An Untimely End

Should risk appetite ever fall
The asset price rally could stall
And that could portend
An untimely end
To trust in the Fed overall

Yesterday afternoon the Fed released their annual financial stability report.  In what may well be the most unintended ironic statement of all time, on the topic of asset valuations the report stated, “However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.” [Author’s emphasis.]  Essentially, the Fed seems to be trying to imply that for some reason, having nothing to do with their policy framework, asset prices have risen and now they are in a vulnerable place.  But for the fact that this is very serious, it is extraordinary that they could make such a disingenuous statement.  The reason asset prices are elevated is SOLELY BECAUSE THE FED CONTINUES TO PURCHASE TREASURIES VIA QE AND FORCE INVESTORS OUT THE RISK CURVE TO SEEK RETURN.  This is the design of QE, it is the portfolio rebalance channel that Ben Bernanke described a decade ago, and now they have the unmitigated gall to try to describe the direct outcome of their actions as some exogenous phenomenon.  If you wondered why the Fed, and truly most central banks, are subject to so much criticism, you need look no further than this.

In Europe, a little-known voice
From Latvia outlined a choice
The ECB may
Decide on one day
In June, and then hawks will rejoice

In a bit of a surprise, this morning Latvian central bank president, and ECB Governing Council member, Martins Kazaks, explained that the ECB could decide as early as their June meeting to begin to scale back PEPP purchases.  His view was that given the strengthening rebound in the economy as well as the significant progress being made with respect to vaccinations of the European population, overall financial conditions may remain favorable enough so they can start to taper their purchases.  This would then be the third major central bank that is on the taper trail with Canada already reducing purchases and the BOE slowing the rate of weekly purchases, although maintaining, for now, the full target.

This is a sharp contrast to the Fed, where other than Dallas Fed president Kaplan, who is becoming almost frantic in his insistence that it is time for the Fed to begin discussing the tapering of asset purchases, essentially every other FOMC member is adhering to the line that the US economy needs more monetary support and any inflation will merely be transitory.  As if to reaffirm this view, erstwhile uber-hawk Loretta Mester, once again yesterday explained that any inflation was of no concern due to its likely temporary nature, and that the Fed has a long way to go to achieve its new mission of maximum employment.

A quick look at the Treasury market this morning, and over the past several sessions, shows that the 10-year yield (currently 1.577%, +0.7bps on the day) seems to have found a new equilibrium.  Essentially, it has remained between 1.54% and 1.63% for about the last month despite the fact that virtually every data release over that timespan has been better than expected.  Thus, despite a powerful growth impulse, yields are not following along.  It is almost as if the market is beginning to price in YCC, which is, of course, exactly the opposite of tapering.  Given the concerns reflected in the Financial Stability Report, maybe the only way to prevent that asset price decline would be to cap yields and let inflation fly.  History has shown bond investors tend to be pretty savvy in these situations, so do not ignore this, especially because YCC would most likely result in a sharply weaker dollar and sharply higher commodity and equity prices.

This morning the market will see
The labor report, NFP
Expecting one mill
The Fed’s likely, still,
To say they’ll continue QE

Finally, it is payroll day with the following current expectations according to Bloomberg:

Nonfarm Payrolls 1000K
Private Payrolls 938K
Manufacturing Payrolls 57K
Unemployment Rate 5.8%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%

The range of forecasts for the headline number is extremely wide, from 700K to 2.1 million, just showing how little certainty exists with respect to econometric models more than a year removed from the initial impact of Covid-induced shutdowns.  As well, remember, even if we get 1 million new jobs, based on Chairman Powell’s goal of finding 10 million, as he stated back in January, there are still another 7+ million to find, meaning the Fed seems unlikely to respond to the report in any manner other than maintaining current policy.  In fact, it seems to me the bigger risk today is a disappointing number which would encourage the Fed to double down!  We shall learn more at 8:30.

As to markets ahead of the release, Asian equities were mixed (Nikkei +0.1%, Hang Seng -0.1%, Shanghai -0.65%) although Europe is going gangbusters led by Germany’s DAX (+1.3%), with the CAC (+0.3%) and FTSE 100 (+0.8%) also having good days.  German IP data (+2.5% M/M) was released better than expected and has clearly been a catalyst for good.  At the same time, French IP (+0.8% M/M) was softer than expected, arguably weighing on the CAC.

Away from Treasuries, European sovereign bonds are all selling off as risk appetite grows, or so it seems.  Bunds (+1.0bps) and OATs (+2.8bps) are feeling pressure, although not as much as Italian BTPs (+4.8bps).  Gilts, on the other hand, are little changed on the day.

Commodity prices continue to rally sharply, at least in the metals space, with gold (+0.3%, +1.5% yesterday), silver (+0.1%, +3.5% yesterday), copper (+2.6%), aluminum (+1.0%) and nickel (+0.2%) all pushing higher.  Interestingly, oil prices are essentially unchanged on the day.

Lastly the dollar is mixed on the session, at least vs. the G10.  SEK (+0.35%) is the leading gainer on what appears to be positive risk appetite, while NZD (-0.25%) is the laggard after inflation expectations rose to a 3-year high.  The other eight are all within that range and split pretty evenly as to gainers and losers.

EMG currencies, though, are showing more positivity with only two small losers (ZAR -0.25%, PLN -0.15%) and the rest of the bloc firmer.  APAC currencies are leading (KRW +0.4%, INR +0.35%, TWD +0.3%) with all of them benefitting from much stronger than forecast Chinese data. We saw Caixin PMI Services rise to 56.3 and their trade balance expand to $42.85B amid large growth in both exports and imports.  Models now point to Chinese GDP growing at 9.0% in 2021 after these releases.

At this point, we are all in thrall to the NFP release later this morning.  The dollar response is unclear to me, although I feel like a strong number may be met with a falling dollar unless Treasury yields start to climb.  Given their recent inability to do so, I continue to believe that is the key market signal to watch.

Good luck, good weekend and stay safe
Adf

So Slyly

The stock market’s feeling some pains
As word is that capital gains
Will soon be taxed highly
As Biden, so slyly
Pays tribute to John Maynard Keynes

It can be no surprise that the Biden administration has begun to float trial balloons regarding higher tax rates as they were a key plank in Biden’s presidential campaign.  Given the remarkable amount of money that this administration seems to want to spend, there needs to be some additional revenue to help pay for things, although the gap between the spending plans and forecast revenue enhancements remains extremely wide.  For instance, while the mooted price tag for the American Jobs Plan, the latest proposal, is on the order of $2.3 trillion, the estimated revenues of the capital gains tax rise is somewhere in the $500 billion to $1 trillion zone.  That’s still a pretty big gap that needs to be filled.  Of course, we know that the Treasury will simply borrow the difference, and based on current form, the Fed will buy most of that.  Who knows, maybe MMT really does work, and everything will work out fine.

Investors, though, seeing the world through a slightly different prism than policymakers, may decide that while the extraordinary equity market rally has been lots of fun, it might be time to take some money off the table.  When the first headlines about a doubling of capital gains taxes hit the tape, US markets fell about 1.3% and finished lower on the day.  Now, we are still a long way from those tax laws being enacted, but do not be surprised if equity markets have more difficulty making new highs going forward.  After all, if the government is going to tax away your gains, the risk/reward equation will change for the worse.  (While on the subject of taxes, there was a rumor that the Treasury was talking about 70% marginal tax rates on Bitcoin and other cryptocurrency gains.  It should be no surprise they suffered as well.)

Attempting, us all, to assure
Lagarde said, t’would be “premature”
To taper our buying
Since we are still trying
To help the recovery endure

Yesterday’s other big story was the ECB meeting where, while policies were left unchanged as expected, there was a great deal of anticipation that Madame Lagarde might offer some hints as to the structural reforms due to be announced in June, or even give a bit more guidance on the current situation within the PEPP.  Alas, the information quotient from this meeting was pretty limited.  Lagarde insisted that increased buying in the PEPP, which was a key outcome from the March meeting, would remain in place, although the pace of purchases does not seem to have increased all that much.  Yet when asked directly about the probability of tapering those purchases, Lagarde was adamant that it was “simply premature” to discuss that subject.

