The narrative now seems to be That tapering’s what we will see The meeting in June Is likely too soon By autumn, though, Jay may agree tran∙si∙to∙ry adjective not permanent. “transitory periods of medieval greatness” per∙sist∙ent adjective continuing to exist or endure over a prolonged period. “persistent rain will affect many areas” Forgive my pedanticism this morning but I couldn’t help but notice the following comment from former NY Fed President William Dudley. “The recent spike in US inflation is likely transitory for now – but it could become more persistent in the coming years as more people return to work.” Now, I don’t know about you, but I would describe the words ‘transitory’ and ‘persistent’ as antonyms. And, of course, we all know that the Fed has assured us that recent rises in inflation are transitory. In fact, they assure us multiple times each day. And yet, here is a former FOMC member, from one of the most important seats, NY Fed president, explaining that this transitory phenomenon could well be persistent. If you ever wondered why the term ‘Fedspeak’ was coined, it was because ‘doublespeak’ was already taken by George Orwell in his classic ‘1984’. Apparently, one does not regain one’s intellectual honesty when leaving a government institution where mendacity is the coin of the realm. However, let us now turn to today’s main story; tapering. The discussion on tapering of QE continues apace and the market is settling on a narrative that the Fed will reduce the amount of its monthly purchases by the end of the year. Certainly, there are a minority of Fed governors who want to get the conversation going in earnest, with St Louis’ James Bullard the latest. And this idea fits smoothly with the concept that the US economy is expanding rapidly with price pressures, even if transitory, building just as rapidly. Just yesterday, Elon Musk compared the shortage in microprocessors needed to build Teslas to the shortage of toilet paper at the beginning of the pandemic last year. (As an aside, one, more permanent, result of that TP shortage is that prices in my local Shop-Rite are significantly higher today than pre-pandemic, at least 40% higher, even though the shortage was transitory no longer persists.) The point is that the combination of shortages of specific items, bottlenecks in shipping and dramatically increasing demand fed by massive government stimulus programs are all feeding into higher prices, i.e. inflation. Even the most committed central bank doves around the world have noticed this situation, and while most are unwilling to alter policy yet, the discussion is clearly beginning. Last night, the RBA omitted their promise “to undertake further bond purchases to assist with progress goals,” despite maintaining their YCC target of 0.10% for 3-year AGB’s. As well, yesterday Fed Governor Lael Brainerd, arguably the most dovish FOMC member, explained, “while the level of inflation in my near-term outlook has moved somewhat higher, my expectation for the contour of inflation moving back towards its underlying trend in the period beyond the reopening remains broadly unchanged.” Apparently, Lael attended the Alan Greenspan school of Fedspeak. Add it all up and you get a market that is convinced that tapering is visible on the horizon and will begin before Christmas 2021. While I don’t doubt it is appropriate, as I believe inflation is not actually transitory, I am also skeptical that the Fed is ready to alter its policy until it sees data showing the employment situation has reached its newly formed goals. I fear that, as usual, the Fed will be late to the tightening party and the outcome will be a far more dramatic policy reversal and much bigger market impact (read stock market decline) than desired. How, you may ask, has this impacted markets today? The big winner has been the dollar, which is firmer against virtually all its counterparts this morning. For instance, NZD (-0.5%) is the laggard in the G10 space after RBNZ comments explaining the balance sheet will remain large for a long time. In other words, while they may stop buying new securities, they will replace maturing debt and so maintain a significant presence in their bond market. Meanwhile, CHF (-0.5%) is under pressure after SNB Vice-president Zurbruegg explained that the bank’s expansive monetary policy, consisting of NIRP and FX intervention is still necessary. The rest of the bloc is also softer, but not quite to that extent with AUD (-0.35%) under pressure from commodity price pullbacks and JPY (-0.35%) suffering after odd comments by a BOJ member that they would respond to any untoward JPY strength in the event the Fed does begin to taper. Emerging market currencies have also been under pressure all evening led by TRY (-0.9%) and KRW (-0.65%). The latter’s movement was a clear response to the PBOC setting its fixing rate for a weaker CNY than the market had anticipated, thus opening the way for a weaker KRW. Given the fact that South Korea both competes aggressively in some markets with Chinese manufacturers, and has China as its largest market, the intricacies of the KRW/CNY relationship are many and complex. But in a broad dollar on scenario, it is not too surprising to see both currencies weaken, and given KRW’s recent strong performance, it had much further to fall. But currency weakness in this bloc is across EEMEA, APAC and LATAM, which tells us it is much more about the dollar than about any particular idiosyncratic stories. In the rest of the markets, equities were mixed in Asia (Nikkei +0.45%, Hang Seng -0.6%, Shanghai -0.75%) while