Thrilled…Chilled

The ECB just must be thrilled
Inflation they’ve tried hard to build
Is finally growing
Though Germany’s showing
The growth impulse there has been chilled

The news from the Continent this morning would seem to be pretty good.  GDP, which rose 2.0% Q/Q in Q2 was substantially higher than the forecast 1.5%.  The growth leadership came from Spain (2.8%) and Italy (2.7%) although France (0.9%) was somewhat lackluster and Germany (1.5%) was extremely disappointing, coming in well below expectations.  At the same time, Eurozone CPI rose to 2.2% in July, above both the expected 2.0% print, and the ECB’s target rate.  Given everything we have heard from Madame Lagarde and virtually every ECB speaker over the past months, this must be quite exciting as it is a demonstration of success of their policies.  It seems that buying an additional €3.3 trillion in assets was finally sufficient to drive inflation higher.  (Well, arguably, what that did was drive up the price of virtually every commodity while government lockdowns were able to reduce productive capacity sufficiently to create massive bottlenecks in supply chains forcing prices higher.)  Nonetheless, the ECB gets to take a victory lap as they have achieved their target.

As an aside, you may recall yesterday’s data that showed German CPI rose a shockingly high 3.8%, a level at which the good people of that nation are very likely horrified.  While the Eurozone, as a whole, continues to recover pretty well, there must be a little concern that Germany is facing a period of stagflation, with subpar growth and higher prices.  Of course, this is the worst possible outcome for policymakers as the remedy for the two aspects require opposite policies and thus a choice must be made that will almost certainly result in greater pain for the economy initially.  Forty years ago, Fed Chair Paul Volcker was able to withstand the political heat when making this decision, but I fear there is not a central banker in the seat who could do so today.

Perhaps the most disappointing aspect of all this is that European equity markets are all in the red, with not a single one responding positively to the data.  Ironically, Spain’s IBEX (-1.0%) is the laggard, despite Spain’s top of the list growth.  Then comes the DAX (-0.8%) and the CAC (-0.25%).  For good measure, the FTSE 100 (-0.9%) is following suit although its GDP data won’t be published for two more weeks.  Arguably, despite this positive news, the ongoing spread of the delta variant seems to be undermining both confidence and actual activity at some level.

Of course, European markets tend to take their cues from what happens in Asia before they open, and last night was another risk-off session there with the Nikkei (-1.8%), Hang Seng (-1.35%) and Shanghai (-0.4%) all sliding.  There are two stories here, one Japanese and one Chinese.  From Japan, the issue is clearly the resurgence of Covid as the recently imposed emergency lockdown has been extended further amid a spike in daily cases to near 10K, higher than the peaks seen in both January and May of this year.  The rapid spread of the disease has policymakers there quite flustered and investors are beginning to show their concern.

China, on the other hand, assures us that they have no Covid problems, rather markets there are suffering over policy decisions.  One observation that might be made is that the government is enhancing regulations on very specific segments of the economy in order to achieve their stated goals from the most recent 5-year plan.  So, education is very clearly seen as critical, far too important for capitalism to have any influence, and I would expect that this industry sector will ultimately privatize and turn into the suggested non-profit organizations.  On the tech side, China is all about hardware type tech, and will do all they can to support companies in that space.  However, companies like Didi, AliBaba and Tencent don’t produce anything worthwhile, they simply consume resources to provide retail services, none of which lead toward Xi Jinping’s ultimate goals.  As such, they are likely to find increasing restrictions on what they do in order to reduce their influence on the economy.

And as I hinted at the other day, there appears to be growing concern that the real estate bubble that exists in China has been a key feature of their demographic problems.  Couples are less likely to have children if they cannot afford to buy a house, and the damage from China’s one-child policy will take generations to repair, although that is a key focus of the government.  As such, do not be surprised if real estate firms come under pressure with respect to things like restrictions on margins and pricing as the government tries to deflate that bubble.  This opens the possibility that yet another sector of the Chinese equity market is going to come under further pressure.  To the extent that Asian markets set the tone for the global day, that does not bode well for the near future.

Interestingly, despite a lackluster performance by the European and Asian equity markets (and US futures, which are all lower this morning), the bond markets are not exactly on fire.  While it is true that Treasury yields have slipped 2.5bps, European sovereigns are either side of unchanged today, with nothing moving more than 0.3bps in either direction.  I would have expected a bit better performance given the equity risk-off signal.

Commodity markets are generally a bit softer with oil (-0.2%) slipping a bit although it has recovered almost all of its losses from two weeks ago and sits at $73.50/bbl.  Gold, after a huge rally yesterday is unchanged this morning, while base metals are mixed (Cu -0.2%, Al +1.4%, Sn +0.15%).  Finally, ags are all softer this morning as weather conditions in key growing areas have improved lately.

Lastly, the dollar can best be described as mixed, with NOK (-0.4%) and AUD (-0.35%) the laggards amid softer oil and  commodity prices while EUR (+0.1%) and CHF (+0.1%) have both edged higher on what I would contend is the ongoing decline in real US interest rates.

Emerging market currencies have performed far better generally with TRY (+0.6%) and PHP (+0.6%) the leaders although both EEMEA and other APAC currencies have performed well.  The lira responded to the Turkish central bank raising its inflation forecast thus implying rates would remain higher there for the foreseeable future.  Meanwhile, the peso seemed to benefit from the idea that the renewed covid lockdown would reduce its balance of payments issues by reducing its trade deficit.  On the other side of the ledger was KRW (-0.3%) which continues to suffer from the uncertainty over Chinese business activity.

