Tag Archives: #FOMC

Infinite Easing

Posted on by

Until “further progress” is made
On joblessness, Jay won’t be swayed
From infinite easing
Which stocks should find pleasing
Explaining how he will get paid

As well, one more time he inferred
That Congress was being absurd
By not passing bills
With plenty of frills
So fiscal relief can be spurred

“We’re going to keep policy highly accommodative until the expansion is well down the tracks.”  This statement from Chairman Powell in yesterday’s post-meeting press conference pretty much says it all with respect to the Fed’s current collective mindset.  While the Fed left the policy rate unchanged, as universally expected, they did hint at the idea that additional QE is still being considered with a subtle change in the language of their statement.  Rather than explaining they will increase their holdings of Treasuries and mortgage-backed securities “at least at the current pace”, they now promise to do so by “at least $80 billion per month” in Treasuries and “at least $40 billion per month” in mortgages.  And they will do this until the economy reaches some still unknown level of unemployment alongside their average 2% inflation target.

What is even more interesting is that the Fed’s official economic forecasts were raised, as GDP growth is now forecast at 4.2% for 2021 and 3.2% for 2022, each of these being raised by 0.2% from their September forecasts.  At the same time, Unemployment is expected to fall to 5.0% in 2021 and 4.2% in 2022, again substantially better than September’s outlook of 5.5% and 4.6% respectively.  As to PCE Inflation, the forecasts were raised slightly, by 0.1% for both years, but remain below their 2% target.

Put it all together and you come away with a picture of the Fed feeling better about the economy overall, albeit with some major risks still in the shadows, but also prepared to, as Mario Draghi declared in 2012, “do whatever it takes” to achieve their still hazy target of full employment and average inflation of 2%.  For the equity bulls out there, this is exactly what they want to hear, more growth without tighter policy.  For dollar bears, this is also what they want to hear, a steady supply increase of dollars that need to wash through the market, driving the value of the dollar lower.  For the reflatonistas out there, those who are looking for a steeper yield curve, they took heart that the Fed did not extend the duration of their purchases, and clearly feel better about the more upbeat growth forecasts, but the ongoing lack of inflation, at least according to the Fed, means that the rationale for higher bond yields is not quite as clear.

After all, high growth with low inflation would not drive yields higher, especially in the current world with all that liquidity currently available.  And one other thing argues against much higher Treasury yields, the fact that the government cannot afford them.  With the debt/GDP ratio rising to 127% this year, and set to go higher based on the ongoing deficit spending, higher yields would soak up an ever increasing share of government revenues, thus crowding out spending on other things like the entitlement programs or defense, as well as all discretionary spending.  With this in mind, you can be sure the Fed is going to prevent yields from going very high at all, for a very long time.

Summing up, the last FOMC meeting of the year reconfirmed what we already knew, the Fed is not going to tighten monetary policy for many years to come.  For their sake, and ours, I sure hope inflation remains as tame as they forecast, because in the event it were to rise more sharply, it could become very uncomfortable at the Mariner Eccles Building.

In the meantime, this morning brings the last BOE rate decision of the year, with market expectations universal that no changes will be forthcoming.  That makes perfect sense given the ongoing uncertainty over Brexit, although this morning we heard from the EU’s top negotiator, Michel Barnier, that good progress has been made, with only the last stumbling blocks regarding fishing to be agreed.  However, in the event no trade deal is reached, the BOE will want to have as much ammunition as possible available to address what will almost certainly be some major market dislocations.  As I type, the pound is trading above 1.36 (+0.8% on the day) for the first time since April 2018 and shows no signs of breaking its recent trend.  I continue to believe that a successful Brexit negotiation is not fully priced in, so there is room for a jump if (when?) a deal is announced.

And that’s really it for the day, which has seen a continuation of the risk-on meme overall.  Looking at equity markets, Asia saw strength across the board (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +1.1%), although Europe has not been quite as universally positive (DAX +0.8%, CAC +0.4%, FTSE 100 0.0%).  US futures markets are pointing higher again, with all three indices looking at 0.5%ish gains at this time.

The bond market is showing more of a mixed session with Treasuries off 2 ticks and the yield rising 0.7bps, while European bond markets have all rallied slightly, with yields declining across the board between 1 and 2 basis points. Again, if inflation is not coming to the US, and the Fed clearly believes that to be the case, the rationale for higher Treasury yields remains absent.

Commodity markets are feeling good this morning with gold continuing its recent run, +0.7%, while oil prices have edged up by 0.3%.  And finally, the dollar is on its heels vs. essentially all its counterparts this morning, in both G10 and EMG blocs.  Starting with the G10, NOK (+1.0%) is the leader, although AUD and NZD (+0.8% each) are benefitting from their commodity focus along with the dollar’s overall weakness.  In fact, the euro (+0.3%) is the laggard here, while even JPY (+0.4%) is rising despite the risk-on theme.  This simply shows you how strong dollar bearishness is, if it overcomes the typical yen weakness attendant to risk appetite.

In the emerging markets, it is also the commodity focused currencies that are leading the way, with ZAR (+0.9%) and CLP (+0.75%) on top of the leaderboard, but strong gains in RUB (+0.7%), BRL (+0.6%) and MXN (+0.5%) as well.  The CE4, have been a bit less buoyant, although all are stronger on the day.  But this is all of a piece, stronger commodity prices leading to a weaker dollar.

On the data front, I think we are in an asymmetric reaction function, where strong data will be ignored while weak data will become the rationale for further risk appetite.  This morning we see Initial Claims (exp 815K), Continuing Claims (5.7M), Housing Starts (1535K), Building Permits (1560K), and Philly Fed (20.0).  Yesterday saw a much weaker than expected Retail Sales outcome (-1.1%, -0.9% ex autos) although the PMI data was a bit better than expected.  But now that the Fed has essentially said they are on a course regardless of the data, with the only possible variation to be additional easing, data is secondary.  The dollar downtrend is firmly entrenched at this time, and while we will see reversals periodically, and the trend is not a collapse, there is no reason to believe it is going to end anytime soon.

Good luck and stay safe
Adf

Much Bluer Skies

Posted on by

Ahead of the Fed, PMI’s
From Europe were quite a surprise
It seems that despite
The lockdowns in sight
The future has much bluer skies

Preliminary PMI data from around the world this morning is the market’s key focus, at least until 2:00 this afternoon when we hear from the Fed.  But, in the meantime, the much better than expected readings surprised the market and are driving yet another increase in risk appetite.  (One wonders if that appetite will ever be sated!)

Starting in Asia, Australian data was considerably stronger than last month, with the Composite figure printing at 57.0, its second highest print in the (short) history of the series.  On the other hand, Japanese data was the sole disappointment, with the Composite slipping 0.1 to 48.0, still pointing to a contracting economy.  The European numbers, however, were all much better than expected with Germany printing 2 points higher than expected at 52.5 on the Composite while France (49.6 Composite) actually beat expectations by 6.6 points.  As such, the Eurozone Composite PMI printed at 49.8, significantly better than expectations of a 45.7 print.  The point here is that while the Eurozone economy is hardly booming (other than German manufacturing), there is a clear sense that the worst may be behind it.

