Tag Archives: #Fed

Dire Straits

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The Vice-Chair explained he foresees
A time when the Fed, by degrees
Will taper their buying
Of bonds while they’re trying
To offset the spread of disease

Soon after they finish that deed
Most members already agreed
To raise interest rates
Unless dire straits
In markets don’t let them succeed

Fed Vice-Chair Richard Clarida certainly surprised markets yesterday with his speech as he laid out his reasoning that the tapering of the Fed’s current QE purchases will occur sooner than many had previously expected.  While he started out with the caveat that the Fed will not be responding to forecasts, but rather to actual economic outcomes, he then proceeded to forecast the exact sequence of events that will occur and create the proper environment for the Fed to first, taper bond purchases and second, eventually raise interest rates.  The market response was immediate, with the bond market selling off sharply, the dollar rallying and equity markets ceding early gains alongside most commodity prices.  After all, a tighter Fed is not nearly as supportive of risk assets, but neither does it imply lower interest rates.  It is also worth noting that coincident with the release of the text of his speech was the release of the ISM Services number which printed at a much higher than expected, and record level, 64.1.  So, a positive data print and a hawkish Fed speaker were sufficient to change a lot of opinions.

But not this author’s, at least not yet.  My baseline view continues to be that the Fed remains in an extremely difficult position where inflation continues at much higher levels than which they expected or with which they are comfortable, but the employment market remains far away from their restated goal of maximum employment.  As well, as Clarida noted yesterday, and as has been repeated by numerous other Fed speakers, they promise they are not going to move on forecasts or survey data, but instead wait for actual numbers (read the NFP data and core PCE) to achieve their preferred levels before altering policy.  This means that tomorrow’s NFP data will be scrutinized even more closely than usual, as Clarida’s comments yesterday imply that even more FOMC members are ready to move.

One problem with the early taper thesis is that the data may not meet the FOMC’s requirements, at least not in the near term.  For instance, yesterday’s ADP Employment release printed at 330K, less than half the expected 690K and basically one-third of the forecasts for NFP tomorrow.  While the month to month correlation between the two data points is not perfect (0.784 over the past 5 years) it is certainly high enough to imply a strong relationship between the two.  The point is that if tomorrow’s NFP number disappoints, which cannot be ruled out, and assuming that the Fed is true to their word regarding waiting for actual data to reach their preferred levels, it would certainly suggest a delay to the tapering story.  Keep in mind, as well, that the Citi Economic Surprise Index, which measures actual releases vs. forecasts, remains in negative territory, implying that the economy is slowing further rather than extending gains seen earlier in the year.  In fact, after the much worse than expected GDP print last week, it appears that growth is already slipping back toward pre-Covid trends of 1.5% – 2.0%.  Oh yeah, none of this includes the impact of the delta variant, which has resulted in numerous lockdowns around the world and augers still slower growth.

On the flip side, though, is the fact that we have seen an increasing number of FOMC members start to accept the idea that tapering will soon be appropriate.  In addition to Clarida, yesterday we also heard from SF Fed President Daly, an avowed dove, who said, “Fed will do something on asset purchases end ’21 / early ’22.”  By my count, that makes at least six different FOMC members who have indicated tapering is coming soon.  Of this group, Clarida is by far the most important, but if even the doves like Daly are coming round to that view, tapering cannot be ruled out.

To taper or not remains the $64 trillion question for all markets, and while the recent trend of the narrative seems to be pushing in that direction, without support from ongoing improvements in employment data (after all, inflation is well through their target), it will still come to naught.

One last thing on inflation.  As the Fed tries to retake the narrative from the market, be prepared for a new description of inflation.  No longer will it be transitory, but rather, perhaps, tolerable.  In other words, they will accept that it is running hotter than their target and make the excuse that it is far more important to get the nation back to work first, at which point they can use those vaunted tools they frequently mention to address rapidly rising prices.

With all this in mind, the next question is, how will these changes impact the markets?  Yesterday’s price action is likely to be a very good case study if the data continues to support an early tapering of purchases.  Any interruption in the flow of money into the capital markets will be felt by both equities and bonds in the same way, they will fall in price, while the dollar is very likely to find a lot of support vs. both G10 and EMG counterparts.  As to commodities, my inclination is that the past year’s rally will pause, at the very least, but given they remain massively undervalued vs. other asset classes, they likely still have some upside.

On to today.  Overnight price action was mixed with the Nikkei (+0.5%) rising somewhat while Chinese shares (Hang Seng -0.8%, Shanghai -0.3%) were under pressure as stories about the next sectors to feel the wrath of regulators (sin stocks) were rampant with those falling and dragging the indices with them.  fortunately, they represent a much smaller portion of the market than the tech sector, so will have a smaller negative impact if that is, indeed, the situation.  Europe is mixed this morning (DAX +0.1%, CAC +0.35%, FTSE 100 -0.2%) as the morning data was inconclusive and investors there are far more concerned with the Fed than anything else.  As to US futures, they are all modestly higher this morning, about 0.2%.