Europe is green, but only just (DAX +0.15%, CAC +0.3%, FTSE 100 +0.1%). US futures are either side of unchanged at this hour as the market tries to digest the tapering story. Remember, much of the valuation premium that exists in the US is predicated on lower forever interest rates. If they start to climb, that could easily spell trouble. Speaking of interest rates, they have edged lower in the session with 10-year Treasury yields down 0.3bps while in Europe, yields have fallen a bit faster (bunds -1.4bps, OATs -1.5bps, gilts -1.2bps). Certainly, there is no keen inflationary scare in this market as of yet. Interestingly, oil prices continue to rise, despite the stronger dollar, with WTI (+1.0%) trading to new highs for the move. But the rest of the commodity space finds itself under pressure this morning as the dollar’s strength takes its toll. Precious metals are softer (Au -0.25%, Ag -0.5%) as are base metals (Cu -0.8%, Al -0.5%) although the ags are holding up. But if dollar strength is persistent, I expect that commodity prices will remain on the back foot. On the data front, today brings only the Fed’s Beige Book this afternoon, as the ADP employment number is delayed due to the Memorial Day holiday Monday. As well, we hear from four Fed speakers, including three, Harker, Kaplan and Bostic, who have been in the tapering camp for several weeks now. However, until we start to see the Treasury market sell off more aggressively, I think tapering will be a nice talking point, but not yet deemed a foregone conclusion. As such, that link between Treasury yields and the dollar remains solid, with the dollar likely to respond well to further discussions of tapering and higher yields. We shall see if that is what comes to pass regardless of the current narrative. Good luck and stay safe Adf
Tag Archives: #dollarup
‘Bout Enough
A storm in the bond market’s brewing
As some central banks start eschewing
The idea QE
Forever, should be
Thus, traders, their longs are undoing
Meanwhile, in the markets for stuff
The Chinese have had ‘bout enough
As prices there soar
Xi’s minions call for
Restraint, or they’ll have to get tough
Heading into the Memorial Day weekend in the US, there are two stories making the rounds this morning. The first is the latest discussion regarding tapering of QE by central banks around the world while the second is a growing discussion on the commodity markets and the impact the Chinese are having via both economic growth and governmental efforts to prevent prices from rising further.
During the past month we have gained more clarity from four key central banks on their future QE activities, but the big three (Fed, ECB and BOJ) have not yet come out with any real guidance. Certainly, we have heard several members of the FOMC opining that the time is coming soon where they will start to consider the idea, if growth continues at its current accelerated pace and if the employment situation improves dramatically. This is, however, by no means the universal view in Washington, at least not yet. With respect to the BOJ, the next MPC member who talks about tapering JGB buying will be the first one to do so. The Japanese have been so invested in this strategy for more than 20 years it will be extraordinarily difficult to even consider a change.
In Frankfurt, however, there is far more disagreement as to the proper steps forward. Unfortunately for the ECB, the lack of a common fiscal framework in the Eurozone is becoming a bigger problem as they remain the only institution capable of supporting the entire group of nations. This is made clear by recent data, which shows that there are very different growth and inflation scenarios, potentially requiring different monetary policy responses, in different countries.
For instance, inflation in Germany, at 2.3% is running a lot hotter than in Italy, at 1.0%. And while the Continent’s average may be around 1.6% right now, it is the Germans that see things as more problematic. Consider that while the Weimar hyperinflation of nearly 100 years ago may seem ancient to most, it was the most searing economic event in the nation’s history and has informed the entire German zeitgeist of thrift and frugality. (Contrast this to the Great Depression, with the concomitant deflation that occurred in the US, and which has informed the US zeitgeist with respect to fear of prices and the economy collapsing.) Remember, the only way to get the Germans to agree to the euro was to promise that the ECB would essentially be a clone of the Bundesbank. That meant keeping a lid on inflation at all times. However, the current situation, where the economic circumstances across the continent are so widely disparate, has put the ECB in a bind. Efforts to support those economies that remain weak with a low inflationary impulse, like Italy, Ireland and Greece, will result in increasing price pressures on those economies that are further ahead in the economic rebound like Germany and the Netherlands.
It is this conundrum that has different ECB speakers saying different things. On the one hand, we have recently heard from Italy’s Panetta, France’s Villeroy and Madame Lagarde that tapering is not appropriate. Yet this morning, Germany’s Isabel Schnabel was far more circumspect with respect to maintaining current policy as she commented, “Rising yields are precisely what we want to see.” That does not seem the comment of someone keen to keep buying bonds. However, for now, the Germans remain in the minority and so the idea that the ECB will mention the tapering of asset purchases at the June meeting seems unlikely.
