Somewhat Misleading

The latest inflation’ry reading
Showed price rises kept on proceeding
But bond markets jumped
While dollars were dumped
This movement seems somewhat misleading

The two market drivers yesterday were exactly as expected, the CPI report and the FOMC Minutes.  The funny thing is it appears the market’s response to the information was contrary to what would have been expected heading into the session.

Starting with CPI, by now you are all aware that it continues to run at a much hotter pace than the Fed’s average 2.0% target.  Yesterday’s results showed the M/M headline number was a tick higher than forecast at 0.4%, as was the 5.4% Y/Y number.  Ex food & energy, the results were right on expectations at 4.0%, but that is cold comfort.  Here’s a bit of bad news though, going forward for the next 5 months, the monthly comps are extremely low, so the base effects (you remember those from last year, right?) are telling us that CPI is going to go up from here.  Headline CPI is almost certain to remain above 5.0% through at least Q1 22 and I fear beyond, especially if energy prices continue to rise.  The Social Security Administration announced that benefits would be increased by 5.9% next year, the largest increase in 20 years, but so too will FICA taxes increase accordingly.

The initial market movement on the release was perfectly logical with the dollar bouncing off its lows while Treasury yields backed up.  Given the current correlation between those two, things made sense.  However, that price action was relatively short-lived and as the morning progressed into the afternoon, the dollar started to slip along with yields.  Thus, leading up to the Minutes’ release, the situation had already turned in an unusual direction.

The Minutes explained, come November,
Or possibly late as December
The time will have come
Where QE’s full sum
Ought fade like a lingering ember

The Minutes then confirmed what many in the market had expected which was that the taper is on, and that starting in either mid-November or mid-December the Fed would be reducing its monthly asset purchases by $15 billion ($10 billion less Treasuries, $5 billion less mortgages).  This timeline will end their QE program in the middle of next year and would then open the way for the Fed to begin to raise rates if they deemed it necessary.

Oddly enough, the bond rally really took on legs after the Minutes and the dollar extended its losses.  So, while the correlation remains intact, the direction is confusing, at least to this author.  Losing the only price insensitive bond buyer while the government has so much debt to issue did not seem a recipe for higher bond prices and lower yields.  Yet here we are.  The best explanation I can offer is that investors have assessed that less QE will result in slowing growth and reduced inflationary pressures, so much so that there is the beginning of talk about a recession in the US early next year.  Alas, while I definitely understand the case for slowing growth, and have been highlighting the Atlanta Fed’s GDPNow trajectory lower, there is nothing about the situation that I believe will result in lower inflation, at least not for quite a while yet.  Thus, a bond market rally continues to seem at odds with the likely future outcome.

Of course, there is one other possible explanation for this behavior.  What if, and humor me here for a moment, the Fed doesn’t actually follow through with a full tapering because equity prices start to fall sharply?  After all, I am not the only one to have noticed that the Fed’s reaction function seems to be entirely based on the level of the S&P 500.  Simply look back to the last time the Fed was trying to remove policy accommodation in 2018.  You may recall the gradual reduction in the size of their balance sheet as they allowed bonds to mature without replacing them while simultaneously, they were gradually raising the Fed funds rate.  However, by Christmas 2018, when the equity market had fallen 20% from its highs, Chairman Powell pivoted from tightening to easing policy thus driving a reversal higher in stocks.  Do you honestly believe that a man with a >$100 million portfolio is going to implement and maintain a policy that will make him poorer?  I don’t!  Hence, I remain of the belief that if they actually do start to taper, still not a given in my mind, it won’t last very long.  But for now, the bond market approves.

Thus, with visions of inflation dancing in our heads, let’s look at this morning’s market activity.  Equity markets are clearly of the opinion that everything is under control, except perhaps in China, as we saw the Nikkei (+1.5%) put in a strong performance and strength throughout most of Asia.  However, the Hang Seng (-1.4%) and Shanghai (-0.1%) were a bit less frothy.  Europe, though, is all in on good news with the DAX (+0.8%), CAC (+0.9%) and FTSE 100 (+0.7%) having very positive sessions.  This has carried over into the US futures market where all three major indices are higher by at least 0.6% this morning.

Bonds, meanwhile, are having a good day as well, with Treasury yields sliding 0.7bps after a nearly 5bp decline yesterday.  In Europe, given those markets were closed during much of the US bond rally, we are seeing a catch-up of sorts with Bunds (-3.7bps), OATs (-3.1bps) and Gilts (-1.6bps) all trading well as are the rest of Europe’s sovereign markets.

On the commodity front, pretty much everything is higher as oil (+1.25%), NatGas (+2.1%) and Uranium (+21.7%!) lead the energy space higher.  Metals, too, are climbing with gold (+0.4%), copper (+0.7%) and aluminum (+3.4%) all quite firm this morning.  Not to worry, your food is going up in price as well as all the major agricultural products are seeing price rises.

As to the dollar, it is almost universally lower this morning with only two currencies down on the day, TRY (-0.9%) and JPY (-0.15%).  The former is suffering as President Erdogan fired three more central bankers who refuse to cut interest rates as inflation soars in the country and the market concern grows that Turkey will soon be Argentina.  The yen, on the other hand, seems to be feeling the pressure from ongoing sales by Japanese investors as they seek to buy Treasury bonds with much higher yields than JGBs.  However, away from those two, the dollar is under solid pressure against G10 (SEK +0.9%, NOK +0.8%, CAD +0.55%) and EMG (THB +0.7%, IDR +0.7%, KRW +0.6%).  Broadly speaking, the story is much more about the dollar than about any of these particular currencies although commodity strength is obviously driving some of the movement as is positive news in Asia on the Covid front where some nations (Thailand, Indonesia) are easing restrictions on travel.

On the data front, this morning brings the weekly Initial (exp 320K) and Continuing (2.67M) Claims numbers as well as PPI (8.7%, 7.1% ex food & energy).  PPI tends to have less impact when it is released after CPI, so it seems unlikely, unless it is a big miss, to matter that much.  However, it is worth noting that Chinese PPI (10.7%) printed at its highest level since records began in 1995 while Korean import and export prices both rose to levels not seen since the Asian financial crisis in 1998.  The point is there is upward price pressure everywhere in the world and more of it is coming to a store near you.

We hear from six more Fed speakers today, but it would be quite surprising to have any change in message at this point.  To recap the message, inflation is proving a bit stickier than they originally thought but will still fade next year, they will never allow stock prices to fall, inflation expectations remain anchored and tapering will begin shortly.

While I still see more reasons for the dollar to rally than decline, I believe it will remain linked to Treasury yields, so if those decline, look for the dollar to follow and vice versa.

Good luck and stay safe
Adf

Far From Surreal

The Fed explained that they all feel
A taper is far from surreal
The goal for inflation
Has reached satiation
While job growth ought soon seal the deal

Heading into the FOMC meeting, the consensus was growing around the idea that the Fed would begin tapering later this year, and the consensus feels gratified this morning.  Chairman Powell explained that, if things go as anticipated, tapering “could come as soon as the next meeting.”  That meeting is slated for November 2nd and 3rd, and so the market has now built this into their models and pricing.  In fact, they were pretty clear that the inflation part of the mandate has already been fulfilled, and they were just waiting on the jobs numbers.