Of course, what makes this so surprising is that the German government has shuttered non-essential businesses until January 10th, with hints that could be extended, after the largest single day fatality count was recorded yesterday.  We are also hearing from other European countries, (France and Italy), that further lockdowns and restrictions on gatherings are being considered as the second (third?) wave of Covid-19 sweeps across the continent.  Yet, not only markets, but businesses have clearly grabbed hold of the idea that the vaccine is going to lead to a swift end to the government intervention in virtually every economy and allow economic activity to resume as it was before.

The spanner in the works, as it were, is that governments are loathe to cede power and control once it is obtained.  If this holds true again, then businesses need to be prepared to have far more rules and restrictions imposed on their operations, something which is typically not associated with an economic boom.  However, for now, it appears that the prospect of the tightest restrictions being lifted outweighs the potential longer-term negative impacts of intrusive government.  So, as Timbuk 3 explained back in 1986, “The Future’s So Bright (I Gotta Wear Shades).

With that in mind, a quick turn to the FOMC meeting today shows us that the market consensus is for no policy changes in scope or size, but rather, more clarity on what is required for the Fed to consider tighter policy in the future.  Expectations continue to center on achieving a specific Unemployment Rate or Inflation Rate or, probably, both in combination.  Perhaps Chairman Powell will resurrect the Misery Index (not the current show on TBS, but the original one defined by Ronald Reagan, when he was running for president in 1980, as the sum of inflation and unemployment.)  For instance, a target of 3.5% Unemployment and 2.0% Inflation would seem to be right where policymakers would be thrilled.  Alas, today we are looking at a reading of 7.9%, with a poor mixture to boot (Unemployment 6.7%, CPI 1.2%).  However, as long as Congress fails to pass a new fiscal stimulus bill, do not be too surprised if the Fed does change the program, with my bet being on Operation Twist redux, where they extend the maturities of their current purchases.  We will find out at 2.

Turning to the markets, all that hunger for risk has shown up in all markets today, with equities and commodities broadly firmer while bonds and the dollar are broadly weaker.  Last night, following the strong equity performance in the US yesterday, we saw less impressive, but still positive price action in Asia with the Nikkei (+0.3%) and Hang Seng (+1.0%) both rallying although Shanghai was flat on the day.  Europe, however, has embraced the PMI data, as well as word that a Brexit deal is approaching (told ya so!) and markets there are all much firmer; DAX (+1.6%), CAC (+0.7%), FTSE 100 (+1.0%).  Finally, US futures are actually the laggards this morning, with all three in the green but the magnitude of those gains more muted than one might have expected, in the 0.2%-0.3% range.

Bond markets have come under pressure as there is certainly no case to own a low yielding haven asset when one can be gorging on risk, but the price declines are far larger in Europe (Bunds and OATs +3.7bps, Gilts +2.7bps) than in the US (Treasuries +1.0bp).  Interestingly, even the PIGS bonds are selling off as it appears Portugal is not quite so interesting a place to hold your cash when the yield there is -0.04% on 10-year paper!

Commodities are firmer, with gold having a second strong performance in a row, up 0.4% this morning, and oil prices are also drifting higher, albeit barely so at this hour.  And finally, the dollar is under significant pressure this morning after breaking through several key technical levels, with only CAD (-0.4%) underperforming in the G10.  And in truth, I cannot find a good reason for the decline as there don’t appear to be either technical or fundamental reasons evident.  On the other side, though, NOK (+0.45%) and GBP (+0.4%) are the leading gainers, although the rest of the space is higher by about 0.3%.  Aside from the Brexit hopes, this is all really about the dollar and the ever-growing conviction that it has much further to fall as 2021 approaches and unfolds.

As to the emerging markets, the CE4, taking their cues from the euro, are leading the way with CZK (+0.75%) and PLN (+0.6%) at the head of the pack.  Beyond those, the gains are less impressive, on the order of 0.2%-0.3%, with APAC currencies little changed overnight and LATAM currencies opening with less oomph than we are seeing in Europe.

On the data front, ahead of the FOMC this afternoon, we see Retail Sales (exp -0.3%, +0.1% ex autos) and then the preliminary PMI data as well (55.8 Manufacturing, 55.9 Services).  My sense is stronger than expected data would have only a limited impact on the dollar, but if the data is weak, another wave lower seems quite possible.

And that is really what we have today.  For now, the dollar is under pressure and likely to remain so.  At 2:00, there is potential for an additional leg lower, if the Fed opts to increase QE or extend maturities, but I cannot make a case for the dollar to benefit from their announcement.  In fact, for now, the only thing that can help the dollar is the fact that it has already moved a long way, and it could be due for a simple trading correction.

Good luck and stay safe
Adf

Not Whether but When

Posted on by

The question’s not whether but when
The Fed adds more money again
With Congress unable
To reach cross the table
It’s up to Jay and his (wo)men

For the first time in months, the top stories today are simply a rehash of the top stories yesterday.  In other words, there is nothing new under the sun, at least with respect to market activities.  There has been nothing new regarding Brexit (talks continue but no word on an outcome); nothing new regarding US fiscal stimulus (talks continue but no word on an outcome);  and nothing new regarding Covid-19 (vaccines have begun to be administered, but lockdowns continue to be the primary tool to fight the spread of the infection).

True, we received some data from China overnight describing an economy that continues to recover, but one whose pace of recovery is barely accelerating and certainly not exceeding expectations.  We saw some data from the UK that described the employment situation as less dire than forecast, but still a mess.  And we saw some inflation data from both Italy and France describing the complete lack of an inflationary impulse on the Continent.  The point is, none of this could be called new information, and so investor response has been extremely muted.

Rather, the story that is developing traction seems to be the question of what the FOMC is going to do when they meet tomorrow.  There seem to be two questions of note; first, will they leave everything just as it is, reiterating their current forward guidance to continue to support the economy until it is deemed capable of recovering on its own, or will they start to attach some metrics to their views; and second, will they leave their current asset purchase program unchanged, or will they alter either the size or tenor?

The bigger picture on this issue needs to consider what we have heard from various Fed speakers prior to the quiet period.  To a (wo)man, they all explained that more fiscal stimulus was critical in helping the economy to recover, and so the fact that none has been forthcoming must be weighing on their views of the future.  This would seem to bias a call for action, not inaction.

Regarding the first question, if we learned anything from the FOMC Minutes three weeks’ ago, it was that there seemed to be movement in the direction of applying metrics to their hitherto vague statements regarding when they will act.  The concern with this approach is that in the wake of the financial crisis, they did just this, explaining that rates would remain near zero until the Unemployment Rate reached their then-current view of full employment, which initially was pegged at 5.0%.  That target was changed several times until it was finally abandoned, as it turned out their models weren’t all that accurate.  Which begs the question, do they want to put themselves in the same position of defining a position and subsequently finding out their initial assumptions were wrong, so they need to change that position?  Remember, credibility is one of a central bank’s most crucial assets and moving targets on policy because of model or forecast errors does not enhance credibility.  In the end, it seems more likely they will not apply hard numbers to their targets, rather much softer views like, full employment rather than a specific unemployment rate; or trend inflation rather than a specific average inflation rate with a timeline attached.

As to the second question, based on positioning indicators, current expectations are pretty evenly distributed as to a change (either more purchases or a Twist) or standing pat.  Again, based on the commentary that fiscal stimulus is crucial and its failure to be agreed, I would lean toward the side of more stimulus to be announced now, perhaps stoking the Christmas rally in equities.  (After all, half the time it seems stoking equity rallies is their entire focus.)