On the data front today, we get the Fed’s key inflation reading; Core PCE (exp 3.7%) as well as Personal Income (-0.3%), Personal Spending (0.7%), Chicago PMI (64.1) and Michigan Sentiment (80.8).  Clearly all eyes will be on the PCE number, where a higher print will likely encourage more taper talk.  However, if it is below expectations, look for a very positive market response.  We also hear from two Fed speakers, Bullard and Brainerd, the former who has turned far more hawkish and has been calling for a taper, while Ms Brainerd is not nearly ready for such action.  And in the end, Brainerd matters more than Bullard for now.

I expect the market will take its cues from the PCE data, with a higher print likely to undermine the dollar while a softer print could well see a bit of a rebound from the past several sessions’ weakness.

Good luck, good weekend 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

Christine Lagarde’s Goal

This morning, Christine Lagarde’s goal
Is focused on how to cajole
The market to see
That her ECB
Has total command and control

Ahead of the ECB statement and the subsequent press conference this morning, markets are mostly biding their time.  Monday’s risk-off session is but a hazy memory and everyone is completely back on board for the reflation trade despite rising numbers of Covid cases as well as newly imposed lockdowns by governments throughout the world.  While that may seem incongruous, apparently, the belief is that any such lockdowns will be for a much shorter period this time than we saw last year, and so the impact on economic activity will be much smaller.

With a benign backdrop, it is worthwhile, I believe, to consider what we are likely to see and hear from the ECB and how it may impact markets.  We already know that they have changed their inflation target from, “close to, but below 2.0%” to ‘2.0%’.  In addition, we have been told that there is a willingness to accept a period of time where inflation runs above their target as the ECB seeks to fine-tune both the message and the outcome.  Of course, when you think about what CPI measures, it is designed to measure the average rate of price increases for the population as a whole, the idea of fine-tuning something of this nature is ridiculous.  Add to that the extreme difficulty in measuring the data (after all, what exactly makes up the consumer basket? and how does it change over time?  and isn’t it different for literally every person?) and the fact that central banks are concerned if inflation prints at 1.7% or 2.0% is ludicrous.  As my friend @inflation_guy (you should follow him on Twitter) always explains, you cannot reject the null hypothesis that 1.7% and 2.0% are essentially the same thing in this context.  In other words, there is no difference between 2.0% inflation, where central bankers apparently feel comfortable, and 1.7% inflation, where central bankers bemoan the impending deflationary crisis.

As well, the ECB is going to explain their new asset purchase process.  Currently, there are two programs, the Public Sector Purchase Program (PSPP) which is the original QE program and had rules about adhering to the capital key and not purchasing more than 33% of the outstanding debt of any nation in order to prevent monetizing that debt.  Covid brought a second program, the Pandemic Emergency Purchase Program (PEPP), which had no such restrictions regarding what was eligible and how much of any particular nation’s bonds could be acquired but was limited in size and time.  Granted they both expanded the size of the program twice and extended its maturity, but at least they tried to make believe it was temporary.  The recent framework review is likely to allow PEPP to expire in March 2022, as currently planned, but at the same time expand the PSPP and its pace of purchases so that there will be no difference at all to the market.  In other words, though they will attempt to describe their policies as ‘new’, nothing is likely to change at all.

Finally, they apparently will be altering their forward guidance to promise interest rates will remain unchanged at current levels until inflation is forecast to reach or slightly surpass 2% and remain there for some time within the central bank’s projection period of two to three years.  Given the decades long lack of inflationary impulse in the Eurozone due to anemic underlying economic growth and ongoing high unemployment, this essentially means that the ECB will never raise rates again.  The ongoing financial repression being practiced by central banks shows no sign of abating and the ECB’s big framework adjustment will do nothing to change that outcome.

Will any of this matter?  That is debatable.  First, the market is already fully aware of all these mooted changes, so any price impact has arguably already been seen.  And second, have they really changed anything?  I would argue the answer to that is no.  While the descriptions of policies may have changed, the actions forthcoming will remain identical.  Interest rates will not move, and they will continue to purchase the same number of bonds that they are buying now.  As such, despite a lot of tongue wagging, I expect that the impact on the euro will be exactly zero.  Instead, the single currency will remain focused on the Fed’s (remember the FOMC meets next week), interest rate policy and the overall risk appetite in the market.

Turning to markets ahead of the ECB announcement we see that risk remains in vogue with strong gains in Asia (Hang Seng +1.85, Shanghai +0.35%, Nikkei closed) and Europe (DAX +0.9%, CAC +0.8%) although the FTSE 100 is barely changed on the day.  US futures are all green and higher by about 0.2% at this hour.

Bond markets have calmed down after a few very choppy days with Treasury yields backing up 1bp and now back to 1.30%, nearly 18 basis points above the low print seen Monday.  European sovereigns are mixed with Gilts seeing yields edge up by 0.8bps, while OATs have seen yields slide 0.8bps and Bunds are unchanged on the day.  Of course, with the ECB imminent, traders are waiting to see if there is any surprise forthcoming so are being cautious.