An interesting aspect of the jobs situation, though, is how they have subtly adjusted their goals.  Back in December, when they first laid out their test of “substantial further progress”, the employment situation showed that some 10 million jobs had been lost due to Covid-19.  Since then, the economy has created 4.7 million jobs, less than half the losses.  Certainly, back then, the idea that recovering half the lost jobs would have been considered “substantial further progress” seems unlikely.  Expectations were rampant that once vaccinations were widely implemented at least 80% of those jobs would return.  Yet here we are with the Fed explaining that recovering only half of the lost jobs is now defined as substantial.  I don’t know about you, but that seems a pretty weak definition of substantial.

Now, given Powell’s hyper focus on maximum employment, one might ask why a 50% recovery of lost jobs is sufficient to move the needle on policy.  Of course, the only answer is that despite the Fed’s insistence that recent inflation readings are transitory and caused by supply chain bottlenecks and reopening of the economy, the reality is they have begun to realize that prices are rising a lot faster than they thought likely.  In addition, they must recognize that both housing price and rent inflation haven’t even been a significant part of the CPI/PCE readings to date and will only drive things higher.  in other words, they are clearly beginning to figure out that they are falling much further behind the curve than they had anticipated.

Turning to the other key release from the FOMC, the dot plot, it now appears that an internal consensus is growing that the first rate hike will occur in Q4 2022 with three more hikes in 2023 and an additional three or four in 2024.  The thing about this rate trajectory is that it still only takes Fed Funds to 2.00% after three more years.  That is not nearly enough to impact the inflationary impulse, which even they acknowledge will still be above their 2.0% target in 2024.  In essence, the dot plot is explaining that real interest rates in the US are going to be negative for a very long time.  Just how negative, though, remains the $64 trillion question.  Given inflation’s trajectory and the current school of thought regarding monetary policy (that lower rates leads to higher growth), I fear that the gap between Fed Funds and inflation is likely to be much larger than the 0.2% they anticipate in 2024.  While this will continue to support asset prices, and especially commodity prices, the impact on the dollar will depend on how other central banks respond to growing inflation in their respective economies.

Said China to its Evergrande
Defaulting on bonds is now banned
So, sell your assets
And pay dollar debts
Take seriously this command

CHINA TELLS EVERGRANDE TO AVOID NEAR-TERM DEFAULT ON BONDS

This headline flashed across the screens a short time ago and I could not resist a few words on the subject.  It speaks to the arrogance of the Xi administration that they believe commanding Evergrande not to default is sufficient to prevent Evergrande from defaulting.  One cannot help but recall the story of King Canute as he commanded the incoming tide to halt, except Canute was using that effort as an example of the limits of power, while Xi is clearly expecting Evergrande to obey him.  With Evergrande debt trading around 25₵ on the dollar, and the PBOC continuing in their efforts to wring leverage out of the system, it is a virtual guaranty that Evergrande is going under.  I wouldn’t want to be Hui Yan Ka, its Chairman, when he fails to follow a direct order.  Recall what happened to the Chairman of China Huarong when that company failed.

Ok, how are markets behaving in the wake of the FOMC meeting?  Pretty darn well!  Powell successfully explained that at some point they would begin slowing their infusion of liquidity without crashing markets.  No tantrum this time.  So, US equities rallied after the FOMC meeting with all three indices closing higher by about 1%.  Overnight in Asia we saw the Hang Seng (+1.2%) and Shanghai (+0.4%) both rally (Japan was closed for Autumnal Equinox Day), and we have seen strength throughout Europe this morning as well.  Gains on the continent (DAX and CAC +0.8%) are more impressive than in the UK (FTSE 100 +0.2%), although every market is higher on the day.  US futures are all currently about 0.5% higher, although that is a bit off the earlier session highs.  Overall, risk remains in vogue and we still have not had a 5% decline in the S&P in more than 200 trading days.

With risk in the fore, it is no surprise that bond yields are higher, but the reality is that they continue to trade in a pretty tight range.  Hence, Treasury yields are higher by 2.4bps this morning, but just back to 1.324%.  Essentially, we have been in a 1.20%-1.40%% trading range since July 4th and show no sign of that changing.  In Europe, yields have also edged higher, with Bunds (+1.6bps) showing the biggest move while both OATs (+0.9bps) and Gilts (+0.6bps) have moved less aggressively.

Commodity prices are mixed this morning with oil lower (-0.7%) along with copper (-0.25%) although the rest of the base metal complex (Al +0.6%, Sn +0.55%) are firmer along with gold (+0.3%).  Not surprisingly given the lack of consistency, agricultural prices are also mixed this morning.

The dollar, however, is clearly under pressure this morning with only JPY failing to gain, while the commodity bloc performs well (CAD +0.8%, NOK +0.6%, SEK +0.5%).  EMG currencies are also largely firmer led by ZAR (+0.9%) on the back of gold’s strength and PLN (+0.6%) which was simply reversing some of its recent weakness vs. the euro.  On the downside, the only notable decliner is TRY (-1.4%), which tumbled after the central bank cut its base rate by 100 basis points to 18% in a surprise move.  In fact, TRY has now reached a record low vs. the dollar and shows no signs of rebounding as long as President Erdogan continues to pressure the central bank to keep rates low amid spiraling inflation.  (This could be a harbinger of the US going forward if we aren’t careful!)

It is Flash PMI day and the European and UK data showed weaker than expected output readings though higher than expected price readings.  We shall see what happens in the US at 9:45. Prior to that we see Initial Claims (exp 320K) and Continuing Claims (2.6M) and we also see Leading Indicators at 10:00 (0.7%).  The BOE left policy on hold, as expected, but did raise their forecast for peak inflation this year above 4%.  However, they are also in the transitory camp, so clearly not overly concerned on the matter.

There are no Fed speakers today although we hear from six of them tomorrow as they continue to try to finetune their message.  The dollar pushed up to its recent highs in the immediate aftermath of the FOMC meeting, but as risk was embraced, it fell back off.  If the market is convinced that the Fed really will taper, and if they actually do, I expect it to support the dollar, at least in the near term.  However, my sense is that slowing economic data will halt any initial progress they make which could well see the dollar decline as long positions are unwound.  For today, though, a modest drift higher from current levels seems reasonable.

Good luck and stay safe
Adf

Avoiding a Crash

The Chinese have taken a stand
Regarding the firm, Evergrande
They’ve added more cash
Avoiding a crash
And now feel they’ve got things in hand

So, now all eyes turn to the Fed
And tapering timing, instead
The question at hand
Is can they withstand
Slow growth while still moving ahead?

Fear was palpable on Monday as China Evergrande missed an interest payment and concerns grew that a major disruption in Chinese debt markets, with the ability to spread elsewhere, was around the corner.  Yesterday, however, investors collectively decided that the world was not, in fact, going to end, and dip buyers got to work supporting equity markets.  The buyers’ faith has been rewarded as last night, the PBOC added net CNY70 billion to the markets to help tide over financing issues.  In addition, an oddly worded statement was released that Evergrande had addressed the interest payment due tomorrow via private negotiations with bondholders.  (Critically, that doesn’t mean they paid, just that the bondholders aren’t going to sue for repayment, hence avoiding a bankruptcy filing.)  As is always the case in a situation of this nature, nothing has actually changed at Evergrande so they are still bankrupt with a massive amount of debt that they will never repay in full, but no government, whether communist or democratic, ever wants to actually deal with the problem and liquidate.  This is the enduring lesson of Lehman Brothers.