But away from that conversation, there is precious little else to discuss today.  A quick tour of markets shows that after yesterday afternoon’s US equity selloff, Asian equities followed suit with modest declines across the board (Nikkei -0.2%, Hang Seng -0.7%, Shanghai -0.1%).  European bourses, which had been modestly higher earlier, are starting to fade a bit, although the DAX (+0.6%) and CAC (+0.3%) remain in the green.  However, the FTSE 100 (-0.3%) has turned lower as the pound has recently started to edge higher.  US futures are all pointing higher, though, with gains of around 0.6% across the board.

Bond prices are mixed, with Treasuries very slightly softer and yields there higher by less than 1 basis point, but European markets starting to find a bid with yields declining modestly across the board.  The outperformers right now are the PIGS, with yield declines of between 1.5 and 4 basis points, while the rest of Europe’s markets are looking at smaller price gains.

Commodities are reversing yesterday’s price action with oil virtually unchanged while gold has rallied 1.0% this morning.  And finally, the best way to describe the dollar is modestly, but not universally, softer.  In the G10, as I write, GBP (+0.4%) has rallied in the past hour although there has been nothing on the tape that would seem to account for the price action.  But most of the bloc is modestly firmer, between 0.1% and 0.2%, with only two laggards, AUD and NZD (both lower by -0.1%) which have responded to China’s announcement they would be banning shipments of coal from Australia going forward.

EMG currencies are also somewhat firmer in general, led by LATAM (BRL, MXN and CLP all +0.50%) with two others showing similar strength (ZAR and RUB).  As to the rest of the bloc, gains and losses are less than 0.2%, which is another way of saying there is no new information there either.  Broadly speaking, this bloc is going to take its cues from the G10 space, and while the consensus for 2021 remains a much weaker dollar, today that is not taking shape.

On the data front, we see Empire Manufacturing (exp 6.3), IP (0.3%) and Capacity Utilization (73.0%) this morning, although none of these seem likely to change any views.  As such, at this point, it seems the best bet is the FX market will follow the broad risk theme, assuming one develops, or will respond to news, perhaps a fiscal stimulus breakthrough will come today, which is likely to lead to further dollar weakness.  But we will have to wait for that.

Good luck and stay safe
Adf

Haven’t a Doubt

Posted on by

The Fed, yesterday, made the case
That fiscal support they’d embrace
But even without
They haven’t a doubt
The dollar they still can debase
Their toolbox can help growth keep pace

As of yet, there is no winner declared in the Presidential election, although it seems to be trending toward a Biden victory.  The Senate, as well, remains in doubt, although is still assumed, at least by the market, to be held by the Republicans.  But as we discussed yesterday, the narrative has been able to shift from a blue wave is good for stocks to gridlock is good for stocks.  And essentially, that remains the situation because the Fed continues to support the market.

With this in mind, yesterday’s FOMC meeting was the market focus all afternoon.  However, the reality is we didn’t really learn too much that was new.  While universal expectations were for policy to remain unchanged, and they were, Chairman Powell discussed two things in the press conference; the need for fiscal stimulus from the government as quickly as possible; and the composition of their QE program.  Certainly, given all we have heard from Powell, as well as the other FOMC members over the past months, it is not surprising that he continues to plea for a fiscal response from Congress.  As I have written before, they clearly recognize that their toolkit has basically done all it can for the economy, although it can still support stock and bond markets.

It is a bit more interesting that Powell was as forthright regarding the discussion on the nature of the current asset purchase program, meaning both the size of purchases and the tenor of the bonds they are buying.  Currently, they remain focused on short-term Treasuries rather than buying all along the curve.  Their argument is that their purchases are doing a fine job of maintaining low interest rates throughout the Treasury market.  However, it seems that this question was the big one during the meeting, as clearly there are some advocates for extending the tenor of purchases, which would be akin to yield curve control.  The fact that this has been such an important topic internally, and the fact that the erstwhile monetary hawks are on board, or seem to be, implies that we could see a change to longer term purchases in December, especially if no new fiscal stimulus bill is enacted and the data starts to turn back lower.  This may well be the only way that the Fed can ease policy further, given their (well-founded) reluctance to consider negative interest rates.  If this is the case, it would certainly work against the dollar in the near-term, at least until we heard the responses from the other central banks.

But that was yesterday.  The Friday session started off in Asia with limited movement.  While the Nikkei (+0.9%) managed to continue to rally, both the Hang Seng (+0.1%) and Shanghai (-0.25%) had much less interesting performances.  Europe, on the other hand, started off with a serious bout of profit taking, as early on, both the DAX and CAC had fallen about 1.5%.  But in the past two hours, they have clawed back around half of those losses to where the DAX (-0.9%) and CAC (-0.6%) are lower but still within spitting distance of their recent highs.  US futures have shown similar behavior, having been lower by between 1.5% and 2.0% earlier in the session, and now showing losses of just 0.5% across the board.  One cannot be surprised that there was some profit taking as the gains in markets this week have been extraordinary, with the S&P up more than 8% heading into today, the NASDAQ more than 9% and even the DAX and CAC up by similar amounts.

The Treasury rally, too, has stalled this morning with the 10-year yield one basis point higher, although we are seeing continued buying interest throughout European markets, especially in the PIGS, where ongoing ECB support is the most important.  Helping the bond market cause has been the continued disappointment in European data, where for example, German IP was released at a worse than expected -7.3%Y/Y this morning.  Given the increasingly rapid spread of Covid infections throughout Europe, with more than 300K new infections reported yesterday, and the fact that essentially every nation in the EU is going back on lockdown for the month of November, it can be no surprise that bond yields here are falling.  Prospects for growth and inflation remain bleak and all the ECB can do is buy more bonds.

On the commodity front, oil is slipping again today, down around 3% as the twin concerns of weaker growth and potentially more supply from OPEC+ weigh on the market.  Gold however, had a monster day yesterday, rallying 2.5%, and is continuing this morning, up another 0.3%.  This is one market that I believe has much further to run.

Finally, looking at the dollar, it is definitely under pressure overall, although there are some underperformers as well.  For instance, in the G10, SEK (+0.6%), CHF (+0.5%) and NOK (+0.5%) are all nicely higher with NOK being the biggest surprise given the decline in oil prices.  The euro, too, is performing well, higher by 0.45% as I type.  Arguably, this is a response to the idea that Powell’s discussion of buying longer tenors is a precursor to that activity, thus easier money in the US.  However, the Commonwealth currencies are all a bit softer this morning, led by AUD (-0.15%) which also looks a lot like a profit-taking move, given Aussie’s 4.2% gain so far this week.

In the emerging markets, APAC currencies were all the rage overnight, led by IDR (+1.2%) and THB (+0.95%) with both currencies the beneficiaries of an increase in investment inflows to their respective bond markets.  But we are also seeing the CE4 perform well this morning, which given the euro’s strength, should be no surprise at all.  On the flipside, TRY (-1.2%) continues to be the worst performing currency in the world, as its combination of monetary policy and international gamesmanship is encouraging investors to flee as quickly as possible.  The other losers are RUB (-0.5%) and MXN (-0.3%), both of which are clearly feeling the heat from oil’s decline.

