Tag Archives: #FOMC

Tapering Talk

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Despite all the tapering talk
The market did not walk the walk
Now sovereigns worldwide
Have seen their yields slide
While stocks are where people all flock

Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing?  That was so two days ago.  With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion.  Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion.  Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals.  In other words, tapering is still a long way in the future.

This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so.  Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals.  Do not be misled into believing the Fed is on the cusp of removing accommodation.  They are not!

A quick look at yesterday’s data highlights why they are still a long way off.  While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth.  As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever.  But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem.  Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.

Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon.  While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.

Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing.  The interesting thing is the contrast between the data from Asia and that from Europe.  It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5.  While a slight decline from the previous month, it is still well into growth territory.  However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7.  There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.

European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end.  As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength.  Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact.  While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.

Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening.  The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.

Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.

Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%).  Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there.  Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day.  US futures are all modestly higher at this point, by roughly 0.25%.

As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps.  But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads.  The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.

Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer.  However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.

Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above.  In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May).  But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4.  In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.

On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00.  Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.

Nothing has changed my view that as go 10-year yields, so goes the dollar.  If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain.  If, however, yields reverse higher, the dollar will find its footing immediately.

Good luck, good weekend and stay safe
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Gazumped

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While measured inflation has jumped
And stock markets, Powell has pumped
The dollar is queasy
As money this easy
Has bulls concerned they’ll get gazumped

But its not just Powell who’s saying
That QE and ZIRP will be staying
Almost to a man
The Fed’s master plan
Is printing and buying…and praying

Once again, yesterday, we heard from several FOMC members and each of them highlighted that the data has not yet come close to describing the “substantial progress” they are seeking with respect to reduced unemployment and so it is not nearly time to begin even thinking about tapering.  Well, except for the lone quasi-hawkish voice of Dallas Fed President Robert Kaplan, who did express concern that the Fed’s actions were part of the reason that asset prices are so high.  But not to worry, Mr Kaplan will not be a voter until 2023, so will not even be able to officially register his disagreement with policy for two more years.  In other words, based on everything we continue to hear, we can expect a series of 9-0 votes every six weeks to maintain current policy.

It is this ongoing messaging, which comes not only from the Fed but from the ECB and BOJ as well, that continues to drive the narrative as well as market prices.  Inflation?  Bah, it’s transitory and while 2021 may see some higher readings, it will all disappear by 2022.  Bubbles?  Bah, central banks cannot detect them and, even if they could, it is not their job to deflate them.  It has become abundantly clear that the three big central banks have jointly decided that the only thing that matters is the unemployment rate, and until that data is back at record low levels, regardless of what else is happening in the economy, the current state of QE and ZIRP/NIRP is going to remain in place.

Thus, it cannot be that surprising this morning that the dollar has begun to slide a bit more in earnest, while risk appetite, as measured by equity prices remains robust.  A very large segment of the punditry continue to harp on concerns over rising inflation and how the Fed and other central banks will be forced to adjust their policy to prevent it from getting out of hand.  But simply listening to virtually every central banker tells us that nothing is going to change.

“Through that April employment report, we have not made substantial further progress,” said Fed Vice-Chair Richard Clarida yesterday.  Meanwhile, from the ECB, Francois Villeroy de Galhau explained this morning, “Today there’s no risk of a return of lasting inflation in the euro area, and so there’s no doubt that the ECB’s monetary policy will remain very accommodative for a long time.  I want to say that very clearly.”  I don’t know about you, but it seems pretty clear that the concept of tapering QE purchases, let alone raising interest rates, is not even on the table.

Now, smaller central banks have changed their tune, notably the Bank of Canada and Sweden’s Riksbank, with the former actually reducing QE purchases while the latter has promised to do so shortly.  As well, the Bank of England has begun the discussion about reducing policy support as the economy there continues to open rapidly, and growth picks up.  As such, it should not be that surprising that those three currencies (GBP +2.75%, CAD +2.1%, SEK +1.9%) are the leading gainers vs. the dollar so far this month.

Perhaps what is also interesting is that the euro is strengthening so clearly vs. the dollar despite the strong words by ECB members regarding the maintenance of easy money.  It appears that the market has a stronger belief in the Fed’s willingness to ignore the repercussions of their policy choices than that of the ECB.  Remember, in the end, Europe remains reliant on Germany as its engine of growth and largest economy, and German DNA, ever since the Weimar hyperinflation in the 1920’s favors tighter policy, not looser.  Madame Lagarde will have a tougher battle to maintain easy policy if the data starts to point higher than will Chairman Powell.  Right now, however, that is all theoretical regarding both banks.  Easy money is here for the foreseeable future, which means that risk appetite is likely to remain strong, driving up stock and commodity prices while the dollar sinks.

What about bonds, you may ask?  Haven’t they been the key driver?  The answer is that they have been the key driver,  but a close look at statistics like inflation breakevens, and more importantly, the shape of the breakeven curve, offer indications that even though near-term expectations are for much higher inflation, more and more investors are buying the transitory story.  If that is, in fact, the case, then there is ample room for bonds to rally as well, which would be quite the shock to all the inflationistas out there.

This morning is exhibit A regarding the impact of increased risk appetite.  Equity markets around the world are higher with Asia (Nikkei +2.1%, Hang Seng +1.4%, Shanghai +0.3%) putting in some very strong performances while Europe (DAX +0.25%, CAC +0.2%, FTSE 100 +0.4%) are all green, but have come off their best levels of the morning.  US futures are also pointing higher, with gains ranging from 0.2% (Dow) to 0.7% (Nasdaq).

The bond market, meanwhile, is directionless, with yields for Treasuries (-0.5bps) and European sovereigns (Bunds 0.0bps, OATs -0.7bps, Gilts +0.7bps) all trading in narrow ranges.  If you consider that given the increase in risk appetite as evidence by stocks, commodities and the dollar, the very fact that bonds are not selling off is actually a bullish sign.

Speaking of commodities, Brent crude (+0.6%) traded above $70/bbl for the first time since November 2018 this morning and WTI is firmer by a similar amount.  Metals prices continue to rally (Au 0.0%, Ag +0.8%, Cu +1.0%, Al +0.7%), as do foodstuffs (Soybeans +0.6%, Wheat +0.75%, Corn +1.7%).  While it is not clear how much longer commodity prices will rally, it seems abundantly clear, based on their price action, that the rally has more legs.