Which means…it’s Fed day!  As we all know, this afternoon at 2:00 the FOMC will release the statement with their latest views and 30 minutes later, Chairman Powell will face the press.  At this time, the topic of most interest to everyone is the timing of the Fed’s reduction in asset purchases, aka tapering.  When we last left this story (prior to the Fed’s quiet period a week and a half ago, pretty much every Fed regional president (Kashkari excluded) and a few minor governors had indicated that tapering was appropriate soon.  On the other hand, the power center, Powell, Brainerd and Williams, had said no such thing, but had admitted that the conversation had begun.

You may recall that at the August FOMC meeting, the Fed indicated that the goal of “substantial further progress” had not yet been met with regard to the maximum employment mandate, although they begrudgingly admitted that the inflation side of the coin had been achieved.  (As an aside, while there has never been an answer to the question of how long an averaging period the Fed would consider with respect to their revamped average inflation target, simple arithmetic shows that if one averages the core PCE data from May 2020 through July 2021, the result is 2.0%.  If the forecast for the August core number, to be released on October 1, is correct at 3.6%, that means that one can head back to March 2020 and still show an average of 2.0%.  And remember, core PCE is not about to collapse back down to 2.0% or lower anytime soon, so this exercise will continue to expand the averaging period.)

Current expectations are that the initial tapering will start in either November or December of this year, and certainly by January 2022.  Clearly, based on the inflation mandate, we are already behind schedule, but the problem the Fed has is that the recent growth data has been far less impressive.  The August NFP data was quite disappointing at 235K, a 500K miss to estimates.  Not only that, while the July data was strong, the June data was also a major miss, which begs the question, was July the aberration or August?  Ask yourself this, will Chairman Powell, who is up for reappointment shortly, tighten policy into an economy where employment growth is slowing?  There is every possibility that tapering is put on hold for a few more months in order to be sure that monetary stimulus withdrawal is not premature.  The fact that a decision like that will only stoke the inflationary fires further will be addressed by an even more strident statement that inflation is transitory, dammit!  My point is, it is not a slam dunk that they announce tapering today.

For a perfect example as to why this is the case, look no further than the ECB, where today we heard another ECB member, the Estonian central bank chief, explain that when the PEPP runs out in March, it would be appropriate to expand the older APP program to pick up the slack.  In other words, they will technically keep their word and let the PEPP expire, but they will not stop QE.  The Fed, ECB and BOJ have all realized that their respective economies are addicted to QE and that withdrawal symptoms will be remarkably painful, so none of them are inclined to go through that process.  Can-kicking remains these central banks’ strongest talent.

OK, to markets ahead of the Fed.  Asia was mixed as the Nikkei (-0.7%) remains under pressure, clearly unimpressed by the BOJ’s ongoing efforts which were reiterated last night after their meeting.  However, Chinese equities (Hang Seng +0.5%, Shanghai +0.4%), not surprisingly, fared better after the liquidity injection.  In Europe, it is all green as further hints that the ECB will let the PEPP lapse in name only has investors confident that monetary support is a permanent situation.  So, the DAX (+0.55%), CAC (+1.1%) and FTSE 100 (+1.2%) are all poppin’.  US futures have also gotten the message and are firmer by about 0.5% this morning.

Bond markets are ever so slightly softer with yields edging up a bit.  Treasuries have been the worst performer although yields are only higher by 1.4bps.  In Europe, Bunds are unchanged while OATs and Gilts have risen 0.5bps each.

Commodity prices, on the other hand, have performed quite well this morning with oil (WTI +1.5%) leading energy higher and base metals (Cu +2.4%, Al +1.6%, Sn +3.6%) all much firmer although gold (0.0%) is not taking part in the fun.  Ags are also firmer this morning as the commodity space is finding buyers everywhere.

The dollar is somewhat softer this morning with NOK (+0.5%) leading the G10 and the rest of the commodity bloc also strong (CAD +0.3%, AUD +0.25%, NZXD +0.25%).  The one true laggard is JPY (-0.3%) which is suffering from the lack of a need for a haven along with general malaise after the BOJ.  In the EMG space, HUF (-0.75%) is the outlier, falling after the central bank raised rates a less than expected 15 basis points after three consecutive 30 basis point hikes, and hinted that despite inflation’s rise, less hikes would be coming in the future.  Away from that, though, there is a mix of gainers and loser with the commodity bloc strong (CLP +0.45%, ZAR +0.4%, RUB +0.4%) while commodity importers are suffering (INR -0.35%, PHP -0.25%, PLN -0.2%).

Ahead of the Fed we see Existing Home Sales (exp 5.89M), but really, look for a quiet market until 2:00 and the FOMC statement.  My view is they will be less hawkish than the market seems to expect, and I think that will be a negative for the dollar, but at this point, all we can do is wait.

Good luck and stay safe
Adf

Far From Benign

There once was a market decline
That seemed, at the time, to consign
Investors with shares
To turn into bears
An outcome quite far from benign

But that was a long time ago
As by afternoon all the flow
Was buying the dip
Thus, proving this blip
Was not a bull market deathblow

I wonder if stock prices declining for 18 hours now counts as a correction.  What had appeared to be the beginnings of a more protracted fall in stocks turned into nothing more than a modest blip in the ongoing bull market.  Some teeth were gnashed, and some positions lightened, but by 3:15pm, it was all over with a 1.3% rebound from that time to the close.  Granted, the S&P 500 did decline 1.7% on the day, but given the substantial buying impulse seen at the end of the day, as well as the change in tone of the market narrative, it certainly feels this morning like the worst is behind us.  While China Evergrande continues to be bankrupt, the new story is that despite its large size, it is not large enough to be a real catalyst for market destruction and, anyway, the PBOC would never let things get to a point where its bankruptcy would lead to contagion elsewhere in the Chinese markets/economy.

As to the last point, be careful with your assumptions.  While this is not meant to be a prediction, consider that President Xi Jinping has spent the last year cracking down on successful firms in China as they have amassed both wealth and power, something that an autocrat of Xi’s nature cannot abide.  So, a fair question to ask is, would Xi let the Chinese economy crash in order to consolidate his power even further?  While I don’t believe he would purposely do that, I would not rule out him allowing things to unfold in a manner he sees as beneficial to his ultimate plans, thus financial distress in China could well be in our future.  And if you are Xi Jinping, the idea that Western markets would react badly to an Evergrande collapse would only be a positive.  My point is, I don’t think you can rule out other motives in this situation.

At any rate, this literally seems like ancient history at this time, with markets all in the green and the market narrative of ‘buy the dip’ proving itself once again to be the proper course of action.  Pavlov himself could not have conditioned retail investors any better than the Fed and other central banks have done over the past decade.

So, with Evergrande in the rearview mirror, the market gets to (re)turn its focus to the FOMC meeting, which begins this morning and whose outcome will be announced at 2pm tomorrow.  That means we are back to talking about tapering.  Will they, or won’t they?  And if they do, when will they start?

