No Aberration

In Europe and in the US

The central banks have made a mess

The latter’s seen prices

Rise up to a crisis

The former is still in distress

But one thing the two of them share

Is neither believes in the scare

That higher inflation

Is no aberration

And tapering they’ll soon declare

We have seen another day of modest overnight activity as market participants across asset classes wait for the next key data inputs.  At this point, the three biggest things on the horizon are Thursday’s ECB meeting and US CPI print and then next Wednesday’s FOMC meeting.  Until those data points are known, tight ranges and lack of trading liquidity are likely to be the hallmarks of all markets.

One of the things that has been something of a mystery is the disconnect between the performance of the US Treasury market and the ostensibly rapid rise in inflationary pressures, with the former essentially discounting the latter completely.  In fact, I would argue this is the key question that must be answered in order to better understand the potential future outcomes.  Arguably, it is also this situation which has allowed the Fed to remain sanguine over the recent jumps in CPI and PCE.

Consider that the bond market is generally assumed to have the greatest sensitivity to future economic activity given its very nature.  After all, the meaning of fixed income is that regardless of future economic performance, bondholders get a stated amount of interest.  It is this feature that keeps bond investors so highly attuned to inflation and inflation expectations as these investors want to ensure the real value of their investments does not decline due to rising prices.  Historically, this has certainly been the case, with bond markets selling off before inflation really took off.  This is also the genesis of the term ‘bond vigilantes’, coined during the Clinton administration to describe the bond market’s unwillingness to fund hugely expansionary fiscal plans and run large government deficits.  My, how the world has changed!

But back then, the Federal Reserve was not in the business of QE.  In fact, while it may have been a theoretical concept, even the Japanese had not yet tried it on for size.  Two plus decades later, though, the role of the Fed has clearly changed given the economic stresses suffered in both the GFC and Covid induced crisis.  QE has gone from an emergency tool to address a unique situation to the go-to tool in the Fed’s (and ECB’s) toolkit.  Thus, have grown the central bank balance sheets and so there has been a lid on interest rates, even if not explicitly via yield curve control.

There is, however, another key change in the world since the bond vigilante days of the late 1990’s; the regulatory requirements for large banks known as GSIBs, (Global Systemically Important Banks) imposed after the GFC.  These 30 institutions are required to maintain additional capital buffers and hold them in so-called High-Quality Liquid Assets (HQLA) which, not surprisingly, include Treasury bonds as well as mortgages and excess reserves.  One of the things that all of these banks do is adjust that portfolio of HQLA to maximize the available revenue, which in a world where yields are zero and negative, is very hard to achieve.  While Treasury bills and IOER pay virtually nothing, Treasury securities out the curve do have positive nominal yields and are thus relatively attractive for the purpose.

This leads to a potential alternative reason for the seeming lack of concern by the Treasury market over future inflation; price insensitive demand for bonds required to be held by large banks.  If these banks are buying and holding more Treasuries than they otherwise would have done in an unfettered world, the price signal from those bonds is likely to be somewhat skewed.  In other words, what if the Treasury market is not telling us there is no fear of inflation, but rather telling us that there are so many price insensitive buyers of bonds, even the excess supply being issued is not enough to scare holders out of the market.  In that case, we will need to get our clues about inflation elsewhere, perhaps from commodity markets.  And of course, commodity prices have done nothing but rally sharply across every class for the past year.  While there is no doubt that the first part of that move was to make up for the severe price dislocations seen at the beginning of the Covid crisis, it is not hard to make the case that the more recent price movement is a response to rising demand meeting inelastic supply.  It is the latter that drives inflation.

The point here is that both the ECB and Fed have consistently maintained that there is no reason to worry over recent high inflation prints and that there is no reason for either of them to adjust their policy mix anytime soon.  If the bond market ‘meter’ is malfunctioning, though, both of these central banks may well find themselves on the wrong side of history, yet again.  Rapidly rising inflation could well come to dominate the policy discussion quite quickly in that case, and maximum employment may recede to a pleasant dream.  Food for thought.

As to market activity today, as mentioned above, we have seen modest movements in both directions amid modest trading volumes.  Starting with equities, Asia saw small losses across the board (Nikkei -0.2%, Hang Seng 0.0%, Shanghai -0.5%) while Europe has been very modestly firmer (DAX 0.0%, CAC +0.2%, FTSE 100 +0.3%).  US futures are mixed as well with DOW (-0.15%) suffering while NASDAQ (+0.3%) are a bit higher and SPX futures are essentially unchanged.  Not much new information here.

Bond markets are mostly a bit firmer this morning with Treasury yields (-1.5bps) falling furthest and European sovereigns all seeing yield declines of about 0.75bps.  With 10-year Treasury yields back to 1.55%, it appears, on the surface, that there is no concern about rising inflation.  But if my proposed thesis is correct, that number could be quite misleading.

Commodity prices are generally coming under pressure this morning, certainly not a sign of imminent inflation, but I would argue this is simple daily price volatility more than anything else.  For example, oil (-0.9%) is leading the pack lower but we are seeing weakness in precious metals (Au -0.2%, Ag -0.5%) and base metals (Cu -0.5%, Ni -0.7%, Fe -1.9%) with only grains continuing to rally as all three major ones are higher by about 1.0% this morning.

Turning to FX, it should be no surprise that there is really no story here this morning either.  The dollar is probably marginally higher overall, but really mostly mixed with small movements in virtually all currencies.  In the G10, NZD (-0.3%) is the biggest mover, but this move has simply taken it back to the middle of its trading range.  And the rest of the bloc has moved far less.  In emerging markets, we have seen two movements of some note with HUF (-0.4%) declining after weaker than expected IP data was released, putting a dent in the idea the central bank may tighten policy, while RUB (+0.4%) rose after yesterday’s higher than expected CPI print has traders believing the central bank is likely to raise rates further.  However, beyond those two moves, there is very little to discuss.

On the data front, the NFIB Small Business Optimism index was released at a disappointing 99.6, below expectations of 101.0 and actually below last month’s reading as well.  That seems to be a result of the difficulty small firms are having in hiring staff.  We also see the Trade Balance (exp -$68.7B) and then the JOLTS Job Openings report (8.2M) later this morning.  But as mentioned at the top, I don’t think anything will matter until Thursday, so look for more range trading until then.

