Tag Archives: #inflation

Transitory is Dead

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Said Jay, transitory is dead
And now when we’re looking ahead
To our consternation
It seems that inflation
Has climbed up to levels we dread

The market heard this and was stunned
Thus, equities quickly were shunned
The dollar was bought
And everyone thought
They’re better off buying the Bund

Finally!  It only took Chairman Powell 9 months to accept the reality on the ground that inflation is not likely to disappear anytime soon.  He officially ‘retired’ the word transitory as a description and confessed that inflation has been more persistent than he and the Fed had forecast.  The question that was not addressed is why the Fed thought that the supply chain bottlenecks were going to be short-lived to begin with.  After all, the primary use of ultra-cheap funding by the corporate community has been capital structure rebalancing (i.e. share repurchases) as that was the most efficient way to improve company valuations.  At least their stock market valuations.  Thus, there was never any evidence that investment was flowing toward areas that were bottle(necke)d up.

Ironically, this was partly Powell’s fault as his continued confidence that inflation was transitory, and bottlenecks would ease discouraged any company from making the investments to ease those very same bottlenecks.  Consider this, why would a company spend money to increase capacity if the benefits to be gained would be so short-lived?  And so, investments were not made, capacity remained the same and the bottlenecks persisted.

But now the Fed has acknowledged that inflation is a problem and Mr Powell has indicated that the pace of tapering QE ought to be increased.  The market read this as a doubling of the pace and so QE is now set to end in March, at least according to the punditry.  We will find out more precisely come the FOMC meeting in two weeks’ time.

Ultimately, the problem for Powell and the Fed is that a more aggressive timeline to tighten policy could potentially have a fairly negative impact on both stock and bond markets.  If that is the case, and there is no reason to believe it won’t be, Mr Powell may find himself in a similar situation as Q4 2018, when comments regarding the fact that the Fed was “nowhere near neutral” interest rates, which implied further tightening, resulted in a 20% decline in the S&P 500 Index and led to the infamous Powell Pivot on Boxing Day, when the Fed stopped tightening and began to ease policy.  Can Powell withstand a 20% decline in the S&P 500 today?  I doubt it.  10%?  Even that will be tough.  In essence, Powell now finds himself caught between President Biden’s growing concerns over inflation and the market’s likely concerns over tighter policy.  If nothing else, we should finally learn the Fed’s true master as this plays out.

So, with that in mind, let’s take a look at how markets have responded overnight.  While yesterday saw an immediate rejection of risk assets, the first bargain hunters have returned and equity markets were largely in the green overnight and on into this morning.  The Nikkei (+0.4%), Hang Seng (+0.8%) and Shanghai (+0.35%) all managed to rally amid mixed data (Japan’s PMI rising to 54.5, China’s Caixin PMI falling to 49.9) and despite ongoing concerns the omicron variant would lead to further lockdowns.

European bourses (DAX +1.4%. CAC +1.3%, FTSE 100 +1.3%) are all much firmer after the PMI data there was generally better than expected.  This is despite the fact that the OECD released its latest forecasts, slightly downgrading global growth for 2021 although maintaining its 2022 global growth forecast of 4.5%.  Pointed comments about the risks of the omicron variant accompanied the release as all the work was done before that variant became known.  Perhaps investors are looking at omicron and assuming it will delay tightening further, thus support equity values.  Finally, US futures are all pointing sharply higher this morning, at least 1.0% with NASDAQ futures +1.5% at this hour.

It should be no surprise, given risk is back in vogue, that bonds are selling off again.  The one thing that has been evident is that volatility in markets has increased and shows no signs of abating until there is a more coherent story and clarity on ultimate central bank policy.  This morning, Treasury yields (+3.6bps) have jumped as have Bunds (+2.7bps), OATs (+3.1bps) and Gilts (+5.6bps).  Perhaps more surprising is that Italian BTPs (+6.5bps) have been the worst performer on the continent as during a risk-on session, these bonds tend to outperform.  Asian bond markets performed in a similar manner as yields rallied everywhere there.

Commodity prices are at least making sense today as we are seeing strength virtually across the board.  Oil (+4.5%) is leading the energy space higher, although NatGas (-3.4%) remains disconnected and is the sole outlier.  Metals are firmer as both precious (Au +0.7%, Ag +0.2%) and industrial (Cu +0.45%, Al +0.7%, Sn +0.3%) see buying interest and agricultural prices are firmer as well.

The dollar, though, has less direction today with the G10 seeing commodity currencies stronger (NZD +0.35%, AUD +0.3%, CAD +0.25%) while financials are under modest pressure (CHF -0.2%, JPY -0.15%, EUR -0.15%).  Now, in fairness, none of these moves are that large and most likely they represent position adjustment more than anything else.  In the emerging markets, TRY (+1.8%) remains the most volatile, rising sharply (more than 8.5% at its peak) after the central bank announced they were intervening due to “unhealthy price formations” in the market.  It seems those price formations have been the result of President Erdogan continuing his campaign to lower interest rates in the face of soaring inflation.  But there were other gainers of note including MXN (+0.9%) backed by oil’s rebound, KRW (+0.8%) on the strength of stronger than forecast output data and CLP (+0.7%) on the rise in copper prices.

Data this morning brings ADP Employment (exp 525K), ISM Manufacturing (61.2) and Prices Paid (85.5) and at 2:00 this afternoon, the Fed releases the Beige Book.  Chairman Powell and Secretary Yellen testify to the House Financial Services Committee starting at 10:00, and remember, that was when the fireworks started yesterday.  I doubt we will see the same type of movement but be alert.

The dollar story has lost its conviction as previously, the thought of a more aggressive Fed would have led to a much firmer dollar.  However, we are not witnessing that type of price action here.  While I still believe that will impact the currency’s near-term movement, right now it appears that many currencies are trading on their own idiosyncratic issues without the benefit of the big picture.  If the Fed does taper more quickly and begin to raise rates, I do expect the dollar will benefit and we can see 1.10 or lower in the euro as there is absolutely no indication the ECB is going to follow suit.  However, I suspect that equity market pain will become too much for the Fed to tolerate, and that any dollar strength will be somewhat short-lived.  Payables hedgers should take advantage over the next few weeks/months, but if you are a receivables hedger, I think patience may be a virtue here.

Good luck and stay safe
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Before Omicron

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There once was a narrative told
Explaining the Fed still controlled
The market’s reaction
Preventing contraction
Thus, making sure stocks ne’er got sold

But that was before Omicron
Evolved and put more pressure on
The future success
Of Fed’ral largesse
With no real conclusion foregone

So, later this morning we’ll hear,
When Janet and Jay both appear,
In front of the Senate
If they’ve still the tenet
That all will be well by next year

Perhaps all is not right with the world.  At least that would be a conclusion easily drawn based on market activity this morning.  Once again, risk is being shed rapidly and across the board.  Not only that, but the market is completely rethinking the idea of tighter monetary policy by the Fed with the growing conclusion that it is just not going to happen, at least not on the timeline that had been assumed a few short days ago.

