Tag Archives: #Fed

Bears Have Retreated

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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

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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

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The lady who once ran the Fed

And, Treasury, now runs instead

Explained higher rates

Right here in the States

Are something that she wouldn’t dread

But when she was Fed Reserve chair

And she had a chance to forswear

That rates should stay low

Her answer was, no

As she was a ZIRP doctrinaire

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

Good luck and stay safe

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Filled with Frustration

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The Beige Book explained ‘round the nation

That growth was up, as was inflation

As well, we all learned

Of job offers spurned

And businesses filled with frustration

Meanwhile, round the world, PMI’s

Of Services were no surprise

As nations reopen

Most people are hopin’

The world will, at last, normalize

Ahead of tomorrow’s NFP report in the US, one which given last month’s extraordinary miss will be closely scrutinized by both investors and the Fed, most markets appear to be biding their time in narrow ranges.  This was largely true yesterday and so far, remains the case in the Asian and European sessions.  This lull in activity offers an excellent time to consider the supporting data that we have received in the past twenty-four hours, as well as the remainder due this morning.

Starting with the Fed’s Beige Book yesterday, the report highlighted the features of the economy we have been hearing about for the past several months.  The lifting of Covid inspired restrictions has led to strong increases in demand for products and services ranging from houses and cars to hotels and restaurants.  Business owners indicated that a combination of supply chain bottlenecks and increased demand have been forcing prices higher and that they saw no reason for that to end soon.  They also continue to comment on their inability to hire the workers necessary to satisfy demand, especially in lower wage segments of the economy.  The anecdote I feel best illustrates the issue came from St Louis where a job fair held by a dozen restaurants to fill more than one hundred open positions drew only twelve candidates!  It certainly appears as though the ongoing extra Federal unemployment benefits being offered through September are discouraging a lot of people from going back to work.

One of the underlying beliefs regarding the Fed’s transitory inflation story is that supply chain interruptions will quickly resolve themselves.  And it is not just the Fed that believes this will be the case, but virtually every other economist as well.  But I wonder, what prompts their faith in that outcome?  After all, with available labor scarce, who is going to relink those chains?  Consider, as well, industries like mining and extraction of raw materials.  Shortages of copper and iron ore require the reopening of mines or excavating new ones.  One of the impacts of Covid was that not only were current operating mines closed, but capex was drastically cut, so there is a significant disruption in the exploration process.  Add to that the rise of ESG as a business objective, which will, at the very least slow, if not prevent, the opening of new sources of these raw materials, and it becomes quite easy to believe that these bottlenecks will remain for more than just a few months.  In fact, it would not be surprising if it was several years before the supply/demand balance in many commodities is achieved.  Given the current assessment is a lack of supply, you can be certain that prices will continue to rise far longer than the Fed will have you believe.

As to the overnight session, we were regaled with the Services PMI data from around the world.  In Asia we saw Australia solid, at 58.0, and right in line with last month, while Japan, 46.5, did show a marginal increase, but remains well below the growth-contraction line of 50.0.  China’s Caixin data, at 55.1, was disappointing vs. expectations as well as lower by 1.2 points compared to April’s reading.  Is the Chinese economy beginning to roll over?  That is a question that is starting to be asked and would also explain the PBOC’s sudden concern over a too-strong renminbi.  In a strong economy, a rising currency is acceptable, but if things are not as good, currency strength is an unwelcome event.  Finally, the last major Asian nation reporting, India, showed awful data, 46.4, demonstrating the huge negative impact the recent wave of Covid infections is having on the economy there.

The European story was a bit better overall, with Germany (52.8 as expected), France (56.6 as expected), Italy (53.1 better than expected) and the Eurozone (55.2 slightly better than expected) all demonstrating the recovery is underway on the continent.  As well, the UK continues to burn brightly with a 62.9 reading, more than a point higher than forecast.  And don’t forget, later this morning the US releases both the PMI data (exp 70.1) as well as ISM Services (63.2) both demonstrating that the US economy remains the global leader for now.  With that in mind, it is kind of odd that the dollar is so hated, isn’t it?

The other data coming this morning will give us our first hints at tomorrow’s NFP with ADP Employment (exp 650K) released 15 minutes before both Initial (387K) and Continuing (3.614M) Claims.  As well, at 8:30 we see Nonfarm Productivity (5.5%) and Unit Labor Costs (-0.4%), which on the surface would indicate there are no wage pressures at all but continue to be distorted by the past year’s data outcomes.