Good luck and stay safe

Adf

Likely Too Soon

The narrative now seems to be
That tapering’s what we will see
The meeting in June
Is likely too soon
By autumn, though, Jay may agree

tran∙si∙to∙ry
adjective
not permanent.
“transitory periods of medieval greatness”

per∙sist∙ent
adjective
continuing to exist or endure over a prolonged period.
“persistent rain will affect many areas”

Forgive my pedanticism this morning but I couldn’t help but notice the following comment from former NY Fed President William Dudley.  “The recent spike in US inflation is likely transitory for now – but it could become more persistent in the coming years as more people return to work.”  Now, I don’t know about you, but I would describe the words ‘transitory’ and ‘persistent’ as antonyms.  And, of course, we all know that the Fed has assured us that recent rises in inflation are transitory.  In fact, they assure us multiple times each day.  And yet, here is a former FOMC member, from one of the most important seats, NY Fed president, explaining that this transitory phenomenon could well be persistent.  If you ever wondered why the term ‘Fedspeak’ was coined, it was because ‘doublespeak’ was already taken by George Orwell in his classic ‘1984’.  Apparently, one does not regain one’s intellectual honesty when leaving a government institution where mendacity is the coin of the realm.

However, let us now turn to today’s main story; tapering.  The discussion on tapering of QE continues apace and the market is settling on a narrative that the Fed will reduce the amount of its monthly purchases by the end of the year.  Certainly, there are a minority of Fed governors who want to get the conversation going in earnest, with St Louis’ James Bullard the latest.  And this idea fits smoothly with the concept that the US economy is expanding rapidly with price pressures, even if transitory, building just as rapidly.  Just yesterday, Elon Musk compared the shortage in microprocessors needed to build Teslas to the shortage of toilet paper at the beginning of the pandemic last year.  (As an aside, one, more permanent, result of that TP shortage is that prices in my local Shop-Rite are significantly higher today than pre-pandemic, at least 40% higher, even though the shortage was transitory no longer persists.)  

The point is that the combination of shortages of specific items, bottlenecks in shipping and dramatically increasing demand fed by massive government stimulus programs are all feeding into higher prices, i.e. inflation.  Even the most committed central bank doves around the world have noticed this situation, and while most are unwilling to alter policy yet, the discussion is clearly beginning.  Last night, the RBA omitted their promise “to undertake further bond purchases to assist with progress goals,” despite maintaining their YCC target of 0.10% for 3-year AGB’s.  As well, yesterday Fed Governor Lael Brainerd, arguably the most dovish FOMC member, explained, “while the level of inflation in my near-term outlook has moved somewhat higher, my expectation for the contour of inflation moving back towards its underlying trend in the period beyond the reopening remains broadly unchanged.”  Apparently, Lael attended the Alan Greenspan school of Fedspeak.

Add it all up and you get a market that is convinced that tapering is visible on the horizon and will begin before Christmas 2021.  While I don’t doubt it is appropriate, as I believe inflation is not actually transitory, I am also skeptical that the Fed is ready to alter its policy until it sees data showing the employment situation has reached its newly formed goals.  I fear that, as usual, the Fed will be late to the tightening party and the outcome will be a far more dramatic policy reversal and much bigger market impact (read stock market decline) than desired.

How, you may ask, has this impacted markets today?  The big winner has been the dollar, which is firmer against virtually all its counterparts this morning.  For instance, NZD (-0.5%) is the laggard in the G10 space after RBNZ comments explaining the balance sheet will remain large for a long time.  In other words, while they may stop buying new securities, they will replace maturing debt and so maintain a significant presence in their bond market.  Meanwhile, CHF (-0.5%) is under pressure after SNB Vice-president Zurbruegg explained that the bank’s expansive monetary policy, consisting of NIRP and FX intervention is still necessary.  The rest of the bloc is also softer, but not quite to that extent with AUD (-0.35%) under pressure from commodity price pullbacks and JPY (-0.35%) suffering after odd comments by a BOJ member that they would respond to any untoward JPY strength in the event the Fed does begin to taper.

Emerging market currencies have also been under pressure all evening led by TRY (-0.9%) and KRW (-0.65%).  The latter’s movement was a clear response to the PBOC setting its fixing rate for a weaker CNY than the market had anticipated, thus opening the way for a weaker KRW.  Given the fact that South Korea both competes aggressively in some markets with Chinese manufacturers, and has China as its largest market, the intricacies of the KRW/CNY relationship are many and complex.  But in a broad dollar on scenario, it is not too surprising to see both currencies weaken, and given KRW’s recent strong performance, it had much further to fall.  But currency weakness in this bloc is across EEMEA, APAC and LATAM, which tells us it is much more about the dollar than about any particular idiosyncratic stories.

In the rest of the markets, equities were mixed in Asia (Nikkei +0.45%, Hang Seng -0.6%, Shanghai -0.75%) while Europe is green, but only just (DAX +0.15%, CAC +0.3%, FTSE 100 +0.1%).  US futures are either side of unchanged at this hour as the market tries to digest the tapering story.  Remember, much of the valuation premium that exists in the US is predicated on lower forever interest rates.  If they start to climb, that could easily spell trouble.

Speaking of interest rates, they have edged lower in the session with 10-year Treasury yields down 0.3bps while in Europe, yields have fallen a bit faster (bunds -1.4bps, OATs -1.5bps, gilts -1.2bps).  Certainly, there is no keen inflationary scare in this market as of yet.

Interestingly, oil prices continue to rise, despite the stronger dollar, with WTI (+1.0%) trading to new highs for the move.  But the rest of the commodity space finds itself under pressure this morning as the dollar’s strength takes its toll.  Precious metals are softer (Au -0.25%, Ag -0.5%) as are base metals (Cu -0.8%, Al -0.5%) although the ags are holding up.  But if dollar strength is persistent, I expect that commodity prices will remain on the back foot.

On the data front, today brings only the Fed’s Beige Book this afternoon, as the ADP employment number is delayed due to the Memorial Day holiday Monday.  As well, we hear from four Fed speakers, including three, Harker, Kaplan and Bostic, who have been in the tapering camp for several weeks now.  However, until we start to see the Treasury market sell off more aggressively, I think tapering will be a nice talking point, but not yet deemed a foregone conclusion.  As such, that link between Treasury yields and the dollar remains solid, with the dollar likely to respond well to further discussions of tapering and higher yields.  We shall see if that is what comes to pass regardless of the current narrative.

Good luck and stay safe
Adf




Quite Premature

In Europe, to pundits’ surprise

The rate of inflation did rise

The ECB’s sure

It’s quite premature

To think prices will reach new highs

Meanwhile at the PBOC

They altered FX policy

Banks there must now hold

More money, we’re told

Preventing the yuan to run free

Two big stories presented themselves since we last observed markets before the Memorial Day holiday in the States; a policy change by the PBOC raising FX reserve requirements in order to encourage less renminbi buying dollar selling, and the release of Eurozone CPI showing that rising demand into supply bottlenecks does, in fact, lead to rising prices.  In line with the second story, let us not forget that Friday’s core PCE reading of 3.1%, was not only higher than anticipated but reinforced the idea that inflation is rising more rapidly than central bankers would have you believe.