As to the commodity story, in the past two weeks we have heard from at least seven different Chinese officials and key organizations about the need for both reducing upward pressure on commodities as well as reducing upward pressure on the renminbi. For the past twenty years, China has been the marginal buyer of most commodities as their economy has grown at a remarkable pace and they have built up extraordinary infrastructure of roads, airports and cities. Thus, they have consumed countless tons of steel, copper and other industrial materials. However, a little considered impact of the pandemic was the dramatic reduction in the capex of mining for industrial metals, which means that future supplies are likely to be less available as the world continues to reopen and growth expands. The natural result has been rising prices as markets anticipate surplus demand relative to forecast supply.
Apparently, the powers that be in China have figured out that rising prices are not conducive to their domestic plans and are now caught between a situation where they benefit from a stronger currency if it puts downward pressure on inflation, but suffer from a stronger currency if it reduces the attractiveness of their export sector. They seem to believe that if they can prevent further strength in CNY while simultaneously talking down commodity prices, they can achieve both their ends. While they have had some success over the past several weeks on the commodity front, CNY has steadily appreciated, gaining more than 3.25% since April 1st. I guess this is one of the difficulties of trying to manage growth, inflation and your currency’s value simultaneously. Something’s gotta give. Right now, it looks like the currency and further strength there should not be a surprise.
As to our holiday shortened session, European equity markets are uniformly higher this morning (DAX +0.6%, CAC +0.7%, FTSE100 +0.3%) although Asia had a more mixed picture with the Nikkei (+2.1%) quite strong but the Hang Seng (0.0%) and Shanghai (-0.2%) less enthusiastic about things. US futures are all green to the tune of about 0.5%, so pending this morning’s data, the rally should continue.
Bond markets are little changed this morning with Treasuries, which saw yields rise 3.5bps yesterday essentially unchanged this morning. EGB’s are generally a tick or two higher with yields lower by less than 1 basis point, as there is much more focus on stocks today.
In the commodity space, oil (+0.5%) continues to rebound from last week’s dip while precious metals are modestly softer this morning (Au -0.2%, Ag -0.8%). The Chinese seem to be having some success in their efforts to push down metals prices with Cu (-1.0%) and Al (-0.4%) leading the way lower.
The dollar, despite the positive risk sentiment in equities, is stronger vs. all its G10 peers, with NZD (-0.85%) and AUD (-0.6%) the worst performers on the day. In truth, the magnitude of this move smacks of position adjustments after the RBNZ’s surprisingly hawkish tone earlier this week led to significant buying in both currencies. But the dollar’s strength is universal as generally positive data releases throughout Europe have not been able to encourage currency buying.
Emerging markets have seen a different picture as the dollar was universally soft overnight and APAC currencies all showed strength while those markets were open, but since then, EEMEA and LATAM currencies have come under pressure. The most notable mover here has been TRY (-0.95%) as ongoing inflation worries continue to undermine faith in the currency both at home and internationally.
The data story today has the chance to be quite interesting with Personal Income (exp -14.2%), Personal Spending (0.5%) and Core PCE (0.6% M/M, 2.9% Y/Y) all coming at 8:30. Then at 10:00 we see Chicago PMI (68.0) and Michigan Sentiment (83.0). In my mind, Core PCE is the number that matters. Given the current market discussion on tapering, a higher than anticipated number there could easily see a bond market sell-off and further support for the dollar. Frankly, based on the fact that every inflation reading this month has been higher than forecast, I see no reason for this to be any different. Look for a high print and the dollar to remain well-bid into the weekend.
Good luck, good weekend and stay safe
Adf
Somewhat Dismayed
The ECB’s somewhat dismayed
That risk appetite, as conveyed
By stocks is excessive
And has made a mess of
Their plans. Now they’re really afraid
It is interesting that two of the most memorable battle cries in financial markets were coined by men of the driest character and background. We all remember the beginning of the Eurozone debt crisis, not ten years ago, when the so-called doom loop created by banks in a given country owning excessive amounts of their own government’s debt and when that debt became suspect (Portugal, Italy, Greece, Spain) the banks in those nations went to the wall. The ECB was forced to step in to save the day, and did so, but things did not calm down until Super Mario Draghi, then ECB President (and now Italian PM) uttered his famous, off-the-cuff, remark of the ECB doing “whatever it takes” to save the euro.