What is becoming apparent at the ECB is that there is a growing divide between the hawks and doves regarding how policy should evolve.  The Frugal four are clearly seeing improved economic activity and the beginnings of rising prices while the more profligate southern countries continue to lag in both economic activity and rate of vaccinations.  It is becoming clear that a single monetary policy is no longer going to be efficient for both groups of countries simultaneously.  When Super Mario was ECB President, he simply ran roughshod over the hawks, but then he had the policy chops to do so on his own.  It remains to be seen if Madame Lagarde will have the same ability.  The upshot is that we could be looking at some more volatility in Eurozone markets if the hawks start speaking in concert and do not back Lagarde.  We shall see.

Away from those stories, though, the market this morning is ostensibly focused on the better than expected PMI data that we have seen around the world.  Starting with Australia last night, and on to Japan and most of Europe and the UK, the big gainer was Services PMI, which is back above 50 everywhere except Japan, which printed at 48.3.  But Australia, the Eurozone and the UK are all back in expansionary territory as anticipation of the great reopening takes hold.  In this regard, the Japanese data makes sense as the nation is about to impose lockdowns again for the next two weeks in Tokyo, Kyoto and two other prefectures, closing bars and restaurants and banning public gatherings.

In addition to the PMI data, UK Retail Sales was quite strong, rising 4.9% M/M ex fuel, as were Japanese Department Store Sales (+21.8%).  With all of this positive data, it can be no surprise that the dollar is under pressure this morning, but it is a bit surprising that equity markets in Europe are under pressure (DAX -0.3%, CAC -0.2%, FTSE 100 -0.4%) and sovereign bond yields are softer (Bunds -1.3bps, OATs -1.2bps, Gilts -0.7bps).  While buy the rumor, sell the news is always a viable thought process, it strikes me that there were no rumors of this type of economic strength.

Finishing the market recap, commodities are firmer (WTI +0.5%, Au +0.1%, Cu +0.8%), which syncs well with the dollar’s weakness.  In the G10 space, the dollar is softer versus the entire spectrum of currencies, with EUR (+0.3%) and GBP (+0.3%) leading the way while JPY (+0.1%) is the laggard today.  In the EMG space, RUB (+0.6%) is the leading gainer after the Bank of Russia raised their base rate by 0.50% to 5.00% in a surprise as only 25bps was expected.  Away from that, the CE4 are all following the euro higher and then commodity currencies are also edging higher, but by much lesser amounts (ZAR +0.2%, MXN +0.2%).  There are a few decliners here, TRY (-0.2%), INR (-0.1%) but the size of the move is indicative of the lack of general interest.  Certainly, both those nations have been suffering more significantly with Covid lately, and it would not be a surprise to see both currencies continue to lag until that situation changes.

On the data front this morning, New Home Sales (exp 885K) is the major number, although preliminary PMI data (61.0 Mfg, 61.5 Services) is also due.  In the US, though, there is far more focus on ISM than PMI.  With the Fed coming up next week, there is no Fedspeak to be had, so as we head into the weekend, it is reasonable to expect a quiet session.  Equity futures are currently slightly in the green, roughly 0.15%, so perhaps the gut reaction to the tax news has passed and won’t have an impact.  But the one thing of which we can be certain appears to be that higher taxes are on the way.  That is a double whammy for equities as higher corporate tax rates will reduce earnings while higher cap gains taxes will encourage selling before those taxes come into effect.

In the end, though, nothing has changed the underlying market driver, the 10-year Treasury.  If yields there continue to slide, the dollar will remain weak across the board.  If they reverse, look for the dollar to rebound.  Next week, after the Fed, we see Core PCE data on Friday.  Currently, that is forecast to rise 1.8%.  a high side surprise there could well shake things up with regard to views on tapering with a corresponding impact on all markets.  But until the Fed on Wednesday, it seems we are in for some slow times.

Good luck, good weekend and stay safe
Adf

Powell Won’t Waver

The story last quarter was prices
Would rise, leading up to a crisis
So, bond markets dropped
The dollar, she popped
And gold bugs all made sacrifices

But now a new narrative line
Explains that inflation’s benign
So, bonds are in favor
As Powell won’t waver
While dollars resume their decline

All year long the market story has been driven by the yield on the 10-year Treasury bond.  Ever since the run-off elections in Georgia in the beginning of January, market anticipation has been for significant growth in the US on the heels of increased vaccination rates and increased fiscal stimulus.  In Q1, Treasury yields rose dramatically, touching as high as 1.77% at their top toward the end of March.  Meanwhile, the dollar, which had been slated to decline all year, rallied versus every emerging market currency and all but CAD, GBP and NOK in the G10.

But, as of the first of this month, the world appears to be a different place, as Treasury bonds have rallied driving yields lower and supporting equity and commodity markets.  At the same time, the dollar has come under broad-based pressure and reversed a large portion of its Q1 gains.

Currently, the narrative appears to be along the following lines: US GDP growth in 2021 is going to be spectacular, well above 6.0% and its strongest since 1984.  Inflation, meanwhile, will print at higher levels for Q2 purely as a result of base effects, but will then resume its long-term downtrend and the Fed will be required to continue to support the economy aggressively in order to meet their goals.  By the way, the Fed’s newly articulated goal is for maximum employment, not full employment, and they have promised to become completely reactive, waiting for hard data to confirm positive results in employment and wages, before considering any efforts to rein in rising prices.

Equity markets still love the story as the implication is that interest rates will not be rising at all this year, nor next year for that matter, at least in the front end of the curve.  Treasury markets, which appeared to get a little panicked in Q1 have reverted to form and seem to be pricing one of two things; either less impressive economic growth, or anticipation that the Fed will expand QE or YCC as Powell and friends seek to prevent any significant rise in yields.  Meanwhile, the dollar is falling again, gold is rising and commodity prices (the one true constant) remain firm.

Have we reached economic nirvana?  Some skepticism might be in order given the myriad issues that can undermine this narrative.  The primary issue is, of course, another wave of Covid spreading throughout the US and the world.  As the virus mutates, it is not clear that the current vaccines are going to be effective preventatives to new strains.  While the vaccination progress in the US and UK has been excellent, with 40% and 50% of their respective populations receiving at least the first dose, the same cannot be said elsewhere in the world.  In fact, the newsworthy item of the day is that India reported 315,800 new cases just yesterday!  Alongside Brazil and Turkey, these three nations, with a combined population of nearly 1.7 billion find themselves in the midst of another serious wave of infection.  Remember that a huge part of the reopening and growth narrative is the ending of the pandemic.  It is still too early to make that claim, and so, perhaps a bit early to count the 2021 GDP growth figures as a given.

However, there is a second issue of note that cannot be ignored, and that is the inflation story.  While it is clear that the Fed has convinced themselves inflation is not a concern, that the elevated readings that are almost certain to come over the next three months will be ‘transitory’, there is a case to be made that rising inflation may have a more lasting impact.

Consider that oil prices have risen dramatically from their levels this time last year and continue to trend higher.  Now, while the Fed looks at core prices, ex food & energy, the reality is that rising energy prices feed into everyday items beyond the cost of filling your gas tank.  Given that virtually everything produced and consumed requires energy to create, eventually higher energy prices feed into the cost of all those products.  It can be even more direct for services such as shipping, where energy price surcharges are common.  But just because something is labeled a surcharge doesn’t mean it hasn’t raised the price of the item consumed.  The point is, rising energy prices and rising commodity prices in general, are leading to higher input costs which will eventually lead to higher prices.  We continue to see the evidence in data like PPI and the price indices in the PMI and ISM data.