The market consensus is clearly that tapering is coming with about two-thirds of market economists forecasting the first reduction in asset purchases will occur in November.  While there are some differing views on how they will taper, the consensus appears to be a reduction of $10 billion of Treasuries and $5 billion of mortgage-backed securities each month until they are done.  So, eight months of reductions takes us to next June if we start in November.  Of course, this assumes that there are no interruptions, and that the Fed leadership remains intact.

First, remember, Chairman Powell’s term is up in February, and while he remains the favorite to be reappointed, it seems the most progressive wing of the Democratic party wants to see someone else, with Lael Brainerd, a current Fed governor and past Treasury Undersecretary, seen as the leading alternative.  Ms Brainerd has consistently been even more dovish than Powell, and if she were to be confirmed for the Chair, it would be easy to believe she halted any tapering at that point.  After all, if one believes in MMT, (which by all accounts Ms Brainerd embraces), why would the Fed ever stop buying Treasuries?  Again, this is not predictive, just something to keep in mind.

Second, the tapering narrative is based on the idea that economic growth coming out of the Covid recession is self-sustaining and no longer needs central bank support.  But what if the recovery is more anemic than currently forecast.  The one consistency we have seen over the course of the past months is that forecasts for economic growth in Q3 and Q4 have declined dramatically.  For instance, the Atlanta Fed’s GDPNow forecast model is pointing to 3.65% currently, down from 5.3% at the beginning of the month and 7.6% just two months ago.  Shortages of certain things still abound and prices on staples like beef, pork, and poultry, continue to rise rapidly.  In short, the situation in the economy is anything but clear.

In this case, the question really becomes, will the Fed turn its attention to inflation, or will it remain focused only on unemployment?  If the inflation heat reaches too high a temperature, then it would be easy to believe tapering will occur far more rapidly.  However, if growth remains the focus, then any reason to delay tapering will be sought.  I remain in the camp that while they may initiate tapering, the Fed will be buying bonds long after June 2022.  We shall see.

A quick turn to markets shows that all is right with the world!  Stocks are almost universally higher as Asia (Hang Seng +0.5%, Shanghai +0.2%) led the beginning of the rebound although Japan (Nikkei -2.1%) was still coming to grips with yesterday’s narrative coming out of their holiday.  Europe is strongly higher this morning (DAX +1.45%, CAC +1.4%, FTSE 100 +1.15%) as fear has rapidly dissipated.  And after the worst US equity session in months, futures this morning are higher by about 0.8% across the board.

It should be no surprise that bonds are for sale this morning with yields mostly higher.   Treasury yields, which fell 6bps yesterday, have bounced slightly, up 1.7bps this morning.  European sovereigns, which saw a lesser rally yesterday have barely sold off with nothing rebounding even a full basis point.  One noteworthy outlier is Greece, whose bonds are sharply higher with 10-year yields declining 4.6bps, after Greek central bank comments that the ECB would never stop buying Greek paper.

Commodity prices are generally firmer with oil (WTI +1.2%) leading although gold (+0.2%), copper (+0.95%) and aluminum (+1.0%) are all embracing the risk rebound.

And finally, the dollar, which had rallied so sharply yesterday morning, has given back all of those gains.  NOK (+0.8%) leads the G10 charge higher with CAD (+0.5%) next in line as oil’s rebound supports both currencies.  The rest of the bloc has seen less exuberance, generally between 0.1% and 0.25%, although JPY (-0.1%) has slipped as its haven status is no longer a benefit.

EMG currencies have seen a little less dramatic movement with the leading gainer CZK (+0.3%) followed by RUB (+0.25%) with the latter benefitting from oil while the former continues to find support based on views its central bank remains hawkish enough to raise rates.  Otherwise, the gainers have been quite modest, 0.2% or less with two currencies falling on the day, ZAR (-0.2%) and PLN (-0.25%).  In both cases, it appears the concerns lie with central bank policy prospects.  However, given the modest size of the decline, it is hardly a key issue.

On the data front, this morning brings Housing Starts (exp 1550K) and Building Permits (1600K), although with the FOMC meeting in the background, neither is likely to move the needle.  And that’s really it for the day as there are no speakers.  As long as we don’t see a bombshell from Evergrande, which seems unlikely in our time zone, today feels like a quiet session with potential modest further dollar weakness.  All eyes will continue to be on tomorrow’s FOMC announcement, and, more importantly, Chairman Powell’s comments at the press conference.  Until then, slow going is likely.

Good luck and stay safe
Adf

To Taper’s Ordained

The Minutes on Wednesday explained
That QE would still be sustained
But ere this year ends
Some felt that the trends
Implied that, to taper’s, ordained

But ask yourself this, my good friends
What happens if tapering sends
The stock market down
Will they turn around
And restart QE as amends?

Remember all the times the Fed tried to tell the world that their current policy stance, notably the massive amount of QE purchases, were not the driving force in the equity market?  Stock market bulls played along with this as well, explaining that historically high valuation measures were all appropriate given the huge corporate profit margins, and had nothing to do with the Fed’s suppression of interest rates along the entire yield curve.  The bulls would point to 30-year interest rates below 2.00% and explain that when you discounted future cash flows at such low levels, it was only natural that stock valuations were high.  The fact that it was the Fed that was simultaneously buying up all the net Treasury issuance, and then some, thus driving rates artificially lower, as well as promising to do so for the foreseeable future was seen as a minor detail.

Perhaps that detail was not as minor as the bulls would have you believe!  Yesterday, the FOMC Minutes were released and the part that garnered all the attention was the discussion on the current asset purchase framework and how it might change in the future.

“Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met. At the same time, most participants remarked that this standard had been achieved with respect to the price- stability goal. (my emphasis) A few participants noted, however, that the transitory nature of this year’s rise in inflation, as well as the recent declines in longer-term yields and in market-based measures of inflation compensation, cast doubt on the degree of progress that had been made toward the price-stability goal since December.”

So, it seems they are in sync on the fact that the employment situation has room to run, and they don’t want to act too early because of that.  But what I find more interesting is that they can use the term ‘price stability’ when discussing inflation running in the 4.0%-5.0% range.  As well, it is apparent that many of the committee members are drinking their own Kool-Aid on the transitory story.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year because they saw the Committee’s “substantial further progress” criterion as satisfied with respect to the price-stability goal and as close to being satisfied with respect to the maximum employment goal. Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year because they saw prevailing conditions in the labor market as not being close to meeting the Committee’s “substantial further progress” standard or because of uncertainty about the degree of progress toward the price-stability goal.” (my emphasis)

But this was the money line, the clear talk that most of the committee expected tapering to begin before the end of the year.  While we have not yet heard any of the three key leaders (Powell, Williams and Brainerd) say they were ready to taper, it seems that most of the rest of the committee is on board.  Jackson Hole suddenly became much more interesting, because if Powell discusses tapering as likely to occur soon, it will be a done deal.  But if he doesn’t explain that tapering is coming soon, it is possible that we see four dissents, at the next meeting.  And how about this for a thought, what if those three are the only votes to stand pat, and the other six voting members want to start the taper?  That would truly be unprecedented and, I think, have major negative market ramifications.  I don’t expect that to occur, but after everything that has occurred over the past 18 months, I wouldn’t rule out anything anymore.