Oil prices continue their sharp rebound from Monday’s virtual collapse, rising another 0.6% and now firmly back above $70/bbl.  It turns out that Monday was a great opportunity to buy oil on the cheap!  Precious metals continue to disappoint with gold (-0.4%) slipping back below $1800/oz, although really just chopping around in a range.  Copper is firmer by 0.8% this morning but the rest of the non-ferrous group is slightly softer.

As to the dollar, it is under pressure virtually across the board this morning as there is certainly no fear visible in markets.  In the G10, NOK (+0.9%) is the leader on the back of oil’s rebound with the rest of the bloc seeing broad-based, but shallow, gains.  In the emerging markets, HUF (+0.55%) is the leader after recent comments from a central banker that they will be raising rates until their inflation goal is met.  (So old school!)  Meanwhile, overnight saw strength in APAC currencies (PHP +0.45%, IDR +0.4%, KRW +0.35%) as positive risk sentiment saw foreign inflows into the entire region’s stock markets.

We do get some data this morning starting with Initial (exp 350K) and Continuing (3.1M) Claims at 8:30 as well as Leading Indicators (0.8%) and Existing Home Sales (5.90M).  Fed speakers remain incommunicado due to the quiet period so as long as the ECB meets expectations the dollar should continue to follow its risk theme, which today is risk-on => dollar lower.

Good luck 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

How They Debase

The world’s central banks, as a whole
Have signaled they need to control
Not only the pace
Of how they debase
Their cash, but of digging for coal

Thus, now the Big 3 have explained
The policies they have ordained
Will fund, efforts, green
But not what is seen
Endorsing ‘brown’ growth unrestrained

Last night’s BOJ meeting resulted in exactly zero monetary policy surprises but did serve to confirm that the central banking community has decided to take on a task well outside their traditional purview; climate change.  While they left policy unchanged, as universally expected, they announced that they would be introducing a new funding measure targeting both green and sustainability-linked loans and bonds.  In other words, as well as purchasing JGB’s, equities and ETF’s, they are going to expand their portfolio into ESG bonds.  The interesting thing is that the universe of ESG bonds in Japan is not that large, so the BOJ is going to wind up buying non-JPY denominated assets.  In other words, they are going to be selling a bunch of newly printed yen and converting it into other currencies to achieve their new goals.  This sounds suspiciously like FX intervention, but dressed in more politically correct clothing.  The impact, however, is likely to be a bias for a somewhat weaker yen over time.  For those of you with yen assets, keep that in mind.

Meanwhile, we have already heard from both the Fed and ECB that they, too, are going to increase their focus on climate.  Here, too, one might question whether this is an appropriate use of central bank resources.  After all, it’s not as though the economy in either place is humming along with solid growth, low inflation and excellent future prospects based on strong productivity.  But hey, combatting climate change is far trendier than the boring aspects of monetary policy, like trying to address rapidly rising inflation without tightening policy and risking a crash in equity markets.

In the end, the only thing this shift in policy focus will achieve is longer-lasting inflation.  The effort to develop new and cleaner energy by starving current energy production of capital will result in higher prices for the stuff we actually use.  Over a long enough time horizon, this strategy can make sense; alas we live our lives in the here and now and need energy every day to do so.  Germany is the perfect example of what can happen when politics overrides economics. Electricity prices in Germany average $0.383 (€0.324) per kWh.  In the US, that number is $0.104 per kWh.  Ever since the Fukushima earthquake led to Germany scrapping their nuclear fleet of power reactors, the price of electricity there has more than tripled.  I fear this is in our future if monetary policymakers turn their attention away from their primary role.

Of course, higher inflation is in our future even if they don’t do this, and there is no evidence yet, at least from the Fed or ECB, that they are about to change the current monetary policy stance that is exacerbating that inflation.  However, almost daily we are seeing markets respond to data and comments from other countries that are far more concerned with the inflationary outlook.  Last week the RBNZ ended QE abruptly and indicated they may start raising rates soon.  Last night, CPI there jumped to 3.3%, the highest level since 2011 and above their target band.  It should be no surprise that NZD (+0.45%) rose after the print as did local yields as expectations for a rate hike accelerated.  In fact, I believe this is what the immediate future will look like; smaller countries with rising inflation will tighten monetary policy and their currencies will appreciate accordingly.

Turning to today’s markets, risk was under pressure overnight after a generally weak US session.  Led by the Nikkei (-1.0%), most of Asia was softer, but not all (Hang Seng 0.0%, Shanghai -0.7%, Australia +0.2%).  Europe, which had been higher on the opening has since drifted down and is now mixed with the DAX (0.0%) unchanged while the CAC (-0.5%) lags the rest of the continent and the FTSE 100 (+0.2%) has managed to hold its early gains.  US futures have also held onto small gains with all three indices up about 0.2%.

Bond markets are somewhat mixed as Treasuries (+2.5bps) sell off after yesterdays rally where yields fell 5bps.  However, European sovereigns are all in demand this morning with yield declines ranging from 1.0 to 1.8 basis points.  Commodity markets show crude slightly higher (+0.15%), gold under pressure (-0.7%) and base metals mixed (Cu -0.3%, Al +0.3%, Sn +0.7%).