And these are just the two largest known issues.  Less probable, but potentially highly significant, we could see increased tension in US-China relations, with a stepped-up trade war, or even a confrontation over the situation in Taiwan.  Neither can one rule out more mischief from Russia, or Middle Eastern strife that could easily impact the supply of oil and hence its price.  The point is, it seems early to declare that the worst is behind us and price securities and risk as though that is the case.

Market activity today is relatively muted as investors and traders await the latest word(s) from Madame Lagarde and the ECB.  Expectations are there will be no changes to policy, but the real hope is that she will give clearer guidance on their plans going forward.  You may recall at the last meeting they expressed some dismay that bond yields had risen as much as they had and promised to increase PEPP purchases.  Since then, while they have increased those purchases, the amount of increase has been less than impressive and yields in Europe, while not rising further, have not returned to previous lower levels.  At the same time, as US yields have fallen back more than 20bps from their recent highs, the euro (+0.2%) has resumed its climb and is back above 1.20 for the first time since early March.  One thing we know is that the ECB can ill afford a stronger euro, so some type of response may be forthcoming.

Speaking of central banks, yesterday’s big surprise came from north of the border as the Bank of Canada, while leaving policy on hold, changed their tune on the timing for the end of QE.  They brought forward their tapering timeline and the market brought forward the rate hike timeline in response.  It seems that the employment situation in Canada has returned far closer to pre-Covid levels than in the US, with more than 90% of the jobs lost having been regained.  While CAD has given up 0.1% this morning, this is after a nearly 1.0% rise yesterday in the wake of the BOC announcement.

A quick look at equity markets around the world shows that Asia had a pretty good session (Nikkei +2.4%, Hang Seng +0.5%, Shanghai -0.25%) while Europe is all green and has been steadily climbing all day (DAX +0.45%, CAC +0.6%, FTSE 100 +0.1%).  US futures, however, are ever so slightly softer, down about 0.15% across the board, although this was after solid rallies yesterday afternoon.  Meanwhile, bond markets are under the barest of pressures with yields edging higher in the US (+0.5bps) and Europe (Bunds +0.4bps, OATs +0.8bps, Gilts -0.4bps), really showing a market waiting for the next piece of data.

Energy prices are under modest pressure this morning (WTI -0.5%), as are precious metals (Au -0.3%, Ag -0.6%) and industrials (Cu 0.0%, Zn -0.2%, Al -0.2%).

It can be little surprise that the dollar is mixed this morning, given the lack of a coherent market theme, although there are some modest surprises.  NOK (+0.25%) for example is stronger in the face of weaker oil prices.  Meanwhile NZD (-0.3%) is the weak link in the G10, on the back of market internals and stop-loss selling.  EMG currencies have a few more substantial movers with RUB (+1.25%) the leading gainer by far after President Putin’s state of the nation address focused entirely on domestic issues rather than feared saber rattling.  This encouraged bond buying and strength in the ruble.  On the other end of the spectrum is TRY (-0.8%) which has seen further investor outflow after reports that the US administration is prepared to raise the issue of the Armenian genocide and put further pressure to isolate President Erdogan.  However, away from those two movers, the rest of the bloc is +/- 0.2% or less.

Aside from the ECB meeting, the US data slate brings Initial Claims (exp 610K), Continuing Claims (3.6M), Leading Indicators (1.0%) and Existing Home Sales (6.11M).  Clearly the Claims data is the most important of the bunch with a strong number possibly helping to halt the Treasury rally and potentially support the dollar.  We are in the Fed quiet period, so no speakers there.

The rest of the day will take its tone from Madame Lagarde, but if she is less than forceful, I would expect the current trend (modestly lower yields, modestly higher equities and modestly weaker dollar) to continue.

Good luck and stay safe
Adf

No Need to be Austere

From every Fed speaker we hear
That prices might rise some this year
But they all confirm
It will be short-term
So, there’s no need to be austere

I feel like today’s note can be very short as there really has been nothing new of note to discuss.  Risk is on the rise as market participants continue to absorb the Federal Reserve message that monetary stimulus is going to continue, at least at the current pace, for at least the next two years.  That’s a lot of new money, nearly $3 trillion more to add to the Fed balance sheet, and if things hold true to form, at least 60% of it will wind up in the equity market.

This was confirmed by four Fed speakers yesterday, including Powell and Vice Chair Clarida, who made it quite clear that this was no time to start tapering, and that rising bond yields were a vote of confidence in the economy, not a precursor to rising inflation.  What about inflation you may ask?  While they fully expect some higher readings in the short run due to base effects, they will be transitory and present no problem.  And if inflation should ever climb to a more persistent level that makes them uncomfortable, they have the tools to address that too!  I know I feel a lot better now.

Europe?  The big news was the German IFO Expectations index printing at a much better than expected 100.4, despite the fact that Covid continues to run rampant through the country.  While they have managed to avoid the massive Easter lockdown that had been proposed earlier this week, the ongoing failure to vaccinate the population remains a damper on activity, or at least the perception of activity.  Otherwise, we learned that Italy is struggling to pay its bills, as they need to find €15 billion quickly in order to continue the present level of fiscal support, but have a much tougher time borrowing, and have not yet received the money from the Eurozone fiscal support package.  In the end, however long the Fed is going to be expanding its balance sheet, you can be sure the ECB will be doing it longer.

The UK?  Retail Sales were released showing the expected gains relative to last month (+2.
1% M/M. -3.7% Y/Y) and excitement is building that given the rapid pace of vaccinations there, the economy may be able to reopen more fully fairly soon.  Certainly, the pound has been a beneficiary of this versus the euro, with the EURGBP cross having declined more than 5% this year, meaning the pound has appreciated vs. the euro by that much.  Perhaps Brexit is not as big a deal as some thought.

Japan?  The latest $1 trillion budget is being passed, which simply adds to the three supplementary budgets from last year totaling nearly $750 billion, with most observers expecting more supplementary budgets this year.  But hey, the Japanese have perfected the art of borrowing unfathomable sums, having the central bank monetize them and maintaining near zero interest rates.  Perhaps it should be no surprise that USDJPY has been rising, because on a relative basis, the Japanese situation does seem worse than that here in the US.

Other than these stories, things are just not that exciting.  The Suez Canal remains closed and we are starting to see ships reroute around the Cape of Good Hope in Africa, which adds more than a week to transit times and considerable expense.  But I’m sure these price rises are transitory too, just ask the Fed.

So, let’s take a quick tour of markets.  Equities are all green right now and were so overnight.  The three main Asian indices, Nikkei, Hang Seng and Shanghai, all rose 1.6% last night after US markets turned around in the afternoon.  European bourses are looking good, with the DAX (+0.6%), CAC (+0.4%) and FTSE 100 (+0.7%) all solidly higher on the day.  As to US futures, both Dow and S&P futures are a touch higher, 0.2% or so, but NASDAQ futures are under a bit of pressure at this hour, -0.3%.

In the bond market, 10-year Treasury yields are higher by 4.1bps in the wake of yesterday’s really mediocre 7-year auction.  While it wasn’t as bad as the last one of this maturity, it continues to call into question just how able the Treasury will be to sell sufficient bonds to fund all their wish list.  Even at $80 billion per month of purchases, the Fed is falling behind the curve here and may well need to pick up the pace if yields start to climb more.  I know that is not their current story, but oversupply is certainly at least part of the reason that Treasuries have been so weak.  And today, despite ECB support, European sovereign bonds are all lower with yields higher by 4.5bps or more virtually across the board.  Either the ECB has taken today off, or there are bigger worries afoot.  One little known fact is that alongside the ECB, European commercial banks had been huge buyers of their own country’s debt for all of last year.  However, that pace has slowed, so perhaps today’s movement is showing a lack of natural buyers here as well.

Commodity prices are pretty much firmer across the board with the exception of precious metals, which continue to suffer on the back of higher US yields.  But oil (+2.3%) is back at $60/bbl and base metals and agricultural prices are all firmer this morning.

