A Fad that is Passing

Said central banks, stop your harassing
Inflation’s a fad that is passing
By next year we see
(Or by ‘Twenty-three)
More bonds you will all be amassing

But lately some central bank hawks
Explained that the recent price shocks
Could well last much longer
With wage growth much stronger
And that might not be good for stocks

As we walk in on this Columbus Day holiday, where US banks and the Federal Reserve are closed, although equity markets remain open, the most notable price movement has been in oil where WTI (+2.8%) has rallied to its highest price since October 2014 and now sits well above the $80/bbl level.  Fortunately, we’ve been constantly reassured that this is a temporary transitory phenomenon by numerous central bankers around the world, most frequently by Chairman Powell and ECB President Lagarde.  The claim continues to be that the only reason prices keep rising is as a result of constricted supply chains amid a massive recovery (due to their actions) from the Covid pandemic economy-wide shutdowns.  Soon enough, they also exhort, these supply chain snafus will have been corrected and then shortages of stuff will be a distant memory as we revert to the steady growth and low inflation economies we have all come to know and love.  It’s such a nice, neat story and I’m confident that they both tell themselves constantly that it is true.

Alas, reality has a nasty way of intruding upon a good storyline and recent energy price action is pretty clearly pointing to a different story than the one being peddled by Powell and Lagarde.  In fact, some of their own colleagues, as well as brethren from other key central banks like the BOE, are singing a different tune, one much more in line with reality.  For instance, last night, Klaas Knot, the Dutch Central bank president and ECB member warned investors not to underestimate inflation risks, “This risky behavior [excessive leverage] is only sustainable at low inflation and interest rates.  From the perspective of healthy risk management, it is also important to take other scenarios into consideration.”  I wonder what other scenarios he is considering.  Refreshingly, he followed that comment with this, “There is more in the inflation process we don’t understand than we do understand,” as humble a comment as one can ever expect from a central banker!

However, given Knot’s constant hawkish rhetoric, markets did not really react to his comments, as they were not terribly new.  Of more interest were comments from two separate BOE members, Governor Andrew Bailey and Michael Saunders, the most hawkish member of the MPC.  In both cases, they commented that the market was quite right to begin pricing in higher interest rates as inflation was becoming more problematic and could be “very damaging” if policymakers don’t act.  Traders did not need much prompting beyond this to reprice interest rate futures such that a first hike of 15 basis points (to 0.25%) is now expected by December, while by the end of 2022, the market is pricing a base rate of 0.75%, so two more hikes after that.  Given that UK CPI is forecast to hit 4.0% in Q4 this year, that still seems awfully far behind the curve, but then compared to the US, where inflation is already well above 4%, even on the PCE measure, and Fed Funds remained pegged at 0.00%-0.25%, that counts as tight policy.  When the comments were first published, the pound did jump as much as 0.45%, however, that has already largely faded and as I type, the pound is only 0.1% higher on the day.

Perhaps these are the first real signs that the central bank community is recognizing inflation may not be as transitory as their models (and political needs) had indicated was likely (and necessary) respectively.  Instead, its persistence is becoming more evident, even to them, and calls for tighter monetary policy to address inflation are likely to grow.  Of course, given the extraordinary levels of leverage in the global monetary system, higher rates are going to be very difficult to achieve without an ensuing dramatic decline in asset prices.  This is the corner into which the Fed (and the ECB) have painted themselves.  (As I’ve said before, if I were Chairman Powell, I would be happy to step down allowing my successor to deal with the mess that is surely coming.)  Even if the Fed does begin to taper QE purchases, they will remain behind the curve for a very long time, and those vaunted ‘tools’, which they keep describing as available, will likely not be used to full effect.  Not only is inflation going to continue to rise, but central banks are going to continue to remain behind the curve for a long time to come.  Be prepared.

Ok, with that in mind, let’s look at markets overnight.  Equities in Asia had a pretty good session, with the Nikkei (+1.6%) and the Hang Seng (+2.0%) both performing well, although Shanghai was unchanged on the day.  Europe (DAX -0.5%, CAC -0.4%), on the other hand, is a little less optimistic.  The outlier here is the UK (FTSE 100 +0.15%) where it seems investors are happy to hear of a central bank willing to address incipient inflation.  US futures are all pointing lower, however, led by the NASDAQ (-0.7%) but -0.4% losses elsewhere.

The Treasury bond market is closed in the US today, but in Europe, the trend is clear, higher yields across the board, which is exactly what we saw in Asia as well.  So, Bunds (+3.5bps), OATs (+3.0bps) and Gilts (+5.0bps) are all selling off sharply with similar movement seen across the continent.  Asia, too saw sharp declines in bond prices with Australia (+8.0bps) leading the way but even China (+6.0bps) falling sharply despite ordinary efforts to prevent volatility in that market.