This morning, we get the payroll data, which given everything else that is ongoing, just doesn’t seem as important as usual.  However, here is what the market is looking for:

Nonfarm Payrolls 593K
Private Payrolls 685K
Manufacturing Payrolls 55K
Unemployment Rate 7.6%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

You may recall that the ADP number was much weaker than expected, although it was buried under the election news wave.  I fear we are going to see a decline in this data as the Initial Claims data continues its excruciatingly slow decline and we continue to hear about more layoffs.  The question is, will the market care?  And the answer is, I think this is a situation where bad news will be good as it will be assumed the Fed will be that much more aggressive.

As such, it seems like another day with dollar underperformance is in our future.

Good luck, good weekend and stay safe
Adf

Most Pundits Agree

Posted on by

No matter what skeptics might say
The Old Lady didn’t delay
They boosted QE
So, Sunak, Rishi
Can spend more each night and each day

But here, when the FOMC
Meets later, most pundits agree
They will not arrange
A policy change
Instead, for more fiscal they’ll plea

As markets are wont to do, they have effectively moved beyond the uncertainty of the US election outcome to the next big thing, in this case central bank activity.  You may recall that on Tuesday morning we learned the RBA cut interest rates again, down to 0.10% and installed a QE program of A$100 billion.  And while these days, A$100 billion may not seem like much, it does represent more than 5% of the Australian economy.  Of course, that action was mostly lost in the election fever that gripped markets at that time.  However, that fever has broken, and the market has come to terms with the fact there is no blue wave.  This has forced participants to collectively create a new narrative which seems to go as follows: gridlock in the US is good for markets because the Fed will be required to do even more, and thus monetary policy will remain easy for an even longer time.  This, as well as the expected lack of a massive stimulus package, is the driver behind the Treasury rally, which is continuing this morning as 10-year yields have fallen a further 3 basis points (30-year yields have fallen even more as the curve continues to flatten.)

Helping along the new narrative, and right on cue, the Bank of England stepped in and increased their QE program by a more than expected £150 billion this morning, allowing Chancellor of the Exchequer, Rishi Sunak, the leeway to expand fiscal support for the economy as the government there imposes a month long lockdown to try to arrest the spread of Covid-19.  Thus, in the UK, the monetary and fiscal policies are aligned in their efforts to prevent an economic collapse while fighting the effects of Covid.  Naturally, markets have voted in favor of further central bank largesse, and as expectations grow for even more support to come, equity investors are buying as quickly as they can.

Which leads us to the FOMC meeting today.  Cagily, they arranged for this meeting to be two days after the election, as they clearly don’t want to become the big story.  Rather, I’m certain that despite each members’ penchant to speak constantly, this is one time they will be as quiet as possible.  Part of this is due to the fact that there is exactly zero expectation that there will be any change in policy.  Rates are already at the effective lower bound, and thus far the Fed has not been willing to countenance the idea of negative rates.  Not only that, their forward guidance has been clear that rates will not be ‘normalized’ until at least 2023, and then, only if it makes sense to do so.  As to QE, they are already engaged in an unbounded program, purchasing $80 billion of Treasuries and $40 billion of Mortgage-backed securities each month.  Certainly, they could increase those numbers, but given the US Treasury has just significantly revised their expected issuance lower, (given the lack of a stimulus bill to fund), the Fed is already scooping up a huge percentage of the paper that exists.  With all that in place, what more can they do?  After all, if they say they won’t raise rates until 2024, will that actually matter?  I think not.  Instead, the one thing on which we can count is that the Statement, and Chairman Powell in the press conference, will repeat the point that more fiscal stimulus is what is needed.

The upshot is that, the most important par of the election outcome, is with regards to the Senate, which while it seems clear the Republicans have held their majority, could possibly turn blue.  But unless that happens, at this stage, the market has clearly turned its attention beyond the election and is voting favorably for more central bank support.  So, let’s see how things are behaving this morning.

After a strong US rally yesterday, especially in the NASDAQ, Asia took the baton and sprinted ahead as well with the Nikkei (+1.7%), Hang Seng (+3.25%) and Shanghai (+1.3%) all having strong sessions.  In fact, as I look through every APAC market, only Vietnam and Laos had negative days, otherwise every Asian nation rallied across every one of their indices.  Europe is no different, with every market in the green (DAX +1.7%, CAC +1.25%, FTSE 100 +0.5%, as well as all the sundry others), and US futures (DOW +1.4%, SPX +1.9%, NASDAQ +2.6%) are pointing to another big day here.

Bonds, as mentioned above, are also still feeling the love as only the UK appears to be adding to the fiscal mix and so central bank support will continue to drive activity until that changes.  This means that while Bunds, OATS and Gilts are all only marginally changed, the PIGS are seeing substantial demand with yields falling 3 basis points for all of them

Gold is doing well, up $15/oz on what seems to be the idea that fiat currencies will continuously be devalued and so something else will serve as a better store of value.  (Bitcoin, by the way, is also rallying sharply, +5% this morning, as many continue to see it as an alternative to gold.)  Oil, on the other hand, is a bit lower this morning, -1.0%, although that is after having rallied nearly 16% so far this week, so a modest correction doesn’t seem out of order.

Finally, the big loser today has been the dollar, which is weaker vs. essentially every other currency.  In the G10, NOK (+1.1%) is the leader, despite the fact that oil is correcting.  More interestingly, EUR (+0.7%) is rallying despite the fact that there is no expectation for Fed activity, and the relative stances of the Fed and ECB remains unchanged.  Now if there is not going to be a blue wave, and therefore no massive fiscal expansion in the US, I’m at a loss as to why the dollar should be sold.  Today, however, selling dollars is the story.

The same is true in the EMG bloc, with RUB (+2.2%) the runaway leader, but 1% or greater gains seen throughout EMEA and LATAM currencies.  Even IDR (+1.3%) which last night posted worse than expected GDP growth, has seen strength.  As long as the narrative continues to be that election uncertainty is a dollar negative, it appears the dollar has further to fall.  That said, I see no cause for a collapse of any type.

Aside from the FOMC today, we see some data as follows: Initial Claims (exp 735K), Continuing Claims (7.2M), Nonfarm Productivity (5.6%) and Unit Labor Costs (-11.0%).  Yesterday, amidst the election discussion, we missed the fact that ADP Employment rose a much less than expected 365K, and the ISM Services number printed at a worse than expected 56.6.  Perhaps, belatedly, that negative news has been impacting the dollar.  But my sense is this is narrative driven and unless the Fed truly shocks one and all, I expect the dollar can drift lower still for the rest of the session.

Good luck and stay safe
Adf

Remarkable

Posted on by

The week ahead’s certain to be
Remarkable, as we shall see
Election reports
More Fedspeak, of sorts
And data on jobs finally

There should be no lack of excitement this week as (hopefully) the election season finally winds down and we can all try to begin planning for the next four years of policy.  At this point, most of the polls continue to show there will be a change in the White House, with a fair number of polls predicting a blue wave, where the Democrats retake the Senate, as well as the Presidency.  The thing about pollsters is they are very much like economists; they take the data they want and extrapolate the information in a linear fashion going forward.  The problem with this approach, both for economists and psephologists, is that very little about life or the human condition is linear.  If anything, my observation is that life is quite cyclical, with the key being to determine when the cycle is changing.  As Yogi Berra is reputed to have said, “it’s tough to make predictions, especially about the future.”  But predictions galore are certainly being made these days.