At any rate, the tapering talk remains topic number one in every market, and one cannot be surprised that the market’s reaction has been a clear risk-off response.  Equity markets around the world are lower, substantially so in Europe; bond markets are rallying as risk is jettisoned; commodity prices are falling, and the dollar is king!

So, let’s take a tour and see where things are.  Starting in Asia, we saw equities decline throughout the region with the Nikkei (-1.1%), Hang Seng (-2.1%) and Shanghai (-0.6%) all under pressure.  But the real pressure was felt in Korea (KOSPI -1.9%) and Taiwan (TAIEX -2.7%).  In fact, the only markets in the region to hold their own were in New Zealand.  Turning to Europe, it is a uniform decline with the DAX (-1.6%), CAC (-2.5%), and FTSE 100 (-2.0%) all falling sharply, with the lesser known indices also completely in the red.  I guess the prospect of less Fed largesse is not seen as a positive after all.  Meanwhile, ahead of this morning’s opening, US equity futures are all sharply lower, on the order of 0.75%.

Turning to the bond market, the prospect of less Fed buying is having an interesting outcome, bonds are rallying.  Of course, this is because Treasuries remain the ultimate financial safe-haven trade and as investors flee risky assets, bonds are the natural response.  So, 10-year Treasury yields have fallen 3.5bps, and we are seeing yields decline in the European market as well, at least those countries that are deemed solvent.  So, Bunds (-1.4bps), OATs (-1.1bps) and Gilts (-3.4bps) are all seeing demand.  Yields for the PIGS, however, are unchanged to higher on the day.

Commodity prices are uniformly lower, except for gold, which is essentially unchanged on the day.  Oil (-3.7%) leads the way down, but we are seeing weakness in base metals (Cu -3.3%) as well as the Agricultural space (Wheat -1.5%, Soybeans -1.2%).

Finally, the dollar is on top of the world this morning, as investors are buying dollars to buy bonds, or so it seems.  In classic risk-off fashion, only the yen (+0.1%) has managed to hold its own vs. the dollar as the rest of the G10 bloc is weaker led by NOK (-0.95%) and AUD (-0.95%).  NZD (-0.7%) and CAD (-0.7%) are also suffering greatly given the commodity weakness story.  But do not ignore the euro (-0.15%) which while it hasn’t moved very far, has managed to finally trade below the key 1.1704 support level, and is set, in my view, to head much lower.

In the EMG space, ZAR (-1.3%) is the leading decliner, falling alongside the commodity complex.  KRW (-0.7%) has given back all of yesterday’s gains as equity outflows continue to dominate the market there, but we are seeing weakness across the board with most currencies falling between 0.3%-0.6% purely on the dollar’s overall strength.

On the data front, this morning brings the weekly Initial Claims (exp 364K) and Continuing Claims (2.8M) as well as Philly Fed (23.1) and Leading Indicators (+0.7%).  There’s no scheduled Fedspeak, but what else can they say after yesterday’s Minutes anyway?  If you recall, Monday’s Empire Mfg was quite weak, so I would not be surprised to see Philly follow suit.  In fact, I think the biggest problem the Fed is going to have is that the data is rolling over and looking like a slowing economy, despite high inflation.  If they keep seeing economic weakness, are they really going to taper into a weakening economy?  They may start, but I doubt they get two months in before they stop, especially if equities continue to revalue (fall).  As to the dollar, for now, I like its prospects and suspect that we are going to trade to levels not seen since June of last year.

Good luck and stay safe
Adf

The Chorus has Grown

T’was only a few months ago
When Kaplan from Dallas said, whoa
The time has arrived
Where growth has revived
And bond buying needs to go slow

Since then, though, the chorus has grown
As seven more members have shown
That they all agree
It’s time for QE
To end and leave markets alone

We continue to hear from more FOMC members that it is time to taper the Fed’s purchases of both Treasuries and mortgage-backed securities.  Last Wednesday, of course, the big news was that Vice-Chairman Richard Clarida came out so hawkishly in his comments, not only calling for tapering bond purchases but also raising rates sooner than the median forecast had anticipated.  Yesterday, three Fed speakers were all on the same page, with Boston’s Eric Rosengren the newest name added to the tapering crew (Bostic and Barkin were already known taperers.)  That takes the count to at least eight (Clarida, Bostic, Barkin, Rosengren, Bullard, Daly, Waller and Kaplan) with the two most hawkish FOMC members, Loretta Mester and Esther George, on the docket for today and tomorrow respectively.  It is not unreasonable, based on their respective histories, to expect both of them to call for tapering as well.  That would make ten of the seventeen members as confirmed supporters of the process.

The question is, will that be enough?  The Fed’s power core for the last several years has been concentrated in four members, Powell, Clarida, Williams and Brainerd.  Of this group, only Clarida has publicly proclaimed it has come time to taper.  And potentially, his importance is diminishing as his term ends within months and he is seen as highly unlikely to be reappointed.  Rather, the talk of the town is that Chairman Powell is also losing fans in the Senate with respect to his reappointment, and that Governor Lael Brainerd is the new leading candidate to become Fed Chair.  As it happens, neither of those two have come out for tapering soon, and in fact, last week, Ms Brainerd was adamant in her belief it was far too early to do so.  The point is, the Fed has never been a democratic institution although it is an extremely political one.  Having a majority of members agree on a view only matters if it is a majority of the right members.  By my count, that is not yet the case.  Perhaps come Jackson Hole in two plus weeks, we will hear the Chairman agree, but tapering is not yet a done deal.

Traders, however, see the world very differently than pundits, and certainly very differently than the Fed itself.  And what has become very clear in the past several days is that traders are increasingly placing bets that tapering is coming…and coming soon.  The combination of all those Fed speakers talking about tapering, the very strong NFP data as well as yesterday’s JOLTs blowout (>10 million jobs are open), and the constant stream of stories about rising wages (just this morning a BBG story on JPM raising salaries to compete to hold onto staff is simply the latest) have been sufficient to logically conclude that it is time for the Fed to begin removing accommodation.  Hence, Treasury yields have backed up nearly 20 basis points from the lows seen last Wednesday morning, the dollar has risen against all its counterparts and the price of oil has fallen by more than 4%.

Looking ahead, the question becomes, is this likely to continue?  Or have we reached a peak?  It is not unreasonable to assume that both George and Mester will call for tapering this week.  It is also not unreasonable to assume that the CPI data tomorrow is going to point to a still rising price environment, whether it ticks slightly higher or lower than last month’s 5.4% headline print.  Any number in that vicinity remains far above the Fed’s average target of 2.0%.  The point is that there is nothing obvious on the horizon that should cause the tapering hawks to back off, at least not until the end of the month.  As such, hedgers need to be prepared for a continuation of the recent price action.

Meanwhile, a look at today’s markets shows that these recent trends remain intact.  While Asian equity markets continue to follow their own drummer (Nikkei +0.25%, Hang Seng +1.25%, Shanghai +1.0%), European bourses continue to struggle (DAX +0.2%, CAC +0.1%, FTSE 100 -0.1%) as do US futures with all three major indices either side of unchanged.  Asia seems to be benefitting from the view that the PBOC is preparing to ease policy further as China responds to the increased lockdowns due to the delta variant of Covid that has been spreading quite rapidly there, in addition to the fact that the Chinese authorities have not named a new target in its seemingly random crackdown of successful companies.