Finally, the dollar is broadly weaker at this hour, with the commodity bloc of the G10 leading that group (NZD +0.5%), NOK (+0.4%), (AUD +0.4%), although the pound (+0.3%) is also doing well after the Retail Sales numbers.  Meanwhile, the havens are under pressure (JPY -0.5%), CHF (-0.15%), as there is no need for a haven when the central bank has your back!

EMG currencies are a bit less interesting, although the APAC bloc was almost uniformly higher by small amounts.  That was simply on the back of the risk-on attitude that was manifest overnight.  The one exception here is TRY (-1.1%) which continues to suffer over the change of central bank leadership and concerns that inflation will run rampant in Turkey.  Two other noteworthy things here were in LATAM, where Banxico left rates on hold at 4.0%  yesterday afternoon and reaffirmed they were entirely focused on data, and that S&P downgrade Chile’s credit rating to A from A+ on the back of the changes in government structure and concerns about the medium term fiscal position.

On the data front we see Personal Income (exp -7.2%), Personal Spending (-0.8%), Core PCE (1.5%) and then at 10:00 Michigan Sentiment (83.6).  To me, the only number that matters is the PCE print, but this is a February number, so not expected to be impacted by the significant base effects from last year’s events.  Of course, given the constant chorus of any rising inflation will be transitory, we will need to see a lot of high prints before the market gets nervous…or will we?  After all, the bond market seems to be getting nervous already.

At any rate, while the dollar is under pressure this morning, my take is that if US yields continue to climb, we are likely to see it retrace its steps.  At this point, I would argue the dollar’s trend is higher and will be until we see much higher inflation readings later this spring and summer.

Good luck, good weekend and stay safe
Adf

Will Not Be Deterred

There once was a really big boat
Designed, lots of cargo, to tote
But winds from the west
Made it come to rest
Widthwise in the Suez, not float

A mammoth cargo ship, the Ever Given has run aground in the Suez Canal while it was fully laden and heading northbound toward the Mediterranean Sea.  The problem is that, at over 400 meters in length, it is blocking the entire waterway in both directions.  The resulting traffic jam has affected more than 100 ships in both directions and could take several days to unclog.  As a point of interest, roughly 12% of global trade passes through the Suez each year, including 1 million barrels of oil per day and 8% of LNG shipments.  The market impact was seen immediately in oil prices which jumped more than 3%, although remain just below $60/bbl after the dramatic sell-off seen in crude during the past week.  Canal authorities are working feverishly to refloat the ship, but given its massive weight, 224,000 tons, they don’t have tugboats large enough to do the job on site.  While larger tugs are making their way to the grounding, things will be messy for a while.  Do not be surprised if oil prices continue to climb in the short run.

The ECB picked up the pace
Of purchases as they embrace
The call to do more
Or else, answer for
The failure in Europe’s workplace

Meanwhile, from the House what we heard
Was Powell will not be deterred
From keeping rates low
If prices do grow
While Janet, on taxes, deferred.

Looking beyond the ship’s bow to the rest of the world, the two key stories so far this week have been the data from the ECB about increased QE purchases, as well as the joint testimony at the House of Representatives by Powell and Yellen.  Regarding the ECB, they announced they had purchased €21 billion in bonds last week, up 50% from the previous weekly pace of €14 billion, and exactly what one would expect given Madame Lagarde’s promise of an increased pace of buying.  Unfortunately for the ECB, European sovereign bond yields rose between 10-15 basis points while they were increasing purchases, as they followed US Treasury yields higher.  The problem for the ECB is that if Treasury yields do continue to rally (and while unchanged this morning, they have fallen back by 13 basis points since Friday’s peak), it is entirely realistic that European bonds will see the same price action regardless of the ECB’s stepped up purchases.  Of course, that is the last thing the ECB wants to see in their efforts to stimulate both growth and inflation.  Essentially, what this tells us is that the ECB does not really have the ability to guide the market in a direction opposite the global macro factors.  Perhaps, whatever it takes is no longer enough!

As to the dynamic duo’s testimony, there was really nothing surprising to be learned.  Powell continues to explain that while things are looking better, the Fed’s focus is on the employment situation and they won’t stop supporting the economy until all the lost jobs are regained.  As to inflation, he pooh-poohed the idea that a short-term burst in prices will have any impact on either inflation expectations or actual longer-term inflation outcomes.  In other words, he has been completely consistent with the FOMC statement and press conference.  As to the diminutive one, she promised that more spending was coming, but that it would be necessary to raise taxes on some people as well as the corporate tax rate.  The working assumption seems to be that corporate taxes are due to head to 28%, from the current 21% level, in the next big piece of legislation.  After that, they both had to defend their positions from rank political comments by Congressfolk trying to burnish their own credentials.

And in truth, those are the stories that are top of the list today, showing just how dull things are in the markets.  However, with that in mind, following yesterday’s late day sell-off in US equities, Asian equities were pretty much lower across the board (Nikkei -2.0%, Hang Seng -2.0%, Shanghai -1.3%) and Europe is entirely in the red as well, albeit not nearly as severely (DAX -0.6%, CAC -0.3%, FTSE 100 -0.3%).  And all this equity price action is despite the fact that PMI data from Japan and Europe was far better than expected, with, for example German Mfg PMI posting a 66.6 reading and Eurozone Mfg posting at 62.4.  Services remains much weaker, but in all cases, the outcomes were better than forecast, although still just below the 50.0 level.  It seems that there is more to the current level of fear than the data.  As to the US, futures here are higher led by the NASDAQ (+0.7%) with the other two major indices up by a more modest 0.3%.

In the bond market, Treasuries are seeing a bit of selling pressure as NY walks in, although the 10-year yield is only higher by 0.5bps.  Meanwhile, in Europe, there is a very modest bond rally (Bunds -1.3bps, OATs -1.4bps, Gilts -0.7bps) which is consistent with the modest risk off theme in equity markets there.  Price action in Asian bond markets, though, has been a bit more frantic with NZD bonds soaring (yields -15.7bps) as investors continue to respond to the government’s efforts to rein in housing prices, thus slowing inflation pressures.  This helped Aussie bonds as well, although yields there only fell 8 basis points.  The one truism is that bond market activity is far more interesting than equity market activity right now.

In the commodity markets, aside from oil’s rally on the supply disruption caused by the ship, price action has been far less significant.  Metals prices are very modestly higher (CU +0.35%, AL +2.1%, AU +0.2%) while the agricultural space is mixed, with a range of gainers and losers.

And finally, in the FX markets, the dollar is broadly stronger this morning, although not universally so.  In the G10, only NOK (+0.6%) and CAD (+0.1%) are firmer with the former clearly responding to higher oil prices, but also to a growing belief that the Norgesbank will be the first G10 bank to raise interest rates.  Meanwhile, the BOC, yesterday, explained that they were immediately stopping the expansion of their balance sheet, halting all programs, so also moving toward a tightening bias.  However, the rest of the bloc is softer, albeit by fairly modest amounts led by GBP (-0.3%) which posted lower than expected inflation readings.

Emerging market currencies are split in their behavior with ZAR (+0.9%), MXN (+0.7%) and RUB (+0.4%) all benefitting from the rising commodity price story while virtually every other currency in both APAC and the CE4 are softer on the decline in risk sentiment.  The one thing that is abundantly clear is that the EMG currencies are following the big risk meme.

Turning to this morning’s data releases, we see Durable Goods (exp 0.5%, 0.5% ex transport) and the preliminary PMI data (Mfg 59.5, Services 60.1).  Yesterday’s New Home Sales data disappointed at just 775K but was chalked up to a lack of supply.  It seems the supply of available housing is at generational lows these days, while prices rise sharply on the back of a doubling of lumber costs.  We also hear from Powell and Yellen again, this time at 10:00am in the Senate, but there is no reason to believe that anything different will be said.  In addition, four more Fed speakers will be heard, although the message continues to be consistent and clear, rates are not going to rise until 2023 earliest, no matter what happens.