Bond markets are showing the difference between central bank policy this morning with Treasuries consolidating yesterday’s declines and unchanged on the day, while European sovereigns (Bunds -1.0bps, OATs -1.2bps) continue to see support from an ECB that is nowhere near tightening policy.  Gilts (+2.0bps) on the other hand, are selling off a bit as the BOE meeting, just ending, revealed several things.  First, they are prepared to go to negative interest rates if they need to.  Second, they will continue their current QE pace of £3.4 billion per week, and third, that they expect inflation to reach 4.0% in Q4 of this year.  They did, however, explain that if things proceed as expected, some tightening, read higher interest rates, may be appropriate.  while the initial move in the GBP was a sharp jump higher, it has already retraced those steps and at +0.2% is only modestly up on the day.

Commodity prices are mixed with oil consolidating after yesterday’s rout and unchanged on the day.  In fact, the same is true of precious and most base metals, as traders are trying to figure out their next move, so likely waiting for tomorrow’s data.

And the dollar, interestingly, is modestly softer vs. the G10 this morning, but that is after a strong rally yesterday in the wake of the Clarida speech.  The commodity bloc is leading the way (AUD +0.35%, NOK +0.3%, NZD +0.25%) despite the lack of commodity price action.  And this also sems to ignore the 6th lockdown in Melbourne since the pandemic began last year, as the delta variant continues to wreak havoc around the world.  The rest of the G10 though, has seen much less movement.  In the emerging markets, PHP (-1.0%) was by far the worst performer overnight as the covid caseload soared to record numbers and concerns over growth expanded.  After that, TRY (-0.6%) is the next worst, as President Erdogan came out with calls for a rate cut despite rampant inflation.  However, away from those two currencies, movement has been on the order of +/- 0.2%, indicating nothing very special.  Essentially, these markets have ignored Clarida.  One last thing to note here is yesterday, the central bank of Brazil raised its SELIC rate by 1.0% to 5.25%, as inflation is exploding there.  However while BRL has been modestly stronger over the past several sessions, this was widely priced in so there was no big movement.

Data-wise, today brings Initial Claims (exp 383K), Continuing Claims (3255K) and the Trade Balance (-$74.2B), none of which seem likely to change any opinions.  Rather, at this point, all eyes are on tomorrow’s NFP data.  We also hear from two Fed speakers, Governor Waller and Minneapolis President KashKari, who is arguably the most dovish of all.  certainly if he starts talking taper, then the die is cast.  We shall see.

As I said, if tapering is on the cards, the dollar will likely test its highs from March/April, so be prepared.

Good luck and stay safe
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Jay’s Watershed

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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
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On Command

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As Covid infections expand
Worldwide, and more meetings get banned
The worry is that
Growth’s surge will fall flat
And stocks will not rise on command

But Monday’s price action was fleeting
As dip buyers now are competing
To add to their stash
Of low value trash
Before the Fed’s next monthly meeting

Come with me on a journey to the past.  A time when investors considered risks as well as rewards and if those risks seemed elevated, those very same investors would consider actually selling stocks and running to the (relative) safety of the government bond market.  Risks could include slower growth, higher inflation or even the recurrence of a global pandemic.  Naturally, under circumstances of that nature, investors displayed caution.  Now, fortunately, situations like that don’t seem to happen very often anymore, although if you think back to…Monday, that seemed to be the developing narrative.   Ahh, but as Dinah Washington crooned so fantastically in 1959, What a Difference a Day Makes.

Monday’s price action and narrative might as well have occurred in 2008 during the GFC given how long ago it seems and how short memories have become over time.  So, all of the angst regarding the spread of the delta variant and additional lockdowns around the world, as well as the impact that would have on the global growth scenario has essentially been expunged from the record and it’s now all sunshine, lollipops and rainbows going forward.  At least, that’s the way it seems this morning.

Yesterday saw a significant rebound in the equity market and a sharp sell-off in Treasury and other government bond markets as the bargain hunters were out in force taking advantage of the 2% dip seen Monday.  After all, it’s not as though there was any new news released to encourage a change in view.  The only data release was Housing Starts which were marginally better than expected, but then everybody knows the housing market is en fuego.  With both the Fed and ECB in their quiet periods ahead of upcoming meetings, there were no central bank statements to help ameliorate concerns that had become manifest on Monday.  Which leads to the conclusion that nothing in the zeitgeist has changed; buy the dip because there is no alternative remains the single most powerful underlying force in markets today.