But let’s start with China, where the renminbi has been appreciating very steadily since last May, rising more than 11% in that time.  initially, this was not seen as a concern as the starting point for USDCNY was well above 7.0, which is a level that had widely been seen as concerning for the PBOC with respect to excessive weakness.  But twelve months later, it has become clear that the PBOC now believes enough is enough.  Remember, the Chinese economy continues to be heavily reliant on exports for total activity, and an appreciation of that magnitude, especially for the low value items that are produced and exported, can be a significant impediment to growth.  Remember, too, that while a strong renminbi helps moderate inflation in China, it effectively exports that inflation to its customers. (We’ll get back to this shortly.)

Ultimately, China’s goal is to continue to grow their economy as rapidly as possible to insure limited unemployment and increased living standards for its population.  To the extent that a strengthening currency would disrupt that process, it is no longer a welcome sight.  Hence the PBOC’s move to reign in speculation for further CNY appreciation.  By raising the FX reserve requirement, they reduce the amount of onshore USD available (banks must now simply hold onto them) hence counting on the dollar to rise in value accordingly.  Or at the very least, to stop sliding in value.  Consider that China’s long-term stated goal is to further internationalize the renminbi, which means that direct intervention is an awkward method of control.  (International investors tend to shy away from currencies that are subject to the whims of a government or central bank).  This effort to change the FX reserve ratio, thus altering the supply/demand equation is far more elegant and far less intrusive.  Look for this ratio, now set at 7%, to rise further should the renminbi continue to appreciate in value.

As to the inflation story, this time Europe is the setting where prices are rising more rapidly than anticipated.  This morning’s CPI print of 2.0% is the first time it has printed that high since November 2018.  Now, price pressures in Europe are not yet to the level seen in the US, where Friday’s data was clearly an unwelcome surprise, but based on the PMI data releases, with the Eurozone composite rising to a record high of 63.1, and the fact that the latest spate of European lockdowns is coming to an end within the next week or two, it appears that economic activity on the continent is set to grow.  So, the demand side of the equation is moving higher.  meanwhile, the rising value of the CNY has raised input prices for manufacturers as well as retail prices directly.  While margins may be compressed slightly, the fact that Eurozone aggregate savings are at an all-time high suggests that there is plenty of money available to spend on higher priced items.  It is this combination of events that is set to drive inflation.

There is, however, a dichotomy brewing as bond markets, both in the US and Europe, do not seem to be indicating a great deal of concern over higher inflation.  Typically, they are the first market to demonstrate concern, usually forcing a central bank response.  But both here in the States, where Friday’s PCE data resulted in a collective yawn (Treasury yields actually fell 1 basis point) and  this morning in the Eurozone, where across major Eurozone countries, German bunds 0.1 bp rise is the only gain, with yields declining slightly elsewhere, the market is telling us that bond investors agree with the central banks regarding the transitory nature of the current rising inflation.  

Perhaps they are right.  While it is difficult to go to the store, any store, and not see that prices for many items have increased during the post-pandemic period, rising inflation means that those price rises will continue for a long time to come, not a simple one-off jump. Both the Fed and the ECB are certain that supply bottlenecks will be loosened soon, thus describing the temporary nature of their inflation views.  However, it is not as clear to me that is the case.  one of the defining features of the global economy during the past decade has been the adjustment of investment priorities at the corporate level, from investing and building new capacity to repurchasing outstanding shares.  This financialization of the economy is not well prepared to expand actual output.  I fear it may take longer than central banks anticipate to loosen those bottlenecks, which means price pressures are likely to be with us for a lot longer than central banks believe.  

A quick tour of markets this morning shows that regardless of Chinese activity or inflation concerns, risk is ON.  While Asia was mixed (Nikkei -0.2%, Hang Seng +1.1%, Shanghai +0.2%), Europe is a green machine (DAX +1.5%, CAC +0.9%, FTSE 100 +1.1%) after strong PMI data across the board.  US markets are not to be left out of this rally with futures in all three major indices rising by about 0.4% at this hour.

As mentioned above, the bond market is far less interesting this morning.  While Treasury yields have backed up 2bps, Europe is going the other way, save Gilts (+1.1bps).  Clearly there is no inflation concern there right now.  And this is despite the fact that oil prices are much higher (WTI +2.8%, Brent +2.1% and >$70/bbl) along with copper (+4.7%) although wedid see Aluminum slip (-0.6%).  Grains are rising as well as is Silver (+0.75%), although gold, which was higher earlier, is back to flat on the day.

The dollar, this morning, is mixed, with roughly an equal number of currencies higher and lower, although the gains are much greater than the losses.  For instance, NOK (+0.7%) is clearly responding to oil’s rise, while SEK (+0.5%) is benefitting from continued strong PMI data.  However, the rest of the G10 space is +/- 0.2% with the pound (-0.25%) the most noteworthy decliner after concerns were raised that a new Covid variant could delay the reopening of the economy.

In the EMG space, KRW (+0.4%) and THB (+0.3%) have been the best performers as both are thriving amid improving economic performance and anticipation that China’s recovery will help support them further.  Meanwhile, on the flipside, TRY (-0.5%) is the laggard followed by INR (-0.4%) and ZAR (-0.3%).  CNY (-0.2%) slipped in the wake of the PBOC action, while INR is suffering as Covid cases continue to surge.  The same is true in South Africa, and Turkey suffered after higher inflation readings than expected.

Data this week is big starting with ISM and culminating in the payroll report.

TodayConstruction Spending0.5%
 ISM Manufacturing60.9
 ISM Prices Paid89.0
WednesdayFed’s Beige Book 
ThursdayADP Employment650K
 Initial Claims395K
 Continuing Claims3.615M
 ISM Services63.0
FridayNonfarm Payrolls650K
 Private Payrolls600K
 Manufacturing Payrolls25K
 Unemployment Rate5.9%
 Average Hourly Earnings0.2% (1.6% Y/Y)
 Average Weekly Hours34.9
 Participation Rate61.8%
 Factory Orders-0.2%

Source: Bloomberg

In addition to this data we will hear from six more Fed speakers, including Chairman Powell on Friday.  All ears will be tuned toward the tapering debate and how this week’s speakers address the situation.  However, if you consider it, if inflation is transitory and growth is going well, why would they need to taper?  After all, they appear to have achieved the nirvana of  explosive growth with no inflation. 

Needless to say, not everyone believes that story.  However, the one story that is gaining credence everywhere is that the dollar is likely to decline going forward.  That was the consensus view at the beginning of the year, and after a quarter of concern, it appears to be regaining many adherents.  To date, the relationship between the dollar and 10-year Treasury yields has been very strong.  It has certainly appeared that the bond drove the dollar.  However, recent activity has been less conclusive.  I still believe that relationship holds, but will be watching closely.  That said, the dollar does feel heavy these days.

