Tag Archives: #FOMC

Inflation Be Damned

Posted on by

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
Adf

Tempting the Fates

Posted on by

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
Adf

Nothing to Fear

Posted on by

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
Adf

Hubris

Posted on by

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
Adf

Suspicions

Posted on by

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
Adf

Both Need Downgrading

Posted on by

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
Adf

No Bonds Will They Shed

Posted on by

Chair Powell explained that the Fed
Cared not about bubbles widespread
Employment’s the key
And ‘til he can see
Improvement, no bonds will they shed

Meanwhile, cross the pond, Ollie Renn
Repeated the mantra again
The ECB will
Not simply stand still
And let euros outgain the yen

At the first FOMC meeting of 2021, Chairman Powell was very clear as to what was in focus, employment.  To nobody’s surprise, they left policy rates on hold and did not change the purchase metrics of the current QE program.  However, in the statement, they downgraded their outlook for the economy, which given the ongoing vaccination program seemed somewhat surprising.  However, the fact that vaccinations are taking longer to be administered than had been expected, seems to be driving their discussion.  He was also explicit that the Fed was set to continue their current program until such time as they achieve their twin goals of maximum employment and 2% average inflation.  Based on the recent rising trajectory of Initial Claims (expected today at 875K) and given even Powell described the fact that the Unemployment Rate likely significantly understates the true situation, it will be a very long time before the Fed even considers reducing their program.

When asked at the press conference following the meeting about potential bubbles in asset markets, with several questions specifically about GameStop stock (a truly remarkable story in its own right), the Chairman was also clear that employment was the thing that mattered, and the Fed was not focused on things like this.  He even explained that the Fed fully expected inflation data to rise this summer but would not waver from their course until maximum employment is achieved.  So, the message is clear, the balance sheet will continue to grow regardless of any ancillary issues that arise.

Keeping our focus on central banks, we turn to the ECB, where this morning it was Finnish Central Bank president Ollie Renn’s turn to explain to the markets that the ECB was carefully watching the exchange rate and its impact on inflation, and would use all the tools necessary to help boost inflation, including addressing a ‘too strong’ euro.  Kudos for their consistency as this was exactly the same message we heard yesterday from Klaas Knot, the Dutch central bank chief.  As well, during yesterday’s session there was an ECB statement that “markets [are] underestimating rate-cut odds.”  You may recall the Knot specifically mentioned the possibility of cutting interest rates by the ECB as well.  All told, there is a consistent message here as well, the euro is a key focus of the ECB and they will not allow it to trade higher unabated.  I have made this point for months, as the dollar bearish views became more entrenched, that the ECB would not sit idly by and allow the euro to rally significantly without responding.  This is the first response.

What are we to conclude from these two messages?  The conclusion I draw is that beggar thy neighbor policies continue to be at the forefront of monetary policy discussions within every major central bank.  While I’m sure they are not actually described in that manner, the results, nevertheless are just that, every central bank is committed to continuing to expand their balance sheet while adding accommodation to their respective economies, and so the relative impact remains muted.  In the end, nothing has changed my view that the Fed will cap yields, which right now are doing a good job of that all by themselves (10-year Treasury yields are -1bp today and back to 1.00%, their lowest level since the break higher on the Georgia election results), and that the dollar will suffer as real yields in the US plummet.  But again, that is Q2 or Q3, not Q1.

Perhaps, what is more interesting is that despite all this promised central bank largesse, yesterday was a massive risk-off session and today is following right in those footsteps.  Starting with equity markets, the bloodbath is universal.  Asia saw sharp declines (Nikkei -1.5%, Hang Seng -2.6%, Shanghai -1.9%) following the US selloff.  And it wasn’t just the main indices, literally every Asian market that was open yesterday fell, most by more than 1%.  European bourses are also all red this morning, but the magnitude of losses has been more muted.  Of course, they got to participate in yesterday’s sell-off, so perhaps that is not too surprising.  As I type, the CAC (-0.1%) is the best performer, with the DAX (-0.6%) and FTSE 100 (-1.0%) suffering more acutely.  Here, too, every market is in the red.  Interestingly, US futures are mixed, with DOW futures actually higher by 0.1%, but NASDAQ futures are down 0.7% after weaker than expected earnings and guidance from some of the Tech megacaps last night.