In the commodity space, while oil is leading the way, pretty much everything except gold is higher with NatGas (+3.8%), copper (+1.4%) aluminum (+2.3%) and the agricultural products all firmer on the day.  Remember this, the longer food and energy prices continue to climb, the more likely those price rises bleed into “core” inflation and drive that higher as well.

Turning to the dollar, the biggest loser today is JPY (-0.6%) as the widening yield differential in favor of the dollar has reached a point where Japanese investors have started to move money more actively into USD investments on an unhedged basis.  At this point, there doesn’t seem to be much reason for JPY to rally, so a test of 115 seems to be far more likely in the near term.  After that, we shall see.  On the plus side, AUD (+0.5%) has been the biggest beneficiary of the commodity rally while surprisingly, neither NOK nor CAD, both unchanged on the day, have seen a boost from the much higher oil prices.

In the EMG bloc, INR (-0.5%) and PHP (-0.4%) are the laggards of note with RUB (+0.3%) the only notable gainer.  Oil is obviously supporting the ruble while the rupee and peso both suffer on the same story, as both India and the Philippines are major oil importers.

On the data front, nothing is released today due to the holiday, but we get some important things this week:

Tuesday NFIB Small Biz Optimism 99.5
JOLTS Job Openings 10.934M
Wednesday CPI 0.3% (5.3% Y/Y)
-ex food & energy 0.2% (4.1% Y/Y)
FOMC Minutes
Thursday Initial Claims 320K
Continuing Claims 2686K
PPI 0.6% (8.7% Y/Y)
-ex food & energy 0.5% (7.1% Y/Y)
Friday Empire Manufacturing 25.0
Retail Sales -0.2%
-ex autos 0.5%
Business Inventories 0.6%
Michigan Sentiment 73.5

Source: Bloomberg

Aside from critical CPI and Retail Sales data, we hear from ten different Fed speakers across more than a dozen events this week, including Governor Brainerd on Wednesday, someone we should be listening to very closely given the rising probability she is named the new Chair.

Right now, the dollar is consolidating its recent gains, but showing no signs of giving any of them back.  I expect that we will see another leg higher in the near future as there is no evidence that either inflation or US yields are going to decline soon.  And right now, I think those are the drivers.  At some point, inflation may become detrimental to the dollar, but for now, buy dollars on dips.

Good luck and stay safe
Adf

Risks They Have Wrought

It’s not clear why anyone thought
The ECB ever would not
Continue to buy
More bonds as they try
To safeguard ‘gainst risks they have wrought

So, when PEPP, next March, does expire
A new plan we’ll get to admire
As Christine will ne’er
Be set to foreswear
Her drive to push bond prices higher

If ever anyone was talking their own book, it was Greek central bank president Yannis Stournaras this morning on the subject of the ECB’s potential actions post-PEPP.  “Asset purchases aim at favorable financing conditions, at smooth transition of monetary policy to prevent any kind of fragmentation in jurisdictions in the euro area.  I’m sure that the Governing Council will continue to aim at this.” [author’s emphasis] These comments were in response to a report that the ECB is considering instituting a new asset purchase program when the emergency PEPP expires in March.  This is certainly no surprise as I posited this exact outcome a month ago (Severely Distraught – Sep 7) and the idea has gained credence since then.

One of the features of the ECB’s APP (original QE program from 2015) is that they are required to purchase bonds based on the so-called capital key in order to give the illusion they are not monetizing national debt.  This means that they must buy them in proportion to the relative size of each economy.  Another feature is that the bonds they purchase must be investment grade (IG).  This rules out Greek debt which currently is rated BB-, 3 notches below IG.  The PEPP, however, given the dire emergency created by governments shutting down their economies when Covid-19 first appeared, did away with those inconveniences and was empowered to buy anything deemed necessary.  Not surprisingly, purchases of bonds from the PIGS was far above their relative economic weight which has served to narrow credit spreads across the entire continent.  If the PEPP simply expires and is not replaced, it is unambiguous that PIGS’ debt would fall sharply in price with yields rising correspondingly, and those nations would find themselves in far worse fiscal shape.  In fairness, the ECB can hardly allow that to happen to just a few nations so they will continue their PEPP purchases in some manner or other.  And I assure you they will continue to purchase Greek debt regardless of its credit rating.

It is useful to compare this future to that of the Fed, where Chairman Powell has indicated that as long as the payroll number this Friday is not a complete disaster (currently expected 500K), a reduction in the pace of QE is appropriate. On the surface, it would be quite reasonable to expect the euro to decline further given what is likely to be a divergence in relative yields.  Yesterday’s ADP Employment report (568K) was better than expected and certainly seems to be of sufficient strength to support the Chairman’s view of continued strength in the labor market.  Thus, if the Fed does begin to taper while the ECB discusses its next version of QE, I would look for the euro’s recent decline to continue.