And finally, the dollar, which as mentioned above is under pressure, is having a really bad day.  Versus its G10 counterparts, the dollar is softer across the board with NZD (+0.7%), NOK (+0.6%) and CHF (+0.55%) leading the way.  But the euro (+0.45%) is also much firmer and now trading above 1.22 for the first time since early February.  If you recall, 1.2350 was the high seen the first week of January, and in order to truly change opinions, the euro will have to trade through that level.  With the dollar so weak, it certainly seems like there is a good chance to get there soon.

EMG markets are also seeing pretty uniform gains with ZAR (+0.7%), HUF (+0.65%) and PLN (+0.6%) leading the way, the former on the back of commodity price strength while the two CE4 currencies are benefitting from the belief that both central banks may be tightening policy shortly as well as the euro’s strength.  But we saw strength overnight in the APAC currencies as well (KRW +0.4%, SGD +0.4%, TWD +0.35%) as they all are responding to the broad-based dollar weakness.

On the data front, today brings Housing Starts (exp 1702K) and Building Permits (1770K), with both simply showing that the housing market remains on fire.  Meanwhile, only Robert Kaplan is scheduled to speak, but we already know what he thinks (tapering needs to start soon) and we also know his is a lone voice in the wilderness.  It would not surprise me if we had a surprise series of comments from another FOMC member just to counter his views.

Looking ahead to the session, there is no reason to believe that the dollar’s weakness is going to change anytime soon.  Unless Treasury yields start to back up smartly, risk appetite is the dominant story today, and that bodes ill for the dollar.

Good luck and stay safe
Adf

Lower Forever’s Outdated

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A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away

The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated

Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm.  Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.

What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today.  Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities.  So, what’s all the hubbub?

Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward.  In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus.  As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data.  Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year.  And they well could do so.

However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it.  And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%.  No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial.  In fact, I doubt two months will qualify.  If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases.  I think the market is way ahead of itself on this issue.

Consider, as well, this puzzle.  The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money.  As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields.  Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt.  One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds.  So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases?  Personally, I cannot do so, it is one or the other.

Which brings us to what can we expect today?  Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement.  As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.

Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets.  If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure.  However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price.  We shall see starting at 2:00 today.

As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals.  Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions.  Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.

Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday.  In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps).  There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates.  By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.

On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level.  While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.

The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%).  The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth.  Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.

EMG currencies are a bit more mixed, with a spread of gainers and losers this morning.  On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty.  A negative ruling could have a major impact on Poland’s banking sector and by extension the economy.  Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news.  On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.

Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact.  Equity futures are biding their time as are most market participants as we all await Mr Powell.  Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.

Good luck and stay safe
Adf

QE Will Wane

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Some pundits have come to believe
That sometime before New Year’s Eve
The Fed will explain
That QE will wane
Though others are sure they’re naïve

So, let’s listen to what the Fed
Has very consistently said
Without hard statistics,
Not simple heuristics,
The idea of tapering’s dead

As a new week begins, all eyes are turning to the central bank conclaves scheduled for the latest clues in monetary policy activity.  Recall last week, the Bank of Canada surprised almost everyone by explaining they would reduce the amount of QE by 25% (C$1 billion/week) as they see stronger growth and incipient inflationary pressures beyond the widely discussed base effects that are coming soon to a screen near you.  This has clearly inspired the punditry, as evidenced by a recent survey of economists carried out by Bloomberg, showing more than 60% of those surveyed expect the Fed to begin to taper QE before the end of this year.  When the same questions were asked in March, less than 50% of those surveyed expected a tapering this year.  Obviously, we have seen a run of very strong survey data, as well as a very strong payroll report at the beginning of this month.  In addition, the vaccine rate has increased substantially, with the combination of these things leading to significantly upgraded economic forecasts for the US this year.

And yet, everything we have heard from Chairman Powell and the rest of the FOMC has been incredibly consistent; they are not even thinking about thinking about tapering monetary policy and will not do so until substantial further progress toward their goals of maximum employment and average inflation of 2.0% are achieved.  In addition, Powell has promised to communicate very clearly, well in advance, that changes are in the offing.  While we have had two strong employment reports in a row, the combined job gains remain a fraction of the 10 million that Powell has repeatedly explained need to be regained.  Arguably, we will need to see NFP numbers north of 750K for the next 6-9 months before the Fed is even close to their target and will consider taking their foot off the proverbial accelerator.

Of course, there is one thing that could force earlier action by the Fed, inflation rising more quickly than anticipated.  As of now, the Fed remains unconcerned over price rises and have made it clear that while the data for the next several months will be rising quickly, it is a transitory impact from the now famous base effects caused by the Covid induced swoon this time last year.  Even then, given the new framework of average inflation targeting, rather than a hard numeric target, a few more months of above 2.0% core PCE will hardly dissuade them from their views as they have nearly a decade of lower than 2.0% core PCE to offset.

But what if inflation is more than a transitory event?  While the plural of anecdote is not data, it certainly must mean something when every week we hear from another major consumer brand that prices will be rising later this year.  Personal care products, food and beverages have all been tipped for higher prices this year.  The same is true with autos and many manufactured goods as the consistent rise in input prices (read commodities) is forcing the hands of manufacturers.  While it is true that, by definition, core PCE removes food & energy prices, to my knowledge, neither toothpaste nor Teslas are core purchases.

The medium-term risk appears to be that inflation runs, not only hotter than the Fed expects, but hot enough that they begin to become uncomfortable with its impact.  While the natural response would be to simply raise rates, given Jay’s effective promise not to raise rates until 2023, as well as the fact that the Treasury can ill afford higher interest rates (nor for that matter can the rest of the economy given the amount of leverage that is outstanding), the Fed may well find themselves in quite a bind later this year.  One cannot look at the price of copper (+1.9% today, 25.6% YTD), aluminum (+1.2%, 21.1%) or iron ore (+0.4%, 16.0%) without considering that those critical inputs, neither food nor energy, are going to drive price pressures higher.  And, by the way, food and energy prices have been rocketing as well (Corn +38% YTD, Wheat +13.1%, Soybeans +18.2%, WTI +26.1%).  Chairman of the Fed may not be that attractive a position by the time Powell’s term ends in February.