For our purposes, however, it is important to continue to game out the potential outcomes, and for hedgers, ensure that proper hedge protection is in place.  Regarding fiscal policy, it seems quite clear that a blue wave will usher in unprecedented levels of additional fiscal stimulus, with numbers of $3 trillion – $5 trillion being bandied about.  If the status quo remains, with President Trump being reelected and the Senate remaining in Republican control, I expect a much smaller stimulus bill, something on the order of the $1.8 trillion that had been discussed up until last week.  Finally, in the event the Republicans hold the Senate, but Mr Biden wins, we are likely to see the reemergence of fiscal conservatism, at least in a sense, and potentially any bill will be smaller.

With that as our backdrop, the consensus view remains that a Biden victory will see a weakening of the dollar, a steepening of the yield curve and an equity market rally.  Meanwhile a Trump victory will see a strengthening of the dollar, a more modest steepening of the yield curve and an equity market rally.  It is quite interesting to me that the consensus is for stocks to continue to rise regardless of the outcome, and for the long end of the bond market to sell off, with only the degree of movement in question.  I have to ask, why is the dollar story different?  The one conundrum here is the expectation of a weaker dollar and a steeper yield curve.  Historically, steep yield curves, implying strong future growth, lead to a stronger dollar.  And after all, it is not as though, the dollar is at excessively strong levels that could lead one to believe it is overbought.  Regardless, this seems to be what is built in at this stage.

Moving on to the FOMC, Thursday’s meeting, two days after the election, is likely to be the least interesting meeting of the year.  It strains credulity that the Fed will act given what could well be a lack of clarity as to the winner of the election.  And even if it is clear, they really have nothing to do at this time.  They are simply going to reiterate the current stance; rates will not rise before 2023, they will continue to purchase bonds ad infinitum, and please, Congress, enact some more fiscal stimulus!

As to Friday’s employment report, it will depend on whether or not the election is settled as to whether the market views the numbers as important.  If the results are known and it is the status quo, then investors will pay attention to the data.  However, if either there is no clear result, or there is a change at the top, this will all be ancient history as the market will be preparing for the new Administration’s policies, so what happened before will lose its significance.  This is especially so given the expectations for a significantly larger fiscal stimulus outcome, and therefore a significant change in economic expectations.

So, that is how we start things off.  Equity markets have shaken off last week’s poor performance and are rebounding nicely.  Asia started things on the right foot (Nikkei +1.4%, Hang Seng +1.5%) although Shanghai was flat on the day despite a better than expected Manufacturing PMI print (53.6).  Europe, meanwhile, is rocking as well, with the DAX (+1.85%) and CAC (+1.8%) both ripping higher while the FTSE 100 (+1.2%) is also having a solid day.  US futures are all pointing sharply higher as well, around 1.5% as I type.

Bond markets are actually mixed this morning, with Treasuries rallying slightly, and yields lower by 1.5 basis points.  However, in Europe, we are seeing bonds sell off (risk is on, after all) although the movement has been quite modest.  After all, with the ECB promising they will be adding new programs come December, why would anyone want to sell bonds the ECB is going to buy?  Of more interest is the fact that Treasury prices are rallying slightly, but this is likely to do with the fact that the market is heavily short Treasury bond futures, and some lightening of positions ahead of the election could well be in order.

On the commodity front, oil prices are falling further, as the renewed wave of lockdowns in Europe has depressed demand, while Libya simultaneously announced they have increased production to 1 million bbl/day, the last thing the oil market needs.  Gold, meanwhile, is moving higher, which strongly suggests it is behaving as a risk mitigant, given the fact neither rates are falling nor is the dollar.

As to the dollar, arguably, the best description today is mixed.  With so much new information yet to come this week, investors and traders seem to be biding their time.  In the G10, it is an even split, with three currencies modestly firmer, (CAD, NZD and AUD all +0.2%) and three currencies modestly weaker (NOK and GBP -0.2%, CHF -0.1%) with the rest essentially unchanged.  The one that makes the most sense is NOK, with oil continuing its slide.  Surprisingly, the pound is weaker given the story circulating that the EU and UK have essentially reached a compromise on the fisheries issue, one of the key sticking points in Brexit negotiations.

Emerging market currencies have a stronger bias toward weakness with RUB (-1.25%) and TRY (-1.0%) leading the way lower.  Clearly, the former is oil related while the lira has been getting pummeled for weeks as investors continue to vote on their views of Turkish monetary policy and the economic potential given new sanctions from the West.  But after those two, most APAC currencies were under pressure, somewhat surprisingly given the Chinese data, however, INR and TWD (-0.45% each) also underperformed last night.  On the plus side, CZK (+0.35%) is the leader, benefitting from a better than expected PMI print.

Speaking of data, Manufacturing PMI’s from Europe were all revised slightly higher, but had little overall impact on the FX markets.  This week, of course brings a great deal of info:

Today ISM Manufacturing 56.0
ISM Prices Paid 60.5
Construction Spending 1.0%
Tuesday Factory Orders 1.0%
Wednesday ADP Employment 650K
Trade Balance -$63.9B
ISM Services 57.5
Thursday Initial Claims 740K
Continuing Claims 7.35M
Nonfarm Productivity 5.2%
Unit Labor Costs -10.1%
FOMC Rate Decision 0.00% – 0.25%
Friday Nonfarm Payrolls 580K
Private Payrolls 680K
Manufacturing Payrolls 51K
Unemployment Rate 7.6%
Average Hourly Earnings 0.2% (4.6% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Consumer Credit $7.5B

Source: Bloomberg

Adding to the mix is the BOE meeting on Thursday as well, while the RBA meets tonight.  To me, this is just trying to level set as we await this week’s extraordinary possibilities.  Nothing has changed my view that the dollar is likely to strengthen as the situation elsewhere in the world, especially in Europe, is pointing to a terrible Q4 outcome economically (and, I fear in the health category) which will continue to weigh on the euro, as well as most emerging markets.  But one thing is clear, is there is a huge amount of uncertainty for the rest of this week.

Good luck and stay safe
Adf

Risk is in Doubt

Posted on by

The chatter before the Fed met
Was Powell and friends were all set
To ease even more
Until they restore
Inflation to lessen the debt

And while Jay attempted just that
His efforts have seemed to fall flat
Now risk is in doubt
As traders clear out
Positions from stocks to Thai baht

Well, the Fed meeting is now history and in what cannot be very surprising, the Chairman found out that once you have established a stance of maximum policy ease, it is very difficult to sound even more dovish.  So, yes, the Fed promised to maintain current policy “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”  And if you really parse those words compared to the previous statement’s “…maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, you could make the case it is more dovish.  But the one thing at which market participants are not very good is splitting hairs.  And I would argue that is what you are doing here.  Between the old statement and Powell’s Jackson Hole speech, everybody already knew the Fed was not going to raise rates for a very long time.  Yesterday was merely confirmation.

In fact, ironically, I think the fact that there were two dissents on the vote, Kaplan and Kashkari, made things worse.  The reason is that both of them sought even easier policy and so as dovish as one might believe the new statement sounds, clearly some members felt it could be even more dovish than that.  At the same time, the dot plot added virtually nothing to the discussion as the vast majority believe that through 2023 the policy rate will remain pegged between 0.00%-0.25% where it is now.  Also, while generating inflation remains the animating force of the committee, according to the Summary of Economic Projections released yesterday, even their own members don’t believe that core PCE will ever rise above 2.0% and not even touch that level until 2023.