For now, the dollar is benefitting from the market’s risk aversion, however, if Treasury yields fall further, I expect that the dollar will lose its luster and equities will find their footing.  On the other hand, if this is the temporary lull before the next lurch higher in yields, look for the dollar to continue to rally.

Good luck and stay safe
Adf

Central Banks Fear

The one thing that’s been crystal clear
Is yields have exploded this year
The question at hand
Since this wasn’t planned
Is what, most, do central banks fear?

For Jay and the FOMC
The joblessness rate is the key
For Christine its growth
And prices, as both
Refuse to respond to her plea

While the bond market has taken a respite from its headlong rush to higher yields, there is no evidence we have seen the top.  Rather, it feels very much like the market has positioned itself for the next leg higher in yields, potentially to kick off after tomorrow’s FOMC meeting.  If you recall, the last Fedspeak on the topic was by Chairman Powell and he was essentially dismissive of the issue as a non-event.  The consistent story has been that higher yields in the back end of the curve is a sign that the economy is picking up and they are doing their job properly, in other words it is a vote of confidence in the Fed.  And he was unambiguous in his discussion regarding the potential to tighten policy; it ain’t gonna happen for at least two to three more years, which is their timeline as to when the employment situation will recover to pre-Covid levels.  Remember, Powell has been explicit that he will not be satisfied until another 10 million jobs have been created and filled.

It has been this intense focus on the employment situation that has driven the Fed narrative that neither inflation or higher yields are of consequence for now or the foreseeable future.  Thus, all the positive US data, both economic and vaccine related, has served to increase expectations of a strong economic rebound consistently supported by front end interest rates remaining at zero.

But the interplay between rising yields and the speed of the recovery remains open to question.  In addition, there is the question of just how high yields can go before the Treasury gets uncomfortable that financing all this deficit spending is going to become problematic.  After all, if yields continue to rise, at some point the cost of carrying all the debt is going to become quite painful for the government.

In fact, it is this issue that has been a key feature of many forecasts of market behavior for the rest of this year and next; at some point, probably sooner rather than later, the Fed is going to step in and cap yields.  But what if the Treasury is looking at this problem from a different perspective, not what actual yields are, but the size of their debt service relative to the economy?  On that measure, despite a more than doubling of Treasury debt outstanding since 2007, interest expense is currently a smaller percentage of GDP than it was back then.  It is important to remember that Treasury debt matures monthly, not just T-bills, but also old notes and bonds, and when those notes and bonds were issued, ZIRP didn’t exist so many carry coupons much higher than the current replacements.  The upshot is that debt service costs have been declining despite the growth in the nominal amount of debt outstanding and are forecast to continue declining for the next 3 years according to the CBO.  So, maybe, Jay is serious that he is unworried about the current level of yields in the 10-year bucket and beyond.

If this thesis is correct, the implications for other markets going forward are significantly different than I believe many are currently considering.  For instance, a further rise in yields will start to have a significant negative impact on equity prices as all of the discounted cash flow models that currently assume zero rates forever to justify the current level of valuations will come crashing back to reality and there will be a realization that price-earnings multiples are unsustainable at current levels.  As well, the dollar bearish theme will likely get destroyed, as it is predicated on the idea that real yields will decline with rising inflation and capped yields.  If yields are not capped, but instead respond to rising inflation expectations by going higher unchecked, the dollar will be a huge beneficiary.  Precious metals?  They will suffer, although base metals should hold their own as growth will support demand and supply continues to be lacking, especially new supply.  And I would be wary of EMG debt as that rising dollar will wreak havoc on emerging market economies.

Perhaps it is the last thing that will cause the Fed to blink, since if the rest of the world slides into another recession amid increased demand for dollars, history has shown the Fed will ease policy to halt that slide.  Of course, for the past thirty years, any significant decline in the US equity market has been sufficient to get the Fed to ease policy, with Q4 2018 the most recent pre-pandemic episode.  But that means those valuations will compress, at least somewhat, before the Fed responds.

Add it all up and we have the opportunity for significantly more volatility in markets going forward, something hedgers need to heed.

As to today, ahead of the Retail Sales release this morning, and of course the FOMC tomorrow, markets are continuing in their quiet consolidation overall, though with a modest risk-on bias.

Equity market screens are all green with gains in Asia (Nikkei +0.5%, Hang Seng +0.7%, Shanghai +0.8%) and Europe (DAX +0.5%, CAC +0.1%, FTSE 100 +0.5%) pretty solid everywhere.  US futures are showing gains in the NASDAQ (+0.5%), but little movement in the other two indices.

Bond markets are also quietly higher, with very modest yield declines in Treasuries (-0.5bps), Bunds (-0.5bps) and Gilts (-1.0bp).  In fact, looking at my screen shows only Italian BTP’s (+1.9bps) and Greek 10-years (+2.8bps) falling as both nations impose stricter lockdowns.  Even JGB’s (-1.0bp) are a bit firmer as market participants await the BOJ’s policy framework Friday.

Commodity prices are under a bit of pressure this morning with oil (-1.3%) leading the way but base metals pretty much all lower as well.  As to the precious metals, they are little changed on the day and are the market with, perhaps, the keenest interest in the Fed meeting tomorrow.  If yields are going to continue to climb unabated, gold and silver will decline.

Finally, the dollar is having a mixed session as well, with a pretty equal split of gainers and losers against the greenback.  In the G10, SEK (+0.3%) and CHF (+0.3%) lead the way higher although both appear to be continuing a consolidation move of the past week.  On the downside, GBP (-0.3%) is the laggard after the EU brought new legal action against the UK on a Brexit related matter.  As to the rest of the space, the movements have been even smaller and essentially irrelevant.

In Emerging Markets, TRY (+0.8%) is the leading gainer as bets grow that the central bank will be raising rates later this week.  Next in line was KRW (+0.6%) which benefitted from large net inflows into the bond market, but after that, things are much less interesting.  On the downside, while there are a number of currencies that have declined this morning, the movements, all 0.2% or less, just don’t need a rationale, they are simply trading activity.

Data wise, we see Retail Sales this morning (exp -0.5%, 0.1% ex autos) a far cry from last month’s stimulus check induced jump of 5.3%.  We also see IP (0.3%) and Capacity Utilization (75.5%) a little later, but the reality is that if Retail Sales is uninteresting, markets are likely to continue to drift until tomorrow’s FOMC meeting.

For today, there seems very little likely to occur, but beware the Fed, if they really are going to allow yields to rise further, we could see some real changes in viewpoint for both equity markets and the dollar.

Good luck and stay safe
Adf

Our Fear and Our Dread

Said Madame Lagarde, don’t misread
The fact that our PEPP has lost speed
The quarter to come
A good rule of thumb
Is twice as much is guaranteed
 
This morning, though, markets have said
That’s just not enough to imbed
The idea your actions
Of frequent transactions
Will offset our fears and our dread
 
As we walk in this morning, there is a distinct change in tone in the markets from yesterday.  It seems that the initial impressions of yesterday’s two big events, the ECB meeting and the 30-year auction, were fleeting, and fear, once again, has taken over.
 
A quick recap shows that ECB President Lagarde, in responding to the growing questions about the reduced pace of ECB PEPP purchases, promised to significantly increase them during the next quarter.  While she refused to quantify ‘significantly’, the analyst community is moving toward the idea that means at least doubling the weekly purchase amounts to ~€25 billion.  At the same time, we heard from several ECB members this morning that this action did not presage increasing the size of the PEPP, which still has approximately €1 trillion in firepower remaining.  Lagarde emphasized the flexible nature of the program and explained that varying the speed of purchases is exactly why that flexibility was created.  However, despite today’s comments, Lagarde also assured us that, if necessary, the ECB could recalibrate the program, which is lawyer/central bank speak for increase the size.
 
