When OPEC, a group of fifteen

Producers, all gathered in Wien

Nobody assumed

The meeting was doomed

To failure, t’was quite unforeseen

Alas, for the group overall

The UAE prince had the gall

To strongly demand

Their quota expand

The Saudis, though, wouldn’t play ball

The big story this morning revolves around the failure to agree, by OPEC+, on new production quotas going forward.  While expansion of output was on the agenda as each member was keen to take advantage of the rising price of crude and its products, it seems the UAE demanded a much larger share of the increase than the Saudis wanted to give.  Ordinarily, this type of horse trading takes place in the background as OPEC likes to show its unity, but for some reason, this particular situation burst into plain sight.  Undoubtedly there are many underlying issues between Saudi Arabia and the UAE, but right now, this is the one that matters.  The result has been that oil continues to rise sharply, up another 1.75% this morning taking the gains this year to nearly 60%.  As is frequently the case in a bullish commodity market, the price curve is in steep backwardation, with the front month contracts being significantly more expensive than the outer months.  This is an indication of a lack of short-term supply, something borne out by the continued drawdown of reserves in storage.

What makes this situation so interesting is the fact that the dollar has not fallen sharply while the price of oil has risen.  Historically, rising commodity prices go hand in hand with a weaker dollar, at least versus its counterpart currencies, but that is not really the case this time.  Thus, for those nations that import oil, their local costs have increased more than proportionally as the lack of dollar weakness means it costs much more local currency to procure each barrel.  For instance, since the start of 2021, the Japanese yen has weakened 6.8% and the Swiss franc has fallen 4.1% while oil’s price has soared.  Neither of these nations produces a drop of oil, so their energy costs have climbed substantially.  In the emerging markets, TRY (-14.1%), ARS (-12.2%), PEN (-8.0%) and THB (-7.0%) are the worst performers this year, none of whom have a significant oil industry and all of whom rely on imports for the bulk of their usage.  A weaker currency and higher oil prices are very damaging to those economies.

The question at hand is whether or not this internecine spat will end soon, with some sort of compromise, or if the UAE will stand its ground under increasing pressure.  One thing to consider is that the US shale producers are not likely to come to the market’s rescue in the near term, if ever, as it appears that even at these prices, the capital flowing into the sector to increase production has not expanded, and if anything, given the green initiatives and demands to stop funding fossil fuel production, is likely to decrease.  We may be approaching a scenario where the US, which continues to pump about 11 million barrels/day, will find itself in very good stead relative to many other developed nations that import a higher percentage of their energy needs.  Arguably, this will help the dollar, which means that for some countries, things are only going to get tougher.

As an aside, there is another commodity that has been performing pretty well despite the dollar’s strength, gold.  Here, too, history has shown that a rising dollar price of gold is highly correlated with a weaker dollar on the foreign exchange markets.  But that is not the current situation, as after a very short-term drop in the wake of the FOMC meeting’s alleged hawkishness, gold has rebounded while the dollar has retained virtually all of its gains from the same meeting.  My sense is that there are larger underlying changes in market perception, one of which is that inflation expectations are becoming embedded.

Of course, that is not evident in the bond market, where Treasury yields remain in their downtrend that began in early May in the wake of the massively disappointing NFP report that month.  Since then, yields have fallen more than 20 basis points and show no sign of slowing down.  Oddly, if the market was pricing in a tapering by the Fed, I would have anticipated bond yields to rise somewhat, so this is simply another conundrum in the market right now.  

Turning to the overnight session, one might argue we are looking at a very modest risk-off session.  Equity markets have been desultory with Asia (Nikkei +0.15%, Hang Seng -0.25%, Shanghai -0.1%) not showing much activity while European bourses (DAX -0.4%, CAC -0.3%, FTSE 100 -0.15%) are a bit softer.  Arguably, the European markets have responded to much weaker than expected German data with Factory Orders falling -3.7% ad the ZEW Expectations Survey falling to 63.3, well below the expected 75.2 reading.  Questions about whether or not the global economy has peaked are starting to be asked as stimulus measures fade away.  By the way, US futures are essentially unchanged at this hour.