It seems that the Omicron variant of Covid is proving to be a bigger deal in investor’s eyes than had been originally assumed.  When this variant was first identified by South African scientists, the initial belief was it was more virulent but not as acute as the Delta variant.  So, while it was spreading quite rapidly, those who were infected displayed milder symptoms than previous variants.  (If you think about the biology of this, that makes perfect sense.  After all, every organism’s biologic goal is to continue to reproduce as much as possible.  If a virus is so severe that its host dies, then it cannot reproduce very effectively.  Thus, a more virulent, less severe strain is far more likely to remain in the world than a less virulent, more deadly strain, which by killing its hosts will die off as well.)

In the meantime, financial markets have been trying to determine just what type of impact this new strain is going to have on economies and whether it will induce another series of lockdowns slowing economic activity, or if it will be handled in a different manner.  And so far, there is no clear conclusion as evidenced by the fact that we saw a massive sell-off in risk assets Friday, a major rebound yesterday and another sell-off this morning.  If pressed, I would expect lockdowns to come back into vogue as despite questions over their overall efficacy, their imposition allows government officials to highlight they are ‘doing something’ to prevent the spread.  Additional bad news came from the CEO of Moderna, one of the vaccine manufacturers, when he indicated that the nature of this variant would likely evade the vaccines’ defense.

So, story number one today is Omicron and how this new Covid variant is going to impact the global economy.  Ironically, central bankers around the world must be secretly thrilled by this situation as the focus there takes the spotlight off their problem, rapidly rising inflation.

For instance, after yesterday’s higher than expected CPI prints in Spain and Germany, one cannot be surprised that the Eurozone’s CPI printed this morning at 4.9%, the highest level since the Eurozone was born in 1997, and far higher than any of the 40 economist forecasts published.  Madame Lagarde wasted no time explaining that this was all temporary and that by the middle of next year inflation would be back to its pre-pandemic levels, but it seems fewer and fewer people are willing to believe that story.  Do not mistake the run to the relative safety of sovereign bonds as a vote of confidence in the central bank community.  Rather that is simply seen as a less risky place to park funds than the equity market, which by virtually every measure, remains significantly overvalued.

This leads to the third major story of the day, the upcoming testimony by Chairman Powell and Treasury Secretary Yellen in front of the Senate Banking Committee.  The pre-released opening comments focus on Omicron and how it can be a risk for both growth and inflation thus once again trying to divert attention from Fed policies as a problem by blaming exogenous events beyond their control.  Of course, this story will resolve itself starting at 10:00, so we will all listen in then.

Ok, with all that as prelude, a quick tour of markets shows just how much risk is in disfavor this morning.  Overnight in Asia we saw broad weakness (Nikkei -1.6%, Hang Seng -1.6%) although once again Shanghai was flat.  Europe is completely in the red (DAX -1.45%, CAC -1.25%, FTSE 100 -1.0%) and US futures are also pointing lower (DOW -1.2%, SPX -1.0%, NASDAQ -0.5%).

Meanwhile, bond markets are ripping higher with Treasuries (-5.1bps) leading the way as yields fall back to levels last seen in early September.  In Europe, Bunds (-2.1bps), OATs (-2.2bps) and Gilts (-4.0bps) are all seeing demand pick up with the rest of the Continent all looking at lower yields despite rising inflation.  Fear is clearly a powerful motivator.  Even in Asia we saw JGB’s (-1.9bps) rally as did Australian and New Zealand paper.

Commodity markets are having quite a day with some really mixed outcomes.  Oil (-2.5%) is back in the red after yesterday’s early morning rebound faded during the day, and although oil did close higher, it was well of the early highs.  NatGas (-5.0%) is falling sharply, which at this time of year is typically weather related.  On the other hand, gold (+0.5%) is bouncing from yesterday and industrial metals (Cu +1.4%, Al +1.6%, Sn +2.7%) are in clear demand.  It seems odd that on a risk-off day, these metals would rally, but there you have it.

Finally, the dollar can only be described as mixed this morning, with commodity currencies under pressure (NOK -0.4%, CAD -0.25%) while financial currencies (EUR +0.5%, CHF +0.5%, JPY +0
4%) are benefitting on receding expectations for a tighter Fed.  PS, I’m sure the risk off scenario is not hurting the yen or Swiss franc either.

Emerging market currencies are demonstrating a broader based strength with TRY (-1.6%) really the only major loser as further turmoil engulfs the central bank there and expectations for lower interest rates and higher inflation drive locals to get rid of as much lira as possible.  Otherwise, PLN (+0.8%) is leading the way higher as expectations for the central bank to raise rates grow with talk now the rate hike will be greater than 50 basis points.  But MYR (+0.8%) and CZK (+0.75%) are also showing strength with the ringgit simply rebounding after a 10-day down move as bargain hunters stepped in, while the koruna has benefitted from hawkish comments from the central bank governor.  It appears that most EMG central banks are taking the inflation situation quite seriously and I would look for further rate hikes throughout the space.

Aside from the Powell/Yellen testimony, this morning brings Case Shiller House Prices (exp 19.3%), Chicago PMI (67.0) and Consumer Confidence (111.0).  As well, two other Fed speakers, Williams and Clarida, will be on the tape, but it is hard to believe they will get much notice with Powell front and center.

The dollar appears to be back following the interest rate story, which means that if expectations of Fed tightening dissipate, the dollar will likely fade as well, at least versus the financial currencies.  Commodities have a life of their own and will continue to dominate those currencies beholden to them.  The tension between potential slower growth and rising inflation has not been solved, and while my view is the Fed will allow inflation to burn still hotter, keep in mind that if they do act to tighten policy, the dollar should find immediate support.

Good luck and stay safe
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Future Pratfalls

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In Germany, and too, in Spain
The people are feeling the pain
Of prices exploding
And therefore corroding
Their standards of living again

Meanwhile from the ECB’s halls
The comments from those know-it-alls
Show lack of concern
As each of them spurn
The idea of future pratfalls

In trading, ‘the trend is your friend’ is a very common sentiment and an idea backed with strong evidence.  One can think of this as analogous to Newton’s first law, i.e. a body in motion stays in motion.  So, when the price action in some market has been heading in one direction over time, it tends to continue in that direction.  This is the genesis of the moving average as a trading tool as the moving average is what defines the trend.  I highlight this because the concept is not restricted to trading but is also evident in many other price series, notably inflation.  When one looks at the history of inflation, it tends to trend in one direction for quite some time with major reversals relatively infrequent.  That is not to say a reversal cannot occur, but if one does, it tends to be the result of a long period of adjustment, not a quick flip of direction.