Bond markets, while edging higher today, have been generally losing ground.  So, while Treasury yields are lower by 0.5bps this morning, they are at 1.32%, well off the lows seen last week.  European sovereigns are generally a touch firmer as well, with yields down by between 0.5bps and 1 bp but they, too, have seen yields climb back a bit lately.

Commodity prices, which have been under severe pressure, are rebounding slightly this morning, although this has the appearance of a trading bounce more than a sea change in view.  Commodity prices are likely to be amongst the hardest hit if the Fed really does start to tighten policy.  But this morning, oil (+2.0%) has rebounded nicely although gold (0.0%) has been unable to bounce from yesterday’s massive sell-off.  Copper (+0.65%) is leading base metals modestly higher and ags have bumped up a bit as well.

As to the dollar, right now it is arguably slightly stronger overall, but only just as there are a mix of gainers and losers vs. the greenback.  In the G10 space, the euro (-0.1%) is continuing toward its test of key support at 1.1704, albeit quite slowly.  The entire space, though, is +/- 0.2% or less, which is indicative of position adjustments rather than news driven activity.

EMG currencies are also mixed with KRW (-0.5%) the weakest of the bunch on the back of concerns over the impact of the delta variant as well as equity market outflows by international investors.  PLN (-0.4%) is the next weakest as central bank comments seemed to delay the timing of a mooted rate hike.  On the flip side, TRY (+0.6%) is the leader as Unemployment data there was released at a much lower than expected 10.6%.

Data today showed that Small Business Optimism has suffered lately with the NFIB Index falling to 99.7.  At 8:30 we see Nonfarm Productivity (exp 3.2%) and Unit Labor Costs (+1.0%), although it is unlikely either will have a big market impact.  Arguably, market participants are all waiting for tomorrow’s CPI data for the next big piece of news.

At this point, the dollar’s modest uptrend remains in place and I see no reason to believe that will change.  At least not until we hear differently from Powell or the data turns much worse.

Good luck and stay safe
Adf

The Tapering Walk

For those who expected a hawk
When Powell completed his talk
T’was somewhat depressing
That Jay was professing
They’d not walk the tapering walk

Then last night, from China, we learned
A falling stock market concerned
The powers that be
Thus, they did agree
To pander to those who’d been burned

Apparently, the Fed is not yet ready to alter its policy in any way.  That is the message Chairman Powell delivered yesterday through the FOMC statement and following press conference.  Though it seems clear there was a decent amount of discussion regarding the tapering of asset purchases, in the end, not only was there no commitment on the timing of such tapering, there was no commitment on the timing of any potential decision.  Instead, Chairman Powell explained that while progress had been made toward their goals, “substantial further progress” was still a ways away, especially regarding the employment situation.

When asked specifically about the fact that inflation was currently much higher than the FOMC’s target and whether or not that met the criteria for averaging 2%, he once again assured us that recent price rises would be transitory.  Remember, the dictionary definition of transitory is simply, ‘not permanent’.  Of course, the question is exactly what does the Fed mean is not going to be permanent?  It was here that Powell enlightened us most.  He explained that while price rises that have already occurred would likely not be reversed, he was concerned only with the ongoing pace of those price rises.  The Fed’s contention is that the pace of rising prices will slow down and fall back to levels seen prior to the onset of the Covid pandemic.

Of course, no Powell Q&A would be complete without a mention of the “tools” the Fed possesses in the event their inflation views turn out to be wrong.  Jay did not disappoint here, once again holding that on the off chance inflation seems not to be transitory, they will address it appropriately.  This, however, remains very questionable.  As the tools of which they speak, higher interest rates, will have a decisively negative impact on asset markets worldwide, it is difficult to believe the Fed will raise rates aggressively enough to combat rising inflation and allow asset markets to fall sharply.  In order to combat inflation effectively, history has shown real interest rates need to be significantly positive, which means if inflation is running at 5%, nominal rates above 6% will be required.  Ask yourself how the global economy, with more than $280 Trillion of debt outstanding, will respond to interest rates rising 600 basis points. Depression anyone?

At any rate, the upshot of the FOMC meeting was that the overall impression was one of a more dovish hue than expected going in, and the market response was exactly as one might expect.  Equity markets rebounded in the US and have continued that path overnight.  Bond markets rallied a bit in the US, although with risk appetite back in vogue, have ceded some ground this morning.  Commodity prices are rising and the dollar is under pressure.

Speaking of risk appetite, the other key story this week had been China and the apparent crackdown on specific industries like payments and education.  While Tuesday night’s comments by the Chinese helped to stabilize markets there, that was clearly not enough.  So, last night we understand that the China Securities Regulatory Commission gathered a group of bankers to explain that China was not seeking to disengage from the world nor prevent its companies from accessing capital markets elsewhere.  They went on to explain that recent crackdowns on tech and educational companies were designed to help those companies “grow in the proper manner”, a statement that could only be made by a communist apparatchik.  But in the end, the assurances given were effective as equity markets in Hong Kong and China were sharply higher and those specific companies that had come under significant pressure rebounded on the order of 7%-10%.  So, clearly there is no reason to worry.

Now, I’m sure you all feel better that things are just peachy everywhere.  The combination of Chairman Powell removing any concerns over inflation getting out of hand and the Chinese looking out for our best interests regarding the method of growth in its economy has led to a strongly positive risk sentiment.  As such, it should be no surprise that equity prices are higher around the world.  Asia started things (Nikkei +0.75%, Hang Seng +3.3%, Shanghai +1.5%) and Europe has followed suit (DAX +0.45%, CAC +0.7%, FTSE 100 +0.9%).  US futures have not quite caught the fever with the NASDAQ (-0.2%) lagging, although the other two main indices are slightly higher.

In the bond market, investors are selling as they no longer feel the need of the relative safety there, with Treasury yields higher by 3bps, while Bunds (+2bps), AOTs (+1bp) and Gilts (+2.7bps) are all under pressure.  But remember, yields remain at extremely low levels and real yields remain deeply negative, so a few bps here is hardly a concern.

Commodity prices have waived off concerns over the delta variant slowing the economy down and are higher across the board.  Oil (+0.25%), gold (+0.85%), copper (+1.1%) and the entire agricultural space are embracing the renewed growth narrative.

Finally, the dollar, as would be expected during a clear risk-on session and in the wake of the Fed explaining that tapering is not coming to a screen near you anytime soon, is lower across the board.  In the G10 space, NZD (+0.6%) and NOK (+0.55%) are leading the way higher, which is to be expected given the movement in commodity prices.  CAD (+0.45%) is next in line.  But even the yen (+0.1%) has edged higher despite the positive risk attitude.  One could easily describe this as a pure dollar sell-off.

In the emerging markets, HUF (+0.85%) is the leader as traders are back focused on the hawkishness of the central bank and an imminent rate hike, now ignoring the lack of EU funding that remains an open issue.  ZAR (+0.8%) is next on the commodity story with KRW (+0.7%) in the bronze medal position as exporters took advantage of the weakest won in nearly a year to sell dollars and then Samsung’s earnings blew away expectations on the huge demand for semiconductors, and funds flowed into the equity market.