Less of us were involved in the markets in December 1996 when then Fed Chair Alan Greenspan uttered the other famous market expression, “irrational exuberance” while speaking about the inflating of the tech bubble (which inflated for another 3 ½ years) and questioning if prices at that time had run too far ahead of sensible valuations.
In hindsight, both of the problems about which these catch phrases were created were the result of policy failures on the part of governments (debt crisis) or the central bank itself (tech bubble), but in neither case was the speaker able to take an objective view, thus calling out forces beyond their control as the cause of the problem.
Since then, both phrases have become part of the financial lexicon as shorthand for a situation that exists and the willingness of central bankers to address a problem. This leads us to this morning’s release by the ECB of their Financial Stability Review where a subsection was titled “Financial markets exhibited remarkable exuberance as US yields rose. (author’s emphasis)” Arguably, the title pales in comparison to ‘irrational exuberance’, but more importantly, it highlights, once again, the inability of a central bank to recognize that the folly of their own policies is what is driving the problems in markets and economies.
Ostensibly they are concerned that a mere 10% decline in US equity markets could result in “…a significant tightening of euro-area financial conditions, similar to around a third of the tightening witnessed after the coronavirus shock in March 2020.” Wow! A 10% decline? If one were looking for a prime example of a fragile economy, clearly the Eurozone is exhibit A. Once again, what we see is a central bank that is unwilling, or unable, to recognize that the fallout from its own policies is the underlying problem while seeking an alternative scapegoat explanation in order to present themselves in the best possible light. After all, if the US markets decline, its not the ECB’s fault!
Inadvertently, perhaps, but clearly, the ECB has outlined one truth; given the synchronicity of central bank policies around the world, all economies are more tightly linked together and will rise and fall together. Although there are those who claim particular markets have better prospects than others, the reality has become that correlations between equity markets around the world are very high, with the only real question how equities correlate to bonds. It is this last issue where we have seen significant changes lately. For quite a long time, the correlation between the S&P 500 and the 10-year US Treasury was positive, meaning that both bond and stock prices rallied and fell together. However, since about February 2021, that relationship has turned around and is now solidly negative, with bond prices rising and stock prices falling. It is this latter relationship that is the classic risk-on / risk-off meme, something that had gone missing for years. Apparently, it is coming back, and that terrifies the ECB.
The timing of the report’s release could not have been better as this morning is a very clear risk-off session. Yesterday afternoon, US equity markets sold off pretty sharply in the last half-hour of the session. That sell-off has persisted throughout Asia (Nikkei -1.3%, Shanghai -0.5%, Hong Kong was closed) and Europe (DAX -1.3%, CAC -1.1%, FTSE 100 -1.1%). US futures are also in the red (Dow -0.6%, SPX -0.8%, Nasdaq -1.2%), so the concerns are global in nature.
A bit more interestingly is the bond market’s behavior, where it appears that owning sovereign paper from any nation is unpopular today. Treasury yields have backed up 2 basis points and we are seeing higher yields throughout Europe as well (Bunds +1.3bps, OATs +0.5bps, Gilts +2.1bps). Apparently, the bond market concerns stem from the UK’s inflation report which showed that while CPI rose, as expected to 1.5%, RPI (Retail Price Index) rose much more than expected to 2.9% Y/Y. While both are designed to be measures of average price increases over time, the RPI considers housing prices and mortgages. Not surprisingly, given the explosion in housing prices, RPI is much higher and rising faster. It also may represent a more accurate representation of people’s cost of living. (Here’s a thought experiment: what would US RPI be right now given CPI just jumped to 4.2%?) At any rate, it appears investors are shunning both stocks and bonds this morning.
Are they buying commodities? Not on your life! Prices in this sector are down across the board led by WTI (-1.8%) but seeing Gold (-0.6%) and Silver (-2.0%) suffering along with base metals (Cu -2.4%, Al -0.9%, Zn -0.85%) and foodstuffs (Soy -0.8%, Wheat -1.7%, Corn -0.3%). Oh yeah, bitcoin, which many believe is a hedge of some sort, is lower by 16% in the past 24 hours and more than one-third in the past week.
So, what are investors buying? Pretty much the only thing higher today is the dollar which has rallied vs. every currency we track. In the G10, NZD (-0.9%) is the laggard followed by NOK (-0.8%) and AUD (-0.7%) with the strong theme there being weakness in the commodity sector. But the European currencies are all under pressure as well, with EUR (-0.2%) and GBP (-0.3%) suffering. Even JPY (-0.4%) is not holding up its end of the risk-off bargain, declining vs. a robust dollar.