Turning to the markets, if I had to characterize them in a theme, it would be idle.  Equity markets are generally flat to lower with the odd exception in Asia (Nikkei +0.4%, Hang Seng -0.4%, Shanghai -1.0%) and Europe (DAX -0.2%, CAC 0.0%, FTSE 100 0.0%).  US futures are also noncommittal this morning, with the NASDAQ (-0.3%) the only one having really moved.

In the bond market, the rally we had seen over the past three weeks has stalled and is starting to cede some ground.  For instance, Treasuries (+3.7bps) are leading the way higher but we are seeing higher yields throughout Europe (Bunds +2.3bps, OATs +2.5bps, Gilts +3.0bps) and even saw gains overnight in Australia (+1.8bps) and Japan (+0.5bps).  Historically, that would have seemed to be a risk-on phenomenon, but given the lack of equity strength, this feels a lot more like an inflationary call.

While the metals space is strong today, oil is actually softer (-1.7%) as concerns over the rampant spread of Covid in India and other emerging markets undermines the vaccine news in the West.

As to the dollar, it is generally, but not universally, weaker this morning.  In the G10, AUD (+0.6%), NZD (+0.3%) and CAD (+0.3%) are the leaders, with all benefitting from the metals rally, which has been sufficient to offset weaker oil prices for the Loonie.  On the downside, NOK (-0.1%) is clearly feeling a bit of pressure from oil, although 0.1% hardly makes a statement.  EMG currencies are showing the same type of price action with TRY (+1.2%) the leading gainer as it rebounds from near-record lows amid hopes the tension with the US will be temporary.  Away from the lira, TWD (+0.5%) rallied on concerns that the Taiwanese government would be pressured by the US with respect to its currency and competition concerns.  We saw similar, but lesser pressure on KRW (+0.4%).  Meanwhile, the modest declines seen in HUF (-0.2%) and MXN (-0.1%) define the other side of the spectrum.

Clearly, the FOMC meeting is the highlight of the week, but there is other important data as well, including the BOJ tonight.

Today Durable Goods 2.5%
-ex transport 1.6%
Tuesday Case Shiller Home Prices 11.8%
Consumer Confidence 112.0
Wednesday FOMC Decision 0.00% – 0.25%
IOER 0.12%
Thursday Initial Claims 550K
Continuing Claims 3.59M
GDP Q1 6.9%
Personal Consumption 10.3%
Friday Personal Income 20.0%
Personal Spending 4.2%
Core PCE 1.8%
Chicago PMI 64.2
Michigan Sentiment 87.5

Source: Bloomberg

The end of the week is where all the action will be, assuming Chairman Powell doesn’t shake things up Wednesday afternoon.  Core PCE is forecast to print at its highest level since February 2020, but if you recall the CPI data, it was a tick higher than forecast as well.  Of course, for now, it doesn’t matter.  This is all transitory.

Nothing has changed my opinion with respect to the relationship between the dollar and the 10-year Treasury yield.  While it is not actually tick for tick, if yields do back up, I would look for the dollar to find its footing in the near term.  I know the dollar bears are back in force, but we need to see a break above the 1.2350 level in the euro to really turn the tide in my view.  Otherwise, we are simply at the bottom of the dollar’s range.

Good luck and stay safe
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Inflation Be Damned

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The Minutes revealed that the Fed
Cares not about outlooks, instead
Inflation be damned
They now are programmed
To wait until growth is widespread

There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh?  Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time.  We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around.  And that’s great!  Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis.  Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive.  And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come.  A cynic might think that those central banks don’t actually believe their own forecasts.

Yesterday’s FOMC Minutes revealed this exact situation.  “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.”  In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates.  On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves.  After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”

It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations.  For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano.  I’ve been sitting on that volcano for many, many years.  It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices.  Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever.  And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.

Thus, the conundrum.  Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue.  Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy.  But every central bank has essentially promised they will be falling behind the curve to fight the current battle.

So, let’s follow this line of thought to some potential conclusions.  Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse.  Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation.  (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!)  Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money.  Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter?  This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B.  And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below).  Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.

So, with that in mind, let’s take a quick tour of the markets.  Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day.  In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher.  As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.

As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs.  European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point.  A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year!  Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget.  Imagine what would happen if yields there rose, even 100 basis points.  And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.

Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector.  And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline.  But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.

In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today.  Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week.  As described above, inflation s clearly not going to be a major policy driver in most economies for now.  But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.

On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon.  But what can the Fed tell us that we don’t already know?

As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well.  And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.

Good luck and stay safe
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Tempting the Fates

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What everyone now can assume
Is Jay and his friends in the room
Will never raise rates
Thus, tempting the fates
In search of a ne’er ending boom

Well, that’s that!  To anyone who thought that the Fed was concerned over rising back-end yields and a steeper yield curve, Chairman Powell made it abundantly clear that it is not even on their radar.  No longer will the Fed be concerned with mere forecasts of economic strength or pending inflation.  As in the Battle of Bunker Hill, they will not “…fire until they see the whites of [inflation’s] eyes”.   “Until we give a signal, you can assume we are not there yet,” Powell explained when asked about the timing of tapering asset purchases and tightening policy.  It would seem that is a pretty clear statement of intent on the Fed’s part, to maintain the current policy for years to come.

To recap, the Fed raised their forecasts for GDP growth to 6.5% in 2021, 3.3% in 2022 and 2.2% in 2023, while increasing their inflation forecasts (core PCE) to 2.2%, 2.0% and 2.1% respectively for the same years.  Finally, their view on unemployment adjusted to 4.5% this year with declines to 3.9% and 3.5% in ’22 and ’23.  All in all, they have quite a rosy view of the future, above trend growth, full employment and no inflation.  I sure hope they are correct, but I fear that the world may not turn out as they currently see it through their rose-tinted glasses.  The market’s biggest concern continues to be inflation, which, after decades of secular decline, appears to be at an inflection point for the future.  This can be seen in the bond market’s reaction to yesterday’s activities.

Prior to the FOMC statement, (which, by the way, was virtually verbatim with the January statement, except for one sentence describing the economic situation), risk was under pressure as equity markets were slipping, 10-year Treasury yields were rallying to new highs for the move and the dollar was firming up.  But the statement release halted those movements, and once the press conference got underway, Powell’s dovishness was evident.  This encouraged all three markets to reverse early moves and stocks closed higher, bonds flat and the dollar softer.  It seems, there was a great deal of positive sentiment at that time.