In the FX markets, aside from kiwi, NOK (+0.25%) has rallied on oil’s rebound from its lows earlier this week, but the rest of the G10 is softer.  It should be no surprise JPY (-0.35%) is the worst performer, while the other currencies are simply drifting slightly lower, down in the 0.1% – 0.2% range.  In the EMG bloc, ZAR (+1.5%) is the big winner as it regains some of the ground it lost earlier in the week on the back of the rioting there.  The government has sent in the army to key hot spots to quell the unrest and so far, it seems to be working thus international investors are returning.  Otherwise, we see gains in RUB (+0.3%) and MXN (+0.3%), both of which benefit from oil and tighter monetary policy from their respective central banks.  On the downside, TWD (-0.4%) has been the worst performer in the bloc as dividend repatriation from foreign equity holders pressured the currency.  This is not a long-term issue.   Away from that, some of the CE4 are drifting lower alongside the euro but there has not been much other news of note.

On the data front this morning we see Retail Sales (exp -0.3%, +0.4% ex autos) as well as Michigan Sentiment (86.5).  After two days of Powell testimony, where he continued to maintain there would be no policy tightening and that inflation is transitory, today we hear from NY’s Williams, one of the key members of the FOMC, and someone who has remains steadfastly dovish.

The dollar’s recent strength seems to have reached its limit so I expect that we could see a bit of a pullback if for no other reason than traders who got long during the week will want to square up ahead of the weekend.

Good luck, good weekend and stay safe
Adf

T’won’t be a Disaster

The Minutes explained that the Fed

Continues, when looking ahead

To brush off inflation

And seek job creation

Though prices keep rising instead

Meanwhile, there’s a new policy





That came from Lagarde’s ECB

T’won’t be a disaster

If prices rise faster

So, nothing will stop more QE

There is no little irony in the fact that the one-two punch of the Fed and ECB reconfirming that ‘lower for longer’ remains the driving force behind central bank policy has resulted in a pretty solid risk-off session this morning.  After all, I thought ‘lower for longer’ was the driver of ongoing risk appetite.

However, that is the case, as yesterday the FOMC Minutes essentially confirmed that while there are two camps in the committee, the one that matters (Powell, Clarida, Williams and Brainerd) remain extremely dovish.  Inflation concerns are non-existent as the transitory story remains their default option, and although several members expressed they thought rates may need to rise sooner than their previous expectations, a larger group remains convinced that current policy is appropriate and necessary for them to achieve their goals of average 2% inflation and maximum employment.  Remember, they have yet to achieve the undefined ‘substantial further progress’ on the jobs front.  Funnily enough, it seems that despite 10 years of undershooting their inflation target, there are several members who believe that the past 3 months of overshooting has evened things out!  Ultimately, my take on the Minutes was that the market’s initial reaction to the meeting 3 weeks ago was misguided.  There is no hawkish tilt and QE remains the norm.  In fact, if you consider how recent data releases have pretty consistently disappointed vs. expectations, a case can be made that we have seen peak GDP growth and that we are rapidly heading back toward the recent trend levels or lower.  In that event, increased QE is more likely than tapering.

As to the ECB, the long-awaited results of their policy review will be released this morning and Madame Lagarde will regale us with her explanations of why they are adjusting policies.  It appears the first thing is a change in their inflation target to 2.0% from ‘below, but close to, 2.0%’.  In addition, they are to make clear that an overshoot of their target is not necessarily seen as a problem if it remains a short-term phenomenon.  Given that last month’s 2.0% reading was the first time they have achieved that milestone in nearly 3 years, there is certainly no indication that the ECB will be backing off their QE programs either.  As of June, the ECB balance sheet, at €7.9 trillion, has risen to 67.7% of Eurozone GDP.  This is far higher than the Fed’s 37.0% although well behind the BOJ’s 131.6% level.  Perhaps the ECB has the BOJ’s ratio in mind as a target!

Adding up the new policy information results in a situation where…nothing has changed.  Easy money remains the default option and, if anything, we are merely likely to hear that as central banks begin to try to tackle issues far outside their purview and capabilities (climate change and diversity to name but two) there is no end in sight for the current policy mix. [This is not to say that those issues are unimportant, just that central banks do not have the tools to address them.]

But here we are this morning, after the two major central bank players have reiterated their stance that no policy changes are imminent, or if anything, that current ultra-easy monetary policy is here to stay, and risk is getting tossed aside aggressively.

For instance, equity markets around the world have been under significant pressure.  Last night saw the Nikkei (-0.9%), Hang Seng (-2.9%) and Shanghai (-0.8%) all fall pretty substantially.  While the Japanese story appears linked to the latest government lockdowns imposed, the other two markets seem to be suffering from some of the recent actions by the PBOC and CCP, where they are cracking down on international equity listings as well as the ongoing crackdown on freedom in HK.  European bourses are uniformly awful this morning with the DAX (-1.7%) actually the best performer as we see the CAC (-2.25%) and FTSE 100 (-1.9%) sinking even further.  Even worse off are Italy (-2.7%) and Spain (-2.6%) as investors have weighed the new information and seemingly decided that all is not right with the world.  As there has been no new data to drive markets, this morning appears to be a negative vote on the Fed and ECB.  Just to be clear, US futures are down uniformly by 1.4% at this hour, so the risk-off attitude is global.