Emerging markets are seeing similar activity with every currency flat to down led by TRY (-0.6%), ZAR (-0.45%) and MXN (-0.4%), all suffering from commodity weakness. CE4 currencies are also under pressure, following the euro down while APAC currencies had less angst overnight, sliding on the order of 0.2%.
On the data front, today only brings the FOMC Minutes from the April meeting, which will be scrutinized to see how much discussion on tapering took place, if any, but let’s face it, other than Robert Kaplan of Dallas, it seems pretty clear from everybody else that has spoken, that it is not a current topic of conversation. As it happens, we will hear from 3 more Fed speakers (Bullard, Quarles and Bostsic) as well, but all of them have been on message since the meeting so don’t look for any changes.
Certainly, based on today’s price action, the idea that 10-year yields are driving the dollar remains alive and well. If yields continue to back up, the dollar will remain bid, and after all, given its recent decline, it has room to move as a simple correction. I continue to look at 1.2350 as the critical level in the euro, and by extension the dollar writ large. A break above there opens the chance for a much more substantial dollar decline. But that does not appear to be on the cards for today.
Good luck and stay safe
Adf
Don’t Get Carried Away
The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away
But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned
Wow! That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected. To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase. Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%. To give some context, the core 0.9% gain was the highest print since 1981. It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.
The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible. His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out. As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month. That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.
House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down. The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live. The statistics show that there is the smallest inventory of homes available in decades. As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material. And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace. A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know. As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining. However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI. That, my friends, will be harder to pass off as transitory.
The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates. However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control. While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.
The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money. Rising inflation is the last thing equity markets can abide, so these declines can not be surprising. The question, of course, is will they continue? A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story. It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels. A loss of confidence that the past is prologue could well see a very sharp correction.
Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session. It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move. While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between. Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.
Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months. The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.
Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative. We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%). At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.
This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy). Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday. In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory. I guess they hope if they say it often enough, people may begin to believe them. But that is hard to do when the prices you pay for stuff continues to rise.
Treasuries remain the key. If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher. If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.
Good luck and stay safe
Adf
Far From our Goals
Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls
There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel. In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come. On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’. I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future. After all, the Fed’s forecasting record is unparalleled…in its futility.
However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.
The problem with this attitude is that it seems to ignore the reality on the ground. Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014. In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump. But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least. At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.
It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020. Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation. The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited. There is a growing belief that we are embarking on a so-called commodity super-cycle. This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.
This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise. Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y. The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand. As such, the market seems entirely prepared for a very large number. From my vantage point, the Y/Y number is not so important today, but the M/M number is. Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.
We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy. We continue to hear them explain that any inflation readings will be transitory. And maybe they are correct. However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply. Talk about a Hobson’s Choice!
Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%). US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).
Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level. There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case. European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts). Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.
Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%). The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.
The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own. NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought. However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected). EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst. KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data. Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.
Other than the CPI data and the Treasury auction, there is no other news or data. Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately. The one thing we know is that they are unlikely to change their tune.
Which brings us back to the 10-year Treasury. It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa. I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact. My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late. In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar. Just beware.
Good luck and stay safe
Adf
The Specter of Growth
The specter of growth’s in the air
So, pundits now try to compare
Which central bank will
Be next to instill
The discipline they did forswear
In Canada, they moved last week
On Thursday, Sir Bailey will speak
Now some pundits wonder
In June, from Down Under
The RBA will, easing, tweak
But what of Lagarde and Chair Jay
Will either of them ever say
Our goals are achieved
And so, we’re relieved
We’ve no need to buy bonds each day
On lips around the world is the question du jour, has growth rebounded enough for central banks to consider tapering QE and reining in monetary policy? Certainly, the data continues to be impressive, even when considering that Y/Y comparisons are distorted by the government-imposed shutdowns last Spring. PMI data points to robust growth ahead, as well as robust price rises. Hard data, like Retail Sales and Personal Consumption show that as more and more lockdowns end, people are spending at least some portion of the savings accumulated during the past year. Meanwhile, bottlenecks in supply chains and lack of investment in capacity expansion has resulted in steadily rising prices adding the specter of inflation to that of growth.
While no developed market central bank head has yet displayed any concern over rising prices, at some point, that discussion will be forced by the investor community. The only question is at what level yields will be sitting when central banks can no longer sidestep the question. But after the Bank of Canada’s surprise move to reduce the amount of weekly purchases at their last meeting, analysts are now focusing on the Bank of England’s meeting this Thursday as the next potential shoe to drop. Between the impressive rate of vaccination and the substantial amount of government stimulus, the UK data has been amongst the best in the world. Add to that the imminent prospect of the ending of the lockdowns on individual movement and you have the makings of an overheating economy. The current consensus is that the BOE may slow the pace of purchases but will not reduce the promised amount. Baby steps.