However, over the ensuing 16 hours, there has been a slight shift in sentiment as evidenced by the fact that the 10-year Treasury is now down 2/3’s of a point with the yield higher by 8 basis points, rising to 1.72%.  This is the highest yield seen since January 2020, pre-pandemic, but certainly shows no sign of stopping here.  In fact, 30-year Treasuries now yield 2.5%, their highest level since July 2019, and here, too, there is no evidence that the move is slowing down.  If anything, both of these bonds appear to be picking up speed in their race to higher levels.  Meanwhile, TIP yields are climbing as well, but not quite as quickly taking the 10-year breakeven to 2.31%.  In other words, that is the market forecast for inflation.  FYI, this is the highest level in this measure since May 2013.  As mentioned above, it appears there is a secular change in inflation on the way.

Perhaps what makes this most remarkable is the dramatic difference in the Fed’s stance and that of some other major central banks.  On the one hand, Madame Lagarde informed us last week that the ECB would be speeding up their PEPP purchases to counter the effect of rising yields.  Again, this morning she explained, “what we are responding to is a yield increase that could get ahead of the expected economic recovery.”   On the other hand, the Norges Bank, while leaving rates on hold at 0.00% this morning predicted it would start raising rates in the “latter half” of this year, far sooner than previous expectations.  Meanwhile, in the emerging markets, we have an even more aggressive story, with the Banco Central do Brazil raising the overnight SELIC rate by a more than expected 0.75% last night, as despite Covid continuing to ravage the country and the economy stuttering, inflation is starting to move higher at a faster pace.

The point here is that after almost a full year of synchronous monetary policy around the world, things are starting to change at different rates in different places.  The one thing almost certain to follow from this change in policies is that market volatility, across all asset classes, is likely to increase.  And since most markets either get measured in dollars, or versus dollars, and the inherent volatility in the US bond market is increasing, we may soon be testing central bank limits of control, especially the Fed’s.  After all, if the 2yr-10-yr spread widened to 2.75%, a level it has reached numerous times in the past, will the Fed remain sanguine on the subject?  Will the stock market implode?  Will the dollar race higher?  These are the questions that are likely to be on our lips going forward.  The fun is just beginning as the Fed embarks on its new policy roadway.

With all that in mind, what is this morning’s session doing?  Based on the different central bank activities, things are performing as one would expect.  The initial warm glow following the FOMC meeting followed into Asia with gains in most major markets there (Nikkei +1.0%, Hang Seng +1.3%, Shanghai +0.5%) although Australia’s ASX 200 fell 0.7% during the session.  Meanwhile, Lagarde’s comments, reiterating that the ECB would be buying more bonds has encouraged equity investors in Europe with gains across the board led by the DAX (+1.2%), although the rest of the set are far less impressive (CAC +0.25%, FTSE 100 +0.1%).  However, US futures tell a different story, as the rising long bond yields are continuing to have a severe impact on the NASDAQ with futures there -1.0% and dragging SPX (-0.3%) down with it although DOW futures have actually edged higher by 0.2%.  This is the ongoing rotation story, out of growth/big tech and into value and cyclical stocks.

In the bond market, the damage is severe with Treasuries leading the way followed by Gilts (+5.5bps) as the market awaits the BOE meeting results, and then much smaller rises in yields on the continent (Bunds +2.6bps, OATs +1.9bps, Italian BTPs +1.7bps) as traders recognize that the ECB is going to prevent a dramatic decline there.

Perhaps the most surprising outcome this morning is in the commodity bloc, where virtually all commodity prices are lower, albeit not by too much.  Oil (-0.3%), gold (-0.5%) and copper (-0.3%) are uniformly under pressure.  This could be a response to the Fed’s benign inflation forecasts, but I think it is more likely a response to the dollar’s strength.

Speaking of the dollar, it is mostly stronger this morning, recouping the bulk of yesterday afternoon’s losses.  In the G10, only AUD (+0.25%) is higher of note after the employment report released overnight showed far more strength than expected (Unemployment Rate fell to 5.8%).  But otherwise, the rest of the bloc is under pressure, once again led by SEK (-0.45%) and CHF (-0.35%), with both currencies seeing outflows on the back of higher USD yields.  In the EMG bloc, TRY (+2.0%) has just jumped higher after the central bank there surprised the market and raised rates by 2.0% rather than the 1.0% expected.  So, like Brazil, despite economic concerns, inflation is rearing its ugly head. However, beyond that, last night saw strength in KRW (+0.6%) after the BOK indicated they will not allow excessive market volatility (read declines) in the wake of the FOMC meeting.  And that was really the extent of the positives.  On the downside, PLN (-0.9%) is the laggard, as the market is concerned over additional Covid closures slowing any comeback and encouraging easier monetary policy further into the future than previously thought.  The rest of the CE4 are in similar, if not as dire straits this morning as the euro’s softness is undermining the whole group.  As to LATAM, the peso is starting the day unchanged and the rest of the continent has not yet opened.

On the data front, today brings Initial Claims (exp 700K), Continuing Claims (4.034M), Philly Fed (23.3) and Leading Indicators (0.3%).  In addition, we hear from the BOE, with no policy change expected, and then Chairman Powell speaks around noon at the BIS conference.  My guess is that there will be a great deal of interest in what he has to say and if he tries to walk back the idea that the Fed is comfortable with the yield curve steepening as quickly as it is. One thing to recognize is that markets can move much faster than anticipated when given a green light.  With the 10-year yield currently at 1.737%, a move to 2.0% by the end of the month is quite realistic.  And my sense is that might raise a few eyebrows at the Mariner Eccles building.

As to the dollar, follow the yields.  If they continue to rise, so will the dollar.  If they stop, I expect the dollar will as well.

Good luck and stay safe
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Nothing to Fear

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There is an old banker named Jay
Who, later, this St Patrick’s Day
Will tell us that rates
Right here in the States
Won’t change ‘til the jobless get pay

Inflation is nothing to fear
As there’s no sign it will appear
But should it arise
More tools he’ll devise
To kill it by end of this year

Welcome to Fed day folks, with the eyes of all market participants anxiously awaiting the stilted prose that is presented every six weeks.  At this point, there is no concern that the Fed is going to actually change policy as it stands, rather the anticipation is all about what they imply about the future path of activity.