Good luck and stay safe

Adf

More Systemic

The winding down of the pandemic

Has fostered a massive polemic

Will rising costs fade

As Powell’s portrayed

Or are they a bit more systemic?

The inflation debate continues to be topic number one amongst market participants as the outcome is seen, rightly, as the key to future economic activity and correspondingly future market price action.  This is true across all asset classes which is why everyone cares so much.

However, not every day brings us new and exciting news on the debate which leaves the markets to seek other catalysts for movement, sometimes really stretching to find a good narrative.  Thus far, today falls under the heading of ‘looking for something to say.’

There has been limited new information released overnight which is likely why the fact that the Bank of Korea, though leaving their policy rate unchanged at 0.50%, has been a topic of conversation as they displayed a more hawkish sentiment, raising both GDP growth and inflation forecasts for 2021, and hinted that they would be looking to end their ultra-expansive monetary policy sooner than previously thought.  Earlier expectations had been rates would not begin to rise until 2023, but now the market is pricing in two 25 basis point rate hikes in 2022.  This is the fourth (BOC, BOE and RBNZ are the others) central bank of a major country that is discussing the beginning of the end of easy money.  Granted, the combined GDP of these four nations, at a touch over $7 trillion, is less than one-third that of the US, but three of them are amongst the ten largest economies in the world and the fourth, New Zealand, has a history of leading the way in monetary policy on a global basis, at least since 1988 when they ‘invented’ the inflation targeting mantra that is prevalent today.

This sentiment of considering when to end easy money is making its way more clearly into the Fed’s talking points as well.  Yesterday, Fed Vice-Chair Quarles remarked, “If my expectations about economic growth, employment and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.”  He is at least the fourth Fed speaker this week to talk about talking about tapering asset purchases which tells us that the discussion is actively ongoing at the Marriner Eccles Building in Washington.  

Perhaps what is even more interesting is the fact that the Treasury market is so nonplussed by the fact that the Fed is clearly considering the timing of a reduction in purchases at the same time we are printing the highest inflation numbers in years and the Federal government is sending out more stimulus checks and spending money like crazy.  You may disagree with Chairman Powell’s policy actions, but you cannot deny the effectiveness of his recent communication policy.  Based on price action in both bond and inflation markets, Powell’s story of transitory inflation has become the accepted truth.  I sure hope he’s right, but my personal, anecdotal observations don’t agree with his thesis.  Whether I’m looking at my cost of living or take a more monetarist view and look at the expansion of the monetary base, both point to a steady rise in prices with no end in sight.  The market, however, cares little about the FX poet’s circumstances and a great deal about Chairman Powell’s pronouncements so until he is proven wrong, it has become clear the market has accepted the transitory story.

With this in mind, a survey of market activity shows pretty limited movement in every asset class.  Equity markets had a mixed session in Asia (Nikkei -0.3%, Hang Seng -0.2%, Shanghai +0.4%) and are having a similiarly mixed session in Europe (DAX -0.3%, CAC +0.5%, FTSE 100 -0.1%).  In other words, there is no theme of note on the risk side.  Meanwhile, US futures are pointing slightly lower on the open, with the worst performer NASDAQ at -0.4% and the others with lesser declines.  None of this points to a major risk theme.

Bond prices are generally a touch softer this morning with Treasury yields higher by 1.2 basis points while Bunds (+1.0bps), OATs (+0.5bps) and Gilts (+1.7bps) have all sold off slightly.  However, in the bigger picture, all of these key bond markets are currently trading with yields right in the middle of their past three month’s activity.  Again, it is hard to define a theme from today’s price action.

Commodity prices add to the mixed view with oil (WTI -0.8%) slightly softer as it consolidates after last month’s powerful rally.  In the metals markets, precious metals are essentially unchanged this morning while industrial metals continue with the mixed theme as Cu (+0.5%) and Zn (+0.3%) are firmer while Al (-0.4%) and Sn (-0.3%) are softer. Ags have seen similar price action with Soybeans softer while both Wheat and Corn are firmer.  One of the stories here has been the recent consolidation across most commodities which has been attributed to China’s efforts to prevent inflation and the expansion of bubbles in property and housing markets.

The dollar, however, is the one thing which has shown some consistency this morning, falling almost across the board.  In fact, in G10, the dollar has fallen against all its counterparts with GBP (+0.4%) the firmest currency, but solid gains in NZD (+0.35%) and CAD (+0.3%) as well.  The pound’s jump has been in the past few minutes responding to the BOE’s Gertjan Vlieghe’s comments that rate hikes are likely to begin in 2022, again, earlier than the market had been figuring.  

EMG currencies are also gaining this morning led by the CE4 (HUF +0.65%, PLN +0.5%) as well as ZAR (+0.4%).  APAC currencies performed well overnight with CNY (+0.25%) rising for the 12th session in the 15 so far this month.  It has become abundantly clear that the PBOC is willing to allow CNY to continue to strengthen despite the potential impact on exports.  This seems to be driven by their desire to cap inflation, especially in commodity prices, as well as the fact that the inflation narrative elsewhere in the world has shown that export clients have been able to absorb some level of price rises.  To achieve both these aims, a modestly stronger renminbi is an excellent help.

On the data front, this morning brings Initial Claims (exp 425K), Continuing Claims (3.68M), the second look at Q1 GDP (6.5%) and Durable Goods (0.8%, 0.7% ex transport).  However, while this is the biggest tranche of data so far this week, tomorrow’s core PCE release remains the most important number of the week in my view as excessive strength there seems to be the only thing that could give the Fed pause in their current views.  Interestingly, we do not hear from another Fed speaker, at least in a scheduled appearance, until next Tuesday, so the data will be our best indication of what is happening.  

Looking at the dollar’s recent price action, we have seen weakness but it has run into pretty strong support.  The link between Treasury yields and the dollar remains strong, and I expect that to be the case until at least the Fed’s June meeting.  In truth, the dollar’s weakness today feels a bit overdone so I anticipate no further declines and potentially, a little rebound.

Good luck and stay safe

Adf

Not Really There

There once was a Fed Reserve Chair
Whose minions explained with fanfare
Though prices were climbing
With all the pump priming
Inflation was not really there

Investors responded with glee
And bought everything they did see
So, risk was a hit
While yields fell a bit
As money remains largely free

Brainerd, Bostic and Bullard, though sounding like a law firm, are actually three FOMC members who spoke yesterday.  In what has been a remarkably consistent performance by virtually every single member of the committee (Robert Kaplan excepted), they all said exactly the same thing: prices will rise due to bottlenecks and shortages in the near-term, but that this was a short-term impact of the pandemic response, and that soon those issues would abate and prices would quickly stabilize again.  They pointed to ‘well-anchored’ inflation expectations and reminded one and all that they have the tools necessary to combat inflation in the event their version of events does not come to pass.  You have to give Chairman Powell credit for convincing 16 ostensibly independent thinkers that his mantra is the only reality.