Last night, the RBA left policy on hold, as universally expected, but the analyst community there is now looking for some changes as well. Again, the economy continues to rebound sharply, with job growth outstripping estimates, PMI data pointing to a robust future and inflation starting to edge higher. While the inoculation rate in Australia has been surprisingly low, the case rate Down Under has been miniscule, with less than 30,000 confirmed cases amid a population of nearly 26 million. The point is, the economy is clearly rebounding and, as elsewhere, the question of whether the RBA needs to continue to add such massive support has been raised. Remember, the RBA is also engaged in YCC, holding 3-year yields to 0.10%, exactly the same as the O/N rate. The current guidance is this will remain the case until 2024, but with growth rebounding so quickly, the market is unlikely to continue to accept that as reality.
These peripheral economies are interesting, especially for those who have exposures in them, but the big question remains here in the US, how long can the Fed ignore rising prices and surging growth. Just last week Chairman Powell was clear that a key part of his belief that any inflation would be transitory was because inflation expectations were well anchored. Well, Jay, about that…5-year Inflation breakevens just printed at 2.6%, their highest level since 2008. A look at the chart shows a near vertical line indicating that they have further to run. I fear the Fed’s inflation anchor has become unmoored. While 10-year Treasury yields (+2.3bps today) have been rangebound for the past two months, the combination of rising prices and massively increased debt issuance implies one of two things, either yields have further to climb (2.0% anyone?) or the Fed is going to step in to prevent that from occurring. If the former, look for the dollar to resume its Q1 climb. If the latter, Katy bar the door as the dollar will fall sharply as any long positions will look to exit as quickly as possible. Pressure on the Fed seems set to increase over the next several months, so increased volatility may well result. Be aware.
As to today’s session, market movement is mostly risk-on but the dollar seems to be iconoclastic this morning. For instance, equity markets are generally in good shape (Hang Seng +0.7%, CAC+0.5%, FTSE 100 +0.6%) although the DAX (-0.35%) is lagging. China and Japan remain on holiday. US futures, however, are a bit under the weather with NASDAQ (-0.4%) unable to shake yesterday’s weak performance while the other two main indices hover around unchanged.
Sovereign bond markets have latched onto the risk-on theme by selling off a bit. While Treasuries lead the way, we are seeing small yield gains in Europe (Bunds +0.5bps, OATs +0.6bps, Gilts +0.5bps) after similar gains in Australia overnight.
Commodity markets continue to power higher with oil (+1.9%), Aluminum (+0.4%) and Tin (+1.0%) all strong although Copper (-0.1%) is taking a breather. Agricultural products are also firmer but precious metals are suffering this morning, after a massive rally yesterday, with gold (-0.5%) the worst of the bunch.
Of course, the gold story can be no surprise when looking at the FX markets, where the dollar is significantly stronger across the board. For instance, despite ongoing commodity strength, and the rally in oil, NZD (-0.9%), AUD (-0.6%) and NOK (-0.5%) are leading the way down, with GBP (-0.25%) the best performer of the day. The pound’s outperformance seems linked to the story of a modest tapering of monetary policy, but overall, the dollar is just quite strong today.
The same is true versus the EMG bloc, where TRY (-1.0%) is the worst performer, but the CE4 are all weaker by at least 0.4% and SGD (-0.5%) has fallen after announcing plans for a super strict 3-week lockdown period in an effort to halt the recent spread of Covid in its tracks. The only gainer of note is RUB (+0.4%) which is simply following oil higher.
Data this morning brings the Trade Balance (exp -$74.3B) as well as Factory Orders (1.3%, 1.8% ex transport), both of which continue to show economic strength and neither of which is likely to cause any market ructions.
Two more Fed speakers today, Daly and Kaplan, round out the messaging, with the possibility of Mr Kaplan shaking things up, in my view. He has been one of the more hawkish views on the FOMC and is on record as describing the rise in yields as justified and perhaps a harbinger of less Fed activity. However, he is not a current voter, and Powell has just told us clearly that there are no changes in the offing. Ultimately, this is the $64 trillion question, will the Fed blink in the face of rising Treasury yields? Answer that correctly and you have a good idea what to expect going forward. At this point, I continue to take Powell at his word, meaning no change to policy, but if things continue in this direction, that could certainly change. In the meantime, nothing has changed my view that the dollar will follow Treasury yields for the foreseeable future.