Of course, the big question is, will the Fed continue to taper if the economic situation in the US starts to show much less impetus?  For instance, the Atlanta Fed’s GDPNow forecast is estimating Q3 GDP growth at 1.333%, MUCH weaker than it had been in the past and a MUCH sharper slowdown than the Fed’s own forecasts.  While the number may well be higher than that, it does speak to a run of weaker than expected economic data in the US.  Inflation, meanwhile, shows no signs of abating soon.  The Fed looks set to find themselves in a very uncomfortable position with the following choices: tighten into slowing growth or let inflation run much hotter than targeted for much longer than anticipated.  (If I were Powell, given the trainwreck that is approaching, I don’t think I would accept the offer of reappointment should it be made!)

In sum, while the decision process in Europe is much easier with slower growth and lower inflation, extending monetary largesse still seems appropriate, in the States, some tough decisions will need to be made.  The problem is that there is not a single person in any Federal position who appears capable of making (and owning) a tough decision.  In fact, it is this lack of demonstrated decision-making prowess that leads to the idea that stagflation is the most likely outcome going forward.

But it is still a few weeks/months before these decisions will need to be made and, in the meantime, Buy Stonks!  Well, at least, that seems to be the investor mindset as fleeting fears over contagion from China Evergrande’s slow motion bankruptcy and comments from Vladimir Putin that Russia would, of course, supply the necessary NatGas for Europe, have been sufficient to remind the equity crowd that a 5% decline from an all-time high price level is an amazing opportunity to buy more stocks.  Hence, yesterday morning’s fears have abated and all is once again right with the world.

(As an aside, it strikes me that relying on a key geopolitical adversary to supply the life’s blood of your economy is a very risky strategy.  But Putin would never use this as leverage for something else, would he?  I fear it could be a very long cold winter in Europe.)

OK, with that in mind, let’s look at markets this morning.  Equity markets are green everywhere ranging from the Nikkei (+0.5%) to the Hang Seng (+3.1%) with all of Europe in between (DAX +1.2%, CAC +1.35%, FTSE 100 +1.0%) while China remains closed.  US futures are also firmer, currently pointing to a 0.75% rise on the open.

Bond markets are in pretty good shape as well.  Yesterday, after substantial early session weakness, they rebounded, and this morning are continuing on that trend.  While Treasuries are only lower by 0.2bps, in Europe we are seeing much better buying (Bunds -1.7bps, OATs -2.1bps, Gilts -1.2bps) with PIGS bonds (Italy -5.1bps, Greece -3.0bps) showing even more strength.

Commodity prices are consolidating after what has been a significant run higher with oil (-1.6%) and NatGas (-2.0%) both off highs seen yesterday morning.  Gold is unchanged on the day while copper (+1.1%) has bounced along with other base metals.  Ags, too, are a bit firmer this morning.

This positive risk attitude has seen the dollar cede some of its recent gains with AUD (+0.35%) leading the way in the G10 on the back of stronger commodity prices, followed by SEK (+0.3%) and NZD (+0.3%) both benefitting from better risk appetite as well.  Only NOK (-0.1%) is under pressure on the back of the oil price decline.  EMG currencies are universally stronger led by ZAR (+0.7%), PHP (+0.6%) and RUB (+0.5%).  ZAR is clearly benefitting from the commodity rally while PHP was higher on some positive growth comments from the central bank there.  The ruble seems to be benefitting from the view that a higher than expected CPI print there will force the central bank to raise rates more than previously anticipated.

On the data front, today brings only Initial (exp 348K) and Continuing (2762K) Claims.  Given tomorrow is payroll day, these are unlikely to move the market.  We also hear from Cleveland Fed president Mester, one of the more hawkish voices, discussing inflation, but my sense is all eyes are on tomorrow’s NFP to make sure that the taper is coming.  As such, today is likely to continue to see risk appetite with higher stock prices and a soft dollar.  But large moves seem unlikely.

Good luck and stay safe
Adf

Recalibrate

Christine said she’d recalibrate
The PEPP, but she clearly did state
No taper’s occurring
Because we’re still spurring
Inflation to reach our mandate

I felt it was important for all of us to be reminded of what tapering means, hence this definition from the Merriam-Webster dictionary:

taper   verb

1               : to become progressively smaller toward one end
2               : to diminish gradually (emphasis added)

But perhaps there is a better source to explain Madame Lagarde’s dissembling comments yesterday; Lewis Carrol.

“I don’t know what you mean by ‘glory,’ ” Alice said.
Humpty Dumpty smiled contemptuously. “Of course, you don’t—till I tell you. I meant ‘there’s a nice knock-down argument for you!'”
“But ‘glory’ doesn’t mean ‘a nice knock-down argument’,” Alice objected.
“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”

Apparently, Madame Lagarde was channeling Humpty Dumpty in her press conference yesterday when she said that while the ECB would be gradually reducing the rate of purchases in the PEPP program in the coming quarter, it was definitely not tapering.  One of the problems this author has with centralbankspeak is that my education taught me based on the plain meaning of the words used.  Hence, claiming that a reduced rate of purchases is not tapering is simply dishonest.  However, central bankers everywhere, led by the Fed and ECB, have come to rely on redefining terms in order to placate both of their masters, markets and governments, who frequently require opposing policies to achieve their goals.