Which brings us to this morning’s situation, where the rally continues in equity markets, bond markets continue to retreat from their recent highs and commodity markets are getting their feet under themselves again.  What about inflation you may ask?  Bah, old news.  Clearly it is transitory as there hasn’t been a higher than expected print in more than a week!  (Well, that’s not strictly true as this morning South African CPI was released at a higher than expected 4.9% which has pushed back on the growing narrative that the SARB might be able to back off its mooted tightening.)  But South Africa is insignificant in the broad scheme of things, so the combination of increasing infections there along with rioting over the imprisonment of former president Jacob Zuma has just not been enough to concern investors in other markets.

One has to give props to the central banking community for their ability to convince economists, politicians and investors that the worsening inflation situation is really a very short-term blip, and that the big problem remains deflation.  Of course, it is not hard to convince politicians once they understand this stance allows for more spending.  Economists tend to be lost in their models so aren’t that important anyway.  Investors, however, have historically taken these things with a bit more skepticism, and the fact that the market is responding in exactly the manner central banks want is the truly surprising outcome.  Nothing has changed my view that this entire house-of-cards-like market will come tumbling down at some point, but it is very clear that as John Maynard Keynes explained in 1924, “the market can stay irrational longer than you can stay solvent.”  In other words, calling the timing of any significant pullback is a fool’s errand, and I will endeavor not to be foolish today.

As to markets today, it is very clear by now that risk is back on.  Equities in Asia were generally higher (Nikkei +0.6%, Hang Seng -0.1%, Shanghai +0.7%) and are quite strong in Europe (DAX +0.9%, CAC +1.4%, FTSE 100 +1.7%).  US futures you ask?  Generally higher as well, with DOW +0.4%, although NASDAQ futures are actually -0.1% at this hour.  The rotation into value seems to be this morning’s view.

The bond market is behaving as expected with investors quickly getting out of their recently added long positions.  Treasury yields are higher by 2.2bps, while Bunds, OATs and Gilts are all about 1.5bps higher this morning.  There is certainly no reason to own bonds when stocks are on the move!

Commodity markets are mixed this morning, although the most important of the bunch, oil, is higher by 1.5% and continuing to rebound from Monday’s substantial declines.  That price action on Monday was clearly technical in nature and shook out a great many weak hands.  The case for higher oil prices remains strong in my view, as the lack of capex in the sector as well as the ESG efforts to starve the industry of capital will result in a supply demand mismatch over time that will only resolve itself with higher prices.  As to the rest of the commodity space, precious metals are mixed (Au -0.5%, Ag 0.7%), as are base metals (Cu -0.2%, al +0.2%) and Ags (Soybeans -0.4%, Wheat +0.4%).  In other words, there is no directional bias here.

Finally, in the currency markets, movement has been a bit more muted overall, and mixed just like elsewhere.  In the G10 bloc, NOK (+0.35%) is following oil higher and JPY (-0.25%) is seeing its haven status work against it as it reverts to form, with the rest of the bloc +/- 0.1% meaning there is nothing to discuss.  In the emerging markets, there is a bit more weakness with ZAR (-0.4%) still suffering from the increased spread of Covid as are KRW (-0.3%) and the CE4 (HUF -0.3%, CZK -0.3%, PLN -0.25%).  On the plus side there is only CNY (+0.2%) which was supported by comments from the central bank claiming they will keep the yuan “basically stable”.

There is no data and no speakers today which means that the FX market is left to watch other markets for its cues.  With risk back in vogue, I expect that the dollar could cede some ground against the majors, but the ongoing issues throughout different emerging markets are likely to continue to weigh on currencies in that sector.

Good luck and stay safe
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How They Debase

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
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Poor Madame Lagarde

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As prices worldwide start to rise

And central banks, rates, normalize

Poor Madame Lagarde

May soon find it hard

To ably, her goals, realize

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Nirvana Awaits

Posted on by

While Powell and friends fail to see

Inflation rise dangerously

Down south of the border

They fear its disorder

And burden on society






So, Mexico shocked and raised rates





While Fedspeak back here in the States





Continues the story





It’s all transitory





And claiming Nirvana awaits





Mexico became the latest emerging market nation to raise interest rates when they surprised the analyst’s community as well as markets by raising their base rate by 0.25% yesterday afternoon to 4.25%.  The FX market response was swift and certain with the peso gaining more than 1.0% in the first minutes after the announcement although that has since slightly abated.  “Although the shocks that have affected inflation are expected to be of a transitory nature, given their variety, magnitude and the extended time frame in which they have been affecting inflation, they may pose a risk to the price formation process,” the Banxico board explained in their accompanying statement.  In other words, although they are paying lip service to the transitory concept, when CPI rose to a higher than expected 6.02% yesterday, it was apparently a step too far.  Expectations for further rate hikes have already been built into the markets while views on the peso are improving as well.