We get our first look at Q2 GDP this morning (exp 8.5%) with the Consumption component expected to rise 10.5% on a SAAR basis.  We also see Initial Claims (385K) and Continuing Claims (3183K).  Recall, last week Initial Claims were a much higher than expected 419K, so weakness here could easily start to cause some additional concern at the Fed and delay the tapering discussion even further.  With the FOMC behind us, we can look forward to a great deal more Fedspeak, although it appears many of the committee members are on vacation, as we only have two scheduled in the next week, and they come tomorrow.  I imagine that calendar will fill in as time passes.

Putting it all together shows that any Fed hawks remain in the distinct minority, and that the party will continue for the foreseeable future.  Overall, the dollar has been trading in a range and had been weakly testing the top of that range.  It appears that move is over, and we seem likely to drift lower for the next several sessions at least, but there is no breakout on the horizon.

Good luck and stay safe
Adf

Tougher for Jay

The Fed once again will convey
Inflation just ain’t here to stay
But every release
That shows an increase
Makes life that much tougher for Jay

Meanwhile, Chinese comments last night
Explained everything was alright
They further suggested
That more be invested
To underscore risk appetite

As we await the FOMC meeting’s conclusion this afternoon, markets have generally remained calm, even those in China.  Apparently, 20% is the limit as to how far any government will allow equity markets to decline. After three raucous sessions in China and Hong Kong, as investors fled from those companies under attack review by the Chinese government for their alleged regulatory transgressions, the Chinese press was out in force explaining that there were no long term problems and that both the economy and stock markets were just fine and quite safe.  “Recent declines are unsustainable” claimed the Securities Daily, a state-owned financial paper.  We shall see if that is the case, especially since there is no indication that the government has finished its regulatory crackdown across different industries.

However, the carnage of the past several sessions was not evident last night as the Hang Seng (+1.5%) rebounded nicely while Shanghai (-0.6%) managed to close 1.5% above the lows seen early in the session.  It hardly seems coincidental that the Chinese reacted to the declines after a 20% fall as that seems to be the number that defines concern.  Recall, in Q4 2018, Chairman Powell, who had been adamant there were no issues and was blissfully allowing the Fed’s balance sheet to slowly shrink while simultaneously raising interest rates made a quick 180˚ turn on Boxing Day when the S&P’s decline had reached 20%.  It seems that no central banker or government is willing to allow a bear market on their watch, even those that need never face the voters.

While forecasting the future is extremely difficult, it seems likely that if President Xi turns his sights on another industry, (Real Estate anyone?) then we could easily see another wave lower across these markets.  While instability is not desired, when push comes to shove, Xi’s ideology trumps all other concerns, and if he believes it is being threatened by the growth and power of an industry, you can be certain that industry will be targeted.  Caveat investor!

As to the Fed, the universal expectation is there will be no policy changes, so interest rates will remain the same and the asset purchase program will continue at its monthly pace of $120 billion.  The real questions center around tapering (will they mention it in the statement and how will Powell address it in the press conference) and the nature of inflation.  While clearly the latter will be described as transitory, will there be some acknowledgement that it is running hotter than they ever expected?

At Powell’s Congressional testimony several weeks ago, he was clear that “substantial further progress” toward their goals of maximum employment and average inflation stably at 2.0%, had not yet been made.  Has that progress been made in the interim?  I think not.  This implies, to me at least, that there is no policy change in the offing for a long time to come.  While there are many analysts who are looking for a more hawkish turn from the Fed in response to the clearly rising price pressures, the hallmark of this (and every previous) committee is that they will stick to their narrative regardless of the situation on the ground.  I expect they will ignore the much higher than expected inflation prints and that when asked at the press conference, Powell will strongly maintain inflation is transitory and will be falling soon.  Monday, I explained my concern that CPI is likely to moderate for a short period of time before heading sharply higher again, and that Powell and the Fed will take that moderation as victory.  Nothing has changed that view, nor the view that the Fed will fall far behind the curve when it comes to fighting inflation.  But that is the future.  For now, the Fed is very likely to remain calm and stick to their story.

OK, with that out of the way, we can peruse the markets, which, as I mentioned above, have been vey quiet awaiting the FOMC.  The other key Asian market, the Nikkei (-1.4%) fell overnight after having rallied during the Chinese fireworks, as the spread of the delta variant of Covid-19 and ongoing lockdowns in Japan have started to concern investors.

Europe, on the other hand, is all green on the screen led by the CAC (+0.75%) with both the DAX (+0.2%) and FTSE 100 (+0.2%) up similar but lesser amounts.  You’re hard pressed to point to the data as a driver as the little we saw showed German Import prices rise 12.9%, the highest level since September 1981, while French Consumer Confidence fell a tick to 101.  Hardly the stuff of bullish sentiment.  US futures, currently, sit essentially unchanged as traders and investors await Powell’s pronouncements.

The bond market is mixed this morning, with Treasury yields edging higher by 1 basis point while most of Europe is seeing a very modest decline in yields, less than 1bp.  Essentially, this is the price action of positions being adjusted ahead of key data.

Commodity prices show oil rising (+0.5%) but very little movement anywhere else in the space with both metals and agricultural prices either side of unchanged on the day.

Lastly, the dollar is ever so slightly stronger vs. most G10 counterparts, with AUD (-0.25%) and NZD (-0.2%) the laggards as concern grows over the economic impact of the ongoing spread of the delta variant.  CAD (+0.25%) is the one gainer of note, seemingly following oil’s lead.  EMG currencies have had a more mixed session with KRW (-0.4%) the worst performer on the back of rising Covid cases and ongoing concerns over what is happening in China.  The only other laggard of note is HUF (-0.3%) which is still suffering from its ongoing political fight with the EU and the result that EU Covid aid has been indefinitely delayed.  On the plus side, RUB (+0.35%) is following oil while CNY (+0.2%) seems to be benefitting from the calm imposed on markets last night.  Otherwise, movement in this space has been minimal.

All eyes are on the FOMC at 2:00 this afternoon, with only very minor data releases before then.  My read is that the market is looking for a slightly hawkish tilt to the Fed as a response to the rapidly rising inflation.  However, I disagree, and feel the risk is a more dovish than expected outcome. The fact that US economic data continues to mildly disappoint will weigh on any decision.  If I am correct, I think the dollar will have the opportunity to sink a bit further, but only a bit.

Good luck and stay safe
Adf

Time to Flee

No longer will President Xi
Allow billionaires to run free
His edict last night
Proved his grip is tight
And showed traders t’was time to flee

The biggest story overnight was the continued crackdown by Chinese authorities on any private industry that has developed a measure of power in the Chinese economy.  While the tale of Didi Chuxing, the Chinese Uber, was seen as a warning, apparently, the government is becoming more impatient over the pace of adherence to the new view.  Briefly, Didi went public and then several days later the Chinese government forced them to remove their app from public availability and crushed their business under the pretext of data security.  Didi shares fell sharply.  Last night the government explained that private education companies, which were teaching the CCP curriculum, were to cease being profit-making companies “hijacked by capitalism”, and essentially will be forced to delist.  It can be no surprise that the prices of these shares fell dramatically, in one case by 98/%, as investors flee as quickly as possible.  This resulted in sharp declines across all indices there with the Hang Seng (-4.1%) and Shanghai (-2.35%) and led to a general risk-off tone.