Good luck and stay safe
Adf
Desperate Straits
In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded
Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits
There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today. In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020. This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020. In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound. If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.
But that is all backward-looking stuff. Our concerns are what lies ahead. In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along. As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment. Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns. (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)
At the same time, the fiscal stimulus taps in Europe are only beginning to drip open. While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level. This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy. Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion. But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval. This is the very definition of a day late and a dollar euro short.
Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity. But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st. Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be. But we also know that the monetary story is critical to financial markets, so cannot ignore that. On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar. Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease. This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.
The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form. In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse. Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.
Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today. Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session. Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there. At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.
European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus. Looking at smaller country indices shows lots of red as well. Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.
Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly. European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.
Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well. The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies. Stuff is in demand!
In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners. We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%). The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again. The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.
On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5). Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number. That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.
In the end, though, it is still the Treasury market that continues to drive all others. If yields resume their rise, look for a stronger dollar and pressure on equities and commodities. If they were to head back down, so would the dollar while equities would find support.
Good luck, good weekend and stay safe
Adf
Lower Forever’s Outdated
A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away
The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated
Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm. Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.
What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today. Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities. So, what’s all the hubbub?
Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward. In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus. As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data. Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year. And they well could do so.
However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it. And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%. No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial. In fact, I doubt two months will qualify. If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases. I think the market is way ahead of itself on this issue.
Consider, as well, this puzzle. The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money. As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields. Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt. One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds. So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases? Personally, I cannot do so, it is one or the other.
Which brings us to what can we expect today? Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement. As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.
Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets. If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure. However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price. We shall see starting at 2:00 today.
As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals. Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions. Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.
Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday. In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps). There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates. By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.
On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level. While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.
The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%). The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth. Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.
EMG currencies are a bit more mixed, with a spread of gainers and losers this morning. On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty. A negative ruling could have a major impact on Poland’s banking sector and by extension the economy. Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news. On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.
Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact. Equity futures are biding their time as are most market participants as we all await Mr Powell. Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.
Good luck and stay safe
Adf
A Simple Statistic
There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic
But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided
The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning. At that time, CPI will be released with the following median forecasts according to Bloomberg:
| CPI MoM | 0.5% |
| -ex food & energy MoM | 0.2% |
| CPI YoY | 2.5% |
| -ex food & energy YoY | 1.5% |
The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018. As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high. After all, last month CPI YoY printed at 1.7%, so this is a big jump. We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs. Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.
Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA. My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data. What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation. And I can’t help but notice how the price of things that I buy seem to continue to rise as well. While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning. Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price. Certainly not gasoline, and even tech items cost more. If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.
Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future. In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all. If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.
Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices. We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities. Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance. Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year. The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions. Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low. However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.
Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon. This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality. In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.
As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus. So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.
Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets. The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder. We also saw yields rise in Australia overnight.
Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains. Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way. In other words, pretty much every market is waiting for CPI to take their cues.
FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data. This is especially odd given oil’s gains in the session. But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number. EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.
The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week. Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option. While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.
At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver. If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck. These days, it is truly binary.
Good luck and stay safe
Adf
Central Banks Scoff
In Italy more cash is needed
Or so Super Mario pleaded
The virus is raging
And Mario’s waging
A war so its spread is impeded
Meanwhile Chairman Jay and his mates
Remain steadfast that in the States
Though forecasts are nice
They will not suffice
It’s hard growth they need to raise rates
And lastly, from China we learned
Inflation just might have returned
Though central banks scoff
Bond markets sold off
As clearly some folks are concerned
In the financial world these days, there is only one true constant, the Fed remains as dovish as possible. Yesterday, Chairman Powell, speaking at an IMF sponsored event, explained that the Fed would continue to aggressively support the economy until it is once again “great”. (And here I thought that description of America was verboten.) He harped on the 9 million to 10 million jobs that are still missing from before the Covid-induced crisis and said any inflationary pressures this year would be temporary. His colleague, SF Fed President Daly doubled down on those comments, once again explaining that the Fed will not react to mere forecasts of growth, they will wait until they see hard data describing that growth is real, before considering tightening policy.
Regarding inflation, Powell, when asked specifically on the subject, explained, “We would be monitoring inflation expectations very carefully. If we see them moving persistently and materially above levels we’re comfortable with, then we’d react to that.” Remember, the Fed constantly reminds us they have the tools to deal with rising inflation. But talk is cheap. It remains an open question as to whether they have the fortitude to address rising inflation in an economy that has not come close to reaching full employment, let alone maximum employment. Recall Q4 2018, when a modest increase in interest rates and gradual reduction in the size of the balance sheet led to a sharp stock market sell-off and a reversal of Fed policies via the “Powell Pivot.” And the economy then was clearly in better shape than now.