As to the market situation, while equity markets in Asia were mixed (Nikkei +0.4%, Hang Seng -1.1%, Shanghai -0.4%), Europe has turned completely red (DAX -0.5%, CAC -0.4%, FTSE 100 -0.9%) despite the solid PMI data.  This feels far more like some profit taking ahead of tomorrow’s data as well as the upcoming ECB meeting next week.  US futures are also under pressure, with all three major indices lower by between 0.5% and 0.75%.

What is interesting about the market is that despite the selloff in stocks, we are seeing a selloff in bonds as well, with Treasury yields higher by 1.5bps and European sovereigns all higher by at least 1 basis point (Bunds +1.1bps, OATs +1.4bps, Gilts +2.7bps).  This, of course, begs the question, if investors are selling both stocks and bonds, what are they buying?

The answer is not clear at this point.  Oil (WTI -0.1%) while outperforming everything else, is still down on the day, as are gold (-0.65%) and silver (-1.4%).  Base metals?  Well, copper (-1.0%) is clearly not the winner, although aluminum (+0.25%) is the only green spot on the screen.  Well, that and agricultural products with Soybeans (+1.25%), Wheat (+1.0%) and Corn (+0.85%) all quite strong this morning, punctuating the idea that food inflation is running at its highest level in more than a decade according to a just released UN report.  That is something I certainly see every week at Shop-Rite and I imagine so does everyone else.

Finally, a look at the FX market shows the dollar is having a pretty good day all around.  In the G10, the pound (+0.1%) is the only currency to hold its own vs. the greenback, with the rest of the bloc lower by between 0.2% and 0.4%.  Frankly, this simply looks like a risk-off session as investors are selling both stocks and bonds across the G10, and no longer need to hold the local currencies.  In the EMG bloc, the story is largely the same, with only INR (+0.25%) rising and the rest of the bloc under some pressure.  The rupee movement seems to be more technical as alongside weak PMI data, the RBI meeting, coming up tonight, is expected to see policy remain unchanged with a dovish bias given the ongoing Covid problems in the country.  On the downside, while most currencies are lower, aside from TRY (-0.5%) on slightly lower inflation, therefore less need to maintain high rates, the rest of the bloc’s declines are only on the order of -0.2%.  Finally, I would be remiss if I didn’t mention yesterday’s price action in LATAM currencies, where we saw significant strength in BRL (+1.5%) and CLP (+1.1%) which has been a broad continuation of funds flowing back into the region.

We have a few more Fed speakers today, but they all say exactly the same thing all the time, it seems, that they are thinking about considering starting a discussion on tapering.  In this vein, there was a big announcement yesterday that the Fed would be unwinding one of the emergency bond buying programs, the secondary market corporate program, and selling out the $13 billion of bonds and ETF’s they own.  Of course, that is such a tiny proportion of their balance sheet, and of that market in truth, it seems unlikely to matter at all.

My observation lately has been that NY tends to go against the prevailing trend for the day during its session, meaning on a day like today, when the dollar is well bid as NY arrives, I would look for a bit of dollar selling.  We shall see, but in fairness, all eyes are really on tomorrow.

Good luck and stay safe

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High Tide

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The dollar continues to slide
But is risk approaching high tide?
Last night t’was the Kiwis
Who hinted that their ease
Of policy may soon subside

As well, from the Fed yesterday
Three speakers had two things to say
It soon may be time
To change paradigm
Inflation, though, ain’t here to stay

“There will come a time in upcoming meetings, we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases.”  So said, Fed Vice-Chairman Richard Clarida yesterday.  “We are talking about talking about tapering,” commented San Francisco Fed President Mary Daly in a CNBC interview yesterday.  And lastly, Chicago Fed President Charles Evans explained, “the recent increase in inflation does not appear to be the precursor of a persistent movement to undesirably high levels of inflation.  I have not seen anything yet to persuade me to change my full support of our accommodative stance for monetary policy or our forward guidance about the path for policy.”

The Fed’s onslaught of forward guidance continues at full speed as virtually every day at least two or three Fed speakers reiterate that policy is perfect for the current situation, but in a nod to the growing chorus of pundits about higher inflation, they are willing to indicate that there will come a time, at some uncertain point in the future, when it may be appropriate to consider rolling back their current policy initiatives.

But ask yourself this; if inflation is going to be transitory, that implies that the current policy settings are not a proximate cause of rising prices.  If that is the case, why discuss tapering?  After all, high growth and low inflation would seem to be exactly the outcome that a central bank wants to achieve, and according to their narrative, that is exactly what they have done.  Why change?