Generally, the Fed statement will start off discussing the nature of the economy and their subjective assessment before going on to describe the actions they are taking.  As this is a quarter-end meeting, their team of PhD’s will have produced new economic forecasts, which based on the recently passed stimulus bill, as well as the recent trend of improving economic activity, is likely to highlight real GDP growth in 2021 of at least 5.0%.  There are many calls on the Street for growth rates topping 7% this year, so 5% would hardly be seen as aggressive.  In addition, while the Fed is acutely aware that inflation numbers are going to rise in the near-term, as the base effects of last year’s Covid inspired economic disaster will now form the comparison, we have consistently heard that any inflation will be transitory and so is of no concern at this time.

The question is, how will they justify continued ZIRP and QE with GDP growth of 5% or more?  And, the answer is that Chair Powell will simply focus on the unemployment situation and once again explain that until those 10 million jobs that were lost to Covid are regained, the Fed will be striving to achieve maximum employment.  It is doubtful there will be any mention of rising yields in the statement, but you can be sure that the first question in the press conference will take up the subject, as will a number of others.

The other thing we get at this quarter-end meeting is the latest dot plot, which is a compilation of each of the FOMC members’ views of where interest rates will be over the next 3 years as well as in the ‘long run’.  The median outcome for each year has become the key statistic and last time it showed that rates were not expected to rise until after 2023, although the longer term view was that 2.5% was likely over time.  However, currently the market is pricing a 0.25% rate hike by December 2022 and two more in 2023 which is far more than the Fed had indicated.  Of great interest to all will be whether this view is changing at the Fed, and some tightening is expected prior to 2023.  Certainly, the bond market is pushing that narrative, with yields continuing to press higher (10-year treasuries are +3bps this morning and, at 1.65%, trading at a new high for the move.)

Remember, too, that prior to the Fed’s quiet period, when the bond market was selling off and yields rising, Powell and friends showed insouciance over the issue, declaring it a vote of confidence in the economy.  At least two weeks ago, there was little concern over rising yields and how they might impact the Fed’s efforts to stimulate further job growth.  Is that still the case?  Since Powell last spoke, the 10-year yield has risen another 9 basis points and shows no signs, whatsoever, of stopping soon.

So, there you have it, the Fed needs to walk that fine line of explaining things are getting better but there is no reason for them to stop providing stimulus.  History has shown that the market reaction comes from the press conference, not the statement, as the nuance of some comment or answer to a question can easily be misinterpreted by market players, and more importantly these days, by algorithms.  FWIW, I anticipate that Powell will continue to slough off any concerns about rising yields and a steepening yield curve and remain entirely focused on the front end.  While I expect several more ‘dots’ to highlight a rise in rates, it would truly be shocking if the median changed.  And in the end, if the Fed looks comfortable with rising yields, they will continue to rise, and with them, I would look for the dollar to follow.

Ahead of the news, markets have been in a holding pattern.  In Asia, the major equity markets were essentially unchanged overnight, with no movement of even 0.05%.  European bourses are generally ever so slightly softer this morning (CAC -0.2%, FTSE 100 -0.3%) although the DAX (+0.1%) has managed to eke out a gain so far.  As to US futures, they too are mixed, with NASDAQ futures (-0.5%) amongst the worst performing of all markets today, although the other two main indices are little changed.

Not only are Treasury yields higher, but we are seeing that price action throughout Europe, with Bunds (+1.9bps), OATs (+2.0bps) and Gilts (+3.3bps) all following the Treasury market.  Either inflation concerns are starting to pick up, or belief in a rebound is starting to pick up, although given the continuation of lockdowns in Europe, and their recent extensions, the latter seems like a harder story to swallow.

Commodity prices are softer pretty much across the board, with oil (-1.15%) leading the way, although weakness in both the base and precious metals is evident as well as in the agricultural space.  And lastly, the dollar is beginning to edge higher as I type, although not by any significant amounts.  In the G10 space, AUD (-0.35%), SEK (-0.3%) and CHF (-0.3%) are the leading decliners although one would be hard pressed to find a fundamental rationale for the movement.  With all eyes on the Fed, essentially all movement so far has been position adjustments amid much lighter than normal trading activity.

In the Emerging markets, RUB (-1.25%) is the weakest of the bunch after a surprising comment by President Biden hit the tape, “Biden says he thinks Putin is a killer.”  Them’s fightin’ words, and it would not be surprising to see an escalation of a war of words going forward, although it is not clear this would impact any currency other than the ruble.  Beyond that, MXN (-0.5%) is the next worst performer, arguably following oil as well as the growing concerns that rising inflation in emerging markets is going to force policy tightening and slowing growth.  This evening, the Banco do Brazil will be announcing their policy with the market anticipating a 0.50% rate hike, the first of many as inflation there continues to run higher than target.  This is being seen as a harbinger of other central bank actions, where they will be forced to fight inflation at the expense of economic activity, and that typically is negative for a currency at the beginning of the battle.

On the data front, today brings Housing Starts (exp 1560K) and Building Permits (1750K) ahead of the FOMC decision this afternoon.  While those numbers are a bit softer than last month, the longer-term trend remains firmly upward.  And then it’s the Fed and Mr Powell’s comments that will drive everything.  Ahead of the Fed, I anticipate limited movement overall, but my expectations are that Powell will continue to ignore rising yields and focus strictly on the front end of the curve as well as the unemployment situation.  If the stories about Secretary Yellen being unconcerned about rising yields are correct, and they are quite believable, then look for the curve to steepen further, and the dollar to test key resistance levels against most of its counterparts.

Good luck and stay safe
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Hubris

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Said Janet, the risk remains “small”
Inflation could come to the ball
But if that’s the case
The tools are in place
To stop it with one conference call

hu∙bris
/ (h)yoobrəs/
noun: excessive pride or self-confidence

“Is there a risk of inflation?  I think there’s a small risk and I think it’s manageable.”  So said Treasury Secretary Janet Yellen Sunday morning on the talk show circuit.  “I don’t think it’s a significant risk, and if it materializes, we’ll certainly monitor for it, but we have the tools to address it.”  (Left unasked, and unanswered, do they have the gumption to use those tools if necessary?)