The juxtaposition yesterday of Mexico with the UK, where the BOE left policy rates on hold at 0.10% and maintained the QE program intact despite raising its inflation forecast to 3.0% for next year, is quite interesting.  Historically, it was the emerging market central banks who would seek growth at any cost and allow inflation to run hot while trying to support the economy and the developed market central banks who managed a more disciplined monetary policy, working to prevent inflation from rising while allowing their economy’s to grow without explicit monetary policy support.  But it seems that another symptom of the Covid-19 pandemic is that it has reversed the ‘polarity’ of central bank thinking.  Mexico is the 4th major EMG nation (Russia, Brazil and Poland are the others) to have raised rates and are anticipated to continue doing so to combat rising prices.  Meanwhile, when the Bank of Canada reduced the amount of its QE purchases, it was not only the first G10 bank to actually remove some amount of monetary largess, it was seen as extraordinary.  





In the States, yesterday we heard from six more Fed speakers and it has become evident that there are two distinct views on the FOMC as to the proper course of action, although to a (wo)man, every speaker exclaimed that inflation was transitory.  Several regional Fed presidents (Bullard, Bostic and Kaplan) are clearly in the camp of tapering QE and potentially raising rates by the end of next year, but the Fed leadership (Powell, Clarida, Williams) are adamantly opposed to the idea of tightening policy anytime soon.  And the thing is, the hawks don’t even have a vote this year, although they do get to participate in the conversation.  The upshot is that it seems highly unlikely that the Fed is going to tighten policy anytime at all this year regardless of inflation readings going forward.  While ‘transitory’ has always been a fuzzy term, my take has always been a 2-3 quarter view, but yesterday we started to hear it could mean 2 years or more.  If that is the case, then prepare for a much worse ultimate outcome along with a much weaker dollar.





As markets and investors digest the latest central bank dogma, let us peruse the latest price action.  Yesterday’s equity market price action led to yet another set of new all-time highs in US indices and even Mexico’s Bolsa rose 0.75% after the rate hike!  Overnight saw a continuation of that view with the Nikkei (+0.65%), Hang Seng (+1.4%) and Shanghai (+1.15%) all rallying nicely.  Perhaps a bit more surprisingly this morning has seen a weaker performance in Europe (DAX -0.15%, CAC -0.1%, FTSE 100 +0.1%) despite slightly better than expected Confidence data out of Germany and Italy.  As vaccinations proceed apace on the continent, expectations for a renewed burst of growth are rising, yet today’s stock markets seem unimpressed.





At the same time, despite all the Fedspeak and concern over inflation, the 10-year Treasury yield has basically been unchanged all week and seems to have found a new home at 1.50%, right where it is now.  Since it had been a harbinger for markets up until the FOMC meeting last week, this is a bit surprising.  As to Europe, bonds there are actually under some pressure this morning (Bunds +1.7bps, OATs +2.9bps, Gilts +1.2bps) although given equity market performance, one is hard-pressed to call this a risk-on move.  Perhaps these markets are responding to the better tone of data, but they are not in sync with the equity space.





In commodity markets, prices are mixed this morning.  While oil (-0.25%) is softer, gold (+0.5%) and silver (+1.0%) are looking awfully good.  Base metals, too, are having a better session with Cu (+0.4%), Al (+1.5%) and Sn (+0.2%) all performing well.  Crop prices are also rising, between 0.25% and 0.5%.  Fear not for oil, however, as it remains firmly ensconced in its uptrend.





And lastly, in FX markets, the dollar is under modest pressure across most of the G10, with the bulk of the bloc firmer by between 0.1% and 0.2%, and only GBP (-0.2%) softer.  While we did see a slightly weaker than expected GfK Consumer Confidence number for the UK last night (-9 vs. expected -7) we also just saw CBI Retail Sales print at a much better than expected level.  In the end, it is hard to ascribe the pound’s movement, or any of the G10 really, to data.  It is far more likely positions being adjusted into the weekend.





In the emerging markets, the dollar is having a much tougher time with ZAR (+1.0%) and KRW (+0.6%) the leading gainers, but a number of currencies showing strength beyond ordinary market fluctuations.  While the rand’s move seems outsized, the strength in commodity prices is likely behind the trend in ZAR lately.  As to KRW, it seems that as well as the general risk on attitude, the market is pricing in the first policy tightening in Seoul and given the won’s recent mild weakness, traders were seen taking advantage to establish long positions.





We have some important data today led by Personal Income (exp -2.5%), Personal Spending (0.4%) and Core PCE (0.6% M/M, 3.4% Y/Y).  Then at 10:00 we see Michigan Confidence (86.5).  I want to believe the PCE data is important, but I fear that regardless of where it prints, it will be ignored as a product of base effects and so not a true reflection of the price situation.  Yesterday, Claims data was a bit worse than expected as was Durable Goods.  This is not to say things are collapsing, but it is growing more and more apparent, at least based on the data, that the peak in the economy has already been seen.  In fact, the Atlanta Fed GDPNow model has fallen back below 10.0% and appears to be trending lower.  The worst possible outcome for the economy would be slowing growth and rising inflation, and I fear that is where we may be heading given the current fiscal and monetary policy settings.  