The market response was one of rainbows and unicorns, with rallies across all assets as risk was snapped up everywhere.  After all, it has been nearly two weeks since the CPI print was released at substantially higher levels than anticipated raising fears amongst investors that the Fed was losing control.  But two weeks of soothing words and relatively benign data has been sufficient to exorcise those inflation demons.  In the meantime, the Fed continues to purchase assets and expand its balance sheet as though the economy is teetering on the brink of destruction while they await the “substantial progress” toward their goals to be met.

One consequence of the Fed’s QE program has been that high-quality collateral for short term loans, a critical part of the financial plumbing of the US (and global) economy has been in short supply.  For the past two months, Treasury bill issues have been clearing at 0.00%, meaning the government’s cost of financing has been nil.  This is due to a combination of factors including the Treasury running down the balances in the Treasury General Account at the Fed (the government’s checking account) and the ongoing Fed QE purchases of $80 billion per month.  This has resulted in the Treasury needing to issue less T-bills while simultaneously injecting more funds into the economy.  Banks, meanwhile, wind up with lots of bank reserves on their balance sheets and no place to put them given the relative dearth of lending.  The upshot is that the Fed’s Reverse Repurchase Program (RRP) is seeing unprecedented demand with yields actually starting to dip below zero.  This is straining other securities markets as well given the bulk of activity in markets, especially derivatives activity, is done on a margin, not cash, basis.  While so far, there have not been any major problems, as the stress in this corner of the market increases, history shows that a weak link will break with broader negative market consequences.  For now, however, the Fed is able to brush off any concerns.

The result of the constant commentary from Fed speakers, with three more on the schedule for today, as well as the fading of the memories of the high CPI print has been a wholesale reengagement of the risk-on meme.  Growth continues to rebound, while zero interest rates continue to force investors out the risk curve to find a return.  What could possibly go wrong?

Today, the answer is, nothing.  Risk is back with a vengeance as evidenced by a strong equity session in Asia (Shanghai +2.4%, Hang Seng +1.75%, Nikkei +0.7%) and a solid one in Europe as well (DAX +0.8%, CAC +0.15%, FTSE 100 0.0%).  The Chinese (and Hong Kong) rally seems to be a product of the PBOC focusing their attentions on the commodity market, not equities, as the source of imbalances and a potential target of interventionist policies thus allowing speculators there to run free.  German equities are the beneficiary of better than expected ZEW data, with both the current conditions (95.7) and Expectations (102.9) indices leading the way.  While yesterday’s US equity rally faded a bit late in the day, futures this morning are all pointing higher by about 0.3%.

Arguably, the FOMC trio had a bigger impact on the bond market, where 10-year Treasury yields are now back below 1.60%, down 1 basis point this morning and at their lowest level in more than two weeks.  It is certainly hard to believe that the bond market is remotely concerned about inflation at this time.  Remember, though, Friday we see the core PCE print, which is the number the Fed truly cares about, and while it is forecast to print above the 2.0% target, (0.6% M/M, 2.9% Y/Y) we also know that the Fed strongly believes this is transitory and is no reason to panic.  Markets, however, if that print is even stronger, may not agree with that sentiment.

Commodity prices are having a less positive day as the ongoing concerns about Chinese actions to prevent price rises continues to weigh on sentiment.  Oil has slipped just a bit (-0.3%) but we are seeing declines in Cu (-0.4%), Al (-1.1%) and Fe (-3.1%), all directly in the crosshairs of the Chinese government.  Agricultural product prices are mixed today while precious metals remain little changed.

Finally, the dollar is mostly lower this morning with broad weakness seen in the EMG bloc, but less consistency in G10.  While SEK (+0.5%) leads the way higher, the rest of the bloc has been more mixed.  NOK (-0.2%) is clearly suffering from oil’s decline, while JPY (-0.2%) seems to be giving ground as havens are unloved.  EUR (+0.25%) has been helped by that German ZEW data as well as the beginnings of a perception that the Fed is going to be more aggressively dovish than the ECB for a long time to come.  In that event, the euro will certainly rise further, although it has a key resistance level at 1.2350 to overcome.

ZAR (+0.7%) leads the emerging market parade higher as concerns over inflation there abate, and South Africa continues to have amongst the highest real yields in the world.  KRW (+0.4%) is next in line as consumer sentiment in South Korea rose to its highest level in 3 years.  The other noteworthy move has been CNY (+0.2%) not so much for the size of the move as much as for the fact that it has breached the 6.40 level and the government has indicated they are going to be taking additional steps to open the FX market in China to help local companies hedge their own FX risks. The only laggard of note is TRY (-0.3%) which is suffering as President Erdogan has replaced yet another member of the central bank’s board, inviting concerns inflation will run higher with no response.

Data today shows Case Shiller Home Prices (exp +12.5%) as well as New Home Sales (950K) and Consumer Confidence (119.0), none of which are likely to change either Fed views or market opinions.   As mentioned above, three Fed speakers will regale us with their sermon on transitory inflation, and I expect that the dollar will remain under pressure for the time being.  In fact, until we see core PCE on Friday, it is hard to make a case that the dollar will turn around and only then if the number is higher than expected.

Good luck and stay safe
Adf

Gazumped

While measured inflation has jumped
And stock markets, Powell has pumped
The dollar is queasy
As money this easy
Has bulls concerned they’ll get gazumped

But its not just Powell who’s saying
That QE and ZIRP will be staying
Almost to a man
The Fed’s master plan
Is printing and buying…and praying

Once again, yesterday, we heard from several FOMC members and each of them highlighted that the data has not yet come close to describing the “substantial progress” they are seeking with respect to reduced unemployment and so it is not nearly time to begin even thinking about tapering.  Well, except for the lone quasi-hawkish voice of Dallas Fed President Robert Kaplan, who did express concern that the Fed’s actions were part of the reason that asset prices are so high.  But not to worry, Mr Kaplan will not be a voter until 2023, so will not even be able to officially register his disagreement with policy for two more years.  In other words, based on everything we continue to hear, we can expect a series of 9-0 votes every six weeks to maintain current policy.

It is this ongoing messaging, which comes not only from the Fed but from the ECB and BOJ as well, that continues to drive the narrative as well as market prices.  Inflation?  Bah, it’s transitory and while 2021 may see some higher readings, it will all disappear by 2022.  Bubbles?  Bah, central banks cannot detect them and, even if they could, it is not their job to deflate them.  It has become abundantly clear that the three big central banks have jointly decided that the only thing that matters is the unemployment rate, and until that data is back at record low levels, regardless of what else is happening in the economy, the current state of QE and ZIRP/NIRP is going to remain in place.