Turning to the bond market, it should be no surprise that with risk being jettisoned, bonds are in high demand.  Treasury yields have fallen 6.5bps this morning, taking the move since Friday to 21bps with the 10-year now yielding 1.25%, its lowest level since February.  Is this really a vote for transitory inflation?  Or is this a vote for assets with some perceived safety? My money is on the latter.  European sovereigns are also rallying with Bunds (-4.1bps), OATs (-2.7bps) and Gilts (-4.8bps) all putting in strong performances.  The laggards here this morning are the PIGS, where yields are barely changed.

In the commodity space, yesterday saw a massive reversal in oil prices, with the early morning 2% rally completely undone and WTI finishing lower by 1.7% on the day (3.6% from the peak).  This morning, we are lower by a further 0.4% as commodity traders are feeling the risk-off feelings as well.  Base metals, too, are weak (Cu -1.75%, Al -0.3%, Sn -0.4%) but gold (+0.7%) is looking quite good as real yields tumble.

As to the dollar, in the G10 space, commodity currencies are falling sharply (NZD -0.75%, AUD -0.7%, CAD -0.6%, NOK -0.6%) while havens are rallying (CHF +0.9%, JPY +0.8%).  The euro (+0.45%) is firmer as well, which given the remarkable slide in USD yields seems long overdue.

Emerging market currencies are seeing similar behavior with the commodity bloc (MXN -0.75%, RUB -0.5%) sliding along with a number of APAC currencies (THB -0.65%, KRW -0.6%, MYR -0.5%).  It seems that Covid is making a serious resurgence in Asia and that has been reflected in these currencies.  On the plus side, the CE4 are all firmer this morning as they simply track the euro’s performance on the day.

On the data front, our last numbers for the week come from Initial (exp 350K) and Continuing (3.35M) Claims at 8:30 this morning.  Arguably, these numbers should be amongst the most important given the Fed’s focus on the job situation.  However, given the broad risk off sentiment so far, I expect sentiment will dominate any data.  There are no further Fed speakers scheduled this week, which means that the FX markets are likely to take their cues from equities and bonds.  Perhaps the correlation between yields and the dollar will start to reassert itself, which means if the bond market rally continues, the dollar has further to decline, at least against more haven type currencies.  But if risk continues to be anathema to investors, I expect the EMG bloc to suffer more than the dollar.

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

Out of Gas

Though prices are forecast to rise
The Treasury market implies
That Jay has it right
And this is the height
Inflation will reach at its highs

Instead, once the base effects pass
Inflation will run out of gas
So there is no need
For Powell to heed
The calls to halt QE en masse

This morning we finally get to learn about two of the three potential market catalysts I outlined on Monday, as the ECB announces their policy decision at 7:45 EDT with Madame Lagarde speaking at a press conference 45 minutes later.  And, as it happens, at 8:30 EDT we will also see the May CPI data (exp 0.5% M/M, 4.7% Y/Y headline; 0.5% M/M, 3.5% Y/Y ex food & energy).  Obviously, these CPI prints are far higher than the Fed target of an average of 2.0% over time, but as we have been repeatedly assured, these price rises are transitory and due entirely to base effects therefore there is no need for investors, or anybody for that matter, to fret.

And yet…one cannot help but notice the rising prices that we encounter on a daily basis and wonder what the Fed, and just as importantly, the bond market, is thinking.  Perhaps the most remarkable aspect of the current inflation discussion is that despite an enormous amount of discussion on the topic, and anecdotes galore about rising prices, the one market that would seem to be most likely to respond to these pressures, the Treasury market, has traded in exactly the opposite direction expected.  Yesterday, after a very strong 10-year auction, where the coverage ratio was 2.58 and the yield fell below 1.50%, it has become clear that bond investors have completely bought into the Fed’s transitory story.  All of the angst over the massive increases in fiscal spending and huge growth in the money supply have not made a dent in the view that inflation is dead.

Recall that as Q1 ended, 10-year yields were up to 1.75% and forecasters were falling all over themselves to revise their year-end expectations higher with many deciding on the 2.25%-2.50% area as a likely level for 10-year yields come December.  The economy was reopening rapidly and expectations for faster growth were widespread.  The funny thing is that those growth expectations remain intact, yet suddenly bond investors no longer seem to believe that growth will increase price pressures.  Last week’s mildly disappointing NFP report is a key reason as it was the second consecutive report that indicated there is still a huge amount of labor slack in the economy and as long as that remains the case, wage rises ought to remain capped.  The counter to that argument is the heavy hand of government, which is both increasing the minimum wage and paying excessive unemployment benefits thus forcing private companies to raise wages to lure workers back to the job.  In effect, the government, with these two policies, has artificially tightened the labor market and historically, tight labor markets have led to higher overall inflation.

The last bastion of the inflationists’ views is that the recent rally in Treasuries has been driven by short-covering and that has basically been completed thus opening the way for sellers to reemerge.  And while I’m sure that has been part of the process, my take, also anecdotal, is that fixed income investors truly believe the Fed at this time, despite the Fed’s extraordinarily poor track record when it comes to forecasting literally anything.  

As an example, two weeks ago, I was playing golf with a new member of my golf club who happened to be a portfolio manager for a major insurance company.  We spent 18 holes discussing the inflation/deflation issue and he was 100% convinced that inflation is not a problem.  More importantly, he indicated his portfolio is positioned for that to be the case and implied that was the house view so his was not the only portfolio so positioned.  This helps explain why Treasury yields are at 1.49%, 25 basis points lower than on April 1.  However, it also means that while today’s data, whatever it is, will not be conclusive to the argument, as the summer progresses and we get into autumn, any sense that the inflation rate is not heading back toward 2.0% will likely have major market consequences.  Stay tuned.