And yet, when listening to both Fed and ECB speakers lately, they would have you believe that the currently entrenched trend higher for prices is the aberration and that in a matter of months they will be back to their old concerns about deflation being the biggest problem for the economy.  One has to wonder at what evidence they are looking to come to that determination as certainly the recent data does not point in that direction.  Just this morning Spanish CPI (5.6%) printed at the highest level since 1992 while Italian PPI (25.3%) printed at the highest level in its history.  From Germany, we have seen CPI prints from several of its states (Hesse 5.3%, Baden Wuerttemberg 4.9%, Bavaria 5.3%, Saxony 5.0%) with the national number (exp 5.5%) due at 8:00 this morning.

Still, none of this seems to be having an impact on the thoughts of ECB members with Lagarde, Schnabel, Villeroy and de Cos all out explaining that this is a temporary phenomenon and that by the middle of next year CPI will be back at their 2.0% target or lower.  Maybe it will be so, but as Damon Runyon so aptly explained, “The race is not always to the swift, nor the battle to the strong; but that is the way to bet.”  In other words, looking at the current trends, it seems far more likely that inflation remains high than suddenly turns around lower.  The biggest problem the central banks have now is that it has become common knowledge that inflation is rising, which means that individual behaviors are adjusting to a new price regime.  And if you listen to the central bank thesis that inflation expectations are a critical input, then they are really in trouble as inflation expectations are clearly rising.

At least the Fed has begun to discuss the idea of removing accommodation, although the Omicron variant of Covid may given them pause, but in Europe, it is not even on the table.  A discussion point that has been raised numerous times lately is the idea of a central bank policy error, either raising rates prematurely to battle phantom inflation or waiting too long to tighten policy and allowing inflation to become more entrenched.  While my money is on the latter, it is very clear that the ECB, at least, and still many Fed members, are far more concerned with the former.  Perhaps they are correct, and all these rising prices will quickly dissipate, and that would be great.  However, I am not counting on that outcome, nor should anyone else at this point until there is ANY proof the Fed or ECB are correct.

Meanwhile, Friday’s dramatic events seem to have been erased from memory as while there are still headlines regarding the Omicron variant, the collective market view appears to be that it is not going to result in another wave of lockdowns and therefore the economic impact will be relatively minor.  As such, we are seeing a reversal of fortune across most markets from their Friday price action.  It should be no surprise that the biggest change comes from oil (+4.75%) which has recouped about one-third of its losses and seems set to continue rebounding.  After all, if the consensus is that Omicron is not going to have much of an impact, then the supply/demand story hasn’t changed and that bodes well for oil prices moving higher.  Elsewhere in the commodity space NatGas (+7.4%) is rising sharply on the back of colder than normal weather, while metals prices (Au +0.1%, Ag +0.5%, Cu +1.7%, Al +1.2%) are all rebounding as well.

In the equity markets, Asia never got a chance to sell off like Europe and the US on Friday so caught up (down?) with the Nikkei (-1.6%) leading the way although the Hang Seng (-1.0%) also suffered.  Shanghai traded flat for the day.  Europe, however, which sold off sharply on Friday, with many markets down more than 4%, has rebounded somewhat this morning (DAX +0.7%, CAC +1.1%, FTSE 100 +1.2%) although these markets are obviously well lower than Thursday’s closing levels.  Finally, US equities sold off sharply in Friday’s abbreviated session, with all three indices down about 2.3% but this morning futures are all rebounding as well, up between 0.6% and 0.8%.

Bonds saw the most dramatic move on Friday, with Treasury yields tumbling 16 basis points while European yields all fell as well, albeit less dramatically.  This morning, with risk back in vogue, bonds are back under pressure with Treasuries (+6.8bps) leading the way but all of Europe (Bunds +2.7bps, OATs +1.5bps, Gilts +3.9bps) also seeing higher yields.

It should come as no surprise that the dollar is also reversing some of Friday’s price action with the commodity bloc doing well (SEK +0.4%, CAD +0.3%, AUD +0.3%) while the financials are under modest pressure (EUR -0.2%).  This movement is nothing more than a reaction to the Friday movement.  EMG currencies are seeing similar price action with the best performers the commodity bloc here (RUB +0.9%, ZAR +0.7%) while weakness has been seen in TRY (-3.45%) and CLP (-0.7%).  The former continues to suffer from President Erdogan’s comments about never raising interest rates to fight inflation while the peso is reacting to early polls showing the leftist, Gabriel Boric, leading ahead of the runoff presidential election in 3 weeks.

It is a week full of data culminating in Friday’s payroll report although it starts out slowly.

Tuesday Case Shiller Home Prices 19.35%
Chicago PMI 67.0
Consumer Confidence 110.7
Wednesday ADP Employment 525K
Construction Spending 0.4%
ISM Manufacturing 61.1
ISM Prices Paid 85.8
Fed Beige Book
Thursday Initial Claims 250K
Continuing Claims 2000K
Friday Nonfarm Payrolls 535K
Private Payrolls 525K
Manufacturing Payrolls 45K
Unemployment Rate 4.5%
Average Hourly Earnings 0.4% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
ISM Services 65.0
Factory Orders 0.5%

Source: Bloomberg

In addition to all that data, we hear from Chairman Powell (and Secretary Yellen) in front of the Senate and House on Tuesday and Wednesday as well as eight more Fed speakers during the week.  If I were a betting man, I would expect that the broad message will continue to be that while inflation is not a long-term problem, it is appropriate to continue to normalize monetary policy now.  And that will be the message right up until markets force them to make a choice by either selling off sharply and forcing an end to policy tightening or running to new highs dragging inflation expectations, as well as inflation, along with them.

Meanwhile, the dollar remains beholden to the latest whims.  If tightening is back on the table, then look for the dollar to resume its uptrend.  However, if Omicron, or something else, causes a change in the message, the dollar seems likely to pull back smartly.

Good luck and stay safe
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Unchecked

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In Europe, the maximum nation
Is facing the scourge of inflation
And so, they are calling,
To help it start falling,
For less money accommodation

But others in Europe reject
The idea inflation’s unchecked
T’would be premature
To tighten, they’re sure
As QE they want to protect

It appears there is a growing rift in the ECB as we are beginning to hear more opposing views regarding the nature of inflation and correspondingly as to the prescription to address the issue.  On the one hand, the hawks have been sharpening their talons with Germany’s Schnabel, Slovenia’s Vasle and Spain’s de Guindos having all warned of inflation’s surprising persistence and explaining that the risk is to the upside for higher inflation still.  Meanwhile, this morning we had an erstwhile Hawk, Austria’s Holzmann, and an uber-dove, Italy’s Panetta pushing back on that view and insisting that the inflation that has been afflicting Europe is being driven by “purely temporary factors” and that premature withdrawal of stimulus would be a mistake.

The surprising feature of this discussion is that the Spanish voice is hawkish while the Austrian is dovish.  Perhaps what that tells us is that, just like in the US, inflation has become a bigger political problem in Spain and the Socialist PM, Pedro Sanchez, is feeling the heat from the population there.  This would not be surprising given inflation is running at 5.4%, the highest level since the introduction of the euro in 1999.  Arguably, the fact that Robert Holzmann seems to be siding with the transitory camp is also quite the surprise, but as they say, politics makes strange bedfellows.  In the end, as long as Madame Lagarde remains at the helm, the doves remain in control.  As such, these comments sound very much like posturing for particular audiences.