Bond markets are pretty much all in the green, with yields lower, but essentially, the entire space has seen yields decline just 1 basis point.  That is not really a sign of panic.  Perhaps, with yields so low, investors are beginning to understand that bonds no longer offer the hedge characteristics for risk that they have historically held.  In other words, is earning -0.64% to hold 10-year bunds really hedging negative outcomes in your equity portfolio?  A key part of the thesis that bonds are a haven is that you earn a stable return during tough times.  These days, that is just not the case, and the risk that yields normalize means the potential losses attendant to holding a bond portfolio at current yields is quite substantial.

Commodity prices are generally softer, but not by very much.  WTI (-0.4%) continues to consolidate its gains from Q4 but has basically gone nowhere for the past two weeks.  Gold (-0.2%), too, is treading water lately, although the technicians are starting to say it is in a mild downtrend.

And finally, the dollar is basically stronger once again this morning.  This is true vs. every G10 currency, with AUD (-0.7%) the worst performer, but all the commodity currencies (NZD -0.5%, CAD -0.4%) under pressure along with the havens (JPY -0.2%, CHF -0.2%).  This is simply another dollar up day, with risk still in question.  In the emerging markets, KRW (-1.35%) is by far the worst performer, suffering from the changing risk appetite as well as weaker than expected earnings from Samsung, the largest company in the country.  Capital exited the KOSPI and drove the won to its lowest level since early November.  But we are seeing weakness in the usual suspects with RUB (-0.6%), MXN (-0.4%) and BRL (-0.3%) all under some pressure.  The outlier here is ZAR (+0.2%) which after a very weak start alongside other commodity linked currencies, has rebounded on the news that the first Covid vaccines would be arriving by the end of the week.

There is a bunch of data this morning led by Initial Claims but also Q4 GDP (exp 4.2%), Leading Indicators (0.3%) and New Home Sales (870K).  This is the first reading for Q4, but the market is more intently focused on Q1 and Q2, so it is not clear the print will matter much.  Housing we know continues to perform extremely well, so the Claims data is likely the most important release, especially given Powell’s focus on employment.

As of now, risk remains on its heels, but it would not be that surprising if things turned around as Powell’s message of non-stop stimulus should encourage the bulls.  If that is the case, I would look for the dollar to cede some of its gains, but it is certainly not a signal to sell aggressively.

Good luck and stay safe
Adf

You’d Better Think Twice

Posted on by

If you thought Lagarde doesn’t care
About how her euros compare
To dollars in price
You’d better think twice
‘Cause she is acutely aware

This morning, her colleague, Klaas Knot
Was clear when explaining they’ve got
The tools they may need
To help them succeed
In cooling a euro that’s hot

With the FOMC meeting on tap for later today, the market is mostly biding its time until they hear if anything will be changing at the Mariner Eccles Building.  However, that seems highly unlikely at this time given the following factors:  first, the last we heard from Chairman Powell was that now is not the time to consider removing any policy accommodation, even if things seem to be looking up; and second, it is not clear that things are looking up.  While certainly there are some parts of the economy that are doing well, notably housing and manufacturing, the service sector remains under severe pressure as lockdowns pervade the country.  True, it appears that some of the more draconian lockdowns may be coming to an end, but the hit to the employment situation has been turning much worse.  Recall, the December NFP data printed at a much worse than expected -140K, and Initial Claims data has been running higher lately than back then.  Too, remember that the Fed modified their mandate to seek to achieve “maximum employment” which means declining NFP data is more likely to drive further policy ease than tightness.

So, in truth, today’s FOMC meeting is likely to be a pretty dull affair, with limited market expectations for any movement of any sort.  On the other hand, the ECB, which met last week and took no further action, remains concerned about the euro’s strength.  I have been quite clear in my warnings that the ECB would not allow the euro to trade higher without a response as they simply cannot afford that outcome.  Remember, the ECB’s playbook (and in truth, most central bank playbooks) defines the reaction function for specific conditions.  According to the book, too low inflation requires lower interest rates and a weaker exchange rate.  In fact, one of the primary reasons to lower interest rates is to weaken the exchange rate.  The idea is that a weak currency can help import inflation while simultaneously helping the competitive stance of that nation’s export community.  The problem with this strategy is that it was designed to be used in isolation.  So, if one country is behaving in that manner, it has a chance to succeed.  Unfortunately, the Covid pandemic has resulted in virtually every country trying to use these tools at the same time, thus canceling out each other’s efforts.