While today’s Treasury movement has been nil, we are seeing yields decline across Europe with Bunds (-1.5bps), OATs (1.9bps) and Gilts (-1.1bps) all seeing a bit of demand on the back of waning risk appetite.  Remember, too, that the inflation impulse in Europe remains far less substantial than that in the US.

Aside from oil (+1.75%) and gold (+0.8%), the rest of the commodity bloc is also pretty firm this morning with Copper (+1.5%) and Iron ore (+1.6%) leading the base metals higher.

Finally, in the FX market, the best way to describe things would be mixed.  The RBA met last night and was more hawkish than anticipated.  They not only indicated they were going to reduce the amount of QE purchases when the current program comes up for renewal, but they appear to be ending YCC as well, explaining that they would not be supporting the November 2024 bonds when they become the 3-year maturity.  Not surprisingly, we saw AUD (+0.6%) rally, which dragged NZD (+0.8%) up even more as traders speculate the RBNZ is going to raise rates as well.  Away from that, though, the bulk of the G10 bloc was softer led by NOK (-0.55%), which given oil’s continued rise makes little sense.  At this point, I will chalk it up to trading technicals as I see no strong rationale.  As to the rest of the bloc, modest declines are the name of the game.

Emerging markets have also seen similar mixed price action with ZAR (+0.25%) the leading gainer on the back of gold’s strength while HUF (-0.65%) is the laggard as the market awaits comments from the central bank regarding its green policy ideas.  The next weakest currency in this bloc is PHP (-0.5%) as the central bank confirmed it would not be reducing stimulus until it had further confidence the economy there would be picking up.

On the data front, there are only a few releases due although we do see the FOMC Minutes tomorrow.

TodayISM Services63.5
WednesdayJOLTs Job Applications9313K
 FOMC Minutes 
ThursdayInitial Claims350K
 Continuing Claims3325K

Source: Bloomberg

Aside from this limited information, we hear from just one Fed speaker tomorrow.  Perhaps the market will have the opportunity to make up its own mind about where things are going to go.

At this point, the Fed narrative remains that inflation is transitory and that they will continue to support the economy going forward.  However, there is a group of FOMC members who clearly believe that it is time to cut back on QE.  That will be the major discussion for the next several months, to taper or not, and if so, how quickly it will occur.  My view continues to be that the core of the Fed is not nearly prepared to taper QE purchases as they know that the ongoing expansion of Federal debt will require the Fed to remain an active part of the market lest things get more concerning for bond traders.

As to the dollar, it remains in its trading range having reached the top of that range last week.  I would not be surprised to see a bit of dollar weakness overall, if for no other reason than the dollar is likely to slip back toward the middle of its range.

Good luck and stay safe

Adf

Poor Madame Lagarde

As prices worldwide start to rise

And central banks, rates, normalize

Poor Madame Lagarde

May soon find it hard

To ably, her goals, realize

Let me start by saying that I will be out of the office starting tomorrow, returning July 6th.

Despite the fact that the markets in the US are showing only limited signs that the Fed is actually considering tightening, the punditry continues to believe that tapering asset purchases is next up on the Fed’s agenda.  In fact, the discussion is becoming granular with respect to which assets they should consider addressing.  The two current theses are; reduce purchases of both Treasuries and Mortgages at a similar rate, or just reduce Mortgage purchases given the bubble the Fed has blown in the housing market.  And there are FOMC members on both sides of that argument although it cannot be surprising that the more dovish members continue to insist that buying $40 billion / month of Mortgage-backed securities is having absolutely no impact on the housing market.  But the point is that the analyst community is fully on board with the idea the Fed is going to be reducing its asset purchases soon.

I highlight this because when combined with the fact that so many other countries are more definitively moving past unlimited policy ease, with some already tightening, it becomes interesting to consider which nations are not considering any policy changes.  And this is where the ECB comes into view.