Turning to other news, Germany is at the center of the most interesting stories today as local politics (the formation of a new government…finally) as well as data (IFO Expectations fell to 94.2) seem to be driving the euro bus, and with the euro, the rest of the markets.  A brief look at the proposed government shows a coalition of the Social Democrats (SPD), the Greens and the Free Democratic Party (FDP) which is a pro-growth, free markets group.  This unprecedented grouping of 3 parties remains tenuous, at best, if only because the underlying belief sets are very different.  It remains unclear how a party whose focus is on less government (FDP) is going to work effectively with a party whose focus is on bigger government (SPD).  Olaf Scholz will be the new PM, a man with long experience in politics and a widely respected name.  As I said before, politics makes strange bedfellows!

On the economic side, this morning’s IFO data was quite disappointing, with Expectations falling back to levels seen in the beginning of the year and reaching a point that foretells of a recession coming.  Adding this to the imminent lockdown scenario (Germany’s Covid caseload jumped by 54K yesterday, with a significant surge ongoing), leaves quite the negative impression for the German economy.  In fact, given this news, it becomes harder for the hawks to make their case as the central bank model continues to believe that slowing growth will slow inflation.  (And while that would be true for demand-pull inflation, the whole cost-push framework is different.)  At any rate, the result is a day where risk is being shed and havens sought.  This is especially so in Germany, where the DAX (-0.6%) is the weakest performer in Europe, while Bunds (-1.7bps) have rallied despite a terrible auction outcome as investors adjust asset mixes.  And the euro?  Down a further 0.3%, trading just above 1.1200, although it appears that there is further to run.

What about the rest of markets?  Well, the Nikkei (-1.6%) fell sharply as investors in Japan expressed concern that the Fed would begin to tighten, and it would have negative impacts throughout the world.  At least that is what they claim.  China, on the other hand saw much less movement with the Hang Seng (+0.1%) and Shanghai (+0.1%) seeing a mix of gainers and losers internally thus offsetting for the index as a whole.  The rest of Europe is generally softer (CAC -0.2%, Spain’s IBEX -0.3%), although the FTSE 100 is basically unchanged on the day.  And after a mixed day yesterday, US futures are pointing modestly lower, -0.2% or so across the board.

As to the rest of the bond market, Treasuries (-2.4bps) are finally rallying after seeing a dramatic 12 basis point rise in the past three sessions.  We have also seen OATs (-0.7bps) rally slightly and Dutch bonds (-1.6bps) all the havens.  It should not, however, be surprising that Italian BTPs (+1.2bps) and Greek bonds (+3.9bps) are being sold as they remain risk assets in full.

On the commodity front, oil, which has been suffering from the SPR release story, seems to have absorbed that risk and after rebounding yesterday is flat this morning.  While still below $80/bbl, my sense is this has further to run higher.  NatGas (-0.25%) is a touch lower in the US as is gold (-0.1%).  However, the industrial metals are performing far better (Cu +0.7%, Al +0.7%, Sn +0.4%).

Lastly, the dollar is generally having a good day again, as risk appetite wanes.  NZD (-0.6%) is the weakest G10 currency after the market was disappointed in their actions last night, only raising the base rate by 0.25% while the whisper number was 0.5%. SEK (-0.4%) is the next laggard, with the krona continuing to suffer on the view that the Riksbank will remain reluctant to tighten policy at all in the face of actions by the Fed and potentially the BOE.  The rest of the bloc is generally softer with only the haven, JPY (+0.1%), showing any strength.

In the EMG space, we need to look away from TRY (+5.6%) which is retracing some of yesterday’s remarkable decline, as it is destined for extreme volatility in the near future.  But elsewhere, there is actually a mixed result with BRL (+0.6%) and PHP (+0.5%) leading the gainers while THB (-0.7%) and RUB (-0.3%) lag the space.  The real is benefitting from the central bank announcement it will be auctioning off 14K contracts in the FX markets, part of their intervention process, while the Philippine peso has benefitted from further investment inflows to the local stock market.  On the flipside, the baht seems to be suffering from concerns that the lockdowns in Europe will reduce tourism there during the high season, while the ruble continues to suffer from concerns over potential military activity and the further negative impacts of sanctions that could follow.

Given tomorrow’s Thanksgiving holiday, all the rest of the week’s data will be released today:

Initial Claims 260K
Continuing Claims 2033K
GDP Q2 2.2.%
Durable Goods 0.2%
-ex Transport 0.5%
Personal Income 0.2%
Personal Spending 1.0%
Core PCE 0.4% (4.1% Y/Y)
Michigan Sentiment 67.0
New Home Sales 800K
FOMC Minutes

Source: Bloomberg

As the GDP data is a revision, it will not garner much attention.  Rather, all eyes will be focused on Core PCE, as if recent form holds, it will print higher than expectations, further forcing the Fed debate.  And of course, the Minutes will be parsed intently as traders try to divine just how quickly things may change next month, especially since Chairman Powell and Governor Brainerd have both been clear that inflation is their primary concern now.

At this point, there is nothing to stand in the way of the dollar and I expect that it will continue to grind higher for a while.  The hallmark of the move so far this month, where the single currency has fallen 3.0%, is that it has been remarkably steady with a majority of sessions showing modest declines.  That pattern seems likely to continue for now unless there is a change from either the Fed or the ECB, neither of which seems likely.  Hedge accordingly.

Have a wonderful Thanksgiving holiday and poetry will return on Monday November 29th.

Good luck, good weekend and stay safe
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Sang the Blues

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The President’s finally decided
That Lael and Jay have now divided
The tasks at the Fed
And both of them said
Inflation just won’t be abided

The bond market took in the news
And quickly adjusted its views
Thus, interest rates rose
While gold felt the throes
Of pain as goldbugs sang the blues

By now, we all know that Chairman Powell has been reappointed to his current role as Fed Chair and Governor Brainerd has been elevated to Vice-Chair.  The underlying belief seems to be that the Biden administration was not prepared for what would likely have been a much more difficult confirmation fight to get Brainerd as Chair and decided to husband whatever political capital they still have left to fight for their spending legislation.  Arguably, the most interesting part of the process was that both Powell and Brainerd, in their remarks, indicated that fighting inflation was a key priority.  As Powell said, “We will use our tools both to support the economy and strong labor market, and to prevent higher inflation from becoming entrenched.”  Now that is a wonderful sentiment, and of course, directly in line with the Fed’s Congressional mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.”  Alas for them both, the tools necessary for the different pieces of the mandate tend to be opposite in their nature.

However, the market response was clear as to its broad belief that tighter Fed policy is on the horizon.  Between those comments and what we heard last week from Governor Waller, vice-Chair Clarida and St Louis Fed President Bullard, it seems clear that the meeting in December is going to be all about the timing of the tapering.  While the progressive wing of the Democratic party remains steadfast in their belief in the power of MMT to deliver prosperity for all, it appears that the reality on the ground, namely that inflation is exploding higher, has become too big a problem to ignore for President Biden.