Of course, one player is much larger than the others, namely the Fed.  The Fed’s ability to ease policy seems to be outstripping that of the ECB, and every other country as well.  Adding to that has been the extraordinary fiscal policy ease we have seen here, which has been larger than elsewhere, and with the still robust expectations of another $1.9 trillion of fiscal support coming, has been one of the defining features of the bearish dollar outlook.

Which brings us to this morning’s comments from Klaas Knot, the Dutch Central Bank President and ECB Governing Council member.  He was quite clear in explaining the ECB has the necessary tools, including interest rate cuts, to prevent any further strengthening of the euro which could undermine inflation.  “That is something we, of course, monitory very, very carefully.  It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going.”  In other words, euro bulls need to understand the ECB is not going to sit by and watch the single currency rally unabated.  It should be no surprise that the market responded to these comments by selling off the single currency, which is now down 0.4% on the day.  Adding to the bearish euro scenario was the release of the German GfK Consumer Confidence survey, which printed at -15.6, its third lowest reading in history, trailing only the May and June readings post the start of the Covid crisis last year.  Once again, I will reiterate my view, while eventually the dollar will decline more sharply as real yields in the US fall into further negative territory later this year, for now, the dollar’s decline seems to be on hold.

Ok, let’s quickly look at markets.  Risk is starting to become more suspect as the morning wears on, with European equity markets now all sharply in the red vs. their earlier little changed price action.  In the wake of the Knot comments, the DAX (-1.55%), CAC (-1.0%) and FTSE 100 (-0.8%) have all sold off hard.  Asian markets, which had closed before the comments, had a more mixed day, with the Nikkei (+0.3%) recouping a little of yesterday’s losses, but the Hang Seng (-0.3%) and Shanghai (+0.1%) doing little overall.  As to US futures, the DOW (-0.9%) and SPU (-1.0%) lead the way down with the NASDAQ (-0.25%) still outperforming after some pretty good earnings data last night from Microsoft.

It should be no surprise that bond markets have found a bid, with Treasury yields lower by 1.4bps, while Bunds (-1.4bps) and OATs (-1.0bps) are also now trading higher.  Again, earlier in the session, yields had actually crept a bit higher, so this reversal of risk attitude is growing.

Commodity markets are being impacted as well, with oil back to flat on the day from early session gains of 0.5% and gold is actually lower by 0.5%.  Only the ags remain well bid, as I guess everyone needs to eat, even during a pandemic.

Finally, the dollar is stronger across the board, with the strength becoming more evident after the Asian close.  In the G10, NOK (-0.9%) is the leading decliner as oil prices have turned, but we are seeing weakness throughout the commodity bloc (AUD -0.6%, NZD -0.4%, CAD -0.4%) as well.  In fact, even the havens are weaker today with both JPY and CHF off by 0.2%.  Today is just a dollar positive day.  In the EMG bloc, the few green spots on the chart are all APAC currencies with very modest gains (KRW +0.2%, TWD +0.1%).  On the other hand, all the markets that are currently open are showing sharp declines led by ZAR (-0.9%), MXN (-0.85%) and RUB (-0.8%).  It is remarkable how closely these three currencies trade to each other.  But really, everything else is weak as well.  There are no specific stories of note here, it is just a day to reduce risk.

On the data front, this morning brings Durable Goods (exp 1.0%, 0.5% ex transport) and then the FOMC statement at 2:00 followed by the Powell press conference at 2:30.  It seems unlikely that the market will react to the Durables data, so things seem to be shaping up as a dollar up day, at least until we hear from Jay.  However, I don’t foresee the dollar exploding higher, just continuing this drift, at least vs. the G10.  EMG is always a different story, so be careful there.