Remember, too, what happened to Humpty Dumpty, a lesson I daresay has been lost on Powell, Lagarde and their comrades-in-arms:

Humpty Dumpty sat on a wall
Humpty Dumpty had a great fall
All the King’s horses and all the King’s men
Couldn’t put Humpty together again.

As economist Herbert Stein explained in 1986, “if something cannot go on forever, it will stop.”  Central bank balance sheets cannot grow indefinitely, at least not without other repercussions.  The most likely relief valve will be the currency, but do not be surprised if there is significant damage to all financial assets at the time investors and markets cease to accept centralbankspeak as a valid guide to the future.

Ever since the GFC, central banks around the world have been aggressively adding liquidity to economies at a far faster pace than those economies create goods and services.  For the first decade of this process, that liquidity mostly found its way into financial markets resulting in the longest bull market in history.  But lately, that liquidity has begun to seep into the real economy on the back of a massive uptick in fiscal stimulus.  The result, you may have noticed, is that financial markets have stopped rising at their previous rate, but the price of stuff you buy every day/week, has started to rise much more rapidly. It is this fact that was the genesis of the ‘transitory’ inflation story, as central banks, notably the Fed, recognize they cannot afford to be blamed for rising consumer inflation, but also cannot afford to fight inflation in the traditional manner of raising interest rates as they are terrified adjusting their current policy will result in a massive market decline.  Hence, I fear the Humpty Dumpty metaphor will wind up being very accurate.  However, he hasn’t fallen yet.

And so, Madame Lagarde did exactly what she set out to do; she was able to explain the ECB would be slowing their PEPP purchases without the market responding in a knee-jerk sell-off.  She placated the hawks on the ECB Council, and watched as Italian BTPs outperformed German bunds thus reducing pressure on the biggest potential problem in Europe.  In the end, kudos are due, at least for now.  I sure hope it lasts, but fear there is much turmoil in our future.

In the meantime, the overall market response to Lagarde has been…buy risk!  Equity markets everywhere are in the green with Asia (Nikkei +1.25%, Hang Seng +1.9%, Shanghai +0.3%) charging ahead and Europe (DAX +0.3%, CAC +0.3%, FTSE 100 +0.3%) following, albeit at a bit slower rate.  US futures, after two lackluster sessions in NY, are pointing higher by 0.4% to start the day.

Of course, with risk appetites whetted, there is no need to hold havens like bonds and so prices there have fallen everywhere with corresponding rises in yields.  Treasuries (+2.9bps) are leading the way but we are seeing Europe (Bunds +1.8bps, OATs +1.9bps, Gilts +1.1bps) all under some pressure as well.  As long as risk is in the ascendancy, I expect that bond yields will continue to edge higher.

Commodity prices are also firmer this morning led by oil (+1.7%) and the entire energy complex.  But metals, too, are up, at least industrial metals with copper (+1.9%), aluminum (+1.6%) and tin (+1.2%) all much stronger and with the latter two pushing to multi-year highs.  While gold is flat on the day, and has been doing very little lately, broadly speaking, the commodity complex continues to perform well.

Finally, the dollar, not surprisingly, is under significant pressure this morning, down versus most of its G10 counterparts, notably the commodity bloc.  NZD (+0.6%), NOK (+0.45%) and AUD and CAD (+0.4%) are all looking strong today bolstered by broad dollar weakness and strong commodity price action.  On the flip side, JPY (-0.2%) is the only real decliner as haven assets are sold, although CHF is also modestly softer.  In the emerging markets, the screen is entirely green led by ZAR (+0.75%), CZK (+0.5%) and IDR (+0.35%).  Rand is clearly in thrall to commodity prices while the koruna is rallying on the back of a much higher than expected CPI print of 4.1%, which has traders looking for a central bank rate increase at the next meeting at the end of the month.  As to the rupiah, it seems this is entirely a result of the risk-on attitude in markets this morning.

On the data front, early this morning the UK released its monthly GDP print at a worse than expected 0.1%, blamed now on the increase of the delta variant.  German CPI was confirmed at 3.9% in August, and Italian IP managed to rise 0.8% in July, a bit better than expected.  Here at home we will see PPI (exp 8.2%, 6.6% ex food & energy) which will continue to challenge the transitory narrative but will not have nearly the impact of next Tuesday’s CPI release.  As well, we hear from the Cleveland Fed’s Loretta Mester this morning, but she has already explained she is ready to taper QE purchases, so unless that story changes, I don’t foresee any impact.

While the dollar is softer this morning, there is no indication it is going to decline substantially at any point in the near future.  Rather, we remain in the middle of the 1.17/1.20 trading range that has capped movement since June.  I see no reason for anything to change here and expect the week to finish in a quiet manner.