As to the ECB, it seems highly unlikely that they will announce any policy changes this morning with the key issue being their discussion of the pace of QE purchases.  You may recall that at the April meeting, the key words were, “the Governing Council expects purchases under PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year.”  In other words, they stepped up the pace of QE to roughly €20 billion per week, from what had been less than €14 billion prior to that meeting.  While the data from Europe has improved since then, and reopening from pandemic induced restrictions is expanding, it would be shocking if they were to change their view this quickly.  Rather, expectations are for no policy change and no change in the rate of QE purchases for at least another quarter.  The inflationary impulse in the Eurozone remains far lower than in the US and even though they finally got headline CPI to touch 2.0% last month, there is no worry it will run away higher.  Remember, too, there is no way the ECB can countenance a stronger euro as it would both impair its export competitiveness as well as import deflation.  As long as the Fed continues to buy bonds at the current rate you can expect the ECB to do the same.

In the end, we can only wait and see what occurs.  Until then, a brief recap of markets shows that things have continued to trade in tight ranges as investors worldwide await this morning’s news.  Equity markets in Asia were very modestly higher (Nikkei +0.3%, Shanghai +0.5%, Hang Seng 0.0%) and in Europe the movement has been even less pronounced (DAX +0.1%, CAC -0.1%, FTSE 100 +0.3%).  US futures are mixed as well with the three major indices within 0.2% of closing levels.

Bond markets, after a strong rally yesterday, have seen a bit of profit taking with Treasury yields edging higher by 0.8bps while Europe (Bunds +1.0bps, OATs +1.6bps, Gilts +0.7bps) have moved up a touch more.  But this is trader position adjustments ahead of the news, not investors making wholesale portfolio changes.

Commodity markets are mixed with crude oil (+0.1%) barely higher while precious metals (Au -0.5%, Ag -0.4%) are under a bit of pressure.  Base metals, however, are seeing more selling pressure (Cu -1.5%, Al -0.2%, Sn -0.7%) while foodstuffs are mixed as wheat is lower though corn and soybeans have edged higher.

Finally, in the FX market, the G10 is generally mixed with very modest movement except for one currency, NOK (-0.5%) which has fallen sharply after CPI data came out much lower than expected thus relieving pressure on the Norgesbank to tighten policy anytime soon.  In the EMG bloc, ZAR (+0.6%) is the leading gainer after its C/A surplus was released at a much stronger than expected 5.0% indicating finances in the country are improving.  But away from that, things have been much less exciting as markets await today’s data and ECB statements.

In addition to the CPI data this morning, as it is Thursday, we will see Initial Claims (exp 370K) and Continuing Claims (3.65M).  Interestingly, those may be more important data points as the Fed is clearly far more focused on employment than on inflation.  But they will not be sensational, so will not get the press.  FWIW my money is on a higher than expected CPI print, 5.0% or more with nearly 4.0% ex food & energy.  However, even if I am correct, it is not clear how big a market impact it will have beyond a very short-term response.  In the end, if Treasury yields continue to fall, I believe the dollar will follow.

Good luck and stay safe
Adf


 


No Aberration

In Europe and in the US

The central banks have made a mess

The latter’s seen prices

Rise up to a crisis

The former is still in distress

But one thing the two of them share

Is neither believes in the scare

That higher inflation

Is no aberration

And tapering they’ll soon declare

We have seen another day of modest overnight activity as market participants across asset classes wait for the next key data inputs.  At this point, the three biggest things on the horizon are Thursday’s ECB meeting and US CPI print and then next Wednesday’s FOMC meeting.  Until those data points are known, tight ranges and lack of trading liquidity are likely to be the hallmarks of all markets.

One of the things that has been something of a mystery is the disconnect between the performance of the US Treasury market and the ostensibly rapid rise in inflationary pressures, with the former essentially discounting the latter completely.  In fact, I would argue this is the key question that must be answered in order to better understand the potential future outcomes.  Arguably, it is also this situation which has allowed the Fed to remain sanguine over the recent jumps in CPI and PCE.

Consider that the bond market is generally assumed to have the greatest sensitivity to future economic activity given its very nature.  After all, the meaning of fixed income is that regardless of future economic performance, bondholders get a stated amount of interest.  It is this feature that keeps bond investors so highly attuned to inflation and inflation expectations as these investors want to ensure the real value of their investments does not decline due to rising prices.  Historically, this has certainly been the case, with bond markets selling off before inflation really took off.  This is also the genesis of the term ‘bond vigilantes’, coined during the Clinton administration to describe the bond market’s unwillingness to fund hugely expansionary fiscal plans and run large government deficits.  My, how the world has changed!

But back then, the Federal Reserve was not in the business of QE.  In fact, while it may have been a theoretical concept, even the Japanese had not yet tried it on for size.  Two plus decades later, though, the role of the Fed has clearly changed given the economic stresses suffered in both the GFC and Covid induced crisis.  QE has gone from an emergency tool to address a unique situation to the go-to tool in the Fed’s (and ECB’s) toolkit.  Thus, have grown the central bank balance sheets and so there has been a lid on interest rates, even if not explicitly via yield curve control.