Let me take you back to a time when the world was a simpler place; the economy was booming, house prices were rising, and making money was as easy as buying a home with 100% borrowed money (while lying on your mortgage application to get approved), holding it for a few months and flipping it for a profit. This was before the GFC, before QE, before ZIRP and NIRP and PEPP and every acronym we have grown accustomed to hearing.  In fact, this was before Bitcoin.

In May 2007, Federal Reserve Chairman Ben Bernanke, responding to a reporter’s question regarding the first inklings of a problem in the sector told us,  “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the sub-prime sector on the broader housing market will likely be limited.”  Ten months later, as these troubles had not yet disappeared, and in fact appeared to be growing, Bennie the Beard uttered his most infamous words, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.”

Notice anything similar about these situations?  A brewing crisis in the economy was analyzed and seen as insignificant relative to the Fed’s goals and, more importantly, inimical to the Fed’s desired outcomes.  As such, it is easily dismissed by those in charge.  Granted, Janet is no longer Fed chair, but we have heard exactly the same story from Chairman Jay and can look forward to hearing it again on Wednesday.

Of course, Bernanke could not have been more wrong in his assessment of the sub-prime situation, which was allowed to fester until such time as it broke financial markets causing a massive upheaval, tremendous capital losses and economic damage and ultimately resulted in a series of policies that have served to undermine the essence of capital markets; creative destruction.  While hindsight is always 20/20, it does not detract from the reality that, as the proverb goes, an ounce of prevention is worth a pound of cure.

But right now, the message is clear, there is no need to be concerned over transient inflation readings that are likely to appear in the next few months.  Besides, the Fed is targeting average inflation over time, so a few months of above target inflation are actually welcome.  And rising bond yields are a good thing as they demonstrate confidence in the economy.  Maybe Janet and Jay are right, and everything is just ducky, but based on the Fed’s track record, a lot of ‘smart’ money is betting they are not.  Personally, especially based on my observations of what things cost when I buy them, I’m with the smart money, not the Fed.  But for now, inflation has been dismissed as a concern and the combination of fiscal and monetary stimulus are moving full speed ahead.

Will this ultimately result in a substantial correction in risk appetite?  If Yellen’s and Powell’s view on inflation is wrong, and it does return with more staying power than currently anticipated, it will require a major decision; whether to address inflation at the expense of slowing economic growth, or letting the economy and prices run hotter for longer with the likelihood of much longer term damage.  At this stage, it seems pretty clear they will opt for the latter, which is the greatest argument for a weakening dollar, but perhaps not so much vs. other fiat currencies, instead vs. all commodities.  As to general risk appetite, I suspect it would be significantly harmed by high inflation.

However, inflation remains a future concern, not one for today, and so markets remain enamored of the current themes; namely expectations for a significant economic rebound on the back of fiscal stimulus leading to higher equity prices, higher commodity prices and higher bond yields.  That still feels like an unlikely trio of outcomes, but so be it.

This morning, we are seeing risk acquisition with only Shanghai (-1.0%) falling of all major indices overnight as Tencent continues to come under pressure after the government crackdown on its financial services business.  But the Nikkei (+0.2%) and Hang Seng (+0.3%) both managed modest gains and we have seen similar rises throughout Europe (DAX +0.2%, CAC +0.3%, FTSE 100 +0.3%) despite the fact that the ruling CDU party in Germany got clobbered in weekend elections in two states.  US futures are also pointing higher by similar amounts across the board.

Bond markets, interestingly, have actually rallied very modestly with Treasury yields lower by 1.2 basis points, and similar yield declines in both Bunds and OATs.  That said, remember that the 10-year did see yields climb 8 basis points on Friday amid a broad-based bond sell-off around the world.  In other words, this feels more like consolidation than a trend change.

Commodity markets have also generally edged higher, with oil (+0.35%), gold (+0.1%) and Aluminum (+1.0%) showing that the reflation trade is still in play.

Given the modesty of movement across markets, it seems only right that the dollar is mixed this morning, with a variety of gainers and laggards, although only a few with significant movement.  In the G10 this morning, SEK (-0.7%) is the worst performer as CPI was released at a lower than expected 1.5% Y/Y vs 1.8% expected.  This has renewed speculation that the Riksbank may be forced to cut rates back below zero again, something they clearly do not want to do.  But beyond this, price action has been +/- 0.2% basically, which is indicative of no real news.

In EMG currencies, it is also a mixed picture with ZAR (+0.7%) the biggest gainer on what appear to be carry trade inflows, with TRY (+0.6%) next in line as traders anticipate a rate hike by the central bank later this week.  Most of LATAM is not yet open after this weekend’s change in the clocks, but the MXN (+0.3%) is a bit firmer as I type.  On the downside, there is a group led by KRW (-0.3%) and HUF (-0.25%), showing both the breadth and depth (or lack thereof) of movement.  In other words, movement of this nature is generally not a sign of new news.

On the data front, all eyes are on the FOMC meeting on Wednesday, but we do get a few other releases this week as follows:

Today Empire Manufacturing 14.5
Tuesday Retail Sales -0.5%
-ex autos 0.1%
IP 0.4%
Capacity Utilization 75.5%
Wednesday Housing Starts 1555K
Building Permits 1750K
FOMC Decision 0.00% – 0.25%
Thursday Initial Claims 700K
Continuing Claims 4.07M
Philly Fed 24.0
Leading Indicators 0.3%

Source: Bloomberg

While Retail Sales will garner some interest, the reality is that the market is almost entirely focused on the FOMC and how it will respond to, or whether it will even mention, the situation in the bond market.  Certainly, a strong Retail Sales report could encourage an even more significant selloff in bonds, which, while seemingly embraced by the Fed, cannot be seen as good news for the Treasury.  After all, they are the ones who have to pay all that interest. (Arguably, we are the ones who pay it, but that is an entirely different conversation.)

As to the dollar, while it has wandered aimlessly for the past few sessions, I get the sneaking suspicion that it is headed for another test of its recent highs as I believe bond yields remain the key market driver, and that move is not nearly over.