Good luck, good weekend and stay safe
Adf

Anything But Preordained

Some pundits think Madame Lagarde
Is ready, the PEPP, to retard
But others believe
She’ll never achieve
Her goals sans her bank’s credit card

Meanwhile data last night explained
That factory prices had gained
The idea inflation
Is due for cessation
Is anything but preordained

Two noteworthy stories this morning are the ECB meeting, where shortly we will learn if the much-mooted reduction in PEPP purchases is, in fact, on the way and Chinese inflation data.  Similar to the Fed, despite a more lackluster economic performance across the Eurozone as a whole, the hawkish contingent of the ECB (Germany, Austria, Finland and the Netherlands) have been extremely vocal in their calls for tapering PEPP bond purchases.  While the Germans have been the most vocal, and are also seeing the highest inflation readings, this entire bloc has a history of fiscal prudence and the ongoing ECB asset purchase programs, which essentially fund fiscal policy in the PIGS, remains a significant concern.  However, the majority of nations in the Eurozone appear quite comfortable with the ongoing purchase programs.  At times like this, one cannot think along the lines of the economic logic of tapering; instead one must consider the political logic.  Remember, Lagarde is a politician, not a true central banker steeped in policy and economics.  To the extent that enough of her constituents believe the current purchase rate of €80 billion to €85 billion per month is appropriate, that is the rate she will maintain.

Markets are generally, I believe, looking for a modest reduction in PEPP purchases, so if the ECB does not adjust purchases lower, I would expect European sovereign bonds (currently slightly firmer with yields lower by about 1 basis point) to rally and the euro (+0.15% this morning) to decline.  European bourses, currently all lower by between 0.25% and 0.75%, are also likely to perform well on the news.

On a different note, China reported its inflation data last night and while CPI there remains muted (0.8% Y/Y), PPI (9.5% Y/Y) is absolutely soaring.  This is the highest reading since August 2008, right before the GFC began, and is the product of rising commodity prices as well as increases in shipping costs and shortages of labor.  The reason this matters so much to the rest of the world is that China continues to be the source of a significant portion of “stuff” consumed by most nations.  Whether that is tee-shirts or iPhones, rising prices at the Chinese factory gate imply further price pressures elsewhere in the world, notably here in the US.  Several studies have shown a strong relationship between Chinese PPI and US CPI, and the logic behind the relationship seems impeccable.  Perhaps a key question is whether or not Chinese PPI increases are also transitory, as that would offer some hope for the Fed.  Alas, history has shown that the moderation of Chinese PPI is measured in years, not months.

Before we turn to today’s markets, I believe it is worthwhile to mention the latest Fedspeak.  Yesterday we heard from NY Fed president John Williams who stayed on message, explaining that substantial further progress had been made on the Fed’s inflation goal, but not yet on the employment goal.  He followed that up by telling us that if things go according to his forecasts, tapering could well begin before the end of the year.  The theme of tapering before the end of 2021, assuming the economy grows according to plan, has been reiterated by numerous Fed speakers at this point, with both Kaplan and Bostic adding to Williams’ comments yesterday.  But what happens if growth does not achieve those lofty goals?  After all, the Atlanta Fed’s own GDPNow data is now forecasting 1.943% growth in Q3.  That seems quite a bit lower than FOMC forecasts.  And yesterday’s JOLTS data showed nearly 11 million job openings are extant, as the supply of willing workers continues to shrink.  A cynic might believe that the current Fedspeak regarding the potential for tapering shortly, assuming data adheres to forecasts, is just a ruse as there is limited expectation, within the Fed, that the data will perform.  This will allow the Fed to maintain their easy money with a strong rationale while sounding more responsible.  But that would be too cynical by half. Do remember, however, Fed forecasts are notoriously inaccurate.

OK, markets overnight are continuing down a very modest risk-off path.  Equities in Asia were generally lower (Nikkei -0.6%, Hang Seng -2.3%) with Shanghai (+0.5%) a major exception.  Ongoing crackdowns on on-line gaming continue to undermine the value of some of China’s biggest (HK listed) companies, while the debt problems at China Evergrande continue to explode.  (China Evergrande is the second largest real estate company in China with a massive debt load of >$350 billion and has been dramatically impacted by China’s attempts to deflate its real estate bubble.  It has been downgraded multiple times and its stock price has now fallen well below its IPO price.  There are grave concerns about its ability to remain an ongoing company, but given the size of its debt load, a failure would have a major impact on the Chinese banking sector as well as, potentially, markets worldwide.  Think Lehman Brothers.)  Alongside the previously mentioned weakness in Europe, US futures are all currently lower by about 0.25%.

Treasury prices are continuing their modest rally, with yields falling another 1.2bps as risk appetite generally wanes.  Given the FOMC meeting is still two weeks away, investors remain comfortable that Treasuries are still a better buy than other securities.  Interestingly, the debt ceiling question does not seem to have reached the market’s collective consciousness yet, although it does offer the opportunity for some serious concern.  However, history shows that despite all the huffing and puffing, Congress will never allow a default, so this is probably the correct behavior.