That combination will be abysmal for the dollar but is unlikely to be clear before many more months have passed.  For now, I expect the dollar will revert to its risk profile, where risk-on days will see weakness and risk-off days see strength.  Today feels far more risk-on like and so a little further dollar weakness into the weekend seems a reasonable assumption.





Good luck, good weekend and stay safe





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			Feeling Upbeat
		


				

			Posted on  by 		

			


		

		

The last central bank set to meet





This month is on Threadneedle Street





No change is expected





Though some have projected





The hawks there are feeling upbeat





Market focus this morning will be on the Bank of England’s policy meeting as it is the last of the major central banks to meet this month.  We have already had a tumultuous time between the ECB’s uber dovishness and the Fed’s seeming turn toward the hawkish side of the spectrum.  Of course, the Fed has largely tried to walk that idea back, but it remains firmly implanted in the market dialog.  As to the UK, growth there, despite more draconian lockdown measures still being imposed in the face of the delta variant of Covid, has been expanding rapidly according to the GDP readings while PMI data points to a continuation of that trend.  Not surprisingly, given the supply side constraints that are evident elsewhere in the world, the UK is also dealing with that issue and so prices have been rising apace.  In fact, the CPI data released last week showed the highest print in more than two years.  Of course, that print was 2.1%, hardly a number to instill fear in anyone’s heart.





And yet, the amount of talk about the need to tighten monetary policy in the UK is remarkable.  At least in the US, we are looking at exceptionally high CPI data, with numbers not seen in decades.  In contrast, CPI in the UK averaged nearly 3.0% for all of 2017, well above the most recent reading.  Not only that, but it was only at the last meeting that the BOE reaffirmed that QE was necessary to support the economy.  The idea that in 6 weeks things have changed that much seems fanciful.  That’s not to say that the committee won’t be discussing potential tightening down the road, especially if recent economic trends continue, but I find it hard to believe that given the ongoing disruptions that are still extant, there can be any serious considerations of change.  As it stands, the market is currently pricing a 15 basis point hike by next June, which would take the base rate back up to 0.25%.  





Arguably, the fact that the market is this focused on what should be a non-event is a good indication of the lack of interesting stories at the moment.  With the ECB and Fed behind us, and with both central banks furiously trying to drive the narrative to their preferred story of transitory inflation and no reason to worry, traders are looking for any opportunity to make a buck.  Some of the previous ideas, whether Bitcoin or meme stocks, have largely lost their luster.  The inflation trade, too, is having a harder time as so many commodity prices have retreated from their early Spring highs.  In this situation, it is not unusual for traders to focus on any potential catalyst far in excess of its importance.  I would contend, that is exactly what we are seeing here and that when the BOE announcement comes, it will have nothing to add to the story.





It can be no surprise, then, that market activity overnight has been extremely quiet overall.  As traders and investors look for the next big thing, volumes tend to decrease, and volatility can abate for a short period of time.  For instance, equity markets in Asia showed almost no pulse with both the Nikkei and Shanghai indices unchanged on the day while the Hang Seng managed to eke out a 0.25% gain.  Europe, on the other hand, is having a go of it, with gains in the DAX (+0.8%) and CAC (+1.0%) after much stronger than forecast confidence data was released.  The FTSE 100 (+0.3% ahead of the BOE) seems to want to join the party but is awaiting the BOE release before really moving.  And, after several desultory sessions with very limited movement in the US, futures this morning are higher by 0.5% across the board.





Bond markets are similarly quiet with modest price declines in Treasuries (+0.8bps), Bunds (+0.9bps) and OATs (+0.9bps) seen at this hour.  Gilts are essentially unchanged, clearly awaiting the BOE meeting before traders are willing to get too involved.





Commodity prices started the session with a mix of gainers and losers, but at this hour, most have turned lower.  Oil (-0.2%) is just backing off slightly but remains in a strong uptrend.  While precious metals (Au +0.2%, Ag +0/6%) stick out for being a bit higher on the day, we are seeing weakness in Copper (-0.2%), Aluminum (-0.4%) and most of the ancillary metals as well as the agricultural space with the three main crops all lower by at least 1.0%.





As to the dollar, it is a bit softer this morning with NOK (+0.4%) the leading gainer despite oil’s reversal from early morning gains.  But there is strength in SEK (+0.3%), NZD (+0.25%) and essentially the entire G10 bloc, albeit only modest in size.  It is difficult to point to specific catalysts for this movement, although Sweden’s PPI data did print much higher than forecast leading to some speculation, they too would soon be tightening policy.





***BOE leave policy unchanged, rates on hold***





The first reaction to the BOE news is a modest decline in the pound (-0.2%) although I expect it will remain choppy for now.