Here’s the thing.  The traditional tool for fighting rising inflation is to raise interest rates above the rate of inflation to create positive real yields.  Now, depending on how you define inflation; CPI, PCE, the core version of either, or the trimmed mean version of either, given where all of those measures currently stand, the minimum amount of rate increases is going to be 300 basis points, with a chance that it could be 400 or more.  Now, ask yourself how an economy that is leveraged to the hilt (total debt/GDP > 895%) will respond to interest rates rising by 300 or 400 basis points.  How about the stock market, with its current Shiller CAPE (cyclically adjusted P/E) above 39 compared to a median of 15.86 over the past 150 years?  How do you think that will respond to the interest rate curve rising by 300 or 400 basis points?  The picture is not pretty.

It remains to be seen just how much pain the Fed and the Administration can stand if the Fed actually does start to tighten policy more aggressively in the face of rapidly rising inflation.  Consider that in Q4 2018, the last time the Fed was trying to ‘normalize’ policy by allowing the balance sheet to run down slowly while also raising interest rates, stocks fell 20% and the result was the ‘Powell Pivot’ on Boxing Day that year, where the Chairman explained that tightening policy wasn’t actually that critical at the time and would end immediately.  At that time the same measure of debt/GDP was ‘merely’ 763% and the CAPE was 29.  We have much further to fall today, and I expect that when/if that starts to happen, the Fed will not blithely continue tightening policy to fight inflation.  Remember the idea that the Fed has painted themselves into a corner?  Well, this is the corner in which they have painted themselves.  They need to raise rates to fight inflation but doing so is likely to provoke a severely negative market, and potentially economic, reaction.

Now, while we are all waiting for that shoe to drop, let’s take a look at how markets responded to the news.  The first thing to note is the bond market, where 10-year yields rose 9 bps yesterday and that trend has continued this morning with yields higher by another 2.3bps.  With the 10-year currently yielding 1.65%, all eyes are on the 1.75% level, the peak seen in March, and the level many see as a critical technical level, a break of which could open up much higher yields.  It should not be surprising that we have seen higher yields elsewhere as well, with European sovereigns (Bunds +5.9bps, OATs +5.7bps, Gilts +4.8bps) responding to three factors this morning; the US market movement, better than expected preliminary PMI data across the continent and hawkish comments from both Isabel Schnabel and Klaas Knot, two ECB members. You may recall last week when I described some Schnabel comments as apparently dovish, and a potential capitulation of the remaining hawks on the ECB.  Apparently, I was mistaken.  Today she was much clearer about the risks of inflation being to the upside and that they must be considered.  If the hawks are in flight, bonds have further to decline.

In the equity markets, yesterday’s news initially brought a rally in the US, but by the end of the day, as bond yields rose, the NASDAQ, which is effectively a very long duration asset, fell 1.25%, although the rest of the US market fared far better.  The overnight session saw a more modest reaction with the Nikkei (+0.1%) and Shanghai (+0.2%) edging higher although the Hang Seng (-1.2%) suffered on weaker consumer and pharma stocks.  Europe has rebounded from its worst levels but is still lower (DAX -0.7%, CAC -0.25%, FTSE 100 0.0%) despite (because of?) the PMI data.  I guess hawkish monetary policy trumps good economic data, a harbinger of what may be on the horizon.  At this hour, US futures are little changed, so perhaps there is good news in store.

News that the Biden administration is releasing 30 million barrels of oil from the SPR along with releases by India and South Korea has weighed on oil prices (WTI -1.5%) although NatGas (+4.8%) is not following along for the ride.  Gold (-0.5%) got clobbered yesterday and is down 2.7% from Friday’s closing levels.  Clearly, inflation fighting by the Fed is not seen as a positive.  As to the rest of the metals complex, it is generally higher as expectations grow that demand around the world is going to pick back up.

Finally, in the FX market, the truly notable mover today is TRY (-11.2%!) which appears to be starting to suffer from a true run in the wake of President Erdogan’s praise of the recent interest rate cut and claiming that Turkey is fighting an “economic war of independence.”  It seems he’s losing right now.  Relative to that movement, nothing else seems substantial although MXN (-0.8%) is feeling pressure from declining oil prices while other EMG currencies slid on the broad strong dollar theme.  In the G10, NZD (-0.5%) is the weakest performer as long positions were cut ahead of the RBNZ meeting next week, but the bulk of the bloc is modestly lower as US interest rates continue to power ahead.

On the data front, we see the preliminary PMI data (exp 59.1 Mfg, 59.0 Services) and that’s really it.  Yesterday’s Existing Home Sales were better than expected, but really, today’s markets will continue to be driven by interest rates and views on how the Fed is going to behave going forward.  Taking Powell at his word means that tighter policy is coming which should help the dollar amid a broader risk-off sentiment.  Plan accordingly.

Good luck and stay safe
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Prices Keep Rising

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In Europe, though prices keep rising
The central bank is emphasizing
No rate hikes are near
In this or next year
So, traders, their views, are revising

Meanwhile in the States the reverse
Is true with inflation much worse
Now traders believe
The Fed’s on the eve
Of trying to tighten their purse

It cannot be surprising that inflation remains topic number one in the markets as its existence is driving virtually every narrative.  For instance, the choice for next Fed Chair is seen as having a direct impact on inflation based on the relative dovishness of Lael Brainerd vs. Jay Powell.  Too, as oil prices have risen so sharply over the past year, driving up the price of gas at the pump and inflation in general, the Biden Administration is now exhorting all nations to release oil from their strategic reserves in order to damp down those price pressures.  And what about wages, you may ask?  As per the WSJ this morning, here is the latest on the just agreed wage deal at Deere & Co, whose workers had been on strike for the past 5 weeks,

“Deere workers returning to assembly plants and warehouses will get an immediate 10% raise, and each worker will receive an $8,500 bonus. Additional 5% pay raises will be provided in 2023 and 2025, and lump-sum bonuses amounting to 3% of workers’ annual pay will be awarded in the three other years.
The deal approved Wednesday also will increase the base pay level for Deere’s continuous-improvement program by about 4%, giving workers more weekly pay from the program if their productivity meets the company’s goals. About two-thirds of UAW-represented Deere workers receive production-based compensation on top of their regular wages, according to the company.”

Apparently, the cost of the settlement is on the order of $3.5 billion, a very substantial portion of their forecast 2021 earnings estimates of $5.8 billion.  It strikes that either Deere is going to be raising prices (likely) to offset that margin compression, or its earnings numbers are going to diminish (also likely) thus putting pressure on its stock over time.  Recall, Chairman Powell has been adamant, and we have heard from numerous other Fed speakers as well, that wage inflation is not imminent and thus recent price rises are likely to be temporary.  This appears to be one more data point that makes the Fed story less plausible.