Commodity prices are rebounding with oil (+0.8%), gold (+0.45%) and copper (+1.3%) leading the way.  The rest of the industrial space is generally firmer although foodstuffs are all softer this morning in anticipation of upcoming crop reports (“sell Mortimer!”)

As to the dollar, it is on its heels this morning, down versus all its G10 counterparts led by NOK (+0.35%) and GBP (+0.3%).  Clearly the former is benefitting from oil’s rise while the pound seems to be benefitting from BOE comments indicating a greater concern with inflation and the fact the Old Lady may need to address that sooner than previously anticipated.  In the EMG bloc, there are far more winners than losers, but the gains have been muted.  For instance, PHP (+0.4%) has been the biggest winner, followed by ZAR (+0.3%) and RUB (+0.25%).  While the latter two are clear beneficiaries of firmer oil and commodity prices, PHP seems to have gained on the back of a potential reversal of Covid lockdown policy by the government, with less restrictions coming.  On the downside, only KRW (-0.25%) was really under pressure as the Asian risk-off environment continues to see local equity market sales and outflows by international investors.

On the data front, this morning brings only Initial (exp 335K) and Continuing (2.73M) Claims.  However, we do hear from four more Fed speakers, with only Chicago’s Evans having yet to say tapering could be a 2021 event.  In truth, at this point, given how consistent the message has been, I feel like data is more likely to drive markets than comments.  Given today’s calendar is so light, I expect we will see another day of modest movement.  The one caveat is if the ECB surprises in some manner, with a greater risk of a more dovish stance than the market assumes.

Good luck and stay safe
Adf

Could Be Dead

The tapering talk at the Fed
Continues as they look ahead
Though growth’s clearly slowing
Inflation is growing
So, QE, next year, could be dead

In Europe, though, it’s not the same
As price rises largely are tame
But plenty of squawks
From ECB hawks
Have feathered the doves with great shame

Central bank meetings continue to be key highlights on the calendar and this week is no different.  Thus far we have already heard from the RBA, who left policy unchanged, as despite inflation running at 3.8% Q/Q, are unwilling to tighten policy amid a massive nationwide lockdown.  After all, how can they justify tighter policy as growth continues to sag?

This morning the BOC meets, and the universal view is that the Overnight Lending rate will be left unchanged at 0.25%.  However, you may recall that the BOC has actually begun to taper its QE purchases, reducing the weekly amount of purchases to C$2 billion from its peak setting of C$4 billion.  Most of the punditry believe that there will be no change in the rate of QE at this meeting as the bank will want to evaluate the impact of the delta variant on the Canadian economy more fully, but most also believe that the next step lower will occur in October.  In either event, though, it seems the currency markets remain far more focused on the US half of the equation than on what the other central bank is doing.  After all, since the BOC began to taper policy in April, the Loonie has weakened by more than 1%, although it did show initial strength in the wake of the surprise announcement.

Turning to tomorrow’s ECB meeting, there has also been a clear delineation between the hawks and doves as to the proper steps going forward.  Given the macroeconomic situation in Europe, where growth is slowing from relatively modest levels and inflation remains far below levels seen in either the US or Canada (or Australia or the UK), it would seem that the doves should retain the upper hand in the discussion.

But one of the key, inherent, flaws in the Eurozone is that different countries tend to have very different economies as well as very different fiscal policies, and so the individual economic outcomes vary greatly.  Thus, while Spain remains mired with excessively high unemployment and lackluster growth prospects, as does Italy, Germany has seen rising prices in a much more sustained fashion, with CPI there running a full percentage point above the Eurozone as a whole.  Given that German DNA is vehemently anti-inflation (a result of the suffering of the Weimar Hyperinflation of the 1920’s), this situation has resulted in Bundesbank President Jens Weidmann and some of his closest colleagues (Austria’s Holtzmann and the Netherlands’ Knot) vociferously calling for a reduction in the rate of purchases in the PEPP.  However, most of the rest of the committee sees no need to slow things down.  The question tomorrow is whether or not Madame Lagarde will be able to tether the hawks.  While there is market talk that tapering will occur, my money is on no change in the pace of purchases.  The direct impact of this should be further modest weakness in the euro and a rebound in European sovereign bond market prices.

As to the Fed, they meet in two weeks’ time and after Powell’s Jackson Hole performance, I think there are vanishingly few players who believe they are going to even announce the tapering schedule then.  However, that does not mean that the segment of the FOMC who are adamantly pro-taper will be quiet, and so expect to hear a steady stream of tapering talk until the quiet period begins on Saturday.  In fact, just last night St Louis President Bullard was interviewed by the FT and reiterated his vocal stance that tapering needs to begin right away.  As well, we will hear from Dallas’ Kaplan later today with his message guaranteed to be the same.  Of more interest will be NY’s Williams, who speaks this afternoon at 1:10pm, and who has yet to voice his tapering opinion.  If he does say tapering is necessary, that would be an important signal, so we must pay close attention.