Quickly turning to the EMG bloc, the dollar is softer here almost universally with RUB (+0.45%) the leading gainer and PLN (+0.4%) right behind it.  The latter is benefitting from talk that rising inflationary pressures will lead to tighter monetary policy, while the ruble, along with the krone, seems to be maintaining its early gains despite oil’s pullback.  





On the data front, this morning brings the usual weekly Initial Claims (exp 380K) and Continuing Claims (3.46M) as well as Durable Goods (2.8%, 0.7% ex transport).  We also get the final look at Q1 GDP (6.4%) which is forecast to be unchanged from the previous reading.  Tomorrow we will see Core PCE, which is the Fed’s preferred inflation measure, but we can discuss that then.





Overall, it is shaping up to be a dull day.  Further comments from the BOE are highlighting the transitory nature of inflation there, with a statement indicating that while 3.0% inflation will be coming, it will not last very long.  As I continue to type, the pound continues to slide, now down 0.3%, and interest rate markets are adjusting as well, with the rate hike scenario being pushed further into the future.  





The one area where we could get some movement is from the Fed speakers, with six on today’s calendar.  Yesterday, Atlanta Fed president Bostic was the first since the FOMC meeting last week, to reiterate that tapering would be appropriate soon as well as higher rates.  But the preponderance of evidence remains that the Fed is uninterested in doing anything for a long while yet.  I think things will get more interesting for them later in the year if inflation figures continue to run hot, but for now, they remain confident they are in control.





As to the dollar, unless we start hearing a lot more hawkish rhetoric from the Fed speakers, my sense is that it will continue to drift slightly lower in its current trading range.





Good luck and stay safe





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			Bears Have Retreated
		


				

			Posted on  by 		

			


		

		

At first, no one thought it could be





That Powell would lessen QE





But less than a week





Was needed to wreak





Destruction ‘pon his new decree




















The bond market bears have retreated





With steepeners now all deleted





While stocks are unsure





If this is the cure





And just how this news should be greeted















Last week’s FOMC meeting continues to be the main topic of market discussion as many assumptions have been questioned, especially those of the inflationist camp.  The change in the dot plot was clearly unforeseen and has been the talk of the market ever since.  Arguably, there are two key questions that have arisen in the wake of the meeting; 1) what happened to the Fed’s insistence that they would not adjust policy preemptively based on forecasts? and 2) is maximum employment no longer deemed to be an Unemployment Rate near 3.5%?





What has been made very clear, however, is that the market still believes the Fed can address inflation, or at the very least, that the market buys the Fed’s transitory inflation narrative.  Regarding the latter, it relies almost entirely on the idea that supply-side bottlenecks will be quickly addressed, thus forcing prices lower and reducing the inflationary threat.  My question is, why do so many assume that restarting production can be accomplished so quickly?  In many cases, businesses have closed, thus no longer manufacturing products.  In others, businesses are running shorter or fewer shifts due to the inability to hire/retain staff to operate.  Glibly, many say that those businesses can simply raise wages to attract staff.  And while that may be true, you can be sure that will result in rising prices as well.  So, if supply returns at a higher price point, is that not still inflationary? 





Under the theory that a picture is worth a thousand words, I have created a decision matrix that outlines my sense of how things may play out over the coming months.  Having observed the Fed and its reaction function to market situations for quite a long time, I remain convinced that despite all the rhetoric regarding maximum employment or inflation expectations, the single most important data point for the Fed is the S&P 500.  History has shown that when it declines sharply, between 10%-20%, they will step in, ease policy in some manner and seek to assuage the investment community regardless of trivialities like inflation, GDP growth or unemployment.  Thus far, nothing the Fed has done has changed that opinion.





Remember, these are my personal views and I assigned rough probabilities along with estimates of what could happen under the defined scenarios.  Ultimately, the question that keeps haunting me is; if inflation is transitory, why would they need to taper policy easing?  After all, the underlying assumption is that the current policy remains economically supportive without negative inflationary consequences, so why change?  I believe the answer to this question belies the entire Fed narrative.  But that’s just me.  The highlighted area is the expected outcome in one year’s time based on Friday’s closing markets (BCOM = Bloomberg Commodity Index).  Interestingly, the math worked out where I saw weaker stocks, higher yields, a weaker dollar and higher commodities.  In truth, if inflation is in our future, that does not seem to be wrong.










As to markets this morning, while Asian equity markets were largely under pressure (Nikkei -3.3%, Hang Seng -1.1%, Shanghai +0.1%), still reeling from the Fed’s allegedly hawkish stance, Europe is modestly firmer (DAX +0.7%, CAC +0.3%, FTSE 100 +0.2%).  Perhaps hawks only fly East.  US futures are also higher this morning, by roughly 0.5%, as the early concerns over tighter policy have clearly been allayed, by what though, I’m not sure.