As of now, the ECB (and BOJ) insist that there are no plans to change their policy mix anytime soon.  And yet, they seem to have the opposite problem of the Fed, the market is pricing in rate increases there, currently a 0.10% hike by the end of Q3, and bond yields have been rising steadily with German bund yields almost back up to 0.00%.  (As an aside, it continues to be remarkable to me that one can make the statement, back up to 0.00%!)  Given the slower trajectory of growth thus far in Europe, especially with respect to inflation readings, Madame Lagarde and her cadre of central bankers certainly have their work cut out for them to maintain the policy stance they desire and believe is necessary to support the economy there.  Will the ECB be forced to ease further in some manner, like extending PEPP in order to achieve their aims?

In contrast, despite the fact that the Fed is talking about talking about tapering, and the dot plot indicated a majority of FOMC members believe they will be raising rates by the end of 2023, the bond market remains sanguine over the prospect of either higher inflation or higher interest rates.  Go figure.  

So, who do we believe when surveying the current situation?  On the one hand, it is always tough to argue with the market.  Whether or not we understand the actual drivers, the collective intelligence of investors tends to be exceptionally accurate at recognizing trends and future outcomes.  On the other hand, the phrase, ‘don’t fight the Fed’ has been around for a long time because it has proven to be an effective input into any investment thesis.  The problem is, when those two indicators are at odds with each other, choosing the likely outcome is extraordinarily difficult, more so than normal.

One way to think about it is that both can be right if you consider they may have differing timelines.  For instance, the market tends to discount actions in the 9 month to 1year timeframe while the Fed may well be considering more immediate actions.  However, in this case, I feel like the Fed is looking at a similar timeline as the market.  Ultimately, as I’ve mentioned before, it appears the Fed remains completely reactive to market movement.  Thus, right now, regardless of their rhetoric, my take is if the market demands easier policy, they will make it known via a sell-off in equities that will result in the Fed stepping in with support.  If, on the other hand, the market is comfortable with the current situation, a continued benign rise in equities is on the cards.  As the Fed has put themselves in the position of reactivity, my money is on the market this time, not the Fed.  We shall see.

As I was quite delayed this morning, a very quick recap of the overnight session shows that risk was under pressure in Asia but that Europe has responded very well to much stronger than expected confidence indicators for manufacturing and consumers across the continent.  So while all three main Asian indices fell about 1.0%, Europe has seen gains of at least 0.6% with the DAX up 1.2%.

As it happens this morning, Treasury prices have edged a bit lower with the 10-year yield rising 2bps, but that was after a nice rally yesterday, so we continue to trade right around 1.50%.  Big picture here is nothing has changed.  European sovereigns are softer as risk appetite improves on the continent, with 2.0bp rises in the major markets.

While oil prices (+0.5%) are a bit firmer, the metals complex is under pressure this morning with gold and silver both down sharply (-1.4%) and base metals also falling (Cu -1.0%, Al -0.7%).

The metals’ movement is more in sync with the dollar, which has rallied against all its G10 peers and most EMG currencies.  AUD (-0.7%) and NZD (-0.7%) are the laggards here with NOK (-0.6%) next in line.  Obviously, oil is not the driver, although Aussie and Kiwi would suffer from metal price declines.  However, it appears that Covid continues to haunt many countries and the market seems to be responding to perceptions that growth will be slowing rather than continuing its recent uptrend.  

In EMG, RUB (-0.8%), PLN (0.65%) and ZAR (-0.6%) are amongst the worst performers with ruble and rand clearly impacted by metals prices while the zloty seems to be suffering from a more classical interpretation of inflation’s impact on a currency, as higher inflation expectations are leading to a weaker currency.

On the data front, Case Shiller House Prices rose 14.88%, higher than expected and continuing the trend that has been in place for more than a year.  Later we get Consumer Confidence exp (119.0) although it seems unlikely with payrolls coming on Friday, that the market will pay much attention.