In Europe, however, there is a full-court press by ECB members to convince the investment and trading communities that they are not going to raise rates anytime soon as inflation there, too, is still transitory.  While it should be no surprise that Mario Centeno, the Portuguese central bank head and ECB member is all-in for never raising rates again, it is a huge surprise that Germany’s Isabel Schnabel is talking about the need to avoid premature tightening as deflation risks still haunt the Eurozone.  Her comments come despite CPI in Germany running at 4.5%, the highest since the reunification in the early 90’s and causing significant domestic strife.  If one was looking for a sign that the ECB doves have coopted the hawks to their side, there is no better indication than this!  As such, traders, who had been pricing for a 10bp rise in the deposit rate by the end of 2022 have pushed that view back nearly 12 months.

In sum, the battle between the central bank narratives and reality continues apace with the central banks, remarkably, holding their own in the face of growing evidence to dispute their claims.  And it is this battle that will continue to drive markets and help maintain volatility as each data point or comment has the ability to alter things at the margin.

So, as we look at markets this morning, remember the backdrop remains, Inflation, friend or foe?

Ok, how has risk appetite been affected by the latest news?  Well, US equities all moved lower yesterday and that carried over into Asia with the Nikkei (-0.3%), Hang Seng (-1.3%) and Shanghai (-0.5%) all in the red.  Part of that is because the Chinese property sector continues to weigh on sentiment there with the latest news that several large property companies, including Evergrande, are set to unload stakes in other companies to raise cash.  While these sales will be at great losses, the imperative for the cash is obvious.  Not surprisingly, selling large stakes of publicly held companies tends to weigh on their stock price and thus the market as a whole.

In Europe, the picture is more mixed (DAX +0.1%, CAC +0.2%, FTSE 100 -0.2%) with the UK seeming to suffer from growing concerns the Johnson government may invoke Article 16 from the Brexit deal which would suspend part of the Northern Ireland solution and could quickly evoke retaliation by the EU.  As to US futures, given it appears to be illegal for two consecutive down days in the equity markets, it should not be surprising that futures are pointing higher by between 0.2% and 0.5% at this hour.

Bond market price action is a very clear result of the central bank narrative as European sovereigns have all seen rallies (lower yields) while Treasuries remain under pressure as investors anticipate higher rates in the States.  This morning the 10-year Treasury yield is higher by 1 basis point while in Europe (Bunds -0.9bps, OATs -1.3bps, Gilts -2.7bps) the entire continent has seen demand pick up and yields decline.  Clearly, if the ECB remains full-bore on QE, it will support these prices for a long time.

Turning to the commodity markets, pretty much the entire space is softer today led by oil (-0.5%), gold (-0.2%) and copper (-0.7%).  But there is weakness across the rest of the industrial and precious metal space as well.  In fact, the only gainers on the day are NatGas (+1.8%) which looks very much like a rebound from its recent sharp sell-off, and the agricultural space, where the big 3 products are all firmer by a bit.

Turning to the FX markets, the dollar is under a bit of pressure this morning, which mostly seems like a pull-back from its recent strength.  Technically, it does seem overbought.  In the G10, NZD (+0.7%) is far and away the leading gainer after the RBNZ published their inflation expectations survey at the highest level in a decade and traders began to price in another 25 basis point rate hike at their meeting next week.  However, after that, the rest of the bloc has seen much more modest strength except for NOK (-0.1%) which is suffering from oil’s recent travails, and JPY (-0.1%) which may be reacting to news that the Kishida government is discussing yet more fiscal stimulus, this time to the tune of ¥78.9 trillion.

Emerging market currencies have a more mixed tone with the outlier continuing to be TRY (-2.1%) as the central bank remained true to form and cut its base rate to 15.0% despite runaway inflation.  Next worst is CLP (-0.7%) which has fallen as the finance ministry has stopped its regular dollar sales to maintain cash balances, but pulling support from the currency, and then we see both MXN (-0.55%) and ZAR (-0.5%) suffering on the back of commodity weakness.  On the plus side, HUF (+0.7%) is the big winner after the central bank raised rates by a more than expected 0.70% in their efforts to fight inflation.

On the data front this morning comes weekly Initial (exp 260K) and Continuing (2120K) Claims as well as the Philly Fed (24.0) and Leading Indicators (0.8%).  The Fed speaker onslaught slows a bit today with only four speakers, although despite yesterday’s plethora of speakers, it doesn’t appear we learned anything new.

For now, the broad narrative remains the Fed is going to be the first large central bank to tighten and that is driving the dollar higher.  While today we seem to be pausing for a bit, this story does not yet appear to have run its course.  Hence, I reiterate for payables hedgers, pick your levels and take advantage of the dollar’s strength for now.  orders are an excellent way to manage this risk.

Good luck and stay safe
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Hawks Now Despair

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The imminent news of the day
Is President Joe will convey
His choice for Fed chair
As hawks now despair
Lael Brainerd will soon lead the way

Her bona fides highlight her views
More policy ease she would choose
Inflation? No worry
But she’s in a hurry
For banks to put under the screws

The word from Washington is that President Biden will be announcing his selection for Fed chair imminently.  The very fact that the news was released using that phraseology implies to some (this author included) that we will have a new Fed Chair going forward, Lael Brainerd.  It is widely known that the President interviewed both Brainerd and Powell last week and ostensibly, Ms Brainerd accorded herself quite well.  It is also widely known that the progressive wing of the Democratic Party, which continues to gain sway over policy decisions, hates Chairman Powell and believes that not only would a Chairwoman Brainerd maintain policies to pay for their wish list, but that she would also be much tougher on the banking industry on a regulatory basis.

Of course, the key question is, can Brainerd win approval from a split Senate?  However, it is not clear that Powell could win approval either.  In Brainerd’s case, the vote would almost certainly be a straight party-line vote with Vice-president Harris casting the tiebreaker if necessary, although, it is quite possible that one or two of the very centrist Republican senators vote yea for her.  Powell, on the other hand, has enemies on both sides of the aisle, as there is a contingent of Republicans who believe he is to blame for the current inflation, while we also know there is a contingent of Democrats, led by Senator Warren, who despise him.  In other words, it doesn’t appear either is a slam dunk despite the fact both are currently on the Fed board and have been approved in the past.

Given we already know how markets have responded to the Powell Chairmanship, let us consider how a Chair Brainerd might be viewed.  Whether it is true or not, the current narrative is that Ms Brainerd would be more dovish than Powell, far less likely to complete the current tapering initiative and potentially seek reasons to further expand the Fed’s balance sheet.  If that were to be the case, one would have to be bullish financial assets with both stocks and bonds benefitting from that policy mix.  In addition, given the current inflationary impulse, and the likelihood that a Chair Brainerd continues to believe in the transitory theory, commodity prices are likely to continue their climb higher.  As to the dollar, based on this thesis, the dollar’s recent rise would likely come to an end, as the ongoing decline in real rates would undermine its value proposition.  You may wonder why bond prices would perform well despite rising inflation and the answer is simple, the ongoing QE purchases would support them, and a change in view regarding the timing of any tightening would likely see the short end of the curve rally, driving rates there much lower as well.