The market liked what it heard, and the result was a bond rally on both sides of the Atlantic.  Several hours later, the results of the Treasury’s 30-year auction were released and, while not fantastic, were also not as disastrous as the 7-year auction from two weeks ago.  In the end, bond yields basically ended the day flat, equities rallied, and the dollar was under pressure all day.  Risk had regained its allure and the bulls were back in command.
 
Aahh, the good old days.  This morning, it is almost as though Madame Lagarde never said a word, or perhaps said too many.  Bond markets are selling off sharply, with 10-year Treasury yields higher by 7 basis points and above 1.60%, while European sovereigns are weaker across the board, led by UK gilts (+5.4bps), but with most continental bonds showing yield gains of 2.0-3.0 basis points.  So, what happened to all the goodwill from yesterday?
 
Perhaps that goodwill has fled from fears of rising inflation after President Biden (sort of) laid out his plan for vaccinating the entire nation by May and reopening the economy by summer.  Many analysts have pointed to the massive increase in savings and combined that with the newest stimulus checks to come (as soon as this weekend according to Treasury Secretary Yellen) and forecast a huge spending surge, significant economic growth and rising inflation. After all, the Atlanta Fed’s GDPNow forecast is at 8.35%, which while slightly lower than a few weeks ago, is still an extremely rapid pace for the US economy.  This pundit, however, questions whether or not that spending surge will materialize.  Historically, after a deeply shocking financial event like we have just experienced, behaviors tend to change, with the most common being a tendency to maintain a higher savings ratio.  As such, expectations for a massive consumer boom may be a bit optimistic.
 
Or, perhaps the goodwill has disappeared after further crackdowns by Chinese authorities on its most successful companies, with TenCent now under the gun, receiving fines and being reined in following their efforts to crush Ant Financial.  The Hang Seng certainly felt it, falling 2.2% overnight, although Shanghai (+0.5%) and the Nikkei (+1.7%) were still euphoric from yesterday’s US equity rally.  Rapidly rising Brazilian inflation (5.2% vs. 3.0% target) could be the cause, as concerns now increase that the central bank, when it meets next week, will be raising rates 0.50% to battle that, despite the economic weakness and ongoing Covid related stresses.
 
There is, however, one other potential cause of the bond market’s poor performance, which I believe is leading to the general risk-off attitude; but it is a sort of inside baseball issue.  The Supplementary Leverage Ratio (SLR) is part of bank regulation that was designed to insure banks would remain stable during hard times and not need to be bailed out, a la 2008.  However, during the initial stresses of the Covid crisis, the Fed suspended the need for banks to count Treasury securities and bank reserves as part of that ratio, thus allowing banks to hold more of those assets on their books while remaining within the regulations.  But this exemption is due to expire on March 31, which means banks either need a LOT more equity capital, or they need to shrink their balance sheet by selling off those excess Treasuries.  And, of course, selling Treasuries is much easier and exactly what we have seen in the past two weeks.  If the Fed does not give further guidance on this issue, and lets it expire, bonds probably have further to fall.  Ironically, that doesn’t seem to fit with what the Fed really wants to happen, as the higher yields would result in tighter financial conditions, especially if equity markets sold off in sync.  So, my guess is the Fed blinks and rolls the exemption over for at least 6 months, but until we know, look for bouts of selling in bonds and all the ensuing market reactions that come with that.
 
Just like today’s, where European markets are lower (DAX -0.6%, CAC -0.1%, FTSE 100 -0.1%) although in the latter two cases not by much and US futures are also lower, especially the tech laden NASDAQ (-1.4%) although also SPX (-0.4%). 
 
Commodity prices are also under a bit of pressure with oil (-0.25%) slipping a bit as well as precious (gold -1.0%) and base (copper -1.25%) metals.  In fact, today is also seeing weakness throughout the agricultural sector, with declines of the 0.75%-1.75% range across the board.
 
And what of the dollar, you ask?  Stronger across the board, with yesterday’s leading gainers showing the way lower today.  NZD (-0.75%), SEK (-0.7%) and CHF (-0.7%) are in the worst shape, but in truth, the entire G10 is under pretty significant pressure with only CAD (-0.15%) showing any signs of holding up as Canadian government bond yields rise right along with US yields. 
 
Emerging market currencies are also under significant pressure this morning, led by TRY (-1.5%) but seeing MXN (-1.3%) and ZAR (-1.0%) also suffering greatly.  In fact, all of LATAM and the CE4 are under significant pressure today but then all of them had seen substantial strength yesterday.  In fact, the two-day movement in many of these currencies is virtually nil.  Their futures will depend on a combination of the ongoing evolution of US interest rates and their unique  domestic situation.  If rising inflation is ignored in order to support these economies, look for much further weakness in that nation’s currency.  In other words, there is every chance that the dollar gains strength broadly against this bloc in the next several months.
 
On the data front, today brings PPI (exp 2.7%, 2.6% core) and Michigan Sentiment (78.5).  Certainly, that PPI data looks like inflation is in the pipeline, but the relationship between PPI and CPI is not nearly as strong as you might think, with just a 0.079% correlation over the past 5 years, although it does have a stronger relationship to core PCE (0.228%).  But if history is any guide, the market will not be flustered by any print at all. 
 
So, today is shaping up as risk-off with both bonds and stocks selling and no commentary from the Fed coming.  Just like yesterday’s risk appetite fed stronger currencies, it appears the opposite is true today.  I don’t expect to see substantial further gains, but a modest continuation of the dollar rally does feel like it is in the cards.
 
Good luck, good weekend and stay safe
Adf
 

On Edge

Two fears have the market on edge
Inflation that many allege
Will drive bond yields higher
Thus, causing a dire
Result, pushing stocks off the ledge

But right now, the bulls rule the roost
As inflation has not been produced
So, Jay and Christine
Have no need to wean
The market from QE’s large boost

Yesterday morning’s CPI release was a touch softer than expected, thus helping to abate fears of the much-mooted inflationary surge arriving soon.  (PS, it is clear that starting next month the CPI data will be much higher, given the year over year comps, with the key question being will that continue through the summer and beyond.)  In the meantime, bond investors, who had clearly been concerned over the rising inflation story, relaxed a bit and bought more Treasuries.  The result was that the early morning rise in yields was unwound.  Of course, the other big news yesterday was the 10-year Treasury auction which was received by the market with general aplomb.  While there was a 1 basis point tail, the bid-to-cover ratio at 2.37 was right in line with recent averages.  One little hiccup, though, was indirect bidders (usually foreign governments) continued their declining participation, falling to 56.8%, with the implication that natural demand for Treasuries is truly sinking.  This latter point is critical because, given the amount of new money the Treasury will need to borrow this year and going forward, it will increase pressure on the Fed to absorb more (i.e. increase QE), or yields will definitely climb.

However, that apparently, is a story for another day.  Equity markets reveled in the low inflation print and modest bond market rally, while the dollar fell pretty much across the board, reversing all of its early gains.

Which brings us to this morning’s ECB meeting, where the question is not about a change in policy, as quite clearly no policy change is in the offing, but rather about the ECB’s utilization and reaction function of its current policy programs.  While sovereign yields have stabilized for the past several sessions, the fact remains that they have not fallen back anywhere near the levels seen at the beginning of the year.  The question market participants have is exactly what will constitute a tightening in financial conditions that might bring a response.

As mentioned yesterday, the ECB has been consistently underutilizing the PEPP compared to recent months, with weekly purchases falling to a net €12 billion despite the rise in yields.  So, it would seem that the ECB does not believe the current yield framework is a hindrance to the economy.  However, you can be sure that Madame Lagarde will field several questions on the topic at this morning’s press conference as market participants try to determine the ECB’s pain threshold.  The last we heard on the topic was that they were carefully watching the market with some of the more dovish members calling for a more active stance to prevent a further climb in yields.

And remember, the ECB is not only focused on sovereign yields, but on the exchange rate as well, which is also officially a key indicator.  With the US inflation story getting beaten back, and US yields slipping, the euro’s concomitant rise will not be welcome.  Now, we remain well below the early January highs in the single currency, but if the euro has bottomed, and more importantly starts that long-term rise that is so widely expected, the ECB will find themselves in yet another sticky situation.  These, however, are stories for a future date, as today the euro is firmly in the middle of recent ranges while sovereign yields are slipping a bit.