Only Thomas Barkin from Richmond speaks on behalf of the Fed today, but there is no reason to believe that it will change any views.  The narrative is still the same.

The dollar is feeling quite strong this morning and seems likely to maintain those gains as the day proceeds.  If the market truly believes the Fed is going to taper, we should see the evidence in the bond market with higher yields.  But for now, the dollar’s strength feels more like short-covering than a change in the long-term view of ultimate dollar weakness.  However, this can persist for a while (just like inflation 😊)

Good luck, and have a great holiday weekend.  I will be back on the 6th.

Adf

A Popular View

It seems that a popular view

Explains that the Fed will pursue

A slowdown in buying

More bonds as they’re trying 

To bid, fondly, QE adieu





At least that’s what pundits all thought

The Powell press conference had wrought

They talked about talking

But are not yet walking

The path to where policy’s taut

It appears virtually unanimous that the punditry believes the FOMC is going to be tightening policy (i.e. tapering) in the ‘near future’.  Of course, the near future is just as imprecise as transitory, the Fed’s favorite word.  Neither of these words convey any specificity, which makes them very powerful in the narrative game, but perhaps not so powerful when directly addressed.  My take on transitory is as follows: initial expectations were it meant 2 or 3 quarters of price pressures which would then dissipate as supply chains were quickly reconnected.  However, it has since morphed into as much as 2 to 3 years given the reality that certain shortages, notably semiconductors, may take much longer to abate as the timeline to build out new capacity is typically 2 to 3 years.  I guess it all depends on your frame of reference as to what transitory means.  For instance, to a tortoise, 2 to 3 year is clearly but a blip in their lives, but to a fruit fly, it is beyond an eternity.  Sadly, the market’s attention span is much closer to that of a fruit fly’s than a tortoise’s so 2 to 3 years feels a lot more permanent than not.  This is especially so since there is no way to know if other, more persistent inflationary issues may arise in the interim.

As to the ‘near future’, that seems to mean somewhere between the middle of 2022 and the middle of 2024.  Here too, the timeline is extremely flexible to accommodate whatever story is trying to be sold told.  When puffing up the strength of the economic recovery, expectations tend toward the earliest estimates.  In fact, we continue to hear from several FOMC members that tapering will soon be appropriate.  However, if we look at who is making those comments (Bullard, Kaplan, Rosengren and Bostic), we find that only Raphael Bostic from Atlanta currently has a vote.  At the same time, those who are least interested in the idea of tapering include the leadership (Powell, Clarida and Williams) as well as the other governors (Bowman, Brainard, Quarles and Waller), and they have permanent votes.  In other words, my take on the FOMC meeting is it was far less hawkish than much of the punditry has described.  And there is one group, which really matters, that is apparently in agreement with me; the bond market!  Treasury prices after an initial sell-off (yield rally) have reversed that move and are essentially unchanged with a flatter yield curve.  It strikes me that if the Fed were to taper, yields would start to rise in the long end as the removal of that support would have a significant negative price impact.

So, if I were to piece together the narrative now it appears to be the following: inflation is still transitory if it remains well above target for the next 2 years and the bond market is convinced that is the case (ostensibly a survey showed that 70% of fixed income managers believe the transitory story).  Meanwhile, despite the transitory nature of inflation, the Fed is going to tighten its monetary policy sometime next year and potentially even raise the Fed Funds rate in 2023.  Personally, that seems somewhat contradictory to me, but apparently cognitive dissonance is a prerequisite to becoming an FOMC member these days.

At any rate, given the lack of actual policy changes by the Fed, all we have is the narrative.  This week we will have four more Fed speakers to continue to reiterate that narrative, that despite the transitory nature of inflation we are going to tighten policy in the future.  Of course, that begs the question, Why?  Why tighten policy if there is no inflation?  Cognitive dissonance indeed.