Of course, this is speculation regarding speculation of a particular outcome.  However, based on the market’s previous responses to these types of policy stimuli, I would contend they are reasonable.  Regardless, this all depends on any announcement.

One thing to note is that the case for a dollar decline is relatively strong in the event the market perception changes regarding further Fed policy tightness.  The dollar has been benefitting from the perception that the Fed is leading the way among the major central banks, with respect to removing policy ease.  If that perception were to change, so will the trajectory of the greenback.

Turning to the markets this morning, after a lackluster day in the US yesterday, where the major indices barely moved, we saw a mixed performance in Asia (Nikkei +0.1%, Hang Seng +1.3%, Shanghai -0.3%) as China continues to feel downward pressure from the real estate sector there.  Europe, on the other hand, is having a better day (DAX +0.5%, CAC +0.4%, FTSE 100 +0.2%) despite growing concerns over NatGas supplies due to some delays in NordStream 2 approvals.  It seems that a combination of ongoing dovish comments from Madame Lagarde and a new analysis by Capital Economics indicating interest rates in Europe will not rise before 2025, have inspired more risk-taking.  Meanwhile, US futures, which had been lower earlier in the session, have now edged back to essentially unchanged on the day.

In the bond market, yesterday saw some very aggressive selling with Treasury yields rising 5 basis points and pretty much dragging the entire space with them.  This morning, however, things have reversed with Treasury yields (-1.9bps) down along with Bunds (-1.9bps), OATS (-2.0bps) and Gilts (-2.0bps).  As long as there is belief in the QE process, bonds will retain a bid.  As an aside, there was an interesting article yesterday from MNI reporting on the fact that Italy and the other PIGS are seeking a permanent change in EU lending rules to insure that they get more money with less strings, as has been occurring during the Covid inspired emergency.  This has all the signs of a new policy that will be enacted, permanently increasing the amount of support that Southern Europe receives from the EU, and likely, over time to build tensions.  I would look for PIGS spreads vs. Bunds to narrow on this conversation, but it will not help the euro.

As to commodities, this morning most are in the green led by oil (+0.4%) which is continuing yesterday’s late day rally although prices are still much lower on the week.  NatGas (+2.8%) is clearly rising in concert with the European story on Nordstream 2 while gold (+0.6%) and silver (+0.85%) continue to confound by rising sharply alongside the dollar.  Ags are a little softer as are base metals (Al -1.6%, Zn -0.9%), so the message from this market is just not clear.

Turning to the dollar, it is broadly stronger this morning with SEK (-0.3%) and CHF (-0.3%) the laggards in the G10 although GBP (+0.25%) and NOK (+0.2%) are both firmer.  Going backwards, NOK is clearly being supported by oil prices while the pound is benefitting from modestly positive employment news amid a spate of releases there.  As to the losers, there is really no news in either currency which implies the general dollar bullish framework continues to be the key driver.  In the emerging markets, TRY (-1.4%) is today’s worst performer as investors fear further rate cuts despite rapidly rising inflation.  Interestingly, RUB (-0.5%) is also under pressure despite oil’s rebound as concerns over rising inflation in Russia are also impacting investment decisions.  CLP (-0.5%) is the other laggard here as a combination of broad dollar strength and concerns over inflation seem to be undermining the peso.

On the data front, we see Retail Sales (exp 1.5%, 1.0% ex autos) as well as IP (0.9%) and Capacity Utilization (75.9%) this morning.  We get the Fed train rolling with five speakers this morning ranging from the most hawkish (George) to the most dovish (Daly).  However, I believe all eyes will be on the Chairmanship story, not comments from underlings.

The dollar broadly continues to rally with the euro having traded to its lowest level since July 2020 and there is nothing that indicates this trend is going to change soon.  While there are good reasons to expect the dollar to eventually decline, right now, higher is the direction of travel so keep that in mind for your hedging.  However, for those with a longer-term view, looking into 2023 and 2024, current levels may well look attractive if payables are the exposure.

Good luck and stay safe
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Ill-Starred

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The latest from Treasury’s Yellen
Is really not all that compellin’
The problem, she said
Is Covid’s widespread
So, prices just won’t stop their swellin’

This morning, then, Madame Lagarde
Repeated her latest canard
If we were to tighten
Too early, we’d heighten
The risk of an outcome, ill-starred

As we begin a new week the only thing that has changed is the date, at least with respect to the official narrative regarding inflation and the economy.  Once again, this weekend, Treasury Secretary Yellen complained explained that Covid-19 is the reason inflation is running so high, and that once the pandemic is under control, prices will slow their ascent.  That seems to ignore the Fed’s balance sheet expansion of $5 trillion since last year, as well as the $5 trillion in special fiscal assistance that has been enacted by the government, the last $1.9 trillion under her guidance.  And of course, she is cheerleading the next $1.75 trillion in the Administration’s plans.  Yet she continues to claim that when Covid recedes, all will be well again.

At the same time, ECB President Christine Lagarde continues along the same lines, pooh-poohing the idea that the ECB should consider tightening policy because the current bout of inflation is only temporary (wisely, she has stopped using the term transitory at this point) and were they to act now, by the time their policy change had any effect on the economy, inflation would already be slowing down on its own.  So, you can be sure that the ECB is not about to alter its policy either anytime soon.  In fact, when the PEPP expires in March next year, you can be certain that the APP, the original Asset Purchase Plan (QE) will be expanded and extended to keep the cocaine flowing into the Eurozone economy’s bloodstream.

Will this process change at any point soon?  The odds remain extremely low in either the US or Europe given the evolution of the membership of both policy boards.  In the US, it appears the odds of a Chairwoman Lael Brainerd grow each day, and with that, the odds of easier monetary policy for an even longer time.  A telling blurb about her views recounts the time when then Chair Yellen wanted to start to raise rates in 2015 and Brainerd argued forcefully against the idea.  History shows that the Fed missed a key opportunity at that time to more fully normalize policy, leading directly to the lack of effective tools they currently possess.  While Chairman Powell has certainly been no hawk, relative to Ms Brainerd, his talons look quite sharp.

At the same time, the news that Bundesbank president Jens Weidmann is stepping down has resulted in the most forceful counterbalance to the large dovish wing in the ECB leaving the governing council.  While the next Buba president is sure to be more hawkish than most ECB members, he will not have the gravitas nor sway that Weidmann holds, and therefore, will be less able to push against the doves.

While smaller economies around the world continue to respond to rapidly rising inflation (just Thursday, Banxico raised the base rate in Mexico another 0.25% to 5.00%) it is abundantly clear that neither the Fed nor ECB is anywhere near that path.  Yes, the Fed has started to marginally slow down balance sheet expansion, but that is not tightening policy under any definition.  It is unclear what type of shock will be necessary to force these two central banks to rethink their current plans, but if history is any guide, central banks tend to overstay their welcome when it comes to easing monetary policy.  You can have too much of a good thing and I fear that is what we are all going to experience at some point in the not too distant future.