Of course, all the real action has been in the bond market, where yields worldwide have fallen sharply since the FOMC meeting.  Not only have yields fallen, but curves have flattened dramatically as well with movement on both ends of the curve, shorter dated yields have risen under the new assumption that the Fed will be raising rates, while the bank end has rallied sharply with yields declining as investors ostensibly believe that inflation is, in fact, transitory.  While the overnight session has seen minimal movement (Treasuries 0.0bps, Bunds =0.4bps, Gilts -0.3bps), the movement since Wednesday has been impressive.  The $64 billion question is, will this new movement continue into a deeper trend, or reverse as new data is released.





Commodity prices have not yet abandoned the inflation story, at least some of them haven’t.  Oil (+0.2%) continues to perform well as demand continues apace and supply remains in the crosshairs of every ESG focused investor.  Precious metals have rallied on the back of declining yields, both real and nominal, but base metals have slipped as there is a growing belief that they were massively overbought on an inflation scare that has now been defused.  Funnily enough, I always had the commodity/inflation relationship the other way around, with higher commodity prices driving inflation.





Finally, the dollar this morning is weaker from Friday’s levels, but still generally stronger from its levels post FOMC.  The crosscurrents here are strong.  On the one hand, transitory inflation means less reason for a depreciating currency while on the other, lower rates that come with less inflation make the dollar less attractive.  At the same time, if risk is going to be back in vogue, the dollar will lose support as well. 





On the data front, there is a fair amount of data this week, although nothing of note today.





TuesdayExisting Home Sales5.71M
WednesdayFlash PMI Manufacturing61.5
 Flash PMIM Services70.0
 New Home Sales871K
ThursdayInitial Claims380K
 Continuing Claims3481K
 Durable Goods2.9%
 -ex transport0.7%
 Q1 GDP6.4%
FridayPersonal Income-2.7%
 Personal Spending0.4%
 Core PCE0.5% (3.9% Y/Y)
 Michigan Sentiment86.5





Source: Bloomberg





As well as all of this, we heard from ten different Fed speakers, including Chairman Powell testifying to Congress tomorrow afternoon.  It would seem there will be a significant effort to fine tune their message in the wake of last week’s meeting and the market volatility.





The dollar’s strength had been predicated on the idea that US yields were increasing and if that is no longer the case, my sense is that the dollar is likely to retrace its recent steps higher.  For those who with currency payables, keep that in mind.





Good luck and stay safe





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			Hard to Explain
		


				

			Posted on  by 		

			


		

		
For those who believe that inflation


Is soon to explode ‘cross the nation


It’s hard to explain


Why yields only wane


Resulting in angst and vexation


But there is a possible clue


That might help the bond bears’ world view


In Q1 Ms. Yellen


Had Treasury sellin’


More bonds than the Fed could accrue


However, that’s no longer true


As Powell, through all of Q2


Will buy more each week


Than Janet will seek


To sell.  Lower yields then ensue.


With the FOMC meeting on the near horizon, traders are loath to take large positions in case there is a major surprise.  At this point, the market appears to broadly believe that any tapering talk is not going to happen until the Jackson Hole meeting in August, so the hawks are not expecting a boost.  At the same time, there is virtually no expectation that the Fed would consider increasing QE, thus the doves remain reliant on the transitory inflation narrative.  As it stands, the doves continue to hold the upper hand as while last week’s CPI print was shockingly high,  there has been much written about the drivers of that number are all due to level off shortly, and inflation will soon head back to its old 1.5%-2.0% range.


One of the things to which the doves all point is the 10-year yield and how it has done nothing but decline since the beginning of the quarter.  Now, that is a fair point, but the timing is also quite interesting.  While pundits on both sides of the discussion continue to point to inflation expectations and supply chain breakages and qualitative measures, there is something that has gotten far less press, but could well account for the counterintuitive movement in Treasury yields amid much higher inflation prints: the amount of Treasuries purchased by the Fed vs. the amount of new Treasuries issued by the Treasury.


In Q1, the US government issued net $342 billion while the Fed bought $240 billion in Treasury securities as part of QE.  (Remember, the other $120 billion was in mortgage-backed securities).  Given that foreign government buying of Treasuries has virtually disappeared, it should be no surprise that yields rose in order to attract buyers.  Q2, however, has seen a very different dynamic, as the US government has only issued $70 billion this quarter while the Fed continues to buy $240 billion each quarter.  With a price insensitive buyer hoovering up all the available securities and more, it is no surprise that Treasury yields have fallen.  Why, you may ask, has the Treasury only issued $70 billion in new debt?  Two things are driving that situation; first, Q2 is the big tax payment quarter of the year, so lots of cash flows into the Treasury; and second, the Treasury at the end of last year had $1.6 trillion in cash in their General Account at the Fed, which is essentially the government’s checking account.  However, they have drawn those balances down by half, thus have not needed to issue as much debt.


