Said Janet, do not be misled
Strong growth is no sub for widespread
Support from the bill
In Congress which will
Insure budget’s stay in the red
Insure higher yields lay ahead
Insure every table has bread

Treasury Secretary Janet Yellen, who polished her dovish bona fides as Fed Chair from 2013 to 2017, has taken her act to the executive branch and is vociferously trying to make the case that recent positive data is of no concern at this time and that the $1.9 trillion package that is slowly wending its way through Congress remains critical for the economy.  “It’s very important to have a big package that addresses the pain this has caused.  The price of doing too little is much larger than the price of doing something big,” was her exact quote in an interview yesterday.  I wonder, is ‘going big’ the new zeitgeist, replacing YOLO?  After all, not only has Ms Yellen been harping on this theme, which has been taken up by others in government, but there is even a weekly TV Show with that name that opens the door to some of the more remarkable, if ridiculous, things people are willing to do to get on TV.

But go big it is, with no indication that the current administration is concerned about potential longer term negative fiscal outcomes.  The pendulum has swung from the Supply Side rationale for fiscal stimulus (cutting taxes to drive incentives) to the MMT rationale for fiscal stimulus (as long as we borrow in our native currency, we can always repay any amount).  History will almost certainly show that this side of the pendulum is no less damaging than the other side, but given that politics is a short-term phenomenon, only concerned with the time until the next election, we are virtually guaranteed to continue down this road to perdition.

Thus far, the results have been relatively benign, first off because the bill has not yet been made into law, although markets clearly assume it will be, and secondly because the depths of the government induced recession from which we are emerging were truly historic, so it takes some time to go from collapse to explosive growth.  The gravest concern for some (this author included) is that we are going to see significant price inflation in the real economy, not just in asset prices, and in the end, the economy will simply suffer from different problems.  But then, isn’t that what elections are really about?  When administrations change it is a cry to address different issues, not improve the overall situation.

So, with that in mind on this Friday, let’s take a tour of the markets.  Today is one of the few sessions so far this year where the major themes entering 2021 are actually playing out according to plan.  As such, we are seeing continued support in the equity space, with yesterday’s modest sell-off being reversed in most markets.  We are seeing bond markets continue to come under pressure with yields rising on the reflation narrative, and we are watching the dollar decline, albeit still firmly in the middle of the trading range it has traced out this year.

In the equity space, while the Nikkei (-0.7%) was under modest pressure, we saw small gains in the Hang Seng (+0.2%) and Shanghai (+0.5%).  Also noteworthy was the Sydney /ASX 200 (-1.3%) which fell after a widely followed analyst Down Under increased his forecast for interest rates by nearly 50 basis points by year end.  Not surprisingly, this helped AUD (+1.0%) which is the best performing currency today.  As to Europe, the gains are more broad-based with both the CAC and DAX rising by 0.5% although the FTSE 100 is basically flat on the day.  Here, too, there was data that helped drive the market narrative with UK Retail Sales disastrous in January (-8.2%, -8.8% ex fuel) weighing on the FTSE despite stronger than expected preliminary PMI data from the UK (Composite PMI rising to 49.8, up more than 8 points from last month).  Meanwhile, German PPI data jumped sharply (+1.4% in Jan), its largest rise since 2008.  I find it quite interesting that we saw a similarly large rise in the US earlier this week.  It appears that inflationary pressures are starting to bubble up, at least in some economies.  French and Italian CPI data remain mired well below 1.0%, a sign that neither economy is poised to rebound sharply quite yet.  As to US futures, they are all green, but with gains on the order of 0.2%-0.3%, so hardly earth-shattering.

Bond markets, however, continue to sell off around most of the world which is feeding a key conundrum.  One of the rationales for the never-ending stock market rally is the low yield environment, but if bond yields keep rising, that pillar may well be pulled out with serious consequences to the bull case.  But in true reflationary style, Treasury yields have backed up 1 basis point and we are seeing larger yield gains in Europe (Bunds +1.7bps, OATs +1.2bps, Gilts +2.1bps).  In fact, the only bonds in Europe rallying today are Super Mario bonds Italian BTPs (-1.5bps) as the market continues to give Draghi the benefit of the doubt with respect to his ability to save Italy’s economy.