Good luck and stay safe
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Suspicions

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Fed staffers relayed their suspicions
That ease in financial conditions
Could lead to distress
Which could make a mess
For Powell and all politicians

But Jay heard the story and said
The risks when we’re looking ahead
Are growth is too slow
Inflation too low
So, money still pours from the Fed

Yesterday’s Fed Minutes left us with a bit of a conundrum as there appears to be a difference of opinion regarding the current state of the economy and financial markets between the Fed staffers and their bosses.  The bosses, of course, are the 19 members of the FOMC, 7 governors including the Chair and vice-Chair and the 12 regional Fed presidents.  The staffers are the several thousand PhD economists who work for that group and develop and run econometric models designed, ostensibly, to help better understand the economy and predict its future path.  On the one hand, based on the Fed’s prowess, or lack thereof, in forecasting the economy’s future path, it is understandable how the bosses might ignore their staffers.  When looking at past Fed forecasts, they are notoriously poor at determining how the economy is progressing, seemingly because the models upon which they rely do not represent the US economy very well.  On the other hand, the willful blindness exhibited by the bosses with respect to the current financial conditions is disqualifying, in itself, of trusting their views.  As I said, quite the conundrum.

This was made a little clearer yesterday when the FOMC Minutes showed that the staff had indicated the following:

The staff provided an update on its assessments of the stability of the financial system and, on balance, characterized the financial vulnerabilities of the U.S. financial system as notable. The staff assessed asset valuation pressures as elevated. In particular, corporate bond spreads had declined to pre-pandemic levels, which were at the lower ends of their historical distributions. In addition, measures of the equity risk premium declined further, returning to pre-pandemic levels. Prices for industrial and multifamily properties continued to grow through 2020 at about the same pace as in the past several years, while prices of office buildings and retail establishments started to fall. The staff assessed vulnerabilities associated with household and business borrowing as notable, reflecting increased leverage and decreased incomes and revenues in 2020. Small businesses were hit particularly hard. [author’s emphasis].

And yet, after hearing the staff reports, neither the FOMC statement nor Chairman Powell at the ensuing press conference referred to elevated asset values or financial system vulnerabilities.  Rather, those, and most other concerns, were described as moderate, while explaining that downside outcomes to inflation still dominated their thinking.  In the intervening 3 weeks, we have seen Treasury yields rise 30 basis points in the 10-year and inflation breakevens rise 22 basis points.  In other words, it is beginning to appear as though the Fed and the market are watching two different movies.  The risk to this scenario is that the Fed can fall dangerously behind the curve with respect to keeping the economy on their preferred path, and may be forced to dramatically shift policy (read raise rates) if (when) it becomes clear rising inflation is not a temporary phenomenon.  Now, while it is likely to take the Fed quite a while to recognize this discrepancy, I assure you, when it occurs and the Fed feels forced to act, the market response will be dramatic.  But for now, that is just not on the cards.  If anything, as we continue to hear from various Fed speakers, there is no indication they are going to consider tighter policy for several years to come.

In the meantime, there is no reason to suspect that market participants will change their short-term behavior, so ongoing manias will continue.  Just be careful with your personal accounts.  Remember, when things turn, return OF capital is far more important than return ON capital!

Now to today’s session.  Once again, the traditional risk memes are a bit confused this morning.  Equity markets have not had a good session with Asia mostly lower (Nikkei -0.2%, Hang Seng -1.6%, although Shanghai reopened with a gain, +0.5%).  European markets are also under pressure (DAX -0.1%, CAC -0.4%, FTSE 100 -0.9%) despite the fact that today marks the beginning of the disbursement of EU-wide support funded by EU-wide bond issuance.  You may remember last July when, to great fanfare, the EU agreed a €750 billion joint debt issuance, to be backed by all members.  Well, we are now seven months later, and they are finally starting to disburse the funds.  And do not seek respite in US futures markets as they are all lower by between 0.25% (DOW) and 0.8% (NASDAQ).

What is interesting is that despite the equity market weakness, bond markets are falling as well.  It appears that growing concerns over rising inflation are outweighing the risk aversion theme.  Thus, 10-year Treasury yields are higher by 1.9bps this morning and we are seeing even larger rises in some European markets (Gilts +4.1bps, OATs +2.6bps, Bunds +1.8bps).  So, I ask you, which market is telling us the true risk story today?

Perhaps if we look to commodities we will get a hint.  Alas, the information here is muddled at best.  Oil prices continue to rise, up another 0.3% this morning, as up to 4 million barrels of daily production in Texas and the Midwest have been shut in because of the winter storms.  That is 36% of US production, and clearly making an impact. Meanwhile, base metals have been mixed with Aluminum higher and Copper lower.  Precious metals?  Mixed as well with gold (+0.4%) rebounding from a couple of really bad sessions while silver (-0.75%) continues to slide.

Thus far, making a claim as to the risk sense of markets is essentially impossible.  So, now we turn to the dollar.  If tradition is a guide, the dollar’s broad weakness, lower vs. all G10 counterparts and many EMG ones as well, would indicate a risk on session.  But if investors are moving into risky assets, why are stocks under uniform pressure? Perhaps they are all moving their money into Bitcoin (+0.2% today, +11.2% in the past week).

But back to the fiat world where we see GBP (+0.6%) as the leading G10 gainer which appears to be a result of traders expecting the UK to recover much faster than Europe given the relative success of their Covid vaccination program.  But even the worst performers, CAD and JPY are higher by 0.15% this morning.  NOK (+0.4%) seems to be benefitting from the ongoing oil rally, and the rest of the bloc may be beginning to see the resumption of the dollar short trade.

EMG currencies are a bit more mixed, with most APAC currencies softening overnight, but LATAM and CE4 currencies benefitting from the dollar’s overall softness.  CLP (+0.5%) leads the way on the strength of rising copper prices, with ZAR (+0.45%) following closely behind.

Yesterday’s US data was surprisingly good, with Retail Sales exploding higher by 5.3% on a monthly basis (I guess the most recent stimulus checks were spent!) and PPI jumping by a full percent, to a still low 1.7%, which may well foreshadow the future of CPI.  We also saw strong IP and Capacity Utilization data.  This morning brings Initial Claims (exp 770K), Continuing Claims (4.425M), Housing Starts (1660K), Building Permits (1680K) and Philly Fed (20.0) all at 8:30. We also have two more Fed speakers, the hyper dovish Lael Brainerd and a more middle of the road dove Rafael Bostic.