Add it all up and it seems pretty clear that the Fed is out of bullets, at least as currently configured with respect to their Congressional mandate and restrictions.  It will require Congress to amend the Federal Reserve Act and allow them to purchase equities in order to truly change the playing field and there is no evidence that anything of that nature is in the cards.  A look at the history of the effectiveness of QE and either zero or negative interest rates shows that neither one does much for the economy, although both do support asset markets.  Given those are the only tools the Fed has, and they are both already in full use (and not just at the Fed, but everywhere in the G10), it is abundantly clear why central bankers worldwide are willing to sacrifice their independence in order to cajole governments to apply further fiscal stimulus.  Central banks seem to have reached the limit of their capabilities to address the real economy.  And if (when) things turn back down, they are going to shoulder as much blame as elected officials can give with respect to who is responsible for the bad news.

With that as background, let’s take a peek at how markets have responded to the news.  Net-net, it hasn’t been pretty.  Equity markets are in the red worldwide with losses overnight (Nikkei -0.7%, Hang Seng -1.6%, Shanghai -0.4%) and in Europe (DAX -0.7%, CAC -0.8%, FTSE 100 -1.0%).  US futures are pointing lower after equity markets in the US ceded all their gains after the FOMC and closed lower yesterday.  At this time, all three futures indices are lower by about 1.0%.

Meanwhile, bond markets, which if you recall have not been tracking the equity market risk sentiment very closely over the past several weeks, are edging higher, at least in those markets truly seen as havens.  So, Treasury yields are lower by 2bps, while German bunds and French OATS are both seeing yields edge lower, but by less than one basis point.  However, the rest of the European government bond market is under modest pressure, with the PIGS seeing their bonds sell off and yields rising between one and two basis points.  Of course, as long as the ECB continues to buy bonds via the PEPP, none of these are likely to fall that far in price, thus yields there are certainly capped for the time being.  I mean even Greek 10-year yields are 1.06%!  This from a country that has defaulted six times in the modern era, the most recent being less than ten years ago.

Finally, if we look to the FX markets, it can be no surprise to see the dollar has begun to reverse some of its recent losses.  Remember, the meme here has been that the Fed would be the easiest of all central banks with respect to monetary policy and so the dollar had much further to fall.  Combine that with the long-term theme of macroeconomic concerns over the US twin deficits (budget and current account) and short dollars was the most popular position in the market for the past three to four months.  Thus, yesterday’s FOMC outcome, where it has become increasingly clear that the Fed has little else to do in the way of policy ease, means that other nations now have an opportunity to ease further at the margin, changing the relationship and ultimately watching their currency weaken versus the dollar.  Remember, too, that essentially no country is comfortable with a strong currency at this point, as stoking inflation and driving export growth are the top two goals around the world.  The dollar’s rebound has only just begun.

Specifically, in the G10, we see NOK (-0.5%) as the laggard this morning, as it responds not just to the dollar’s strength today, but also to the stalling oil prices, whose recent rally has been cut short.  As to the rest of the bloc, losses are generally between 0.15%-0.25% with no specific stories to drive anything.  The exception is JPY (+0.2%) which is performing its role as a haven asset today.  While this is a slow start, do not be surprised to see the dollar start to gain momentum as technical indicators give way.

Emerging market currencies are also under pressure this morning led by MXN (-0.7%) and ZAR (-0.6%).  If you recall, these have been two of the best performing currencies over the past month, with significant long positions in each driving gains of 5.3% and 7.1% respectively.  As such, it can be no surprise that they are the first positions being unwound in this process.  But throughout this bloc, we are seeing weakness across the board with average declines on the order of 0.3%-0.4%.  Again, given the overall risk framework, there is no need for specific stories to drive things.

On the data front, yesterday’s Retail Sales data was a bit softer than expected, although was generally overlooked ahead of the FOMC.  This morning saw Eurozone CPI print at -0.2%, 0.4% core, both still miles below their target, and highlighting that we can expect further action from the ECB.  At home, we are awaiting Initial Claims (exp 850K), Continuing Claims (13.0M), Housing Starts (1483K), Building Permits (1512K) and the Philly Fed index (15.0).

Back on the policy front, the BOE announced no change in policy at all, leaving the base rate at 0.10% and not expanding their asset purchase program.  However, in their effort to ease further they did two things, explicitly said they won’t tighten until there is significant progress on the inflation goal, but more importantly, said that they will “engage with regulators on how to implement negative rates.”  This is a huge change, and, not surprisingly the market sees it as another central bank easing further than the Fed.  The pound has fallen sharply on the news, down 0.6% and likely has further to go.  Last night the BOJ left policy on hold, as they too are out of ammunition.  The fear animating that group is that risk appetite wanes and haven demand drives the yen much higher, something which they can ill afford and yet something which they are essentially powerless to prevent.  But not today.  Today, look for a modest continuation of the dollar’s gains as more positions get unwound.

Good luck and stay safe
Adf

Whom He Must Obey

Posted on by

The question is, what can he say?
You know, course, I’m talkin’ ‘bout Jay
Can he still, more, ease?
In order to please
The markets whom he must obey

Fed day has arrived, and all eyes are on the virtual Marriner Eccles Building in Washington, where the FOMC used to meet, prior to the current pandemic.  In the wake of Chairman Powell’s speech at the end of August, during the virtual Jackson Hole symposium, where he outlined the new Fed framework; analysts, economists and market participants have been trying to guess when there will be more details forthcoming regarding how the Fed plans to achieve their new goals.  Recall, stable prices have been redefined as ‘an average inflation rate of 2.0% over time’.  However, Powell gave no indication as to what timeline was considered, whether it was fixed or variable, and how wide a dispersion around their target they are willing to countenance.  So generally, we don’t know anything about this policy tweak other than the fact that, by definition, inflation above 2.0% will not be considered a sufficient reason to tighten monetary policy.  There are as many theories of what they are going to do as there are analysts propagating them, which is why this meeting is seen as so important.

As it is a quarterly meeting, we will also see new Fed economic forecasts and the dot plot will be extended to include the FOMC membership’s views of rates through 2023.  As to the latter, the working assumption is that virtually the entire committee expects rates to remain at current levels throughout the period.  Reinforcing this view is the futures market, where Fed Funds futures are essentially flat at current levels through the last listed contract in August 2023.  Eurodollar futures show the first full rise in rates priced for June 2024.  In other words, market participants are not looking for any policy tightening anytime soon.

Which begs the question, exactly what can Jay say that could be considered dovish at this point?  Certainly, he could explain that they are going to increase QE, but that is already defined as whatever is deemed necessary to smooth the functioning of markets.  Perhaps if he defines it as more than that, meaning it is supposed to help support economic activity, that would be interpreted as more dovish.  But isn’t infinite QE already as much as they can do?

It seems highly unlikely that the committee will give a fixed date as to when policy may eventually tighten.  But it is possible, though I think highly unlikely as well, that they define what level of inflation may require a change in policy.  The problem with that theory is there are too many potential paths down which inflation can wander.  For instance, if core PCE increased to 2.5% (a BIG if) and remained stable there for six months, would that be enough to force an adjustment to policy?  Would one year be the right amount?  Five years?  After all, core PCE has averaged 1.6% for the past ten years.  For the past twenty, the average has been 1.72%.  In fact, you have to go back over the past 32 years in order to calculate the average core PCE at 2.0%.  And of course, this is the problem with the Fed’s new framework, it doesn’t really tell us much about the future of policy other than, it is going to be ultra-easy for a long, long time.