There is, however, another key change in the world since the bond vigilante days of the late 1990’s; the regulatory requirements for large banks known as GSIBs, (Global Systemically Important Banks) imposed after the GFC.  These 30 institutions are required to maintain additional capital buffers and hold them in so-called High-Quality Liquid Assets (HQLA) which, not surprisingly, include Treasury bonds as well as mortgages and excess reserves.  One of the things that all of these banks do is adjust that portfolio of HQLA to maximize the available revenue, which in a world where yields are zero and negative, is very hard to achieve.  While Treasury bills and IOER pay virtually nothing, Treasury securities out the curve do have positive nominal yields and are thus relatively attractive for the purpose.

This leads to a potential alternative reason for the seeming lack of concern by the Treasury market over future inflation; price insensitive demand for bonds required to be held by large banks.  If these banks are buying and holding more Treasuries than they otherwise would have done in an unfettered world, the price signal from those bonds is likely to be somewhat skewed.  In other words, what if the Treasury market is not telling us there is no fear of inflation, but rather telling us that there are so many price insensitive buyers of bonds, even the excess supply being issued is not enough to scare holders out of the market.  In that case, we will need to get our clues about inflation elsewhere, perhaps from commodity markets.  And of course, commodity prices have done nothing but rally sharply across every class for the past year.  While there is no doubt that the first part of that move was to make up for the severe price dislocations seen at the beginning of the Covid crisis, it is not hard to make the case that the more recent price movement is a response to rising demand meeting inelastic supply.  It is the latter that drives inflation.

The point here is that both the ECB and Fed have consistently maintained that there is no reason to worry over recent high inflation prints and that there is no reason for either of them to adjust their policy mix anytime soon.  If the bond market ‘meter’ is malfunctioning, though, both of these central banks may well find themselves on the wrong side of history, yet again.  Rapidly rising inflation could well come to dominate the policy discussion quite quickly in that case, and maximum employment may recede to a pleasant dream.  Food for thought.

As to market activity today, as mentioned above, we have seen modest movements in both directions amid modest trading volumes.  Starting with equities, Asia saw small losses across the board (Nikkei -0.2%, Hang Seng 0.0%, Shanghai -0.5%) while Europe has been very modestly firmer (DAX 0.0%, CAC +0.2%, FTSE 100 +0.3%).  US futures are mixed as well with DOW (-0.15%) suffering while NASDAQ (+0.3%) are a bit higher and SPX futures are essentially unchanged.  Not much new information here.

Bond markets are mostly a bit firmer this morning with Treasury yields (-1.5bps) falling furthest and European sovereigns all seeing yield declines of about 0.75bps.  With 10-year Treasury yields back to 1.55%, it appears, on the surface, that there is no concern about rising inflation.  But if my proposed thesis is correct, that number could be quite misleading.

Commodity prices are generally coming under pressure this morning, certainly not a sign of imminent inflation, but I would argue this is simple daily price volatility more than anything else.  For example, oil (-0.9%) is leading the pack lower but we are seeing weakness in precious metals (Au -0.2%, Ag -0.5%) and base metals (Cu -0.5%, Ni -0.7%, Fe -1.9%) with only grains continuing to rally as all three major ones are higher by about 1.0% this morning.

Turning to FX, it should be no surprise that there is really no story here this morning either.  The dollar is probably marginally higher overall, but really mostly mixed with small movements in virtually all currencies.  In the G10, NZD (-0.3%) is the biggest mover, but this move has simply taken it back to the middle of its trading range.  And the rest of the bloc has moved far less.  In emerging markets, we have seen two movements of some note with HUF (-0.4%) declining after weaker than expected IP data was released, putting a dent in the idea the central bank may tighten policy, while RUB (+0.4%) rose after yesterday’s higher than expected CPI print has traders believing the central bank is likely to raise rates further.  However, beyond those two moves, there is very little to discuss.

On the data front, the NFIB Small Business Optimism index was released at a disappointing 99.6, below expectations of 101.0 and actually below last month’s reading as well.  That seems to be a result of the difficulty small firms are having in hiring staff.  We also see the Trade Balance (exp -$68.7B) and then the JOLTS Job Openings report (8.2M) later this morning.  But as mentioned at the top, I don’t think anything will matter until Thursday, so look for more range trading until then.

Good luck and stay safe

Adf

A ZIRP Doctrinaire

The lady who once ran the Fed

And, Treasury, now runs instead

Explained higher rates

Right here in the States

Are something that she wouldn’t dread

But when she was Fed Reserve chair

And she had a chance to forswear

That rates should stay low

Her answer was, no

As she was a ZIRP doctrinaire

“If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view.  We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade.  We want them to go back to a normal interest rate environment, and if this helps a little bit to alleviate things then that’s not a bad thing, that’s a good thing.”  So said Treasury Secretary Janet Yellen in a Bloomberg News interview as she was returning from the G7 FinMin meeting in London.