With all that in mind, markets overnight have started to take a somewhat dimmer view of risk, especially in Europe.  In fact, looking around, only the Nikkei (+0.9%) has been able to see any positivity as the rest of Asia (Hang Seng -0.1%, Shanghai -0.1%) edged lower while Europe (DAX -0.7%, CAC -0.4%, FTSE 100 -0.5%) are seeing much greater selling.  That said, the situation on the Continent was worse earlier in the session with losses everywhere greater than 1.0%.  US futures, meanwhile, are essentially unchanged on the morning, although leaning slightly lower.

In the bond market, buyers have returned with Treasury yields falling 2.4bps, reversing half of yesterday’s climb.  But Europe, too, is seeing demand for havens with Bunds (-1.2bps), OATs (-1.5bps) and Gilts (-1.0bps) all decently bid this morning.  Certainly, if the ECB does reduce its PEPP purchases you can expect yields across the board in Europe to rise.  And, in fact, that is why I don’t expect that to occur!

In a bit of a conundrum, commodity prices are generally higher, alongside the dollar.  Looking at WTI (+1.4%), it seems that energy is on the rise everywhere.  (Pay attention to Uranium, which has rallied 32% in the past month and is structurally bullish as current demand is significantly greater than the run rate of production.)  But weirdly, other than copper (-0.8%) every other key commodity is higher this morning with Au (+0.3%), Al (+0.5%) and Soybeans (+0.7%) leading the way.

This is strange because the dollar is broadly, albeit generally modestly, higher this morning.  In the G10, EUR, CAD and DKK are all softer by 0.2% while only NZD (+0.1%) has managed any gains on the back of the strength in commodity prices.  In the emerging markets, the situation is far more pronounced with TRY (-1.0%) leading the way lower after the central bank indicated rate cuts were coming, although we also saw weakness overnight in KRW (-0.75%), THB (-0.5%) and TWD (-0.4%).  All of these Asian currencies suffered on a pure risk-off viewpoint as equity markets in these nations fell as well.  But it’s not just APAC currencies as we are seeing weakness in EMEA with HUF (-0.5%) and PLN (-0.3%) also under pressure.

On the data front, today brings the JOLTS Job Openings report (exp 10.049M) which continues to indicate the labor market is quite tight despite the payroll data last week.  And after that we get the Fed’s Beige Book at 2:00.  To my mind, Williams’ speech at 1:10pm is the most important story of the day, so we will need to pay close attention when he starts speaking.

Overall, it appears that the dollar bulls have regained the upper hand and are slowly pushing the greenback higher versus most counterparts.  If Williams does agree tapering is needed, I expect the dollar to take another leg higher.  But if he is clear that there is no rush, especially with the delta variant impact, look for the dollar to cede some of its recent gains and equity markets to regain a little spring in their step.

Good luck and stay safe
Adf

Severely Distraught

At Jackson Hole, Powell explained
Inflation goals have been attained
But joblessness still
Is high, so they will
Go slow ere their bond buying’s waned

The market heard slow and they thought
The stock market had to be bought
So, prices keep rising
And it’s not surprising
The hawks are severely distraught

In my absence, clearly the biggest story has been Chairman Powell’s Jackson Hole speech, where he promised at some point that the Fed would begin to taper their bond purchases, but that it was still a bit too early to do so.  He admitted that inflation had achieved their target but was still quite concerned over the employment portion of the Fed’s mandate, hence the ongoing delay in the tapering.  And perhaps he was prescient as after Jackson Hole the NFP number was a massively disappointing miss, just 235K vs 733K median forecast.  And to be clear, that number was well below the lowest forecast of 70 estimates.  The point is, the evolution of the economy is clearly not adhering to the views expressed by many, if not most, FOMC members.  We have begun to see significant reductions in GDP growth forecasts for the second half of the year, with major investment banks all cutting their forecasts and the Atlanta Fed’s GDPNow number falling to a remarkably precise 3.661% for Q3.

With this as a backdrop, it can be no surprise that the dollar has fallen dramatically during the past two weeks.  For instance, in the G10, NOK (+4.2%) and NZD (+4.2%) both led the way higher as commodity prices rebounded, oil especially, and the US interest rates fell.  In fact, the only currency to underperform the dollar since my last note has been the Japanese yen (-0.15%), which is essentially unchanged.  The story is the same in the EMG space with virtually every currency rising led by ZAR (+6.9%) and BRL (+4.1%).  In fact, only Argentina’s peso (-0.65%) managed to decline over the previous two weeks.  The point is, the belief in a stronger dollar, based on the idea of the Fed tapering QE and then eventually raising interest rates, has come a cropper.  The question is, where do we go from here?