Thus, it cannot be that surprising this morning that the dollar has begun to slide a bit more in earnest, while risk appetite, as measured by equity prices remains robust.  A very large segment of the punditry continue to harp on concerns over rising inflation and how the Fed and other central banks will be forced to adjust their policy to prevent it from getting out of hand.  But simply listening to virtually every central banker tells us that nothing is going to change.

Through that April employment report, we have not made substantial further progress,” said Fed Vice-Chair Richard Clarida yesterday.  Meanwhile, from the ECB, Francois Villeroy de Galhau explained this morning, “Today there’s no risk of a return of lasting inflation in the euro area, and so there’s no doubt that the ECB’s monetary policy will remain very accommodative for a long time.  I want to say that very clearly.”  I don’t know about you, but it seems pretty clear that the concept of tapering QE purchases, let alone raising interest rates, is not even on the table.

Now, smaller central banks have changed their tune, notably the Bank of Canada and Sweden’s Riksbank, with the former actually reducing QE purchases while the latter has promised to do so shortly.  As well, the Bank of England has begun the discussion about reducing policy support as the economy there continues to open rapidly, and growth picks up.  As such, it should not be that surprising that those three currencies (GBP +2.75%, CAD +2.1%, SEK +1.9%) are the leading gainers vs. the dollar so far this month.

Perhaps what is also interesting is that the euro is strengthening so clearly vs. the dollar despite the strong words by ECB members regarding the maintenance of easy money.  It appears that the market has a stronger belief in the Fed’s willingness to ignore the repercussions of their policy choices than that of the ECB.  Remember, in the end, Europe remains reliant on Germany as its engine of growth and largest economy, and German DNA, ever since the Weimar hyperinflation in the 1920’s favors tighter policy, not looser.  Madame Lagarde will have a tougher battle to maintain easy policy if the data starts to point higher than will Chairman Powell.  Right now, however, that is all theoretical regarding both banks.  Easy money is here for the foreseeable future, which means that risk appetite is likely to remain strong, driving up stock and commodity prices while the dollar sinks.

What about bonds, you may ask?  Haven’t they been the key driver?  The answer is that they have been the key driver,  but a close look at statistics like inflation breakevens, and more importantly, the shape of the breakeven curve, offer indications that even though near-term expectations are for much higher inflation, more and more investors are buying the transitory story.  If that is, in fact, the case, then there is ample room for bonds to rally as well, which would be quite the shock to all the inflationistas out there.

This morning is exhibit A regarding the impact of increased risk appetite.  Equity markets around the world are higher with Asia (Nikkei +2.1%, Hang Seng +1.4%, Shanghai +0.3%) putting in some very strong performances while Europe (DAX +0.25%, CAC +0.2%, FTSE 100 +0.4%) are all green, but have come off their best levels of the morning.  US futures are also pointing higher, with gains ranging from 0.2% (Dow) to 0.7% (Nasdaq).

The bond market, meanwhile, is directionless, with yields for Treasuries (-0.5bps) and European sovereigns (Bunds 0.0bps, OATs -0.7bps, Gilts +0.7bps) all trading in narrow ranges.  If you consider that given the increase in risk appetite as evidence by stocks, commodities and the dollar, the very fact that bonds are not selling off is actually a bullish sign.

Speaking of commodities, Brent crude (+0.6%) traded above $70/bbl for the first time since November 2018 this morning and WTI is firmer by a similar amount.  Metals prices continue to rally (Au 0.0%, Ag +0.8%, Cu +1.0%, Al +0.7%), as do foodstuffs (Soybeans +0.6%, Wheat +0.75%, Corn +1.7%).  While it is not clear how much longer commodity prices will rally, it seems abundantly clear, based on their price action, that the rally has more legs.

And finally, the dollar, which as mentioned above is under pressure, is having a really bad day.  Versus its G10 counterparts, the dollar is softer across the board with NZD (+0.7%), NOK (+0.6%) and CHF (+0.55%) leading the way.  But the euro (+0.45%) is also much firmer and now trading above 1.22 for the first time since early February.  If you recall, 1.2350 was the high seen the first week of January, and in order to truly change opinions, the euro will have to trade through that level.  With the dollar so weak, it certainly seems like there is a good chance to get there soon.

EMG markets are also seeing pretty uniform gains with ZAR (+0.7%), HUF (+0.65%) and PLN (+0.6%) leading the way, the former on the back of commodity price strength while the two CE4 currencies are benefitting from the belief that both central banks may be tightening policy shortly as well as the euro’s strength.  But we saw strength overnight in the APAC currencies as well (KRW +0.4%, SGD +0.4%, TWD +0.35%) as they all are responding to the broad-based dollar weakness.

On the data front, today brings Housing Starts (exp 1702K) and Building Permits (1770K), with both simply showing that the housing market remains on fire.  Meanwhile, only Robert Kaplan is scheduled to speak, but we already know what he thinks (tapering needs to start soon) and we also know his is a lone voice in the wilderness.  It would not surprise me if we had a surprise series of comments from another FOMC member just to counter his views.

Looking ahead to the session, there is no reason to believe that the dollar’s weakness is going to change anytime soon.  Unless Treasury yields start to back up smartly, risk appetite is the dominant story today, and that bodes ill for the dollar.

Good luck and stay safe
Adf

To ZIRP They’ll Adhere

The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt

In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere

It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions.  For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm.  Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year.  Which means that the entire argument is based on dueling forecasts of the future beyond that.  In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.

What is transitory?  Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now.  According to Merriam-Webster, it describes something of brief duration or temporary.  Which begs the question, what is brief?  Is 3 months brief?  6 months?  Longer?  Arguably, brief depends on the context involved.  For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.

There continue to be strong arguments in favor of both sides of the argument.  On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years.  No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices.  As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items.  Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral.  In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.

Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains.  In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices.  We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation.  Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support.  As they are wont to say, the Fed can’t print copper or corn.  The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?

Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets.  By now, you are all aware I remain in the inflationist camp and have been for a while.  I cannot ignore the rising prices I see every time I go into a store.  But the deflationists make excellent points.  This argument discussion will rage for at least another two months and the July CPI release.  Until then, the one thing that seems clear is that market volatility is likely to remain significant.

As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed.  At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well.  US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.

Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively.  Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.

Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).

Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs.  Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%).  Much of this movement seems to be on the back of positioning rather than fundamental news.  On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.

EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region.  CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line.  On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.

Not a ton of data this week, but here is what we see:

Today Empire Manufacturing 23.9
Tuesday Housing Starts 1705K
Building Permits 1770K
Wednesday FOMC Minutes
Thursday Initial Claims 455K
Continuing Claims 3.64M
Philly Fed 41.9
Friday Existing Home Sales 6.08M

Source: Bloomberg

The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total.  Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.

With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck.  This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along.  If you are in the deflationist camp, it’s the opposite.  But remember, at a point in time, inflation will undermine the dollar’s value.  Just not right away.

Good luck and stay safe
Adf

They Haven’t the Nerve

It’s not just the Federal Reserve
Who thinks that inflation’s steep curve
Is likely short-term
And so reconfirm
For rate hikes, they haven’t the nerve

In Mexico, Chile, Peru
Each central bank chose to eschew
The chance to raise rates
For like in the States
They pray that inflation’s not true

Inflation remains the key talking point in every market these days.  This means not just equity, bond and commodity markets, but also geographically, not just the US, but literally every country in the world.  And in every one of these situations the two camps remain strongly at odds over the likely permanence of rising prices.  In the US, of the 16 current members of the FOMC, only one, Dallas’s Richard Kaplan, is concerned that inflation may be more than transitory.  Meanwhile the Bank of Canada has already made their move to begin tapering QE over concerns that rising inflation may become a bigger problem in the future.

Of course, inflation is not just a G10 phenomenon, it is a global one, arguably more so an issue in emerging markets than in developed ones.  Given the timing of recent central bank actions, I thought it would be interesting to take a quick look at Latin America for a sense of how other nations are dealing with rising prices.

Mexico – Banco de Mexico left its overnight rate at 4.00% for the third consecutive month yesterday despite the fact that CPI is running at 6.08% and they are currently focused on targeting 3.0% inflation.  Clearly, those numbers don’t seem to go together well, but the explanation is that the disappointingly slow rebound in the economy after last year’s Covid induced disaster has the central bank determined to help support economic growth at the risk of allowing higher inflation to become entrenched.  Not only that, they have committed to maintaining policy rates here until growth picks up further.  Look for higher inflation going forward.

Chile – Banco Central de Chile left its overnight rate at a record low of 0.50% yesterday for the 13th consecutive month despite the fact that inflation is running at 3.3%, above its 3.0% target, and trending sharply higher.  While the rise in copper prices has been an extraordinary boon to the country, given its reliance on the metal for so much of its export earnings (nearly 30%), the economy is still recovering from last year and the central bank deemed economic support, especially in this time of political uncertainty, more important than price stability.

Peru – Banco Central de Reserva del Peru left its rate at 0.25%, also a record low, for the 13th consecutive month despite the fact that inflation is running at 2.4% vs. BCRP’s 2.0% target.  Here, too, political considerations are in the mix given the upcoming second round of presidential elections and the concern that a little known left-wing school teacher may become president next month.  Here, too, the board explained that policy was appropriate for the current situation despite higher than desired inflation.

These moves contrast with Brazil, which raised rates last week by 0.75%, to 3.50%, for the second consecutive meeting and are set to do so again in June.  Of course, CPI in Brazil, which is targeted at 3.0%, is currently running at 6.76% and climbing quickly.  If it weren’t for Argentina (CPI 46.3%) Brazil would be suffering the worst inflation in Latin America.  (I exclude Venezuela here as it is impossible to measure the inflation rate given the utter collapse of the economy and monetary system.)

It seems that the central banking community is filled with a great number of people who are either innumerate or highly political.  Neither of these characteristics make for an effective and independent central bank, and given the plethora of central bankers worldwide who exhibit these tendencies, it is a fair bet that rising prices are going to be a feature of our lives, no matter where we live, for a long time to come.  The point is, it is not just the Fed that is willfully blind to the evidence of rising prices, it is a widely held viewpoint.

Today, however, the markets have decided to agree with the predominant central bank view that inflation is a transitory phenomenon as evidenced by the fact that risk appetite is back in vogue.  It starts with the bond market, where Treasury yields are falling (-1.9bps) and now 6 basis points below the levels reached after Wednesday’s CPI data.  Yesterday’s PPI data, though also higher than expected, had virtually no impact on markets.  In Europe, Gilts (-3.1bps) are also rallying along with Bunds (-0.8bps) although French OATs are flat on the day.

This renewed confidence in a lack of inflation scare has had a much bigger impact on the equity markets, where once again, buying the dip seemed to be the correct move.  Asia saw robust gains (Nikkei +2.3%, Hang Seng +1.1%, Shanghai +1.8%) and Europe is having a solid day as well (DAX +0.7%, CAC +0.7%, FTSE 100 +0.7%).  US futures are pointing to a continuation of yesterday’s rally with NASDAQ (+1.0%) leading the way, but all three indices higher by at least 0.5%.

Commodity prices are rising led by oil (+1.25%) and precious metals (Au +0.5%, Ag +0.7%) although the base metals are a bit more mixed (Cu -0.8%, Fe -5.2%) after China instituted price restrictions against steel producers in order to try to quash the recent explosion higher in steel prices.

As to the dollar, it should be no surprise that it is broadly softer this morning against both its G10 and EMG counterparts.  NOK (+1.1%) leads the way higher on the back of oil’s rally but we are seeing solid gains in NZD (+0.6%) and SEK (+0.5%) on the back of broadly positive risk appetite.  In the EMG bloc, only TWD (-0.03%) managed to lose any ground after another day of significant foreign equity outflows and an uptick in Covid cases.  Otherwise it is all green led by TRY (+0.85%), HUF (+0.6%) and MXN (+0.45%).  Turkey’s lira, which is approaching all time lows appears to be seeing a simple trading bounce as there is no news to drive things.  Mexico is clearly benefitting from the oil rally while Hungary’s forint is the beneficiary of a growing belief that the central bank there is going to raise rates to fight rising inflation.  As I said, there are several central banks that still try to focus on reality rather than wishful thinking, but they seem to be few and far between.

This morning brings Retail Sales (exp 1.0%, 0.6% ex autos) as well as IP (0.9%), Capacity Utilization (75.0%) and Michigan Sentiment (90.0).  On the central bank front, only Richard Kaplan, the lone hawk standing, speaks today, so look for more discussion about the need to think about tapering QE.  The thing is, the market is fully aware that he has no support in this stance and so it will not likely have any impact.

With the inflation scare behind us for at least another two weeks (Core PCE will be released at the end of the month), it seems the way is open for more risk-on sentiment.  This means bond yields are unlikely to rise very much and the dollar will therefore remain under pressure.

Good luck, good weekend and stay safe
Adf

Don’t Get Carried Away

The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away

But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned

Wow!  That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected.  To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase.  Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%.  To give some context, the core 0.9% gain was the highest print since 1981.  It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.

The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible.  His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out.  As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month.  That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.

House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down.  The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live.  The statistics show that there is the smallest inventory of homes available in decades.  As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material.  And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace.  A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know.  As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining.  However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI.  That, my friends, will be harder to pass off as transitory.

The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates.  However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control.  While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.

The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money.  Rising inflation is the last thing equity markets can abide, so these declines can not be surprising.  The question, of course, is will they continue?  A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story.  It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels.  A loss of confidence that the past is prologue could well see a very sharp correction.

Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session.  It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move.  While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between.  Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.

Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months.  The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.

Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative.  We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%).  At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.

This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy).  Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday.  In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory.  I guess they hope if they say it often enough, people may begin to believe them.  But that is hard to do when the prices you pay for stuff continues to rise.

Treasuries remain the key.  If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher.  If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.

Good luck and stay safe
Adf

Far From our Goals

Said Brainerd, “we’re far from our goals”
Of helping to max out payrolls
So, patience is needed
Else we’ll be impeded
And Biden might drop in the polls
Thus, we must maintain the controls

There is a single hymnal at the Marriner Eccles Building in Washington, DC and every FOMC member continues to read from that gospel.  In short, the current view is that things are getting better, but there is still a long way to go before the economy can continue to grow without Fed support, therefore, the current policy mix is appropriate and will be for a long time to come.  On the subject of inflation, when it was even mentioned by any of the six Fed speakers yesterday, it was pooh-poohed as something of no concern, widely recognized that it will rise in the short-term, but universally expected to be ‘transitory’.  I don’t know about you, but it certainly makes me feel much better that a group of 6 individuals, each extremely well-paid with numerous perks accorded to their office, and each largely out of touch with the world in which the rest of us live, are convinced that they can see the future.  After all, the Fed’s forecasting record is unparalleled…in its futility.

However, that is the situation as it currently stands, the Fed remains adamant that there is no need to taper its QE program, no need to raise interest rates anytime soon and that the current policy mix will address what ails the US economy.

The problem with this attitude is that it seems to ignore the reality on the ground.  Exhibit A is the news today that average gasoline prices across the nation crossed above $3.00/gallon for the first time since 2014.  In fairness to the Fed, some portion of this is a result of the shutdown of the Colonial Pipeline, where a number of states on the East Coast find themselves with no gasoline to pump.  But do not be mistaken, as I’m sure everyone is aware, gasoline prices have been rising sharply for the past 6 months, at least.  At issue now is just how much higher they can go before having more deleterious effects on the economy, let alone on many individuals’ personal situation.

It is not just gasoline, but pretty much all commodities that have been rallying sharply since the pandemic induced lows of April 2020.  Since its nadir, for example, the GSCI has more than doubled, but that merely brings it back to its level of the prior five years, when there was no concern over commodity driven inflation.  The difference this time is that due to a combination of the Covid-induced breakdown in supply chains and a massive reduction in Capex by the mining and extraction sector, the prospect of equilibrium in this space in the near term is limited.  There is a growing belief that we are embarking on a so-called commodity super-cycle.  This would be defined as a long-term period where commodity demand outstrips supply and commodity prices rise continually, generally doubling or tripling from the previous lows.

This discussion is an excellent prelude to this morning’s CPI release, where the analyst community is looking for a 0.2% M/M rise which translates into a 3.6% Y/Y rise.  Ex food and energy, expectations are for 0.3% M/M and 2.3% Y/Y.  The sharp rise in the annual headline rate is exactly what the Fed has been discussing as base effects, given this time last year, the economy was seeing price deflation on the back of the economy’s shutdown, with transportation, hospitality and leisure prices collapsing due to a forced lack of demand.  As such, the market seems entirely prepared for a very large number.  From my vantage point, the Y/Y number is not so important today, but the M/M number is.  Consider that a 0.3% reading, if strung over twelve months, comes to an annual inflation rate of more than 3.6%, considerably above the Fed’s target.

We continue to hear one Fed speaker after another explain that while the economy is improving, they must still maintain ultra-easy monetary policy.  We continue to hear them explain that any inflation readings will be transitory.  And maybe they are correct.  However, if they are not, and inflation embeds itself more deeply into the national psyche, the Fed will find themselves in an unenviable position; either raise interest rates to combat inflation (you know, the tools they have) and watch the financial markets fall sharply; or let inflation run hot, and allow the dollar to fall sharply while eventually watching financial markets fall sharply.  Talk about a Hobson’s Choice!

Now to markets, which after yesterday’s selloff in the US equity space, albeit with a close that was well off session lows, we saw a mixed Asian session (Nikkei –1.6%, Hang Seng +0.8%, Shanghai +0.6%) and are seeing a similar performance in Europe (DAX +0.25%, CAC 0.0%, FTSE 100 +0.35%).  US futures, on the other hand, are uniformly pointing lower at this hour, down between 0.35% (DOW) and 0.6% (NASDAQ).

Bond markets, after yesterday’s worldwide rout, have seen a small rebound with Treasury yields edging lower by 0.5bps, although still hanging around the 1.60% level.  There is an overwhelming consensus that 10-year Treasury yields are set to rise substantially, but so far, that has just not been the case.  European markets are seeing yield declines of between 1bp (Bunds and OATs) and 2bps (Gilts).  Today brings two critical data points, first the US CPI data shortly and then the US 10-year Treasury auction will be closely scrutinized to determine if there is a crack in demand for our seemingly unlimited supply of Treasury paper.

Commodity prices are broadly higher led by oil (WTI +1.3%) with base metals continuing to climb as well (Cu +0.7%, Al +0.5%, Ni +1.0%).  The same cannot be said of the precious metals space, though, with both gold (-0.2%) and silver (-0.8%) seeing some selling on profit taking.

The dollar is in fine fettle this morning, rallying against 9 of its G10 counterparts with only CAD (+0.1%) holding its own.  NZD (-0.6%) and AUD (-0.5%) are in the worst shape as both respond to weaker than expected Chinese monetary growth which implies that the Chinese economy may not be growing as quickly as previously thought.  However, the European currencies are all modestly softer as well on worse than expected Eurozone IP data (0.1% vs. 0.8% expected).  EMG currencies are also under pressure this morning, with the APAC currencies feeling it the worst.  KRW (-0.45%), THB (-0.4%) and SGD (-0.25%) are leading the way lower, also on the back of the Chinese monetary data.  Interestingly, TWD (-0.03%) is barely changed despite an equity market rout (TAIEX -4.1%) and concerns about growth in China.

Other than the CPI data and the Treasury auction, there is no other news or data.  Well, that’s if you exclude the continuing parade of Fed speakers, with today’s roster of 4 positively sparse compared to what we have seen lately.  The one thing we know is that they are unlikely to change their tune.

Which brings us back to the 10-year Treasury.  It continues to be the market driver in my view, with higher yields leading to a stronger dollar and vice versa.  I suspect that this morning’s CPI data may print higher than forecast, but it is not clear to me if that will truly have an impact.  My bigger fear is that broad risk appetite may be waning given the leadership of the equity rally has been suffering of late.  In this situation, we could easily go back to a classical risk-off framework of lower stocks, higher bond prices (lower yields) and a stronger dollar.  Just beware.

Good luck and stay safe
Adf