Wrapping it all up shows a weak dollar, weak bond prices and weak stock prices.  It feels like at least one of these needs to adjust its trajectory for the day to make any sense, but as of now, I am not willing to bet which.  As far as the FX market goes, we appear to be rangebound for now, although any eventual break still feels like it will be for a lower dollar.

Good luck and stay safe
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Both Need Downgrading

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Excitement in markets is fading
With GameStop and silver both trading
Much lower today
As sellers convey
The message that both need downgrading

Well, it appears that the GameStop bubble is deflating rapidly this morning, which is only to be expected.  Short interest in the stock has fallen from 140% of market cap to just 39% as of yesterday’s close.  This means that there is precious little reason for it to rally again, as, if you recall, the company’s business model remains a bad fit for the times.  The top tick, last Thursday, was $483 per share.  In the pre-market this morning it is trading at $172, and I anticipate that before the end of the month, it will be trading back to its pre-hype $17-$18 level.  But it was fun while it lasted!

Meanwhile silver, yesterday’s story, has also fallen sharply, -4.7% as I type, as the mania there seems to have been more readily absorbed by a much larger market.  The conspiracy theory that the central banks and JP Morgan have been manipulating the price lower for the past several decades has always been hard to understand but was certainly more widespread than I expected.  The major difference between silver and GME though, is that silver has a real raison d’etre as an industrial metal, as well as a traditional store of wealth and monetary metal.  Last year silver’s price rose 46.5%, leading all precious metals higher.  And, in the event that inflation does begin to show itself again, something I believe is coming soon to a screen near you, there is a strong case to be made for it to rally further.  This is especially so given the ongoing debasement of all fiat currencies by central banks around the world as they print more and more each day.

Down Under the RBA stunned
The market and every hedge fund
Increasing QE
As they want to see
The Aussie increasingly shunned

While other major central banks stood pat in their recent policy meetings, the RBA last night surprised one and all by increasing the amount of QE by A$100 billion, at A$5 billion / month, meaning they will continue the program well into 2022.  As well, they explained that they would not consider raising rates until 2024 at the earliest as they work to push unemployment lower.  This means, the overnight rate will remain at 0.1% and YCC for the 3-year bond will also remain at that level.  Interestingly, the market had tapering on its mind, as ahead of the meeting AUD had rallied nearly 0.6%, with analyst discussions of tapering rampant.  As such, it is no surprise that the currency gave up those gains immediately upon the release of the statement, and has now fallen 0.25% on the day, the worst laggard in the G10.

With the FOMC meeting behind us, Fed speakers are going to be inundating us with their views for the next month, so be prepared for a lot more discussion on this topic.  Remember, before the quiet period ahead of the January meeting, four regional presidents were talking taper, with two seeing the possibility of that occurring late in 2021.  Chairman Powell, however, tried to squelch that theory in the statement and press conference.   Yesterday, uber-dove Neel Kashkari expressed his view that it is “..key for Fed to keep foot on monetary policy gas.”  Meanwhile, Raphael Bostic and Eric Rosengren both harped on the need for additional fiscal stimulus to revive the economy, with Bostic once again explaining that tapering when economic growth picks up will be appropriate, although giving no timeline.  (He was one of the four discussing a taper ahead of the meeting.)  We have seven more speakers this week, some of them multiple times, so there will certainly be headline risk as this debate plays out in public.

But for now, markets are sanguine about the possibility of central bank tightening in any way, shape or form, as once again, risk is being embraced across the board.  Starting in Asia, we saw green results everywhere (Nikkei +1.0%, Hang Seng +1.2%, Shanghai +0.8%), with the same being true in Europe (DAX +1.1%, CAC +1.6%, FTSE 100 +0.5%).  US futures are pointing in the same direction with gains on the order of 0.75% at 7:00am.

Bond markets are also on board the risk train, with yields rising in Treasuries (+2.9 bps) and throughout Europe (Bunds +2.7bps, OATs +2.2bps, Gilts +3.1bps).  Part of this positivity seems to be coming from the release of Eurozone Q4 GDP data, which was not quite as bad, at -0.7% Q/Q (-5.1% Y/Y) as forecast.  That outcome, though, was reasonably well known ahead of time as both Germany and Spain printed Q4 GDP at +0.1% in a surprise last week.  Unfortunately, the ongoing lockdowns throughout Europe, which have been extended into March in some cases, point to another quarter of economic contraction in Q1, thus resulting in a second recession in short order on the continent.  With that in mind, while we have not heard much from ECB speakers lately, it is certainly clear that there is no taper talk in Frankfurt at this time.

Which takes us to the currency markets.  The G10 bloc is split with EUR (-0.25%) matching AUD’s futility, while the rest of the European currencies are all modestly lower.  Commodity currencies, however, are holding their own led by CAD (+0.35%) which is benefitting from oil’s rally (+1.3%), although NOK (+0.1%) has seen less benefit.  EMG currencies, however, lean toward gains this morning, with MXN (+0.8%), BRL (+0.6%) and RUB (+0.6%) leading the way, each benefitting from higher commodity prices.  Even ZAR (+0.5%) is higher despite the lagging in precious metals.  But that story is far more focused on ZAR interest rates, which are an attractive carry play in a risk on scenario.  The laggards in this bloc are basically the CE4, tracking the euro, and even those losses are minimal.

While there is no data this morning in the US, we do have important statistics coming up later in the week as follows:

Wednesday ADP Employment 50K
ISM Services 56.7
Thursday Initial Claims 830K
Continuing Claims 4.7M
Nonfarm Productivity 4.0%
Unit Labor Costs -3.0%
Factory Orders 0.7%
Friday Non Farm Payrolls 60K
Private Payrolls 100K
Manufacturing Payrolls 31K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B
Consumer Credit $12.0B

Source: Bloomberg

So, plenty to see, but will we learn that much?  Obviously, all eyes will be on the payroll data, which given the rise in Initial Claims we have seen during the past month seems unlikely to surprise on the high side.  As such, anticipating sufficient data exuberance to get the Fed doves to talk about tapering seems remote.

Adding it all up leaves the current short dollar squeeze in place, with an opportunity, I think, for the euro to trade back below 1.20 for a time, but nothing we have seen or heard has changed my view that the dollar will fall in the second half of the year.  For those of you with payables, hedging sooner rather than later should be rewarded over time.

Good luck and stay safe
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