The Feathers of Hawks

It seems like the feathers of hawks
Turn whiter when each of them talks
On Monday, Loretta
Said policy betta
Stay easy for pumping up stocks

For those of you not familiar with a word ladder, it is a type of puzzle where you start with a word, Hawk, for example, and change one letter in each step, while maintaining the order of the letters, to form another word and keep doing so until you arrive at the desired second word.  The object is to complete this task in as few moves as possible.  In this way, this morning’s task is to use a word ladder to turn hawk into dove (one possible answer below).

Once upon a time, in the economic community, there were two schools of thought as to how monetary policy would best serve a nation.  There were hawks, who believed that Ludwig von Mises and Friedrich Hayek had identified the most effective way for central banks to behave; namely minimalist activity and allowing the markets to work.  The consequences of this policy view were that economic cycles would exist but would be moderated naturally rather than allowing bubbles to inflate and interest rates would be set by the intersection of supply and demand.  On the other side of the debate were the doves, whose hero was John Maynard Keynes (although Stephanie Kelton of MMT fame is quickly rising up the ranks) and who believed that an activist central bank was the most effective.  This meant constant monetary interventions to support demand, alongside fiscal interventions to support more demand.  As to the consequences of this policy, like unsustainable debt loads, or rising inflation, they were seen as ephemeral and unimportant.

But that was soooo long ago, at least a full year.  In the interim, Covid-19 appeared as a deadly and virulent disease. While we have learned that it is particularly dangerous for the elderly and for those with comorbidities, there is also another group which has basically been made extinct, monetary hawks in public policy positions.  For the longest time, the two most hawkish members of the FOMC were Kansas City’s Esther George and Cleveland’s Loretta Mester.  However, at the very least, Ms. Mester has now shown that she coos like a dove as per her comments yesterday about US monetary policy, “We’re going to be accommodative for a very long time because the economy just needs it to get back on its feet.

The global central bank community is all-in on the idea that ZIRP, NIRP and QE are the new normal, and as long as equity markets around the world continue to rally, they are not going to change their views.  In a related note, the BOJ is in the midst of continuing its policy review and the question of how they should describe their ETF purchases has come up.  It seems that while a number of board members would like to pare back the purchases, they are unwilling to explain that for fear the market would misinterpret their adjustments as a policy change and the result would be a sharp equity market sell-off.  And we know that cannot be tolerated!

The point is, no matter which central bank you consider, they have all reached the point where their previous actions have resulted in fragile markets and they appear to have lost the ability to change policy.  In other words, there is no end in sight to easy money, inflation be damned.

Which, of course, is exactly what we saw yesterday in markets, as equities rallied in the US, with all three major indices closing at new all-time highs.  Asian markets mostly followed through with the Nikkei (+0.4%), Hang Seng (+0.5%) and Shanghai (+2.0%) all nicely firmer, although Australia’s ASX (-0.9%) couldn’t find any love.  And perhaps, that is the story in Europe, as well, this morning, with various shades of red painting the screen.  The DAX (-0.5%) is the worst performer, with both the CAC (-0.1%) and FTSE 100 (-0.1%) more pink than red.  As to US futures, they find themselves in the unusual position of being negative at this hour, but only just, with all three indices looking at losses of between 0.1% and 0.2%.

Bond markets are clearly in more of a risk-off mood than a risk-on one, with Treasury yields lower by 2.2bps this morning and more than 4bps lower than the peak seen yesterday.  European markets have seen less movement, with yields in the major markets all down less than one basis point, hardly a strong signal, although notably, Italian 10-year yields, at 0.502%, have traded to a new historic low level.  Excitement over the prospect that Super Mario can fix Italy remains high.

On the commodity front, oil’s early gains have reversed, and it is now essentially flat on the day, although it remains within pennies of the highs set early this morning above $58/bbl.  Gold (+0.7%) is rebounding strongly, from the lows seen last Tuesday, with silver (+1.3%) even stronger.  Of course, all these non-fiat currency plays pale in comparison to Bitcoin (+17%) which exploded higher as the progenitor of one bubble (a certain EV maker in California) explained it bought $1.5 billion worth of Bitcoin for its Treasury reserves.

With this type of price action in commodities, as well as with the ongoing conversion of US monetary hawks into doves, it should not be surprising that the dollar is lower this morning, pretty much across the board.  In the G10 space, CHF and JPY are leading the way higher (+0.6% each) as investors seem to be running for havens not called the dollar.  But the euro (+0.45%) has also gained nicely and any thoughts that January’s price action was anything other than a short-term correction are now quickly fading away.  It will be interesting to see how the market responds to tomorrow’s CPI data, as that has the opportunity, if it prints higher than forecast, to alter views on real interest rates.  I have maintained that declining real yields will undermine the dollar, but I have to admit, I didn’t expect it to happen this early in the year.

EMG currencies are also firm this morning, led by ZAR (+0.6%) and RUB (+0.5%), on the back of commodity price rises, but with a pretty uniform strength throughout the CE4 and LATAM.  The one exception is BRL (-0.3%), the worst performing currency in the world this morning, as a lower than expected CPI print for January has traders shedding the belief that the central bank may be forced to raise rates any time soon.

On the data front, NFIB Small Business Optimism printed lower than last month and worse than expected at 95.0, not a good sign for the economy, but probably a boost for the view that more stimulus is coming.  At 10:00, we see JOLTs Job Openings (exp 6.4M), although that tends to be ignored.

The only Fed speaker today is St Louis’ Bullard, whose tendencies before Covid-19 were dovish, and he certainly hasn’t changed his views.  As such, and given that the market seems to have rejected the notion of a further USD correction higher, it looks like the dollar’s downtrend is getting set to resume.

Good luck and stay safe

One possible answer:  I would love to see others