Good luck and stay safe
Adf

No Bubble’s Detected

Posted on by

While Jay and his friends at the Fed
Claim when they are looking ahead
No bubble’s detected
So, they’ve not neglected
Their teachings and won’t be misled

But China views markets and sees
Their policy has too much ease
So, money they drained
As they ascertained
Investors, they need not appease

Perhaps there is no clearer depiction of the current difference between the Fed (and truly all G10 central banks) and the PBOC than the fact that last night, the PBOC drained liquidity from the market.  Not only did they drain liquidity, they explained that they were concerned about bubbles in asset markets like stocks and real estate, inflating because of current conditions.  Think about that, the PBOC did not simply discuss the idea that at some point in the future they may need to drain liquidity, they actually did so.  I challenge anyone to name a G10 central banker who could possibly be so bold.  Certainly not Chairman Powell, who tomorrow will almost certainly reiterate that this is not the time to be considering the removal of policy support.  Neither would ECB President Lagarde venture down such a road given the almost instantaneous damage that would inflict on the PIGS economies.

One cannot be surprised that stock markets fell in Asia after this action, with the Hang Seng (-2.6%) leading the way, while Shanghai (-1.5%) also fared poorly.  By contrast, the Nikkei’s -1.0% performance looked pretty good.  It should also be no surprise that the stock markets of the APAC nations whose trade relations with China define their economies saw weak outcomes.  Thus, Korea’s KOSPI (-2.1%) and Taiwan’s TAIEX (-1.8%) suffered as well.  And finally, it cannot be surprising that the Chinese renminbi traded higher (+0.15%) and is pushing back to levels last seen in June 2018.

Arguably, the key question here is, what does this mean for markets going forward?  Despite constant denials by every G10 central banker, it remains abundantly clear that equity market froth is a direct result of central bank policy.  The constant addition of liquidity to the economic system continues to spill into financial markets and push up equity (and bond and other asset) prices.  If the PBOC action were seen as a harbinger of other central bank activity, I expect that we would see a very severe repricing of risk assets.  However, a quick look at European equity markets shows that no such thing is occurring.  Rather, the powerful rally we are seeing across the board on the continent today (DAX +1.5%, CAC +1.1%, FTSE MIB +0.85%) indicates just the opposite.  Investors are not merely convinced that the ECB will never remove liquidity, but we are likely seeing some of the money that fled Asia finding a new home amid the easy money of Europe.

If the PBOC continues down this road, it is likely to have a far greater impact over time.  In fact, if they are successful in deflating the asset bubbles in China without crushing the economy, something that has never successfully been done by any central bank, it would certainly bode well for China going forward, as global investors would beat a path to their door.  While that is already happening (in 2020, for the first time, China drew more direct investment than the US), the speed with which it would occur could be breathtaking, especially in the current environment when capital moves at a blinding pace.  And that implies that Western equity markets might lose their allure and deflate.  The irony is that a communist nation firmly in the grip of the government would be deemed a better investment opportunity than the erstwhile bastion of free markets.  Ironic indeed!

However, that will only take place over a longer time frame, while we want to focus on today.  So, don’t ignore this occurrence, but don’t overreact either.

In the meantime, a look at today’s activity shows that there is little coherence in markets right now.  As you’ve seen, European equity markets are rallying nicely despite the fact that the Italian government just fell as PM Giuseppe Conte resigned.  A few months ago, this would have been seen as a significant negative for Italian assets, but not anymore.  Not only are Italian stocks higher, but BTP’s have seen yields decline another 3 basis points, taking their rally since Friday to 10 basis points!  As I have often written, BTP’s and the bonds of the other PIGS countries trade more like risk assets than havens, so it should be no surprise they are rallying.  In fact, haven assets all over are declining with Treasuries (+2.2bps), Bunds (+1.4bps) and Gilts (+1.6bps) all being sold today.

Recapping the action so far shows APAC stocks falling sharply, European stocks rallying sharply and haven bonds falling.  Is that risk-on?  Or risk-off?  Beats me!  Commodity prices point to risk-on, with oil rising 0.55% and most agricultural products higher by between 0.4%-1.0%.