This is just one of the conundra that is attendant to the current Fed policy.  On the one hand, they claim that their policy is appropriate for the current circumstance and that they need to see substantial further progress toward their goals of maximum employment and average 2% inflation before considering changing that policy.  On the other hand, we have now heard from five separate FOMC members that a discussion about tapering asset purchases is coming, which implies that they are going to change their policy.  Allegedly, the Fed is not concerned with survey data, but want to see hard numbers showing they have achieved their goals before moving.  But those hard numbers aren’t here yet, so why discuss changing policy?

The cynical answer is that the Fed actually doesn’t focus on unemployment and inflation, but rather on the equity markets foremost and the bond market secondarily.  Consider, every time there has been a sharp dislocation lower in stocks, the Fed immediately cuts rates to try to support the S&P.  This has been the case since the Maestro himself, Alan Greenspan, responded to the 1987 stock market crash and has served to inflate numerous bubbles since then.

A more charitable explanation is that they have begun to realize that they are in an increasingly untenable position.  Since the GFC, the Fed has consistently been very slow to reduce policy accommodation when the opportunity arose and so the history shows that rates never regain their previous peak before the next recession comes along.  Recall, the peak in Fed funds since 2009 was just 2.50%, reached in December 2018 just before the Powell Pivot in the wake of a 20% drawdown in the S&P 500.  In fact, since 1980, every peak in Fed Funds has been lower than the previous one.  The outcome of this process is that the Fed will have very little room to cut rates to address the next recession, which is what led to QE in the first place and more importantly has served to reduce the Fed’s influence on the economy.  Arguably, then, a major reason the Fed is keen to normalize policy is to retain some importance in policymaking circles.  After all, if rates are permanently zero, what else can they do?

It is with this in mind that we turn our attention elsewhere in the world, specifically to New Zealand, where the RBNZ signaled that its Official Cash Rate (Fed funds equivalent) may begin to rise in mid-2022.  This is a full year before previous expectations and makes the RBNZ the 3rd G10 central bank to talk about tightening policy sooner than thought.  The Bank of Canada has already started to taper QE purchases and the BOE has explained they will be starting next year as well.  It should be no surprise that NZD (+1.15%) is the leading gainer in the FX market today, nor that kiwi bonds sold off sharply with 10-year yields rising 8bps.

Do not, however, mistake this for a universal change in policy paradigm, as not only is the Fed unwilling to commit to any changes, but the BOJ remains in stasis and the ECB, continues to protest against any idea that they will be tightening policy soon.  For instance, just this morning, ECB Executive Board Member and Bank of Italy President, Fabio Panetta, said, “Only a sustained increase in inflationary pressures, reflected in an upward trend in underlying inflation and bringing inflation and inflation expectations in line with our aim, could justify a reduction in our purchases.  But this is not what we projected in March.  And, since then, I have not seen changes in financing conditions or the economic outlook that would sift the inflation path upward.”

Investors and traders have been moving toward the view that the ECB would be tapering purchases before 2023 as evidenced by the rise in the euro as well as the rise in European sovereign yields.  But clearly, though there are some ECB members (Germany, the Netherlands) who would be very much in favor of that action, it is by no means a universal view.  Madame Lagarde will have her hands full trying to mediate this discussion.

For now, the situation remains that the central bank narrative is still the most important one for markets, and the fact that we are seeing a split amongst this august group is a key reason FX volatility remains under pressure.  The lack of an underlying theme to drive the dollar or any bloc of currencies in one direction or the other leaves price action beholden to short-term effects, large orders and the speculator community.  We need a new paradigm, or at least a reinvigoration of the old one to get real movement.

In the meantime, the dollar continues to drift lower as US yields continue to drift lower.  Right now, the bond market appears to have faith in the Fed narrative of transitory inflation, and as long as that is the case, then a weaker dollar and modestly higher stock prices are the likely outcome.

Today’s price action, NZD excepted, showed that to be the case, with APAC currencies performing well, but otherwise a mixed bag.  Equity markets are marginally higher and bond yields have largely fallen in Europe, although Treasuries are little changed after a 4bp decline yesterday.  Gold is actually the biggest winner lately, having traded back above $1900/oz as investors watch the slow destruction of fiat currency values.  But in the FX space, the USD-Treasury link remains the most important thing to watch.