With two potential landmines behind us, risk appetite has been reawakened, with asset purchases across virtually all classes.  For instance, overnight saw equity market strength across the board (Nikkei +0.6%, Hang Seng +1.65%, Shanghai +2.4%) although Europe’s early gains have mostly diminished and markets are little changed ahead of the ECB (DAX -0.1%, CAC +0.1%, FTSE 100 -0.35%).  US futures, though, are largely booming, led by the NASDAQ (+1.9%) but seeing solid gains in the other indices as well.

On the bond front, Treasury yields are lower by 1.9 basis points, back to 1.50%, while we are seeing more modest declines in the major European bond markets, on the order of 0.5bps for all of them.

Oil prices are firmly higher (WTI +1.2%) as is the entire energy complex.  Metals prices, too, are rising with both precious and base seeing a resumption of demand.  Meanwhile agricultural prices are generally moving up in sync.  Once again, to the extent that commodity price rises are a harbinger of future inflation, the signs are clearly pointing in that direction.

The dollar, meanwhile, which reversed yesterday’s early gains to close lower across the board, has continued in that direction with further losses this morning.  CHF (+0.5%) leads the way in the G10, which given the fact it had been the biggest loser over the past month, falling more than 5.6%, should be no surprise.  But the rest of the bloc is seeing gains in the commodity focused currencies with AUD (+0.45%), NZD (+0.4%) and CAD (+0.3%) next in line.  Perhaps the biggest surprise is that NOK (0.0%) is not along for the ride.

EMG currencies are also broadly firmer led by BRL (+1.6%) which is following on yesterday’s 2.5% rally as the central bank has been actively intervening to stem the real’s recent weakness.  Concerns remain over rising inflation, and expectations for rising policy rates are growing there, which would likely support the currency even more.  But we are seeing strength in ZAR (+1.0%), CLP (+1.0%) and MXN (+0.65%) as well, clearly all benefitting from the commodity story.  However, virtually the entire bloc is firmer given today’s increasing risk-on attitude.

Aside from the ECB meeting, with the statement published at 7:45 and the press conference at 8:30, we see Initial Claims (exp 725K), Continuing Claims (4.2M) and the JOLTs Job Openings survey (6.7M).  Again, no Fed speakers so look for the dollar to follow risk attitude and the movement in real yields.  Those are both pointing toward a lower dollar as the day progresses, and I see no reason to fight that absent comments from a surprising source.  Unless Madame Lagarde fumbles the press conference, look for this little risk bounce to continue.

Good luck and stay safe
Adf

Powell’s Dismay

The ECB’s Christine Lagarde
Is finding that markets are hard
As bond yields keep climbing
She needs more pump priming
Or Europe will truly be scarred

Meanwhile in the US today
The 10-year sale gets underway
A sloppy result
Just might catapult
More QE, to Powell’s dismay

Markets have had a relatively uneventful evening as participants await some important new information.  The first clue will come this afternoon when the results of the US 10-year bond auction are released.  Remember, this interest rate is arguably the most important rate in the world, as it serves as the basis for trillions of dollars of debt in both the public and private sectors.  And while the on-the-run 10-year bond is probably the single most liquid security in the world, its recent volatility belies that statement.  In fact, this morning, ahead of the auction, we are seeing selling pressure with the yield rising 3.3 basis points to 1.56%, within spitting distance of its recent highs and up a pretty remarkable 65 basis points year-to-date.

The reason today’s auction of $38 billion is being so keenly watched is that two weeks ago, the 7-year note auction was flat out awful, with a long tail and low indirect interest.  This means that there wasn’t really that much demand, especially from investors, as opposed to the primary dealers who are forced to bid.  That auction served as the catalyst for the 15-basis point rise in the 10-year the last week of February.  You may recall that coincided with a 100-point decline in the S&P 500 and commensurate declines in equity markets around the world.

And that is why this is seen as so critical.  With the knowledge that the House is voting on the $1.9 trillion stimulus bill today, and it will certainly pass along a party-line vote, investors recognize that there is going to be a lot more issuance upcoming.  After all, the government will need to borrow a lot of money to fund that stimulus.  If this benchmark auction goes poorly, meaning it doesn’t generate substantial bidding interest outside the primary dealers, we could well be in for another sharp decline in equity markets as the bond market sells off further.  Remember, too, the Fed is in its quiet period so will not be able to make comments in order to support the market.

Yesterday saw an impressive rebound by equity markets around the world after a serious bout of selling almost everywhere.  A good result today is likely to help keep that going, but a poor auction will almost certainly show that yesterday was the proverbial “dead cat bounce.”  And folks, if the auction goes poorly, look for the dollar to make new highs against pretty much every currency, especially emerging market counterparts., but the G10 too.

Which brings us to the ECB and Madame Lagarde.  Today is the first day of the ECB’s March meeting and the market is putting pressure on them as well.  As Treasury yields have climbed, so too have European government bond yields, with, for instance, 10-year bund yields 30 basis points higher on the year, albeit still firmly in negative territory at -0.30%.  But the question being raised is why the ECB hasn’t been more active with its PEPP program during this yield rally.  After all, we have heard from a number of different ECB members that they are closely monitoring sovereign yields and they explicitly told us that was a key benchmark for them.  And yet, their net purchases through the PEPP have declined during the past several weeks to €14.8 billion a week, down from the more than €18 billion they had been purchasing previously.  So, clearly, they have the capacity to do more.  Why then haven’t they been more active?  At this point, nobody really knows, and you can be certain that at tomorrow’s press conference it will be a hot topic.

Of course, it may be that they want to leave themselves extra ammunition in the event the Treasury auction goes poorly and there is another bond market rout.  But that is a far more cynical stance than I would attribute to any central bank.  The risk for the ECB is that European sovereign yields begin to rise faster than Treasury yields both crimping economic support and simultaneously supporting the euro.  And the one thing we know is the ECB wants a weaker euro, in fact they desperately need a weaker euro to help their exporting economies as well as to try to stoke their much-desired inflation.  As Ricky Ricardo used to say, ‘Christine, you got some ‘splainin’ to do!’

So, as we await the results of the auction, let’s take a quick tour of the overnight price action.  The best description of markets is mixed, with modest overall activity.  In the equity space, the Hang Seng (+0.5%) led the way on the high side, while both the Nikkei and Shanghai were essentially flat on the session.  Australia’s ASX 200, meanwhile, fell 0.8%.  As I said, mixed.  The story is no different in Europe with the CAC (+0.6%) the leader with the DAX (+0.3%) doing fine but the FTSE 100 (-0.2%) slipping back a bit.  And so, it cannot be surprising that US futures are behaving in the same manner, with NASDAQ (-0.3%) suffering while DOW (+0.25%) is slightly higher and SPX futures are little changed.

Other than the Treasury market, the yield picture is also mixed, with major European bond markets +/- 0.5bps or less.  This looks like a market biding its time for the two big stories to come.  Intrigue continues to build in Japan where the results of the BOJ’s review will be announced at their meeting next week and we have heard from Kuroda-san that there will be no change in the 10-year yield curve target while a key deputy, Amamiya-san, has left the door open to a widening of that 0.20% range around 0.0%.

In the commodity world oil (+0.5%) is firmer, but just looking at the products, that modest rally is not universal.  Metals are mixed (that word keeps coming up) with copper and aluminum both higher while tin and zinc are lower.  Precious metals are modestly softer as well after a huge rally yesterday.