It’s funny how the move in yields just might be a simple supply/demand story, but that is not nearly as much fun as the narrative game.  So, let’s take a glimpse into Q3 planned Treasury issuance, which is widely available on the Treasury’s own website.  “During the July – September 2021 quarter, Treasury expects to borrow $821 billion in privately-held net marketable debt, assuming an end-of-September cash balance of $750 billion.”  The Fed, of course, is expected to buy another $240 billion in Treasuries in Q3, however, that appears to be a lot less than expected issuance.  My spidey-sense is tingling here, and telling me that come July, we are going to start to see yields turn higher again.  Far from the idea of tapering, if yields are rising sharply akin to Q1’s price action, we could see the Fed increase QE!  After all, somebody needs to buy those bonds.  And while this will be going on in the background, what we will largely read about is the changes in the narrative and inflation expectations.  As Occam pointed out with his razor, the simplest explanation is usually the best.


If this, admittedly, rough analysis has any validity, it is likely to have some very big impacts on markets in general, and on the dollar in particular.  In fact, if yields do reverse and head higher, especially if we move toward that 2.0% 10-year yield (or further) look for the dollar to find a lot of support.


As to market activity today, things remain fairly quiet with the recent positive risk attitude intact, but hardly excessively so.  Starting with equities in Asia, the Nikkei (+0.75%) had a nice gain after a better than expected IP print but was lonely with a holiday in China and through much of the continent keeping other markets closed.  Europe is in the green, but the gains are mostly modest (DAX +0.2%, CAC +0.2%, FTSE 100 +0.4%) as a slightly better than expected IP print along with continued dovish comments from Madame Lagarde help underpin the equity markets there.  Meanwhile, US futures are also modestly higher, but the NASDAQ’s 0.3% rise is by far the largest.


Turning to the bond market this morning, Treasury yields have backed up 0.8bps, but remain well below the 1.50% level which was seen as key support.  As per the above, I imagine that it will be a month before the real fireworks begin.  In Europe, while we did hear from Lagarde, we also heard from uber-hawk Robert Holtzmann, Austria’s central bank president, who was adamant that barring another Covid related shutdown, the PEPP will end in March.  Italian BTP’s were the most impacted bond from those comments with yields rising 2.0bps, while the main markets are seeing virtually no movement this morning.


In the commodity space, there is a real dichotomy today with oil (+0.7%) continuing its recent rally while gold (-1.1%) has fallen sharply.  Base metals have been mixed with relatively modest movement, but agricultural prices have fallen sharply (Soybeans -0.8%, Wheat -2.6%, Corn -2.8%) which appears to be a response to improved weather conditions.


Finally, the dollar has no real direction this morning.  NOK (+0.35%) is the leading gainer in the G10 on the back of oil’s rally but after that, there is a mix of gainers and losers, none of which have moved 0.2% implying no real new driving forces.  In the EMG bloc, last night saw KRW (-0.5%) catch up to Friday’s dollar rally, and this morning we see ZAR (-0.45%) as the worst performer on what seems to be market technicals, with traders beginning to establish new ZAR shorts after a very strong rally during the past year.  Some think it has gone too far.  But really, the FX market is not terribly interesting right now as we all await the Fed on Wednesday.


On the data front, there is some important information coming as follows:






Tuesday
Retail Sales
-0.6%





-ex autos
0.4%





PPI
0.5% (6.2% Y/Y)





-ex food & energy
0.5% (4.8% Y/Y)





IP
0.6%





Capacity Utilization
75.1%




Wednesday
Housing Starts
1640K





Building Permits
1730K





FOMC Decision
0.00% – 0.25%




Thursday
Initial Claims
360K





Continuing Claims
3.42M





Philly Fed
31.0





Leading Indicators
1.3%






Source: Bloomberg


So, while tomorrow will see much discussion regarding the growth narrative after Retail Sales, the reality is everybody is simply focused on the Fed on Wednesday.  Until then, I expect range trading.  After that…


Good luck and stay safe


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			A ZIRP Doctrinaire
		


				

			Posted on  by 		

			


		

		
The lady who once ran the Fed


And, Treasury, now runs instead


Explained higher rates


Right here in the States


Are something that she wouldn’t dread


But when she was Fed Reserve chair


And she had a chance to forswear


That rates should stay low


Her answer was, no


As she was a ZIRP doctrinaire


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


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


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


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


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


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


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


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


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


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






Tuesday
NFIB Small Biz Optimism
100.9





Trade Balance
-$68.5B





JOLTS Job Openings
8.3M




Thursday
ECB Meeting






CPI
0.4% (4.7% Y/Y)





-ex food & energy
0.4% (3.4% Y/Y)





Initial Claims
370K





Continuing Claims
3.7M




Friday
Michigan Sentiment
84.2






Source: Bloomberg


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


Good luck and stay safe


Adf