Good luck and stay safe
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Not Really There

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There once was a Fed Reserve Chair
Whose minions explained with fanfare
Though prices were climbing
With all the pump priming
Inflation was not really there

Investors responded with glee
And bought everything they did see
So, risk was a hit
While yields fell a bit
As money remains largely free

Brainerd, Bostic and Bullard, though sounding like a law firm, are actually three FOMC members who spoke yesterday.  In what has been a remarkably consistent performance by virtually every single member of the committee (Robert Kaplan excepted), they all said exactly the same thing: prices will rise due to bottlenecks and shortages in the near-term, but that this was a short-term impact of the pandemic response, and that soon those issues would abate and prices would quickly stabilize again.  They pointed to ‘well-anchored’ inflation expectations and reminded one and all that they have the tools necessary to combat inflation in the event their version of events does not come to pass.  You have to give Chairman Powell credit for convincing 16 ostensibly independent thinkers that his mantra is the only reality.

The market response was one of rainbows and unicorns, with rallies across all assets as risk was snapped up everywhere.  After all, it has been nearly two weeks since the CPI print was released at substantially higher levels than anticipated raising fears amongst investors that the Fed was losing control.  But two weeks of soothing words and relatively benign data has been sufficient to exorcise those inflation demons.  In the meantime, the Fed continues to purchase assets and expand its balance sheet as though the economy is teetering on the brink of destruction while they await the “substantial progress” toward their goals to be met.

One consequence of the Fed’s QE program has been that high-quality collateral for short term loans, a critical part of the financial plumbing of the US (and global) economy has been in short supply.  For the past two months, Treasury bill issues have been clearing at 0.00%, meaning the government’s cost of financing has been nil.  This is due to a combination of factors including the Treasury running down the balances in the Treasury General Account at the Fed (the government’s checking account) and the ongoing Fed QE purchases of $80 billion per month.  This has resulted in the Treasury needing to issue less T-bills while simultaneously injecting more funds into the economy.  Banks, meanwhile, wind up with lots of bank reserves on their balance sheets and no place to put them given the relative dearth of lending.  The upshot is that the Fed’s Reverse Repurchase Program (RRP) is seeing unprecedented demand with yields actually starting to dip below zero.  This is straining other securities markets as well given the bulk of activity in markets, especially derivatives activity, is done on a margin, not cash, basis.  While so far, there have not been any major problems, as the stress in this corner of the market increases, history shows that a weak link will break with broader negative market consequences.  For now, however, the Fed is able to brush off any concerns.

The result of the constant commentary from Fed speakers, with three more on the schedule for today, as well as the fading of the memories of the high CPI print has been a wholesale reengagement of the risk-on meme.  Growth continues to rebound, while zero interest rates continue to force investors out the risk curve to find a return.  What could possibly go wrong?

Today, the answer is, nothing.  Risk is back with a vengeance as evidenced by a strong equity session in Asia (Shanghai +2.4%, Hang Seng +1.75%, Nikkei +0.7%) and a solid one in Europe as well (DAX +0.8%, CAC +0.15%, FTSE 100 0.0%).  The Chinese (and Hong Kong) rally seems to be a product of the PBOC focusing their attentions on the commodity market, not equities, as the source of imbalances and a potential target of interventionist policies thus allowing speculators there to run free.  German equities are the beneficiary of better than expected ZEW data, with both the current conditions (95.7) and Expectations (102.9) indices leading the way.  While yesterday’s US equity rally faded a bit late in the day, futures this morning are all pointing higher by about 0.3%.

Arguably, the FOMC trio had a bigger impact on the bond market, where 10-year Treasury yields are now back below 1.60%, down 1 basis point this morning and at their lowest level in more than two weeks.  It is certainly hard to believe that the bond market is remotely concerned about inflation at this time.  Remember, though, Friday we see the core PCE print, which is the number the Fed truly cares about, and while it is forecast to print above the 2.0% target, (0.6% M/M, 2.9% Y/Y) we also know that the Fed strongly believes this is transitory and is no reason to panic.  Markets, however, if that print is even stronger, may not agree with that sentiment.

Commodity prices are having a less positive day as the ongoing concerns about Chinese actions to prevent price rises continues to weigh on sentiment.  Oil has slipped just a bit (-0.3%) but we are seeing declines in Cu (-0.4%), Al (-1.1%) and Fe (-3.1%), all directly in the crosshairs of the Chinese government.  Agricultural product prices are mixed today while precious metals remain little changed.

Finally, the dollar is mostly lower this morning with broad weakness seen in the EMG bloc, but less consistency in G10.  While SEK (+0.5%) leads the way higher, the rest of the bloc has been more mixed.  NOK (-0.2%) is clearly suffering from oil’s decline, while JPY (-0.2%) seems to be giving ground as havens are unloved.  EUR (+0.25%) has been helped by that German ZEW data as well as the beginnings of a perception that the Fed is going to be more aggressively dovish than the ECB for a long time to come.  In that event, the euro will certainly rise further, although it has a key resistance level at 1.2350 to overcome.