And finally, the dollar is the one thing not really mixed, but rather broadly higher this morning.  Against the G10, only NOK (0.0%) has managed to hold its own on the back of the oil rally, while CHF (-0.4%) and JPY (-0.3%) are both suffering on what appears to be their lagging interest rate performance.  In the EMG bloc, TRY (+0.5%) is the only gainer of note, however, its movement appears to be positioning related rather than fundamental.  On the downside, there is a broad range of weaker currencies across all three main geographies, although none is weaker by more than 0.3%.  Again, it appears that traders are biding their time for news.

On the data front, today is CPI day with expectations for a 0.4% M/M (1.7% Y/Y) headline rise and a 0.2% M/M (1.4% Y/Y) ex food & energy print.  Based on the past 9 months, I would expect the odds are for a beat on the high side as we have seen in 6 of those readings.  And then it’s the auction.  We remain in the Fed’s quiet period, so look for the dollar to meander this morning and take its cues from the auction like every other market starting at 1:00pm when the results are released.  My money is on a less than stellar auction, higher yields, lower stocks and a stronger dollar.  We shall see.

Good luck and stay safe
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No Paradox

In Europe, the ECB hawks
Explained in their most recent talks
The rising of late
In THE 10-year rate
Was normal and no paradox

At home, hawks are also reduced
To cheering the 10-year yield’s boost
Since Powell’s a dove
And rules from above
The hawks can’t shake him from his roost

In a world where every central bank is adding massive amounts of liquidity, how can you determine which central bankers are hawks and which are doves?  Since no one is allowed to make the case that short-term rates should be raised to try to slow down rising inflation, the next best thing for the hawks to do is to cheer on the rise in longer term yields.  And that continues to be the number one story in markets around the world, rising bond yields.  Yesterday saw Treasury yields rise 9 basis points as investors continue to see US data point to rising inflationary pressures.  The ISM Services Price Index rose to its highest level since 2008, just like we saw in the Manufacturing Index on Monday.  Even official inflation measures continue to print a bit higher than forecast, a sign that underlying price pressures are quite widespread.

In the past, this type of economic data would encourage the hawkish contingent of every central bank to argue for raising the short-term rate.  But hawkish views appear to have been written by Dr Seuss, as they have been removed from the canon of financial discussion.  Which leaves the back end of the curve the only place where they can express their views.  And so, we now hear from Klaas Knot, Dutch central bank president that rising government bond yields are a “positive story”, while Jens Weidmann, Bundesbank president explained that these moves are not “a particularly worrisome development.”  We have heard the same thing from Fed speakers as well, although not universally, as the doves, notably Lael Brainerd, hint at Fed action to prevent an unruly market.  My take is an unruly market is one that goes in the opposite direction to their desires.

But despite the central bank commentary, it is becoming ever clearer that inflationary pressures are rising around the world.  We have spent the past 40 years in an environment of constantly decreasing inflation as a combination of globalization and technological advancement have reduced the cost of so many things.  And while technology continues to march forward, globalization is under severe attack, even from its previous political cheerleaders.  This is evident in the current US administration, where strengthening and localizing supply chains is a goal, something that will clearly increase costs.  Add to that increased shipping costs alongside capacity shortages and rising energy costs, and you have the makings of a higher price regime.  (An anecdote on rising price pressures: a friend of mine who lives in Paris told me the prices of the following foods; fresh salmon €60/kg, 1 grapefruit €2.25 and 1 avocado €2.65.  I checked my supermarket app and found the following prices here in New Jersey; fresh salmon $9.99/lb, 1 grapefruit $1.00 and 1 avocado $2.50.  Prices are high and rising everywhere!)

The final piece of this puzzle is broad economic activity, which the data continues to show has seen a real burst in the US, although there is still concern over the employment situation.  Every survey has shown the US economy growing rapidly in Q1 with the Atlanta Fed’s GDPNow forecast currently at 10%.  Adding it all up leads to the following understanding; it is not only the Fed that is willing to run the economy hot, but every G10 central bank, which means that monetary support will continue to flow for years to come.  Combining that activity with the massive fiscal support and the still significant supply bottlenecks that were a result of the government shutdowns in response to Covid brings about a scenario where there is a ton of money in the system and not enough goods to satisfy the demand.  If central banks don’t tap the breaks, rising prices and price expectations will lead to rising yields, and ultimately to declining equities.  The only asset class that will continue to perform is commodities, because owning “stuff” will be a better trade than owning paper assets.  And that’s enough of those cheery thoughts.

On to today’s markets, where, alas, risk is being jettisoned around the world.  After yesterday’s tech led selloff in the US, Asian equity markets really got hammered (Nikkei -2.1%, Hang Seng -2.1%, Shanghai -2.1%) and European markets are also under the gun (DAX -0.45%, CAC -0.3%, FTSE 100 -1.0%).  US futures?  All red at this hour, down about 0.3%, although that is off the lows seen earlier this morning.

Bond yields, meanwhile, despite my discussion of how they are rising, have actually slipped back a bit this morning in classic risk-off price action.  So, Treasuries (-1.9bps), Bunds (-2.6bps), OATs (-2.1bps) and Gilts (-4.1bps) are all rallying.  But this is not a trend change, it is merely indicative of the fact that now that yields have backed up substantially, the concept of government bonds as an effective risk mitigant is coming back in vogue.  After all, when 10-yr Treasuries yield 0.7%, it hardly offers protection to a portfolio, but at more than double that rate, it is starting to help a little in times of stress.

Commodity prices are mixed this morning with oil taking back early session losses to sit unchanged as I type, but base metals in the midst of a modest correction after a remarkable rally for the past several months.  This morning copper (-4.1%) and Nickel (-8.2%) are leading the way lower, but with the ongoing economic activity and absence of new capacity, these are almost certainly temporary moves.  Gold, which has been under significant pressure lately seems to have found a floor, perhaps only temporarily, at $1700, but given the dollar’s ongoing strength, it cannot be surprising gold remains under pressure.

As to the dollar, I would say it is very modestly stronger today, although what had earlier been virtually universal has now ebbed back a bit.  In the G10, CHF (-0.4%) and JPY (-0.3%) are the worst performers, which given the risk attitude is actually quite surprising.  I think the Swiss story is actually a Polish one, where Poland has refused to support local banks who took out CHF loans and have been suffering from currency strength far outstripping the interest rate benefits.  It seems, concern is growing that these loans may be restructured and ultimately impact the Swiss banks and Swiss economy.  Meanwhile, the yen’s weakness stems from a poor response to a 30-year bond sale last night, where yields rose 3.5 bps amid a very weak bid-to-cover ratio for the sale.  Perhaps even the Japanese are getting tired of zero rates!  But away from those two currencies, the rest of the bloc is +/- 0.2% or less, indicating nothing of real interest is going on.

EMG currencies are also mixed with Asian currencies suffering amid the broad risk off environment overnight and CE4 currencies lower on the back of euro weakness.  On the plus side, BRL (+0.7%) and MXN (+0.6%) are the leading gainers, which appears to be an ongoing reaction to aggressive central bank of Brazil intervention to try to prevent further weakness there.  In this space too, the broad risk appetite will continue to remain key.

On the data front we see a bunch of stuff starting with Initial Claims (exp 750K) and Continuing Claims (4.3M), but we also see Nonfarm Productivity (-4.7%), Unit Labor Costs (6.6%) and Factory Orders (2.1%) this morning.  Perhaps of more importance we hear from Chairman Powell today, right at noon, and all eyes and ears will be focused on how he describes recent market activity as well as to see if he hints at any type of Fed response.  Many pundits, this one included, believe there is a cap to how high the Fed will allow yields to rise, the question is, what is that cap.  I have heard several compelling arguments that 2.0% is where things start to become uncomfortable for the Fed, but ultimately, I believe that it will depend on the data.  If the data starts to show that the economy is under pressure before 2.0% is reached, the Fed will step in at that time and stop the madness.  Until then, as we have heard from central bankers worldwide, higher yields in the back end are a good thing, so they will continue to be with us for the foreseeable future.  And yes, that means that until US inflation data starts to print higher, and real yields start to decline, the dollar is very likely to retain its bid.

Good luck and stay safe
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