Finally, looking at the dollar gives us almost no further information.  While the SEK (-0.25%) is under pressure on a complete lack of news, and the NZD (+0.2%) has moved higher after PM Arcern explained that the country would remain closed to outside travelers until the pandemic ended, the rest of the bloc is +/- 0.1% or less.  In the EMG bloc, the picture is also mixed, with KRW (-0.5%) the worst performer followed by IDR (-0.3%).  Given China’s monetary move last night, this should be no surprise.  On the plus side, TRY (+0.7%) leads the way followed by BRL (+0.4%), with the former benefitting from the IMF raising its GDP growth forecast to 6% in 2021, from a previous estimate of 5%. Meanwhile, the real has benefitted from the news that the BCB meeting last week contained discussions of raising interest rates from their current historically low level of 2.0%.  Concern over inflation picking up has some of the more hawkish members questioning the current policy stance.  Certainly, given that BRL has been one of the worst performing currencies for the past year, having declined 26% since the beginning of 2020, there is plenty of room for it to rise on the back of higher interest rates.

On the data front, this morning brings Case Shiller Home Prices (exp +8.7%) and Consumer Confidence (89.0).  On the former, this reflects historically low mortgage rates and a lack of inventory.  As to the latter, it must be remembered that this reading was above 120 for the entire previous Administration’s tenure until Covid came calling.  Alas, there is no indication that people are feeling ready to head back to the malls and movies yet.

With the FOMC on tap for tomorrow, I expect that the FX market will take its cues from equities.  If the US follows Europe, I would expect to see the dollar give up a little ground, but as I type, futures are little changed with no consistent direction.  While the dollar’s medium-term trend lower has been interrupted, for now, it also appears that the correction has seen its peak.  However, it could take a few more sessions before any downward pressure resumes in earnest, subject, naturally, to what the Fed tells us tomorrow.

Good luck and stay safe
Adf

Covid Comes Calling

Posted on by

The German economy’s stalling
In Q1, as Covid comes calling
But still there’s belief
That fiscal relief
Will stop it from further snowballing

Consensus is hard to find this morning as we are seeing both gains and losses in the various asset classes with no consistent theme.  Perhaps the only significant piece of news was the German IFO data, which disappointed across the board, not merely missing estimates but actually declining compared with December’s data.  This is clearly a response to the renewed lockdowns in Germany and the fact that they have been extended through the middle of February.  The item of most concern, is that the manufacturing sector, which up until now had been the brightest spot, by far, is also seeing softness.  Now part of this problem has to do with the fact that shipping has been badly disrupted with insufficient containers available to ship products.  This has resulted in higher shipping costs and reduced volumes, hence reduced sales.  But part of this issue is also the fact that since virtually all of Europe is in lockdown, economic activity on the continent is simply slowing down.  It is the latter point that informs my view of the ECB’s future activities, namely non-stop monetary ease for as far as the eye can see.

When combining that view, the ECB will continue to aggressively ease policy, with the fact that the Fed is also going to continue to ease policy, it becomes much more difficult to estimate which currency is going to underperform.  Heading into 2021, the strongest conviction trade across markets was that the dollar was going to decline sharply, continuing the descent from its March 2020 highs.  And that’s exactly what we saw…for the first week of the year.  However, since then, the dollar has reversed those losses and currently sits higher on the year vs. most currencies.  My point is, and has consistently been, that in the FX market, the dollar is a relative game, and the policies of both nations are critical in establishing its value.  Thus, if every nation is aggressively easing policy, both monetary and fiscal, then the magnitude of those policy efforts are critical.  Perhaps, the fact that Congress has yet to pass an additional stimulus bill, especially given the strong belief that the Blue Wave would quickly achieve that, has been sufficient to change some views of the dollar’s future strength (weakness?).  Regardless, the one thing that is clear is that the year has just begun and there is plenty of time for more policy action as well as more surprises.  In the end, I do believe that as inflation starts to climb in the US, and real interest rates fall to further negative levels, the dollar will ultimately fall.  But that is a Q2-Q3 outcome, not really a January story.