With Jay in the mirror, rearview
It’s Christine’s time, now, to come through
On Thursday we’ll hear
If she’s set to steer
The ECB toward Waterloo

As the market walks in after the Labor Day holiday in the US, we are seeing the beginnings of a correction of the past two week’s price action, at least in the FX markets.  Surveying the overnight data shows a minor dichotomy in Germany, where IP (+1.0%) rose a bit more than expected although the ZEW Surveys were both softer than expected.  Meanwhile, Eurozone GDP grew at a slightly better than previously reported 2.2% quarterly rate in Q2, although that does not include the most recent wave of delta variant imposed lockdowns.  In other words, we are no longer observing either uniform strength or weakness in the data, with different parts of each national economy being impacted very differently by Covid-19.  One other thing to note here is the decline in support for the ruling CDU party in Germany where elections will be held in less than two weeks.  It seems that despite 16 years of relative prosperity there, under the leadership of Chancellor Angela Merkel, the populace is looking for a change.  This matters to the FX markets as a change in German economic policy priorities is going to have a major impact on the Eurozone, and by extension the euro.  Of course, at this point, it is too early to tell just what that impact may be.

Of more immediate interest to the market will be Thursday’s ECB meeting, where, while policy settings will not be altered, all eyes and ears will be on Madame Lagarde to understand if the ECB, too, is now beginning to consider a tapering of its QE purchases.  Last week, CPI data from the Eurozone printed at 3.0%, its highest level since September 2008, and well above the ECB’s 2.0% target (albeit not quite as far above as in the US).  This has some of the punditry starting to expect that the ECB, too, is ready to begin to taper QE.  However, the Eurozone growth impulse remains significantly slower than that in the US, and with the area unemployment rate still running at an uncomfortably high 7.6%, (much higher in the PIGS), it remains difficult to see why they would be so keen to begin removing accommodation.  Given the ECB storyline, similar to the Fed, is that inflation is transitory, there is no reason to believe the ECB is getting set to move soon.  Rather, I expect that although the PEPP may well end next March on schedule, it will simply be replaced with either an extension or expansion of the original APP, and likely both.  The reality is that the bulk of the Eurozone would see a collapse in growth without the ongoing support of the ECB.

Turning away from that happy news, a quick survey of markets shows that equities in Asia have continued their recent strong performance (Nikkei +0.9%, Hang Seng +0.7%, Shanghai +1.5%), all of which have rallied sharply in the past two weeks.  Europe, however, has not embraced today’s data, or is nervous about potential ECB action, as markets there are a bit softer (DAX -0.3%, CAC -0.1%, FTSE 100 -0.4%).  US futures markets are essentially unchanged at this hour, continuing their recent very slow grind higher.

Of more interest today is the bond market, where Treasury yields have rallied 4.1 basis points and we are seeing higher yields throughout Europe as well (Bunds +3.9bps, OATs +4.3bps, Gilts +3.2bps).  During my break, yields have managed to rally 10bps (including today) which really tells you that the market is still completely in thrall to the transitory story.  Either that, or the Fed continues to absorb any excess paper around.  However, higher yields seem to be helping the dollar more than other currencies despite similar size movements.

While the movement has not been significant, especially compared to the dollar weakness seen during the past two weeks, we are seeing strength in the dollar vs G10 currencies (AUD -0.5%, CAD -0.4%); EMG currencies (ZAR -0.6%, TRY -0.6%); and commodities (WTI -0.6%, Au -0.7%, Cu -1.1%).  Looking at today’s price action, it appears that US rate movement has been the dominant driver.

On the data front, it is a remarkably quiet week with just a handful of numbers:

Wednesday JOLTs Job Openings 10.0M
Fed’s Beige Book
Thursday Initial Claims 335K
Continuing Claims 2744K
PPI 0.6% (8.2% Y/Y)
-ex food & energy 0.5% (6.6% Y/Y)

Source: Bloomberg

We also hear from six Fed speakers, with NY President Williams the most important voice.  But thus far, the Fed’s messaging has been quite effective as they continue to assuage fixed income investors with the transitory tale and thus interest rates remain near their longer-term lows.  While at some point I expect this narrative to lose its hold on the investment community, it does not appear to be an imminent threat.

While I was out, the market flipped its views from concern over tapering leading to higher interest rates, to when tapering comes, it will be “like watching paint dry”*.  FX investors and traders determined there was no cause for a much stronger dollar, and so the buck gave back previous gains and now sits back in the middle of its trading range.  As such, we need to search for the next potential catalyst to change big picture views.  While my money is on the collapse of the transitory narrative, and ensuing dollar weakness, you can be certain the Fed will fight hard to keep that story going.  In other words, I expect that the trading range will remain intact for the foreseeable future.  Trade accordingly.

Good luck and stay safe
Adf

*June 15, 2017 comments from then Fed Chair Janet Yellen regarding the normalization of Fed policy and the balance sheet, where she described the process as similar to watching paint dry.  It turns out, that policy process was a bit more exciting, especially in Q4 2018 when equity markets fell 20% and Chair Powell was forced to abandon that policy.

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
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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
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