In Europe, the maximum nation
Is facing the scourge of inflation
And so, they are calling,
To help it start falling,
For less money accommodation
But others in Europe reject
The idea inflation’s unchecked
T’would be premature
To tighten, they’re sure
As QE they want to protect
It appears there is a growing rift in the ECB as we are beginning to hear more opposing views regarding the nature of inflation and correspondingly as to the prescription to address the issue. On the one hand, the hawks have been sharpening their talons with Germany’s Schnabel, Slovenia’s Vasle and Spain’s de Guindos having all warned of inflation’s surprising persistence and explaining that the risk is to the upside for higher inflation still. Meanwhile, this morning we had an erstwhile Hawk, Austria’s Holzmann, and an uber-dove, Italy’s Panetta pushing back on that view and insisting that the inflation that has been afflicting Europe is being driven by “purely temporary factors” and that premature withdrawal of stimulus would be a mistake.
The surprising feature of this discussion is that the Spanish voice is hawkish while the Austrian is dovish. Perhaps what that tells us is that, just like in the US, inflation has become a bigger political problem in Spain and the Socialist PM, Pedro Sanchez, is feeling the heat from the population there. This would not be surprising given inflation is running at 5.4%, the highest level since the introduction of the euro in 1999. Arguably, the fact that Robert Holzmann seems to be siding with the transitory camp is also quite the surprise, but as they say, politics makes strange bedfellows. In the end, as long as Madame Lagarde remains at the helm, the doves remain in control. As such, these comments sound very much like posturing for particular audiences.
Turning to other news, Germany is at the center of the most interesting stories today as local politics (the formation of a new government…finally) as well as data (IFO Expectations fell to 94.2) seem to be driving the euro bus, and with the euro, the rest of the markets. A brief look at the proposed government shows a coalition of the Social Democrats (SPD), the Greens and the Free Democratic Party (FDP) which is a pro-growth, free markets group. This unprecedented grouping of 3 parties remains tenuous, at best, if only because the underlying belief sets are very different. It remains unclear how a party whose focus is on less government (FDP) is going to work effectively with a party whose focus is on bigger government (SPD). Olaf Scholz will be the new PM, a man with long experience in politics and a widely respected name. As I said before, politics makes strange bedfellows!
On the economic side, this morning’s IFO data was quite disappointing, with Expectations falling back to levels seen in the beginning of the year and reaching a point that foretells of a recession coming. Adding this to the imminent lockdown scenario (Germany’s Covid caseload jumped by 54K yesterday, with a significant surge ongoing), leaves quite the negative impression for the German economy. In fact, given this news, it becomes harder for the hawks to make their case as the central bank model continues to believe that slowing growth will slow inflation. (And while that would be true for demand-pull inflation, the whole cost-push framework is different.) At any rate, the result is a day where risk is being shed and havens sought. This is especially so in Germany, where the DAX (-0.6%) is the weakest performer in Europe, while Bunds (-1.7bps) have rallied despite a terrible auction outcome as investors adjust asset mixes. And the euro? Down a further 0.3%, trading just above 1.1200, although it appears that there is further to run.
What about the rest of markets? Well, the Nikkei (-1.6%) fell sharply as investors in Japan expressed concern that the Fed would begin to tighten, and it would have negative impacts throughout the world. At least that is what they claim. China, on the other hand saw much less movement with the Hang Seng (+0.1%) and Shanghai (+0.1%) seeing a mix of gainers and losers internally thus offsetting for the index as a whole. The rest of Europe is generally softer (CAC -0.2%, Spain’s IBEX -0.3%), although the FTSE 100 is basically unchanged on the day. And after a mixed day yesterday, US futures are pointing modestly lower, -0.2% or so across the board.
As to the rest of the bond market, Treasuries (-2.4bps) are finally rallying after seeing a dramatic 12 basis point rise in the past three sessions. We have also seen OATs (-0.7bps) rally slightly and Dutch bonds (-1.6bps) all the havens. It should not, however, be surprising that Italian BTPs (+1.2bps) and Greek bonds (+3.9bps) are being sold as they remain risk assets in full.
On the commodity front, oil, which has been suffering from the SPR release story, seems to have absorbed that risk and after rebounding yesterday is flat this morning. While still below $80/bbl, my sense is this has further to run higher. NatGas (-0.25%) is a touch lower in the US as is gold (-0.1%). However, the industrial metals are performing far better (Cu +0.7%, Al +0.7%, Sn +0.4%).
Lastly, the dollar is generally having a good day again, as risk appetite wanes. NZD (-0.6%) is the weakest G10 currency after the market was disappointed in their actions last night, only raising the base rate by 0.25% while the whisper number was 0.5%. SEK (-0.4%) is the next laggard, with the krona continuing to suffer on the view that the Riksbank will remain reluctant to tighten policy at all in the face of actions by the Fed and potentially the BOE. The rest of the bloc is generally softer with only the haven, JPY (+0.1%), showing any strength.
In the EMG space, we need to look away from TRY (+5.6%) which is retracing some of yesterday’s remarkable decline, as it is destined for extreme volatility in the near future. But elsewhere, there is actually a mixed result with BRL (+0.6%) and PHP (+0.5%) leading the gainers while THB (-0.7%) and RUB (-0.3%) lag the space. The real is benefitting from the central bank announcement it will be auctioning off 14K contracts in the FX markets, part of their intervention process, while the Philippine peso has benefitted from further investment inflows to the local stock market. On the flipside, the baht seems to be suffering from concerns that the lockdowns in Europe will reduce tourism there during the high season, while the ruble continues to suffer from concerns over potential military activity and the further negative impacts of sanctions that could follow.
Given tomorrow’s Thanksgiving holiday, all the rest of the week’s data will be released today:
|Core PCE||0.4% (4.1% Y/Y)|
|New Home Sales||800K|
As the GDP data is a revision, it will not garner much attention. Rather, all eyes will be focused on Core PCE, as if recent form holds, it will print higher than expectations, further forcing the Fed debate. And of course, the Minutes will be parsed intently as traders try to divine just how quickly things may change next month, especially since Chairman Powell and Governor Brainerd have both been clear that inflation is their primary concern now.
At this point, there is nothing to stand in the way of the dollar and I expect that it will continue to grind higher for a while. The hallmark of the move so far this month, where the single currency has fallen 3.0%, is that it has been remarkably steady with a majority of sessions showing modest declines. That pattern seems likely to continue for now unless there is a change from either the Fed or the ECB, neither of which seems likely. Hedge accordingly.
Have a wonderful Thanksgiving holiday and poetry will return on Monday November 29th.
Good luck, good weekend and stay safe