It is with this in mind that the market has embraced the idea that the dollar must naturally fall as a consequence.  And that is a fair point.  If the Fed continues to out-ease all other central banks, then the dollar is quite likely to continue to soften.  But as we have seen already from numerous ECB speakers, and are likely to see from the BOE tomorrow, the Fed is not acting in a vacuum.  FX continues to be a relative game, as the differential in policies between currencies is the driving factor.  And while Madame Lagarde did say she was not concerned about the euro’s strength, you may recall that she also indicated, once upon a time, that it was not the ECB’s job to worry about Italian government bond yields.  That was her position for at least a day before the ECB figured out that was their entire job and created the PEPP.  My point is, if Jay comes across as more dovish somehow, you can be certain that every other central bank will double down on their own policy ease.  No country wants to be the one with the strong currency these days.

But for now, the market is still of the opinion that the Fed is out in the lead, and so the dollar continues to drift lower.  This morning, we see the dollar weaker against the entire G10 bloc with NOK (+0.6%) the leader on the back of oil’s 2.5% rally, although GBP (+0.5%) is also firmer after UK inflation data showed smaller declines than forecast, perhaps alleviating some of the pressure on the BOE to ease further.  At least that’s the thought right now.  But even the euro, after ultimately slipping yesterday, has rallied a modest 0.15% although it remains below 1.19 as I type.

Emerging market currencies are behaving in a similar manner, as the entire bloc is firmer vs. the greenback.  Once again ZAR (+0.95%) leads the pack on the combination of firmer commodity prices (gold +0.5%), the highest real yields around and faith that the Fed will continue to ease further.  But we are seeing MXN (+0.5%) gaining on oil’s rally and CNY (+0.35%) following up yesterday’s gains with a further boost as expectations grow that China’s economy is truly going to be back to pre-Covid levels before the end of the year.  Overall, it is a day of dollar weakness.

Other markets have shown less exuberance as Asian equity markets were essentially flat (Nikkei +0.1%, Hang Seng 0.0%, Shanghai -0.3%) and European bourses are also either side of flat (DAX -0.1%, CAC +0.1%, FTSE 100 -0.1%).  US futures, naturally, continue to rally, with all three indices looking at gains of 0.4%-0.6% at this time.

Government bond markets remain dull, with another large US auction easily absorbed yesterday and 10-year yields less than a basis point different than yesterday’s levels.  In Europe, actually, most bond yields have edged a bit lower, but only one to two basis points’ worth, so hardly a sign of panic.

As to the data story, yesterday saw a much better than forecast Empire Manufacturing number (+17.0) boding well for the recovery.  This morning brings Retail Sales (exp 1.0% headline, 1.0% ex autos) at 8:30, and then the long wait until the FOMC statement is released at 2:00pm.  Chairman Powell will hold his press conference at 2:30, and if he manages to sound dovish, perhaps we see further dollar declines and equity rallies.  But I sense the opportunity for some disappointment and perhaps a short-term reversal if he doesn’t invent a new dovish theme.  In that case, look for the dollar to recoup today’s losses at least.

Good luck and stay safe
Adf

Fear Has Diminished

Posted on by

From Asia, last night, what we learned
Was China, the corner, has turned
The lockdowns are finished
And fear has diminished
Thus spending, in spades, has returned

The major news overnight comes from China, where the monthly release of data on IP, investment and Retail Sales showed that the Chinese economy is clearly regaining strength.  Arguably, the most noteworthy number was Retail Sales, which while still lower by -8.6% YTD, has rebounded to be 0.5% higher than August of last year.  Anecdotally, movie theaters there have seen attendance return to ~90% of pre-Covid levels, obviously far above anything seen here or in most of Europe.  In addition to the Retail Sales data, IP there rose 5.6% Y/Y and Property Investment rose a greater than forecast 4.6% on a YTD basis.  Overall, while these numbers are still well below the data China had been reporting pre-Covid, they point to Q3 GDP growth in excess of 3.0%, with some analysts now expecting GDP to grow as much as 6% in the third quarter.

With this unalloyed good economic news, it should be no surprise that the renminbi has performed well, and in fact, CNY is one of the top performers today, rising 0.5% and trading to levels not seen since May of last year.  While there are still numerous concerns regarding different aspects of China’s economy, notably that its banking sector is insolvent amid massively underreported bad loans, on the surface, things look better than almost anywhere else in the world.  Perhaps what is more surprising is that the equity market in Shanghai, which rose 0.5% overnight, did not have a better day.

Down Under, the RBA noted
That Aussie, though not really bloated
Would be better off
In more of a trough
Thus, helping growth there be promoted

Meanwhile, the Minutes of the most recent RBA meeting showed that while they couldn’t complain that the Aussie dollar was overvalued, especially given the recent rebound in commodity prices, they sure would like to see it lower to help the export sector of the economy.  However, despite reaffirming they would continue to support the economy, and that yield curve control wasn’t going anywhere, they gave no indication they were about to increase their support.  As such, AUD (+0.6%) is the top G10 performer of the session, and it is now pushing back to the 2-year highs seen earlier this month.

Turning to Europe, the two stories of note come from the UK and the ECB.  In Parliament, PM Johnson had the first reading of his bill that is set to unilaterally rewrite the Brexit deal with the EU, and it passed handily.  It appears that Boris believes he needs even more leverage to force the EU to accede to whatever demands remain in the negotiations, and he is comfortable playing hardball to achieve his ends.  The Europeans, however, continue to believe they have the upper hand and claim they are prepared to have the UK leave with no deal.  Politics being what it is, I imagine we won’t know the outcome until the last possible date, which is ostensibly next month at the EU Summit.

In the meantime, the market is starting to get concerned that a hard Brexit is back on the table and that the pound has much more to fall if that is the outcome.  While the market is not at record long GBP position levels, it is still quite long pounds.  The options market has been pricing more aggressively, with implied volatility around 12% for year-end (compared to 3-month historic volatility of just 9%) and risk reversals 2.5 points for the GBP puts.  While the pound has fallen a bit more than 4% since its peak on September 1st, it is still well above levels seen when fears of a hard Brexit were more prevalent.  As this new bill makes its way through Parliament, I suspect the pound will have further to decline.

As to the ECB, we have had yet more verbal intervention, this time from Italian Executive Board member, Fabio Panetta, who repeated that the ECB needs to remain vigilant and that though they have done a great job so far, they still may need to do more (i.e. ease further) in order to achieve their inflation goals.  The euro, however, continues to drift higher, up another 0.25% this morning, as the market appears to be preparing for a more aggressive FOMC statement and implicit further easing by the Fed.  While I believe it is too early for the Fed to more clearly outline their explicit plans on how to achieve average inflation of 2.0%, clearly there are many market participants who believe the Fed will be the most aggressive central bank going forward and that the dollar will suffer accordingly.  We shall see, but as I have repeatedly indicated, and Signor Panetta helped reiterate, the ECB will not stand idly by and allow the euro to rally unabated.