There is another inflation issue I find puzzling as well, and that is the Fed’s inexorable faith that the Core PCE number is the right way to measure inflation. This is especially true since a number of Fed members, including Powell, have been vocal in their view that the U-3 Unemployment Rate, the one published the first Friday of each month, is a very imperfect indicator of the overall jobless situation despite its long history as a key indicator. So, happily, they are willing to question the totality of the information available from a single data point. And yet, while they pay some lip service to inflation expectations, they are absolutely beholden to a single inflation data point, and one that has very little in common with most people’s reality. One would think that given their broad-mindedness regarding unemployment, that same attitude might extend to inflation. Alas, my understanding is that their econometric models don’t work well with any other data point, and so rather than building models based on reality, they create their reality from the data that works.
While on the subject of inflation, Chinese data overnight showed that, while CPI rose only 0.4% Y/Y, PPI rose a much greater than expected 4.4%. This matters because China remains the world’s major manufacturing center and if prices at the factory are rising there, the implication is that those higher prices are coming to a product near you soon. Another sign of pending inflation comes from an IHS Markit report explaining that the PMI price data is running at its highest level since 2008 and is showing no signs of slowing down. Add to this the increases in shipping costs, and rising prices for every day items seem in store. Thank goodness the Fed has tools!
A quick look at Europe shows a tale of two countries, with Italy heading into its fourth wave of lockdowns and PM Draghi putting together a €40 billion support package following on from a €30 billion package a few months ago. The vaccine rollout remains slow and insufficient and the government has closed bars and restaurants (and that’s really a crime, given just how good the food is there!) Germany, on the other hand, is leading the hawkish contingent of the ECB along with the Dutch, in pushing for tapering the PEPP activity as those economies have been far more resilient to the virus and are starting to see some price pressures. Granted, this morning’s German IP data (-6.4% Y/Y) was much worse than expected, but forecasts remain quite positive there. Unlike the Fed, the ECB seems to be turning a bit more hawkish, indicating the Frugal Four are gaining in power. ECB PEPP purchases declined to just €10.2 billion last week, far below their average in Q1 and even more surprising given Madame Lagarde’s comments in the wake of the ECB meeting that they would be far more active in Q2.
Adding all the new information together brings us to a market situation this morning where Treasury bonds have sold off, yields are higher by 5 basis points in the US and about 4 basis points in the major European markets except Italy, where they are 8 basis points higher. Equity markets are mixed in Europe (DAX +0.1%, CAC +0.25%, FTSE -0.1%) after broad weakness in Asia (Hang Seng -1.1%, Shanghai -0.9%) and US futures are little changed to slightly higher at this time.
Rather, it is the dollar that is today’s big winner, rallying against all its G10 counterparts with NOK (-0.6%) the laggard on still soft oil prices, but weakness seen in JPY (-0.3%) and AUD (-0.25%) with smaller declines elsewhere. The yen’s weakness appears corrective in nature, as it had strengthened 1.7% in the past week. While Aussie is simply chopping about in its recent 0.7550/0.7675 trading range and slipping today.
In the EMG bloc, CZK (-0.65%) is the worst performer, followed by RUB (-0.5%) and KRW (-0.3%), although the bulk of the bloc is somewhat softer this morning. Here, too, we appear to be seeing some trading reactions to the past week’s dollar weakness, although the bigger trend remains for dollar strength.
On the data front, PPI (exp 0.5%, 3.8% Y/Y) is the only release with the core expectations (0.2%, 2.7% Y/Y) also well above the Fed target. Of course, the relationship between PPI and Core PCE is limited at best, however, it is certainly indicative of the fact that there are rising price pressures throughout many sectors of the economy. It is not unreasonable to expect them to show up in PCE soon, as they will certainly begin to show up in CPI next week.
Only one Fed speaker is on the docket today, Dallas Fed President Kaplan, but it would be beyond shocking if he said anything that was different than what we have both read and heard this week; nothing will change until the hard data achieves their targets.
Despite new information this morning, or perhaps because of it, the market theme remains the same, Treasury yields are the key driver of markets, with the dollar following in step while equities will have an inverse relationship. And, while Treasury yields are off their recent highs, they appear to have finished this short-term correction. I have a feeling the dollar will be firmer today and continue with that into next week, at least.
Good luck, good weekend and stay safe
Adf
fxpoetry 