And remarkably, that is basically the biggest piece of news from overnight.  At this point, traders and investors are turning their attention to the FOMC meeting on Wednesday, although there are no expectations for policy shifts yet.  However, the statement, and Chairman Powell’s press conference, will be parsed six ways to Sunday in order to try to glean the future.  Based on what we heard from a majority of Fed speakers before the quiet period began, there is no current concern over the backup in Treasury yields, and there is limited sentiment for the Fed to even consider tapering their policy of asset purchases, with just four of the seventeen members giving it any credence.  One other thing to remember is that the annual rotation of voting regional presidents has turned more dovish, with Cleveland’s Loretta Mester, one of the two most hawkish members, being replaced by Chicago’s Charles Evans, a consistent dove.  The other changes are basically like for like, with Daly for Kashkari (two extreme doves) and Barkin and Bostic replacing Harker and Kaplan.  These four are the minority who discussed the idea that tapering purchases could be appropriate by the end of the year, so, again, no change in voting views.

With this in mind, we can see the lack of consistent message from overnight activity.  Asian equity markets were all firmer, led by the Hang Seng (+2.4%), with the Nikkei (+0.7%) and Shanghai (+0.5%) trailing but in the green.  However, Europe has fared less well after the soft IFO data with all three major markets (DAX, CAC and FTSE 100) lower by -0.6%.  As to US futures, they are the perfect embodiment of a mixed session with NASDAQ futures higher by 0.8% while DOW futures are lower by 0.2%,

Bond markets, though, have shown some consistency, with yields falling in Treasuries (-1.0bp) and Europe (Bunds -1.7bps, OATs -1.5bps, Gilts -2.2bps).  The biggest winner, though, are Italian BTPs, which have rallied more than half a point and seen yields decline 5.3 basis points.  It seems that concerns over the government falling have abated.  Either that or the 0.70% yield available is seen as just too good to pass up.

On the commodity front, oil prices have edged up by the slightest amount, just 0.1%, as the consolidation of the past three months’ gains continues.  Gold has risen 0.4%, but there is a great deal of discussion that, technically, it has begun a downtrend and has further to fall.  Again, consistent with my view that real interest rates are likely to decline sharply in Q2, when inflation really starts to pick up, we could easily see gold slide until then, before a more emphatic recovery.

And lastly, the dollar, where both G10 and EMG blocs show a virtual even split of gainers and losers.  Starting with the G10, NZD (+0.3%) is today’s “big” winner, with SEK (+0.25%) next in line.  Market talk is about the reduction of restrictions in Australia’s New South Wales state as a reason for optimism in AUD (+0.15%) and NZD.  As for SEK, this is simply a trading move, with no obvious catalysts present.  On the flip side, the euro (-0.1%) is the worst performer, arguably suffering from that German IFO data, with other currencies showing little movement in either direction.

The EMG bloc is led by TRY (+0.4%), as it seems discussions between Turkey and Greece to resolve their competing claims over maritime boundaries is seen as a positive.  After the lira, though, no currency has gained more than 0.2%, which implies there is nothing of note to describe.  On the downside, ZAR (-0.4%) is the worst performer, which appears to be a positioning move as long rand positions are cut amid concerns over the spread of Covid and the lack of effective government response thus far.

On the data front, the week is backloaded with Wednesday’s FOMC clearly the highlight.

Tuesday Case Shiller Home Prices 8.65%
Consumer Confidence 89.0
Wednesday Durable Goods 1.0%
-ex transport 0.5%
FOMC Meeting 0.00%-0.25% (unchanged)
Thursday Initial Claims 880K
Continuing Claims 5.0M
GDP Q4 4.2%
Leading Indicators 0.3%
New Home Sales 860K
Friday Personal Income 0.1%
Personal Spending -0.4%
Core PCE 1.3%
Chicago PMI 58.0
Michigan Sentiment 79.2

Source: Bloomberg

So, plenty of stuff at the end of the week, and then Friday, two Fed speakers hit the tape.  One thing we know is that the housing market continues to burn hot, meaning data there is assumed to be strong, so all eyes will be on the PCE data on Friday.  After all, that is the Fed’s measuring stick.  The other thing that we have consistently seen during the past six months is that inflationary pressures have been stronger than anticipated by most analysts.  And it is here, where the Fed remains firmly of the belief that they are in control, where the biggest problems are likely to surface going forward.  But that is a story for another day.  Today, the dollar is wandering.  However, if the equity market in the US can pick up its pace, don’t be surprised to see the dollar come under a little pressure.

Good luck and stay safe
Adf