Apparently, President Xi is no longer willing to accept that anybody else in China can have some measure of power or influence beyond his control.  Other changes involve the payment networks Alipay and Wechat, which are on the verge of being subsumed by China’s upcoming CBDC, the e-yuan.  Exclusive rights for things like music licenses are being removed and essentially, it appears that capitalism with Chinese characteristics is morphing into a full-blown state-owned economy.  We cannot be too surprised by this; after all, Xi Jinping has been ruling with an increasingly tighter grip on all segments of the economy and he is a clear adherent to strict communism.  Remember, the definition of communism is that all property is publicly (read government) owned.  We have not seen the last of this process so be careful going forward.

The ECB told us that they
Would no longer stand in the way
Of prices that rise
Until they surmise
That growth has made major headway

Now later this week from the Fed
Some pundits think, shortly ahead,
They’ll slow down their buying
Of bonds, as they’re trying,
To counter, inflation, widespread

Inflation (whether CPI or PCE), is a price series that demonstrates characteristics similar to every other price series like stocks or bonds or currencies.  There are trend movements, there are overshoots in both directions that tend to correct and there are periods of consolidation.  One of the best definitions of a trend is a series that makes either higher lows and higher highs, or conversely, lower highs and lower lows.  In other words, something that is trending higher will typically trade to a new high level and then after a period, pull back somewhat, a normal correction, before moving on to further new highs.  When the uptrend is in force, each high is higher than the last, and, more importantly, each low is higher than the last.  I make this point because I am concerned that when looking at the backgrounds of all the FOMC members, not one of them has any trading history.

This is important because, my sense on the inflation story is that it is quite realistic that we see a slowdown in price growth in the next several months, where 5.4% headline CPI falls to 4.8% and 4.5% and so forth, as this price series goes through a correction just like the stock, bond and currency markets.  Of course, if this is what we see, it is almost guaranteed that Chairman Powell, and his band of merry men (and women) will be all over the tape crowing over the transitory nature of inflation.

Alas, my concern is that given what I believe is a strong uptrend in inflation, this retracement in CPI (and PCE) will stop at a higher level than the previous lows and set itself up for another, more powerful move higher.  In the meantime, the Fed will have waved away any concerns over inflation as they continue to pump unlimited liquidity into the system to run the economy as hot as possible.  After all, in their collective mind, they will have proven inflation is transitory.  However, the next leg higher in CPI and PCE is liable to be far more severe, occurring far more quickly than the Fed expects, and lead to a more permanent unanchoring of inflation expectations.

It will also put the Fed in an even tighter bind than they currently find themselves.  This is because if CPI prints 6%, or 7% or more, the market is far less likely to accept their jawboning as a reason to maintain low yields and high stock prices.  Rather, they will be forced to decide between addressing inflation, which means raising interest rates sharply and significantly impacting, in a very negative way, the real economy, as well as asset markets; or they will have to come up with some other way to measure inflation such that it is not rising at such a ferocious clip but is still seen as credible.  One of their dilemmas is that, politically, inflation is already becoming a problem for the Biden administration, and that is at 5%.  Be prepared for the Misery Index (a Ronald Reagan invention that was the sum of CPI and the Unemployment Rate) to become a popular meme from all of President Biden’s opponents going forward.

Oh yeah, if you think that letting inflation run hot like that is going to goose equity market returns, especially when starting from such incredibly steep valuations, you would be wrong.  History shows that when inflation rises above 5%, equity markets do not provide any type of real hedge.  Let me be clear that this is not going to play out by autumn 2021, but could very well be the case come summer or autumn 2022, a particularly difficult time for the incumbent party in Washington as mid-term elections will be upcoming and the party in power tends to get the blame for economic problems.

What about the dollar you may ask?  In this scenario, the dollar is very likely to suffer greatly, so keep that in mind as you look ahead to your hedging needs for next year and beyond.

In the meantime, the Chinese inspired sell-off has led to some risk concerns, but not (yet) a widespread sell-off.  For instance, the Nikkei (+1.0%) managed to rally in the face of the Chinese equity market declines although, outside Japan, the screens are basically all red in Asia.  European bourses are somewhat lower (DAX -0.4%, CAC -0.25%, FTSE 100 -0.25%) as they respond to the general negative tone in risk as well as a much weaker than expected German IFO reading of 101.2, well down from last month’s reading.  However, these levels are well off the session lows, as are US futures, which are down on the order of -0.25%, although were much lower earlier.

Bond markets are a little more mixed as Treasury yields fall 3.2bps (taking real yields to historic lows of -1.12%) but European sovereigns are more mixed with Bunds unchanged and OATs (+0.8bps) and Gilts (-0.8bps) not giving us any direction.

Commodity prices are mostly lower led by oil (-0.8%), although gold (+0.3%) is showing some positive haven characteristics.  Clearly, declining real yields are also supporting the precious metals.  Foodstuffs are softer (about which everyone except farmers are happy) and base metals are mixed with copper (+1.35%) leading the way higher although both Al (-0.4%) and Sn (-0.3%) are under pressure.

Finally, the dollar is not exhibiting its ordinary risk-off attitude this morning, as it is broadly softer vs. its G10 counterparts with only AUD (-0.1%) down on the day, arguably given concerns of changes with the Chinese economy.  But the rest of the bloc is marginally higher as I type led by SEK (+0.35%) and GBP (+0.3%), both of which are seeming to respond to reopening economies.

In the EMG space, however, there are many more decliners than gainers, led by RUB (-0.45%) on the back of oil’s weakness, but also KRW (-0.4%) which is feeling the pinch of the change in tone from China.  This story is going to be the second biggest driver, after the Fed, for a while, I think.

Of course, this week brings the FOMC meeting, but also Q2 GDP and Core PCE, so there is much to look forward to here.

Today New Home Sales 800K
Tuesday Durable Goods 2.0%
-ex Transport 0.8%
Case Shiller Home Prices 16.2%
Consumer Confidence 124.0
Wednesday FOMC Rate Decision 0.00% – 0.25%
IOER 0.15%
Thursday Q2GDP 8.5%
Initial Claims 380K
Continuing Claims 3192K
Friday Personal Income -0.4%
Personal Spending 0.7%
Core PCE 0.6% (3.7% Y/Y)
Chicago PMI 63.3
Michigan Sentiment 80.8

Source: Bloomberg

Obviously, the Fed is the big story as the data that comes before will not be seen as critical.  The GDP print will be quite interesting, but it is widely accepted that this is the peak and we will be slowing down from here.  However, Friday’s Core PCE number will really be scrutinized as another high print will make Powell’s task that much harder with respect to convincing people that inflation is transitory, especially if their favorite indicator keeps running higher.  Ultimately, I expect we will see a short-term retracement on the rate of inflation before the next leg up and that is the one about which we should all be concerned.

As to today’s market, if equity markets manage to shake off their concerns over Chinese activities, the dollar seems likely to continue with today’s soft tone.  If not, though, look for a rebound.

Good luck and stay safe
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T’won’t be a Disaster

The Minutes explained that the Fed

Continues, when looking ahead

To brush off inflation

And seek job creation

Though prices keep rising instead

Meanwhile, there’s a new policy





That came from Lagarde’s ECB

T’won’t be a disaster

If prices rise faster

So, nothing will stop more QE

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe

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