In the meantime, as markets continue to try to figure out what exactly is happening, we wind up with paralysis by analysis and relatively limited movement.  For instance, equity markets in Asia were all essentially unchanged overnight, with not one of them moving even 0.1%.  Europe, on the other hand is having a tougher go this morning with red across the screen (DAX -0.1%, CAC -0.5% and FTSE 100 -0.5%) with a real outlier as Spain’s IBEX (-1.5%).  There has been no data released but there is growing concern that the Delta variant of Covid is going to cause another lockdown in Europe before they finished reopening the first time.  This is based on the fact that we have seen lockdowns reimposed in Australia, Japan, Singapore and Israel after all those nations seemed to be moving forward.  As to US futures, they are either side of unchanged at this hour awaiting some clarity on anything.

It can be no surprise that bond markets are rallying slightly with Treasuries (-1.7bps) leading the way but small yield declines in Europe as well (Bunds -0.8bps, OATs -1.1bps, Gilts -1.8bps).  With equity markets under pressure, this is a natural reaction.  And if you consider the reasoning, worries over another Covid wave, then slower growth would be expected.

Funnily enough, Covid is having a currency impact today as well.  In the G10, the new Health Minister, Sajid Javid, has said he wants to see the country return to normal “as soon and as quickly as possible.”  Despite the equity market concerns, the FX market saw that as bullish and the pound (+0.2%) is the leading gainer in the G10 this morning.  But as the morning has progressed and risk sentiment has become less positive, the dollar is starting to asset itself against most of the rest of the bloc with NZD (-0.35%) and NOK (-0.3%) the laggards.  Both of these are under pressure from declining commodity prices as oil (-0.1%) is sagging a bit.

In the EMG bloc, ZAR (-0.8%) is in the worst condition this morning as the Delta Covid variant has increased its spread and the government is behind the curve in treating the issue.  But we saw weakness overnight in THB (-0.6%), and this morning the CE4 are all under the gun as well.  And the story seems to be the same everywhere, tighter Covid restrictions are undermining currencies while positivity is helping them.

It is a big data week as it culminates in the payroll report on Friday:

TuesdayCase Shiller Home Prices14.85%
 Consumer Confidence119.0
WednesdayADP Employment550K
 Chicago PMI70.0
ThursdayInitial Claims389K
 Continuing Claims3335K
 ISM Manufacturing61.0
 ISM Prices Paid86.0
FridayNonfarm Payrolls700K
 Private Payrolls600K
 Manufacturing Payrolls25K
 Unemployment Rate5.7%
 Average Hourly Earnings0.3% (3.6% y/Y)
 Average Weekly Hours34.9
 Participation Rate61.7%
 Trade Balance-$71.3B
 Factory Orders1.5%

Source: Bloomberg

Obviously, all eyes will be on the payroll data as the Fed has made it clear that employment is their key focus for now.  There was an interesting story in the WSJ this morning highlighting how the states that have ended the Federal Unemployment Insurance bonus have seen an immediate pickup in employment with jobs suddenly being filled.  That bodes well for the future, but it also means we will have this issue for another quarter if all the states that maintain the bonuses continue to do so.

As mentioned above, several Fed speakers will be out selling the narrative that inflation is transitory, but tapering may be coming anyway.  (A cynic might think they are not being totally honest in what they are saying, but only a cynic.)

A quick top down look at the FX market leads me to believe that individual national stories are currently the real drivers.  So those nations that are raising interest rates to fight inflation (Mexico, Brazil, Hungary, Russia) are likely to see their currencies hold up.  Those nations that are having serious relapses in Covid infections (South Africa, much of Europe) are likely to see their currencies come under pressure.  Where the two meet (South Korea), it seems to depend on the day as to which way the currency goes.  With that in mind, though, I would bet the monetary policy story will have more permanence will be the ultimate driver.

Today, the dollar seems to be in fine fettle as risk is on the back foot given the increasing Covid concerns over the Delta variant.  But do not be surprised if tomorrow is different.

Good luck and stay safe

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