And those are really today’s stories.  Risk appetite continues to be fed by perceptions of further easy money from all central banks and we have seen equity markets continue their rebound from the short correction at the beginning of the month.  While Asia was mixed, Europe is in the green and US futures are pointing higher as well.  Treasuries are a touch lower, with yields up about 1 basis point, but the reality here is that yields have been in a very tight range for the past month.  In fact, the idea that the Fed needs to introduce yield control is laughable as it appears to already be in place.

As to the rest of the FX market, the dollar is under pressure everywhere, although Aussie and cable are the two leaders in the G10 space.  Elsewhere, there appears to be less conviction, or at least less rationale to buy the currency aggressively.  In the EMG bloc, ZAR is the leader, rising 1.2% this morning, continuing its strengthening trend that began back in August and has seen a nearly 7% appreciation in the interim.  Otherwise, there has been less excitement, with more modest gains on the back of generic USD weakness.

For today, we see Empire Manufacturing (exp 6.9) this morning as well as IP (1.0%) and Capacity Utilization (71.4%).  Alas, with the Fed meeting tomorrow and all eyes pointed to Washington, it seems unlikely that the market will respond to any of this data.  Instead, with the market clearly comfortable selling dollars right now, I see no reason for the buck to do anything but drift lower on the day.

Good luck and stay safe
Adf

Nations Regress

Posted on by

When two weeks ago I last wrote
The narrative was to promote
A dollar decline
Which did intertwine
With hatred for Trump ere the vote

But since then the dollar’s rebounded
While experts galore are confounded
Poor Europe’s a mess
While nations regress
On Covid, where hope had been founded

I told you so?  Before my mandatory leave began, the market narrative was that the dollar was not merely falling, but “collapsing” as everything about the US was deemed negative.  The background story continued to be about US politics and how global investors were steadily exiting the US, ostensibly because of the current administration.  Adding to that was Chairman Powell’s speech at the virtual Jackson Hole symposium outlining average inflation targeting, which implied that the Fed was not going to respond to incipient inflation by raising rates until measured inflation was significantly higher and remained there sufficiently long to offset the past decade’s period of undershooting inflation.  In other words, if (when) inflation rises, US interest rates will remain pegged to the floor, thus offering no support for the dollar.  While there were a few voices in the wilderness arguing the point, this outcome seemed assured.

And the dollar did decline with the euro finally breeching the 1.20 level, ever so briefly, back on September 1st.  But as I argued before leaving, there was no way the ECB was going to sit by idly and watch the euro continue to rally without a policy response.  ECB Chief economist Philip Lane was the first to start verbal intervention, which was sufficient to take the wind out of the euro’s sails right after it touched 1.20.  Since then, the ECB meeting last week was noteworthy for not discussing the euro at all, with market participants, once again, quickly accepting that the ECB would allow the single currency to rally further.  But this weekend saw the second volley of verbal intervention, this time by Madame Lagarde, VP Guindos, Ollie Rehn and Mr Lane, yet again.  Expect this pattern to be repeated regularly, every euro rally will be met with more verbal intervention.

Of course, over time, verbal intervention will not be enough to do the job, which implies that at some point in the future, we will see a more intensive effort by the ECB to help pump up inflation.  In order of appearance look for a significant increase in QE via the PEPP program, stronger forward guidance regarding the timing of any incipient rate hikes (never!), a further cut to interest rates and finally, actual intervention.  In the end, there is absolutely no way that the ECB is going to allow the euro to rally very much further than it already has.  After all, CPI in the Eurozone is sitting at -0.2% (core +0.4%), so far below target that they must do more.  And a stronger euro is not going to help the cause.

Speaking of inflation, I think it is worth mentioning the US situation, where for the second straight month, CPI data was much higher than expected.  While many analysts are convinced that the Fed’s rampant asset purchases and expansion of the money supply are unlikely to drive inflation going forward, I beg to differ.  The lesson we learned from the GFC and the Fed’s first gargantuan expansion of money supply and their balance sheet was that if all that money sits in excess reserves on commercial bank balance sheets, velocity of money declines and inflation is absent.  This time, however, the new funds are not simply sitting on the banks’ collective balance sheets but are rather being spent by the recipients of Federal government largesse.  This is driving velocity higher, and with it, inflation.  Now, whatever one may think of Chairman Powell and his Fed brethren, they are not stupid.  The Jackson Hole speech, I believe, served two purposes.  First, it was to help investors understand the Fed’s reaction function going forward, i.e. higher inflation does not mean higher interest rates.  But second, and something that has seen a lot less press, is that the Fed has just moved the goalposts ahead of what they see as a rising tide of inflation.  Now, if (when) inflation runs hot over the next 12-24 months, the Fed will have already explained that they do not need to respond as the average inflation rate has not yet achieved 2.0%.  It is this outcome that will eventually undermine the dollar’s value, higher inflation with no monetary response, but we are still many months away from that outcome.

Turning to today’s activity, after two weeks of broad dollar strength, as well as some equity market pyrotechnics, we are seeing a bit of a dollar sell-off today.  It would be hard to characterize the markets as risk-on given the fact that European bourses are essentially flat on the day (DAX -0.1%, CAC +0.1%) while Asian equity markets showed only modest strength at best (Nikkei, Hang Seng and Shanghai all +0.6%).  Yes, US futures are pointing higher by 1.0%, but that seems more to do with the two large M&A deals announced than anything else.

In the meantime, bond markets have shown no indication of risk being on, with 10-year Treasury yields essentially unchanged since Friday at 0.67%, and effectively unchanged since I last wrote on August 28!  The same is largely true across European government bond markets, with, if anything, a bias for risk-off as most of those have seen yields slide one to two basis points.

And finally, the dollar’s specifics show GBP (+0.6%) to be the top G10 performer, which given its recent performance, down more than 4% since I last wrote, seems to be a bit of a breather rather than anything positive per se.  In the UK, today sees the beginning of the Parliamentary debate regarding PM Johnson’s proposed rewrite of aspects of Brexit legislation, which many think, if passed, will insure a hard Brexit.  As to the rest of the bloc, gains are mostly in the 0.25% range, with the most common theme the uptick in economists’ collective forecasts for economic prospects compared with last month.

Interestingly, in the EMG bloc, movement is less pronounced, with MXN (+0.4%) the biggest gainer, while RUB (-0.4%) is the laggard.  Clearly, as both are oil related, oil is not the driver.  However, when EMG currencies move less than 0.5%, it is hard to get too excited overall.

On the data front this week, the big story is, of course, the FOMC meeting on Wednesday, but we have a bunch of things to absorb.

Tuesday Empire Manufacturing 6.0
IP 1.0%
Capacity Utilization 71.4%
Wednesday Retail Sales 1.0%
-ex autos 1.0%
Business Inventories 0.2%
FOMC Rate Decision 0.00%-0.25%
Thursday Initial Claims 850K
Continuing Claims 13.0M
Housing Starts 1480K
Building Permits 1520K
Friday Leading Indicators 1.3%
Michigan Sentiment 75.0

Source: Bloomberg

What we have seen lately is the lagging indicators showing that the bounce after the reopening of the economy was stronger than expected, but there is growing concern that it may not be sustainable.  At the same time, the only thing interesting about the FOMC meeting will be the new forecasts as well as the dot plot.  After all, Jay just told us what they are going to do for the foreseeable future (nothing) two weeks ago.

Good luck and stay safe
Adf