What are we to make of these comments?  Arguably, the first thing to note is that the myth of Fed independence is not merely shattered, but rather that the Treasury now explicitly runs both fiscal and monetary policy.  Can Chairman Powell resist a call for higher rates from his boss?  And yet this is diametrically opposed to everything we have heard from the majority of the FOMC lately, namely until “substantial further progress” is made toward achieving their key goal of maximum employment, policy is going to remain as is.  In other words, they are going to continue to buy $120 billion per month of Treasury and mortgage backed paper.  However, QE’s entire raison d’etre is to keep rates lower.  Does this mean tapering is going to begin soon?  Will they be talking about it at next week’s FOMC meeting?  Again, based on all we had heard up through the beginning of the quiet period, there was only a small minority of FOMC members who were keen to slow down the purchases.  Is Yellen a majority of one by herself?

The other thing that seems odd about this is that elsewhere in the interview she strongly backed the need for the proposed $4 trillion of additional government spending, which is going to largely be funded by issuing yet more Treasury debt.  I fail to understand the benefit, for the Treasury (or taxpayers) of spending more on debt service due to higher interest rates.  Or perhaps, Yellen was simply saying she thought spreads over Treasuries should rise, so others paid more, but the US still paid the least amount possible.  Somehow, though, I don’t believe the latter sentiment is what she meant.  (A cynic might assume she was short Treasuries in her PA after Friday’s data and was simply looking for a quick profit.  But, of course, no government official would ever seek to gain personally from their official role…right?)

Regardless of her motivation, the market took it to heart and 10-year Treasury yields have backed up 2.5 bps this morning, although that is after Friday’s very strong rally (yields fell more than 7 basis points) on the back of the weaker than expected NFP report convinced the market that tapering was now put off for much longer.

Which brings us to Friday’s data.  Once again, the NFP report missed the mark, with a gain of 559K, well below the 675K expected.  Interestingly, despite last month’s even bigger miss, revisions were miniscule, just 27K higher.  So, at least according to the BLS, job growth is not nearly as fast as previously expected/hoped.  What makes this so interesting was last week’s ADP data showed nearly 1 million new jobs were taken.  It appears that Covid has had a significant impact on econometric models as well as the economy writ large.  Of course, the stock market took this goldilocks scenario as quite bullish and we saw equity markets rally nicely on Friday.

In sum, Yellen’s comments seem a bit out of step with everything we had previously understood.  There is, though, one other possibility.  Perhaps Ms Yellen understands that inflation is not going to be transitory and that the Fed may well find itself forced to raise rates to address this situation.  If this is the case, then the fact that the Treasury Secretary has already explained she thinks higher rates would be “a good thing,” it leaves the Fed the leeway needed to address the coming inflationary wave.  One thing is certain, the inflation discussion is going to be with us for quite a while yet.

Market activity overnight has been fairly dull despite the Yellen comments, with equity markets mixed in Asia (Nikkei +0.3%, Hang Seng -0.45%, Shanghai +0.2%) although European markets have started to climb after a very slow start (DAX +0.2%, CAC +0.3%, FTSE 100 +0.3%).  US futures are mixed to slightly lower as NASDAQ futures (-0.35%) feel the force of potentially higher interest rates, while the other two indices are little changed.  (Remember, tech/growth stocks are akin to having extremely long bond duration, so higher interest rates tend to push these stocks lower.)

As mentioned, Yellen’s comments have led to Treasuries falling, and we have seen the same behavior in Europe with sovereigns there looking at yields higher by between 1.5 and 2.0 bps at this hour.  Higher interest rates have also had a negative impact on commodity prices with oil (-0.4%), gold (-0.25%), copper (-1.0%) and aluminum (-1.0%) all under pressure.  The one exception in the commodity space is foodstuff where the grains are all higher by at least 1.5% this morning.

Finally, the currency market is mixed although arguably leaning toward slight dollar weakness.  In the G10, the most notable mover is NOK (+0.5%) which is gaining despite oil’s weakness on the assumption that it will be the first G10 country to actually raise interest rates, with Q4 this year now targeted.  But away from that, the other 9 currencies are within 0.2% of Friday’s close with no stories of note.  In the emerging markets, MXN (+0.85%) is the runaway leader after yesterday’s elections handed AMLO a loss of his supermajority in the Mexican congress.  It seems investors are glad to see a check on his populist agenda of spending.  Beyond that, we see TRY (+0.5%) benefitting from hopes that President Biden’s meeting with Turkish President Erdogan will result in reduced tensions between the two countries.  And lastly, KRW (+0.3%) continues to see investment inflows drive the currency higher.

On the data front, there was nothing of note overnight, but this week has some important activities, namely US CPI and the ECB meeting.

Tuesday NFIB Small Biz Optimism 100.9
Trade Balance -$68.5B
JOLTS Job Openings 8.3M
Thursday ECB Meeting
CPI 0.4% (4.7% Y/Y)
-ex food & energy 0.4% (3.4% Y/Y)
Initial Claims 370K
Continuing Claims 3.7M
Friday Michigan Sentiment 84.2

Source: Bloomberg

Clearly, all eyes will be on CPI later this week as while widely expected to be rising again due to base effects, it is important to remember that it has risen far faster than even those expectations.  While the Fed remains quiet, the ECB is likely to reiterate that it is going to be keeping a ‘stepped up pace’ of asset purchases.  Although there is a great deal of belief in the dollar weakness story, I assure you, the ECB is not interested in the euro rallying much further.  Just like the Chinese, it appears most countries have had enough of a weak dollar.  Until the next cues, however, it seems unlikely that there will be large movement in the FX market.

Good luck and stay safe

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