In the commodity space, oil has ceded some of its recent gains with WTI (-2.25%) back below $60/bbl, although still higher by 22% this year.  Precious metals are slightly softer and base metals are mixed with Copper (+1.9%) the true outperformer.

Finally, in the FX market, the dollar is under pressure against the entire G10 space and much of the emerging market space.  In G10, we already discussed Aussie, which has helped drag NZD (+0.7%) higher in its wake.  But the rest of the bloc is seeing solid gains of the 0.3%-0.4% variety with the pound (+0.15%) the laggard after that Retail Sales data.  However, the pound did trade above 1.40 briefly this morning for the first time since April 2018, nearly three years ago.

In the Emerging markets, CNY (+0.5%) has been the biggest gainer with CLP (+0.4%) right behind on the strong copper showing.  However, the CE4 have all tracked the euro higher and are performing well today.  On the downside, BRL (-0.6%), ZAR (-0.5%) and MXN (-0.4%) are the laggards, with the real suffering after cryptic comments from President Bolsonaro regarding fuel price rises by Petrobras and potential government action there.  Meanwhile, the peso has been under pressure of late after Banxico’s 25bp rate cut last week, and growing talk that there could be others if inflation remains quiescent.  And lastly, South Africa suffered almost $1 billion of outflows from the local bond market there, with ensuing pressure on the rand.

On the data front this morning we get Existing Home Sales (exp 6.6M) and the preliminary US PMI data (58.8 Mfg, 58.0 Composite), although as we already learned, strong US data is irrelevant in the fiscal decision process right now.  Two more Fed speakers, Barkin and Rosengren, are on the docket for today, but again, until we hear of a change from Chairman Powell, it is unlikely that the other Fed speakers are going to have much impact.

Summing things up, right now, the reflation trade, as imagined on January 1st, is playing out.  Quite frankly, the dollar is simply trading in a new range (1.1950/1.2150) and until the euro can make new highs, above 1.2350, I would not get too excited.  The one thing that is very true is that market liquidity is shallower than it has been in the past which explains the choppiness of trading, but also should inform hedging expectations.

Good luck, good weekend and stay safe

Go Big

This morning, a former Fed chair
Will speak and is set to declare
It’s time to “go big”
In order to dig
The nation out from its despair

After a quiet holiday shortened session yesterday, markets are showing modest positivity overall, although European equity markets seem to be lacking any oomph.  However, most other risk indicators are pointing to a resumption of risk appetite with haven assets declining, commodity prices rising and the dollar under pressure.

Though we await the outcomes from three key central bank meetings later this week, there is little in the way of data to consider otherwise, so market participants are looking for other potential catalysts.  Chief among those catalysts today is the testimony by former Fed Chair, Janet Yellen, in the Senate as she is being vetted for Treasury Secretary in the new administration.

According to the release of the prepared statement, ahead of questions, she will explain that the US has been suffering from a K-shaped recovery for many years (in fact since she exacerbated that situation as Fed chair) and therefore the government needs to support policies that will help more people.  On the subject of issuing more Treasury debt, it appears she has weighed the consequences of excessive government debt and will say, with rates so low, it is time to “go big” and issue even more in order to fund the new administration’s priorities.  One other key topic of market interest is the dollar, where she will explain that a market set exchange rate is the best possible outcome, and that should be true of all nations.

For our purposes, the question is how these policies will impact markets overall, and the dollar specifically.  It is abundantly clear from the Treasury market’s performance ever since the Georgia run-off elections (10-year yields have risen 20.6 basis points, including 3.6 today) that the market is already anticipating the Treasury ‘going big’ when it comes to further debt issuance.  In fact, that is part and parcel of the reflation trade that has come back into vogue, with the expected further steepening of the yield curve.  In other words, while there may be some pushback from specific Senators, it seems implausible that reconfirming there will be significant new debt issuance to fund deficits will be seen as a mainstream concern.  Rather, the question will be how the Fed will respond when interest rates continue to rise and the cost of funding all that new debt issuance increases.