ZAR (+0.7%) leads the emerging market parade higher as concerns over inflation there abate, and South Africa continues to have amongst the highest real yields in the world.  KRW (+0.4%) is next in line as consumer sentiment in South Korea rose to its highest level in 3 years.  The other noteworthy move has been CNY (+0.2%) not so much for the size of the move as much as for the fact that it has breached the 6.40 level and the government has indicated they are going to be taking additional steps to open the FX market in China to help local companies hedge their own FX risks. The only laggard of note is TRY (-0.3%) which is suffering as President Erdogan has replaced yet another member of the central bank’s board, inviting concerns inflation will run higher with no response.

Data today shows Case Shiller Home Prices (exp +12.5%) as well as New Home Sales (950K) and Consumer Confidence (119.0), none of which are likely to change either Fed views or market opinions.   As mentioned above, three Fed speakers will regale us with their sermon on transitory inflation, and I expect that the dollar will remain under pressure for the time being.  In fact, until we see core PCE on Friday, it is hard to make a case that the dollar will turn around and only then if the number is higher than expected.

Good luck and stay safe
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Retrogression

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To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression

“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”  This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity.  Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.

No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything.  So, is this really as hawkish as the commentariat would have us believe?  Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report.  Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy.  Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time.  Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).

The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis.  That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”

Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do.  The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion.  In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco.  Of that group, Chicago’s Evans and SF’s Daly are uber-dovish.  Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all.  This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months.  Do not get overexcited about the Fed tapering.

Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive.  Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released.  Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session.  In other words, it was hardly a rout based on the Minutes.  The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit.  Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.

As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%.  But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps.  This is hardly the sign of a market preparing for a Fed change of heart.  European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps).  Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.

Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%).  However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions.  The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day.  Agricultural products, though, maintain their bids with small gains across the board.

Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April.  This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.

Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes.  Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%).  Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night.  However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.

Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%).  All of these are benefitting from the broad based, but mild, dollar weakness.  The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.

Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0).  Then at 10:00 we see Leading Indicators (1.3%).  On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.

Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment.  Look for the dollar to drift lower on the day.

Good luck and stay safe
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Don’t Get Carried Away

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The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away

But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned

Wow!  That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected.  To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase.  Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%.  To give some context, the core 0.9% gain was the highest print since 1981.  It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.

The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible.  His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out.  As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month.  That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.

House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down.  The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live.  The statistics show that there is the smallest inventory of homes available in decades.  As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material.  And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace.  A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know.  As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining.  However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI.  That, my friends, will be harder to pass off as transitory.

The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates.  However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control.  While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.

The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money.  Rising inflation is the last thing equity markets can abide, so these declines can not be surprising.  The question, of course, is will they continue?  A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story.  It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels.  A loss of confidence that the past is prologue could well see a very sharp correction.

Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session.  It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move.  While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between.  Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.

Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months.  The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.

Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative.  We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%).  At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.

This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy).  Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday.  In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory.  I guess they hope if they say it often enough, people may begin to believe them.  But that is hard to do when the prices you pay for stuff continues to rise.

Treasuries remain the key.  If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher.  If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.

Good luck and stay safe
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Far From our Goals

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Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls

There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel.  In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come.  On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’.  I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future.  After all, the Fed’s forecasting record is unparalleled…in its futility.

However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.

The problem with this attitude is that it seems to ignore the reality on the ground.  Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014.  In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump.  But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least.  At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.

It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020.  Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation.  The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited.  There is a growing belief that we are embarking on a so-called commodity super-cycle.  This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.

This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise.  Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y.  The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand.  As such, the market seems entirely prepared for a very large number.  From my vantage point, the Y/Y number is not so important today, but the M/M number is.  Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.

We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy.  We continue to hear them explain that any inflation readings will be transitory.  And maybe they are correct.  However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply.  Talk about a Hobson’s Choice!

Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%).  US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).

Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level.  There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case.  European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts).  Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.

Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%).  The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.

The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own.  NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought.  However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected).  EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst.  KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data.  Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.

Other than the CPI data and the Treasury auction, there is no other news or data.  Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately.  The one thing we know is that they are unlikely to change their tune.

Which brings us back to the 10-year Treasury.  It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa.  I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact.  My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late.  In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar.  Just beware.

Good luck and stay safe
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An Untimely End

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf