Tag Archives: #inflation

Gazumped

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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

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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

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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

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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

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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

Devil-May-Care

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It wasn’t all that long ago
When Powell and friends let us know
That prices might rise
But that in their eyes
T’was something we soon would outgrow

And lately it seems they were right
As chains of supply get more tight
But so far, they’re clear
The Fed has no fear
Inflation could rise overnight

Investors, though, don’t seem to share
That attitude, devil-may-care
Instead they’re rebelling
And stocks they are selling
While bond markets, too, they forswear

Perhaps as a prelude to tomorrow’s CPI data here in the US, last night we saw Chinese inflation data.  Chinese data, though, has a very different meaning than US data.  From China, markets care far more about PPI than about CPI, as China continues to be the world’s factory floor.  So, a rising PPI in China may presage rising retail prices elsewhere in the world.  Consider this when looking at the Chinese data, where PPI rose a more than expected 6.8%, it’s highest print since October 2017, while CPI there rose only 0.9%, a tick less than forecast.  The proximate cause of the sharp rise in PPI has been the ongoing explosion higher in commodity prices.  All their input costs are rising (iron ore, steel, copper, energy, etc.) thus producers are forced to raise their prices.  While retailers have not yet passed through all the cost increases in China, manufacturers and retailers elsewhere in the world have not been so sanguine on the issue.  Instead, the combination of rising commodity prices and shortages in key intermediate goods, like semiconductors, has been more than sufficient to push up prices.

It should be no surprise that markets, in general, are not applauding this outcome, and in fact, are concerned that this is just the beginning of the move in prices.  On the one hand, we continue to hear from both the Fed and the ECB that there is no reason to consider tightening policy at this time as neither bank has achieved their policy aims.  On the other, there is no sign that the supply side damage that was caused by the pandemic is anywhere close to being repaired.  Reduced supply meeting ongoing artificially high demand is guaranteed to raise prices.  I guess the Fed and ECB will soon be quite pleased with themselves for having created inflation.  The rest of us?  Not so much.

However, this policy mistake action in the face of the current conditions is what is driving market prices, which today are wholly in the red, and in substantial size.  Equity markets worldwide (Nikkei -3.1%, Hang Seng -2.1%, DAX -2.2%, CAC -2.0%, FTSE 100 -2.2%) have been under severe pressure ever since yesterday’s US tech slump, but bond markets, too, are seeing significant selling pressure, with Bunds, OATs and Gilts all seeing yields climb by 4 basis points this morning.  In other words, investors are explaining they don’t want to hold financial assets in an inflationary environment.  In fact, there is a great deal of buzz in the markets about some of the large interest rate bets that are being made in both Eurodollar and Euribor futures markets, where very large size option trades are being executed with the aggressor buying put options as part of large risk reversals.  It seems there is very little concern over interest rates declining from current levels, and rightly so, but expectations for higher rates well before either the Fed or ECB has indicated they are considering changing tack are the new normal.

What, you may ask, has this done for the dollar?  That is a much tougher question to answer as the outcome has been far less clear.  I have been adamant that the 10-year Treasury yield has been the key driver of the dollar’s value for virtually all of 2021, and despite the sell-off in European sovereigns this morning, Treasury yields are unchanged at 1.60%.  Heading into tomorrow’s CPI data, as well as another round of Treasury refunding starting with today’s 3-year auction of $40 billion (a total of $108 billion will be auctioned this week), it appears that investors and traders are not certain what to do.  Despite economic data that points to quickening growth, we continue to hear from Fed speaker after Fed speaker that they are not even close to considering tapering QE, let alone raising interest rates.  Well, except for the lone(ly) hawk, Dallas Fed President Robert Kaplan.  But yesterday, both Chicago’s Mike Evans and SF’s Mary Daly were clear it is far too early to consider tapering QE.  Today brings six more Fed speakers, none of whom have a history of hawkishness.

In the end, if inflation continues to rise while Treasury yields remain rangebound due to QE, as real yields decline, look for the dollar to follow.  Breakeven inflation rates continue to trade at multi-year highs (5-year 2.73%, 10-year 2.53%) and are indicating a strong belief that inflation is picking up pace. While the Fed continues to tell us they “have the tools” necessary to combat any potential inflation, the only thing of which we can be sure is they not only “have the tools” required to support markets (and the economy by extension), but that they will use those tools. When it comes to fighting the inflation battle, though, not a single current FOMC member is battle tested.  Given this asymmetry, it is not surprising that we are seeing an increase in market bets on higher interest rates.

Back to the dollar, which is actually under a bit of pressure this morning, along with all those other assets. In the G10, only CHF (-0.1%) is softer as we are seeing gains from the European bloc (NOK, SEK +0.4%, EUR +0.3%) leading the way.  Arguably, this is on the back of the much better than expected German ZEW expectations index, which printed at its highest level in more than 10 years.  Meanwhile, the pound (+0.1%) and commodity bloc here are having a much less interesting session.

In the emerging markets, Asian currencies felt pressure overnight on the tech stock decline with KRW (-0.5%), TWD (-0.4%) and MYR (-0.3%).  On the other hand, the CE4 have all followed the euro higher and we are seeing strength in ZAR (+0.5%), RUB (+0.6%) and MXN (+0.5%), despite oil’s small slide (-0.8%).

All in all, today is shaping up as another one that will be driven by the yield story.  In order for the dollar to really turn around its recent weakness, we will need to see a very significant risk-off event, with Treasuries rallying and fear abundant.  But so far, the current equity decline has not been sufficient to get those juices flowing.  As such, I still would err on the side of a weaker dollar.

Good luck and stay safe
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To Make Jay Concerned

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On Friday the payroll report
Surprised folks by coming up short
Is growth really slowing?
Or else, is this showing
A government data distort?

This morning, though, all eyes have turned
To metals and stuff that is burned
As those prices soar
They seem to have more
Potential to make Jay concerned

With all that anticipation leading up to the payroll report on Friday, it sure turned out differently than expected.  You may recall that the median forecast for the headline number was a cool million new jobs, with a survey range from 700K to 2.1 million.  The result, 266K plus a reduction of 140K from the previous month was, in a word, awful.  In fact, it was the largest statistical miss since the data began.  Now, the analyst community is busy trying to figure out what went wrong.

There are a couple of possible answers, each with its own implications.  The simplest explanation is that the combination of exiting from an unprecedented, government-imposed economic shutdown is not easily modeled and when combined with the vagaries of seasonal adjustments to the data, analysts’ models were simply wrong.  It is important to remember that the seasonal adjustments in this data stream are quite large relative to the reported data, so this is quite a viable explanation.

A second possible explanation, and one favored by the current administration, is that the data shows the economy needs more government support as too many people are falling through the cracks.  On the other hand, the business community continues to complain how difficult it is to hire qualified employees, especially in the service sector, as the ongoing government unemployment largesse is paying more than many low paying service sector jobs.  (The story of the entire workforce of a Dollar General store upping and quitting en masse is the quintessential symbol of this concept.)  Another facet of this argument is the skills mismatches that exist as, for example, erstwhile airline staff may not be able to analyze data for an IT firm, effectively resulting in a hiring need and unemployed worker at the same time.

While skills mismatches certainly exist, they always have, arguably one way for businesses to obtain staffing is to pay more for the roles in question.  The risk in that strategy is, especially for small businesses, increased labor costs will force companies to raise prices at the risk of losing business.  Based on Friday’s report, this is clearly not yet the default choice of the small business owner.  Odds are, though, especially as demand for all products and services increases with the reopening of the economy more generally, that this is going to be the outcome.  Higher wages to get workers and higher prices for goods and services.

Occam’s Razor suggests that the first explanation, data uncertainty, is the most likely cause for Friday’s massive statistical miss.  However, don’t expect the other two arguments to disappear as they are each very compelling for the currently competing political narratives.  Ultimately, we will find out more through the data for the rest of this month and get to do this all over again in June.

On the topic of rising prices, though, this morning has much more to offer, specifically in the commodity space.  The big weekend news has been about a cyberattack on Colonial Pipeline, which happens to be the largest pipeline for oil products like gasoline and diesel, to the East Coast.  With the pipeline shut, (apparently the pipeline can still carry the products, but the company cannot track how much fuel is being consumed, and thus charge accordingly), gasoline and product prices are rising, dragging up oil prices as well (WTI +0.5%).  But of more interest is the metals sector where prices are exploding higher.  Not only are precious metals (Au +0.45%, AG +1.25%) higher, but industrial base metals are really rocking (Fe +5.1%, Cu +2.6%, Al +1.9%, Ni +0.8%).  This is, of course, one of the key features of the inflation is coming narrative, sharply rising commodity prices will work their way into the price of stuff.  But inflation is a measure of the ongoing change in prices over time.  The Fed’s argument is that these prices will have an impact in the short run, but unless commodity prices continue rise year after year, the effect will be ‘transitory’.

The counter to the Fed’s argument is that we are currently embarking on the beginning of a commodity super-cycle, a price phenomenon where prices trend in one direction for many years on end, often 10-15 years.  If this argument is correct, and the prices of copper and iron ore are just beginning their climb, then the Fed is going to find themselves with a whole lot of trouble in the future.  But right now, it is merely dueling forecasts and narratives, so nothing is clear.

With all the excitement in commodities, things are pretty quiet in the financial markets.  Equity markets in Asia were a bit higher (Nikkei +0.55%, Hang Seng 0.0%, Shanghai +0.25%) while European bourses are mixed (DAX -0.25%, CAC -0.2%, FTSE 100 +0.15%).  US futures are also mixed with Dow (+0.3%) continuing last week’s rally while NASDAQ (-0.25%) continues to feel pain from the ongoing rotation out of tech.

Bond markets are not buying the inflation narrative at this point with Treasuries (-0.5bps) seeing slightly lower yields while Bunds and OATs are essentially unchanged on the day.  The only real mover is the Gilt market (+1.7bps) which has rallied after weekend elections failed to give the Scottish National Party a majority in the Scottish Parliament and thus the prospect of a referendum to allow Scotland to leave the UK seems to be pushed back.

The outcome of the Scottish vote helped the pound as well, with GBP rallying 0.9% this morning, far and away the best performer in the FX markets.  Amid broad-based dollar weakness, the pound’s performance still stands out.  Next in line, in the G10, is AUD (+0.5%) which is a clear beneficiary of the rise in commodity prices.  In fact, iron ore is Australia’s largest commodity export.  NZD and CAD (both +0.2%) are lesser beneficiaries and the rest of the block, save JPY (-0.2%) is slightly firmer.  The yen seems to be suffering from the latest poll showing PM Suga’s popularity continuing to slide and bringing some uncertainty to the situation there with an election due by the end of the year.

Asian currencies were the big beneficiary in the EMG space led by KRW (+0.7%), IDR (+0.6%) and CNY (+0.3%).  The story there continues to be the anticipated strong growth rebound combined with the dollar’s weakness.  Remember, Chairman Powell has essentially promised that US rates are going to remain at zero regardless of what happens for at least another year.  As it happens, TWD (+0.3%) has traded to its strongest level since 1997, as the robust economic situation, plus the huge demand for semiconductors has more than offset any geopolitical concerns.

Data this week is back-loaded as follows:

Tuesday NFIB Small Biz Optimism 100.8
JOLTs Job Openings 7.5M
Wednesday CPI 0.2% (3.6% Y/Y)
-ex food & energy 0.3% (2.3% Y/Y)
Thursday Initial Claims 495K
Continuing Claims 3.64M
PPI 0.3% (5.8% Y/Y)
-ex food & energy 0.4% (3.7% Y/Y)
Friday Retail Sales 1.0%
-ex autos 0.9%
IP 1.0%
Capacity Utilization 75.1%
Michigan Sentiment 90.1

Source: Bloomberg

Obviously, CPI will be very interesting, as will Retail Sales.  We also hear from 13 more Fed speakers this week, all of whom are certain to repeat the mantra that the economy needs more support and they will not be changing policy anytime soon.  Remember, inflation is transitory…until it’s not.

The dollar is starting the week off on the back foot.  If we continue to hear Fed speakers insist that policy is not going to change, and we continue to see inflationary consequences rise, the dollar will weaken further.  In the end, 10-year Treasury yields remain the key number to watch.  As long as they remain within the recent range, the dollar is likely to remain soft.  If they should break higher, though, watch out.

Good luck and stay safe
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The Seeds of Inflation

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Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory

But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone

Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation.  It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip.  The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives.  But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed.  (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)

For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%.  While both those results were exactly as forecast, the trend for both remains sharply higher.  The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation?  After all, it is not as though the data comes with a disclaimer.  Ultimately, a decision is going to have to be made that rising prices are becoming a problem.  Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.

For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession.  The June data will be the first test as that monthly CPI print last year was a robust 0.5%.  Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities.  But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand.  In fact, it is this uncertainty that is the primary rationale for corporate hedging.  There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results.  FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.

This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing.  Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%.  Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector.  In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday.  The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency.  Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.

Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds.  So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged.  Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets.  Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.

Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%).  The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs.  Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.

It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher.  Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today.  Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength.  There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.

As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.

Today ISM Manufacturing 65.0
ISM Prices Paid 86.1
Construction Spending 1.7%
Tuesday Trade Balance -$74.3B
Factory Orders 1.3%
-ex transport 1.8%
Wednesday ADP Employment 875K
ISM Services 64.1
Thursday Initial Claims 540K
Continuing Claims 3.62M
Nonfarm Productivity 4..2%
Unit Labor Costs -1.0%
Friday Nonfarm Payrolls 978K
Private Payrolls 900K
Manufacturing Payrolls 60K
Unemployment Rate 5.7%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%
Consumer Credit $20.0B

Source: Bloomberg

As well, we hear from five Fed speakers, including Chairman Powell this afternoon.  Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.

Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future.  Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact.  Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar.  We shall see.  As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast.  While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.

Good luck and stay safe
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Filled With Froth

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Said Jay, markets seem filled with froth
But let me tell you, we are loth
To even discuss
The tapering fuss.
To ZIRP and QE we are troth

Now, ask yourself what markets heard
Jay cooed like his favorite white bird
So, dollars were sold
Investors bought gold
With equity bulls undeterred

The Chairman was very clear yesterday afternoon in his press conference, the Fed is not anywhere near thinking about changing their current policy mix.  While paying lip service to the idea that if inflation turns out not to be ‘transitory’ they have the tools to address it, the overwhelming belief in the Mariner Eccles Building appears to be that by autumn, inflation will be a thing of the past and the Fed will still have their foot on the proverbial accelerator.

This does raise the question that, if economic growth is rebounding so smartly, why does the Fed need to buy $120 billion of assets each month and maintain their policy rate at 0.00%?  While I am just an FX guy, it seems to me that the current policy stance is more appropriate for an apocalyptic economic crisis, something like we suffered last year or in 2008-9, rather than for an economy that is growing at 7.0% or more.  But that’s just me.  Clearly, Chairman Powell and his committee are concerned that the economy cannot continue to grow on its own, else they wouldn’t be doing what they are doing.

When it comes to the tapering of asset purchases, Powell was also explicit that it is not nearly time to consider the idea.  Yes, we had one good NFP number, but we need a string of them to convince the Fed that we are past the worst of things.  Remember, the opening two lines of the Fed statement continue to be about Covid.  “The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.  The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world.”  Until such time as that statement changes, we don’t need to hear the press conference to know that nothing is going to change.

With this in mind, let us consider the potential impact on markets.  Starting with Treasuries, it seems reasonable to assume that yields are reflective of investors collective view on inflation going forward.  The Fed has been purchasing $120 billion / month since last June and is not about to change.  At this stage, it would appear the market has factored those purchases into the current yield.  This means, future movements are far more likely to be indicative of the evolving view on inflation.  Yesterday, after the press conference, 10-year yields slipped by 4bps, but this morning, they have recouped those losses and we currently sit at 1.65%.  With commodity prices clearly still on a massive roll (WTI +1.4%, Cu +0.8%), while the Fed is convinced that any inflation will be transitory, it is not obvious that the rest of the market agrees.  Powell said the Fed would need to see a string of strong data.  Well, next week the early expectations for NFP are 888K, which would be two very strong months in a row.  Is that a string?  Certainly, it’s a line.  But I doubt it will move the needle at the Fed.  Maximum employment is still a long way off, and there will be no changes until then.  As inflation readings climb, and they will, Treasury yields will continue to climb as well.  There is nothing magical about 1.75%, the level reached at the end of March, and I expect that by the end of Q2, we will be looking at 10-year yields close to, or above 2.0%.

If Treasury yields are at 2.0%, what happens to equity markets?  In this case, it is not as clear cut as one might think.  First off, this Fed clearly has a different reaction function to data than previous iterations as they have been explicit that pre-emptive tightening to prevent potential future inflation is not going to happen.  This implies that any rise in yields is not reflective of expected Fed policy changes, but rather as a response to rising inflationary pressures.  History has shown that when inflation rises but stays below 3.0%, equity markets can remain buoyant, but once that threshold has been breached, it is a different story.  Remember, especially in the tech sector, but in truth quite generally, the reason low rates boost the stock market is because any discount cash flow model, when discounting at ultra-low rates means current values should be higher.  This is why rising yields become a problem for equity prices. In fact, it is reasonable to analogize being long growth stocks to being long bond duration, so when bond prices fall and yields rise accordingly the same thing happens to those stocks.  If this relationship holds going forward, and inflationary concerns do continue to percolate in the market, it would appear equity prices could be in for a bumpy ride.

Clearly, that is not yet the case (after all, inflation hasn’t yet reared its ugly head), as evidenced by the overnight price action in the wake of Powell’s comments.  Asia was strong (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +0.5%) and most of Europe is as well (CAC +0.55%, FTSE 100 +0.7%) although the German DAX (-0.25%) is a bit of a laggard this morning as concerns over Q1 GDP rise due to the third Covid wave.  US futures, though, are all-in with Jay, rising between 0.5% (Dow) and 1.0% (NASDAQ).  That makes sense given the assurances that there will be no tapering forever the foreseeable future.

As to the dollar, there are two different narratives at odds here.  On the one hand, the fundamentalists continue to point to a weaker dollar in the future as rising inflation tends to devalue a currency, and when combined with the massive fiscal deficit policy, a dollar decline becomes the only outlet available for pressure on the economy.  On the other hand, rising yields tend to support the dollar, so as Treasury yields continue to rise, if they stay ahead of the inflation statistics, there is reason to believe that the dollar has further to gain from here.  Of course, if inflation outstrips the rise in nominal yields such that real yields decline, we could easily have a situation with higher nominal Treasury yields and a much weaker dollar.  For now, the inflation data is lagging the Treasury market, but I suspect that by the end of May, that will not be the case, meaning the long-awaited dollar decline has a much better chance to get started then.

In the meantime, the dollar has softened ever so slightly this morning.  Versus G10 currencies, only JPY (-0.25%) has declined as the rebound in Treasury yields this morning seems to be garnering interest in the Japanese investment community.  But, while the dollar is softer vs. everything else, nothing has even moved 0.2%, which implies there is no news beyond the Fed.  In the EMG space, the dollar is also largely softer, led by HUF (+0.5%), THB (+0.45%) and INR (+0.45%).  HUF continues to benefit from the relatively hawkish stance of the central bank, while the baht rallied despite a reduction in the 2021 GDP estimate to 2.3% as Covid infections increase in the nation.  Meanwhile, INR appears to be the beneficiary of the Fed’s stance as clearly, the ongoing domestic disaster regarding its response to the latest wave of Covid infections cannot be seen as a positive.

On the data front, we start with Initial Claims (exp 540K) and Continuing Claims (3.59M) but also see the first look at Q1 GDP (6.6%), with a range of estimates from 4.5% to 10.0%!  With the Fed meeting behind us, we should start to hear from FOMC members again, but today only has Governor Quarles discussing financial regulation, a much drier subject than inflation.  Tomorrow, however, we will see the latest Core PCE data, and that has the chance to move things around.

As of now, the dollar remains on its back foot given the Fed’s clear message that tapering is a long way off and easy money is here for now.  However, if Treasury yields start to rise further, especially if they get back toward the 1.75% level, I expect the dollar will rebound.  On the other hand, if Treasuries remain quiet, the dollar probably has further to fall.

Good luck and stay safe
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Ephemeral

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Inflation remains
Ephemeral in Japan
Will Suga as well?

Leadership in Japan remains a fraught situation as highlighted this week.  First, three by-elections were held over the weekend and the governing LDP lost all three convincingly.  PM Yoshihide Suga is looking more and more like the prototypical Japanese PM, a one-year caretaker of the seat.  Previous PM, Shinzo Abe, was the exception in Japanese politics, getting elected and reelected several times and overseeing the country for more than 8 years.  But, since 2000, Suga-san is the 9th PM (counting Abe as 1 despite the fact he held office at two different times).  In fact, if you remove Abe-san from the equation, the average tenor of a Japanese PM is roughly 1 year.  Running a large country is a very difficult job, and in the first year, most leaders are barely beginning to understand all the issues, let alone trying to address whichever they deem important.  In Japan, not unlike Italy, the rapid turnover has left the nation in a less favorable position than ought to have been the case.

Of course, long tenure is no guarantee of success in a leadership role, just ask BOJ Governor Haruhiko Kuroda.  He was appointed to the role in February 2013 and has been a strong proponent of ultra-easy monetary policy as a means to stoke inflation in Japan.  The stated target is 2.0%, and for the past 8 years, the BOJ has not even come close except for the period from March 2013-March 2014 when a large hike in the Goods and Services Tax raised prices on everyday items and saw measured inflation peak at 3.7% in August.  Alas for Kuroda-san, once the base effects of the tax hike disappeared, the underlying lack of inflationary impulse reasserted itself and in the wake of the Covid-19 pandemic lockdowns, CPI currently sits at -0.2%.

Last night, the BOJ met and left policy on hold, as expected, but released its latest economic and inflation forecasts, including the first look at their views for 2023.  Despite rapidly rising commodity prices as well as a slightly upgraded GDP growth forecast, the BOJ projects that even by 2023, CPI will only rise to 1.0%.  Thus, a decade of monetary policy largesse in Japan will have singularly failed to achieve the only target of concern, CPI at 2.0%.

Personally, I think the people of Japan should be thankful that the BOJ remains unsuccessful in this effort as the value of their savings remains intact despite ZIRP having been in place since, essentially, 1999.  While they may not be earning much interest, at least their purchasing power remains available.  But the current central bank zeitgeist is that 2.0% inflation is the holy grail and that designing monetary policy to achieve that end is the essence of the job.  The remarkable thing about this mindset is that every nation has a completely different underlying situation with respect to its demographics, debt load, fiscal accounts and growth capabilities, which argues that perhaps the one size fits all approach of 2.0% CPI may not be universally appropriate.

In the end, though, 2.0% is the only number that matters to a central banker, and for now, virtually everyone worldwide is trying to design their policy to achieve it.  As I have repeatedly discussed previously, here at home I expect that soon enough, Chairman Powell and friends will find themselves having to dampen inflation to achieve their goal, but for now, pretty much every G10 central bank remains all-in on their attempts to push price increases higher.  That means that ZIRP, NIRP and QE will not be ending anytime soon.  Do not believe the tapering talk here in the US, the Fed is extremely unlikely to consider it until late next year, I believe, at the earliest.

Delving into Japanese monetary policy seemed appropriate as central banks are this week’s story line and we await the FOMC outcome tomorrow afternoon.  In addition to the BOJ, early this morning Sweden’s Riksbank also met and left policy unchanged with their base rate at 0.0% and maintained its QE program of purchasing a total of SEK 700 billion to help keep liquidity flowing into the market.  But there, too, the inflation target of 2.0% is not expected to be achieved until 2024 now, a year later than previous views, and there is no expectation that interest rates will be raised until then.

What have these latest policy statements done for markets?  Not very much.  Overall, risk appetite is modestly under pressure this morning as Japan’s Nikkei (-0.5%) was the worst performer in Asia with both the Hang Seng and Shanghai indices essentially unchanged on the day.  I would not ascribe the Nikkei’s weakness to the BOJ, but rather to the general tone of malaise in today’s markets.  European equity markets have also been underwhelming with red numbers across the board (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%) albeit not excessively so.  Here, too, apathy seems the best explanation, although one can’t help but be impressed with the fact that yet another bank, this time UBS, reported significant losses ($774M) due to their relationship with Archegos.  As to US futures, their current miniscule gains of 0.1% really don’t offer much information.

Bond prices are also under very modest pressure with 10-year Treasury yields higher by 1.1bps and most of Europe’s sovereign market seeing yield rises of between 0.5bps and 1.0bps.  In other words, activity remains light as investors and traders await the word of god Powell tomorrow.

Commodity prices, on the other hand, are not waiting for anything as they continue to march higher across the board.  Oil (+0.8%) is leading the energy space higher, while copper (+1.1%) is leading the base metals space higher.  Gold and silver have also edged slightly higher, although they continue to lag the pace of the overall commodity rally.

The dollar, which had been uniformly higher earlier this morning is now a bit more mixed, although regardless of the direction of the move, the magnitude has been fairly small.  In the G10 space, the leading decliner is AUD (-0.2%) which is happening despite the commodity rally, although it is well off its lows for the session.  That said, it is difficult to get too excited about any currency movement of such modest magnitude.  Away from Aussie, JPY (-0.2%) is also a touch softer and the rest of the G10 is +/- 0.1% changed from yesterday’s closing levels, tantamount to unchanged.

EMG currencies have seen a bit more movement, but only TRY (+0.75%) is showing a substantial change from yesterday.  it seems that there is a growing belief that the tension between the US and Turkey regarding the Armenian genocide announcement by the Biden administration seems to be ebbing as Turkish President Erdogan refrained from escalating things.  This has encouraged traders to believe that the impact will be small and return their focus to the highest real yields around.  But away from the lira, gainers remain modest (KRW +0.25%, TWD +0.2%) with both of these currencies benefitting from equity inflows.  On the downside, ZAR (-0.35%) is the laggard as despite commodity price strength, focus seems to be shifting to the broader economic problems in the nation, especially with regard to a lack of power generation capacity.

Data this morning brings Case Shiller Home Prices (exp 11.8%) and Consumer Confidence (113.0), neither of which is likely to have a big impact although the Case Shiller number certainly calls into question the concept of low inflation. With the FOMC tomorrow, there are no Fed speakers today, so I anticipate a relatively dull session.  Treasury yields continue to be the underlying driver for the dollar in my view, so keep your eyes there.

Good luck and stay safe
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