As to the dollar, while it appears she will not explicitly state a preference with respect to a weak or strong dollar, it seems pretty clear that the combination of the new administration debt policies with a Fed that is unlikely to allow interest rates to rise to true market-clearing levels will result in significantly more negative real yields as inflation continues to rise.  The result of this process will inevitably be a much weaker dollar.  While the market is currently in a consolidation phase, the dollar’s weakness has been manifesting since last spring.  And though positioning in this trade is huge, it does not mean the idea underpinning those positions is wrong.  As well, I believe there will be a very clear signal for when the dollar will begin it next leg lower; the Fed hinting at   whatever rate mitigation strategy they choose will be clear evidence that the negative real yield structure will expand, and the dollar will henceforth decline more substantially.  However, it could well be several months before that is the case, as we will need to see a continued climb in inflation data as well as the increased debt issuance to drive nominal interest rates higher thus forcing the Fed’s response.

But, as I said, that dollar story is still several months into the future, so let us focus on today’s happenings.  Overall, risk appetite is continuing to improve.  Asian equity markets were mostly stronger (Nikkei +1.4%, Hang Seng +2.7%) although Shanghai (-0.8%) didn’t manage to join in the fun.  While money is flowing rapidly into Hong Kong, it seems there is some concern that the PBOC may be tapping the brakes on liquidity in the real estate market in China, thus removing some of the spare cash and hurting equities as a side effect.  Europe, though, has had a different type of session this morning, with the three main markets all just marginally higher (DAX +0.3%, CAC +0.1%, FTSE 100 +0.2%) and several continental exchanges in the red.  The most notable piece of data from the Eurozone was the German ZEW Expectations survey, which was released slightly better than expected at 61.8, which while historically low, does indicate continue confidence in a recovery there.  US futures, though, are all in for more government spending and are currently higher by between 0.65% (DOW) and 1.0% (NASDAQ).  Clearly, there is no concern over too much debt there.

Speaking of debt, bond markets are behaving as you would expect in a risk-on scenario, with haven bonds declining around the world.  While Treasury yields have risen the most on the day, we seen Bunds (+1.1bps), OATs (+0.5bps) and Gilts (+1.5bps) all under pressure this morning.  Similarly, the PIGS are seeing demand grow on the back of increasing risk appetite with yields in those four nations’ bonds declining between 1 and 2 basis points.

Commodity prices are firmer with oil higher by 0.4% and the ags al looking at gains of between 0.25% and 2.0%, with most of them at multi-year highs.  And finally, the dollar is under pressure almost universally, with only JPY (-0.3%) weaker in the G10, the classic risk-on price action.  SEK (+0.9%) and NOK (+0.8%) are leading the way higher here, with oil clearly supporting the latter while the former is simply demonstrating its high beta with respect to the euro (+0.45%).

In the EMG bloc, ZAR (+1.3%) leads the way on the stronger commodity story, while BRL (+0.85%) and HUF (+0.8%) are next in line.  The real seems to be responding to both firmer commodity prices as well as news that the Covid vaccination program, which had been delayed through bureaucratic misfires, is finally set to get going, which is especially important given the surge in cases there.  As to HUF, the story is more about the CE4 rallying with the euro than with any specific economic or political stories from the country.  But the entire EMG bloc is higher, with the worst performers simply unchanged on the day.

On the data front, there is no mainstream data today, and no Fed speakers either as we are in the quiet period ahead of next Wednesday’s FOMC meeting.  Which brings us back to Yellen’s testimony as the most significant potential new information we are likely to see.  As Fed chair, she was one of the most dovish in history and there is no reason to believe that she will have changed that stance as Treasury secretary.  Instead, I fear we will see a virtual combination of the Fed and Treasury, and the resultant monetization of US debt will be a long term drag on the economy amid rising inflation.  That is not a dollar positive, I assure you, but not today’s problem.

Good luck and stay safe