In the meantime, however, nothing seems to stop the march higher in equity markets and today is no exception.  Last night in Asia, the Nikkei (+0.6%) and Hang Seng (+0.25%) both moved higher although Shanghai (-0.2%) continues to be weighed down by the property sector with Evergrande as well as several other developers barely able to continue as going concerns.  Europe is generally firmer as well led by the CAC (+0.4%) and DAX (+0.1%) although, here too, there is a laggard in the form of the FTSE 100 (-0.2%) after housing prices slipped and seemed to portend a slowing in the economy there.  US futures are currently about 0.2% higher on the day.

In the bond market, which has been remarkably volatile lately, this morning is showing a respite, with Treasury yields (-0.3bps) nearly unchanged and similar modest yield declines throughout Europe (bunds flat, OATs -0.5bps, Gilts -0.9bps).  At this stage, the bond bulls and bears are fighting to a draw and waiting the next key signal.  Certainly, inflation would have you believe that yields should rise, but between ongoing QE and concerns over a slowing economy, the bond bulls are still in the driver’s seat.

In the commodity markets, oil is continuing last week’s sell-off, down 1.5% this morning with WTI back below $80/bbl. NatGas (-0.9%), too is falling, at least in the US, but not in Europe, where Gazprom, which had increased flows for a few days, seems to have cut back yet again.  I fear it is going to be a long, cold winter on the continent.  In the metal’s markets, gold (-0.1%) has edged lower this morning although has been performing quiet well over the past two weeks having rallied more than 6%.  But all the base metals (Cu -0.3%, al -0.7%, Sn -0.8%) are under pressure, hardly a sign of robust growth on the horizon.

Overall, the dollar is under modest pressure this morning, although recall, it has been quite firm for the past several weeks.  In the G10, AUD (+0.45%) and NZD (+0.4%) are the leading gainers as investors are sensing an opportunity in recently rising bond yields there.  Interestingly, NOK (+0.35%) is also higher despite oil’s decline, although this appears to be more of a technical correction than a trend change.  In the EMG bloc, ZAR (+0.9%) and RUB (+0.7%) are the leading gainers, both on the strength of expectations for further policy tightening by their central banks.  On the downside, PHP (-0.65%) is the key laggard as importers were seen selling dollars to pay for things like oil and gas.

Data this week is led by Retail Sales and comes as follows:

Today Empire Manufacturing 22.0
Tuesday Retail Sales 1.3%
-ex Autos 1.0%
IP 0.8%
Capacity Utilization 75.9%
Wednesday Housing Starts 1580K
Building Permits 1630K
Thursday Initial Claims 260K
Continuing Claims 2123K
Philly Fed 24.0
Leading Indicators 0.8%

Source: Bloomberg

In addition, we have ten Fed speakers on the calendar across fifteen different speaking engagements.  Be prepared for at least a little movement from that cacophony.

For now, the medium-term trend remains for dollar strength, despite today’s price action, as ongoing high inflation readings continue to drive the idea that the Fed will actually tighten policy at some point.  While that remains to be seen, it is the current market view, and I would not stand in its way.

Good luck and stay safe
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Shocked

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The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked

Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?

I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory.  Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles.  However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass.  In fact, back in the day, the Fed was still concerned about deflation.

Well Jay, how about now?  Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows.  And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years.  One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship.  The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.

And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond.  Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.

As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September.  While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement.  In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.

The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions.  While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act.  Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10.  Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.

So, how are markets digesting this news?  Not terribly well.  At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared.  However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit.  US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices.  Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.

Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps.  Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day.  But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out.  This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour.  But the rest of Europe is not so lucky, especially with the PIGS still under pressure.  I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.

Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs.  This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates.  NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October.  It seems that some of those fears have abated.  Gold, however, continues to rally, up another 0.4% today and about 4% in the past week.  Perhaps it has not entirely lost its inflationary magic.

And finally, the dollar continues to perform very well after a remarkable performance yesterday.  For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%.  ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse.  But don’t discount the euro having taken out every level of technical support around and falling 1%.  This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun.  In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements.  The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age.  The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.

With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly.  There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk.  In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term.  Later on?  Perhaps a very different story.

Good luck and stay safe
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Growing Disdain

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There is now a silver haired queen
Whose role since she came on the scene
Has been to explain,
With growing disdain,
Inflation is still unforeseen
 
Her minions, as well, all campaign
To make sure the message is plain
Though prices are rising
They won’t be revising
Their plans, or so said Philip Lane
 
There is a growing disconnect between the ECB and the rest of the world’s central banks.  While the transitory narrative has been increasingly taken out back and shot, the ECB will not let that story die.  Just today, ECB Chief Economist Philip Lane defended the ECB stance, explaining, “If we look at the situation over the medium term, the inflation rate is still too low, below our 2% target.  This period of inflation is very unusual and temporary, and not a sign of a chronic situation.  The situation we are in now is very different from the 1970’s and 1980’s.”  [author’s emphasis]  In other words, in case Madame Lagarde’s comments from last week that the ECB is “very unlikely” to raise rates next year, were not clear, the ECB is telling us that their mind is made up and there will be no policy tightening in the foreseeable future.
 
In fairness, raising interest rates will not convince Russia to pump more natural gas through the pipelines to help mitigate the dramatic rise in prices there.  Nor will it help build new semiconductor fabs to alleviate that shortage.  However, what it might do is reduce demand for many things thus easing supply constraints and perhaps encouraging prices to fall.  After all, that is exactly what tighter monetary policy is supposed to do.  The problem with that logic, though, is that there isn’t a central banker on the continent that is willing to risk slowing down growth in order to address rapidly rising prices.  The politics of that move would likely bring more rioters into the streets.  Once again, central banks’ vaunted independence is shown to be a sham.  They are completely political and beholden to the government in charge at any given time.
 
And so, we are left with a situation where prices continue to rise throughout the world while the two largest economic areas, the US and Eurozone, maintain the easiest monetary policy in history.  Yes, I know the Fed said it would begin to reduce its QE purchases, but even if they do reduce purchases by $15 billion / month, they are still going to expand their balance sheet by a further $420 billion and interest rates are still at zero.  There remains virtually zero chance that inflation is going to fade as long as the current incentive structure remains in place. 
 
Speaking of the Fed, Friday’s NFP data was substantially better than expected with job growth rising 531K and revisions higher for the previous two months of an additional 235K.  The Unemployment Rate fell to 4.6% and wages continue to climb smartly, +4.9% Y/Y.  (Of course, on a real basis, that is still negative given the current 5.4% CPI with expectations that on Wednesday, the latest release will jump to 5.9%.)  However, Chairman Powell has indicated that the Fed believes there is still a great deal of slack in the labor market, based on the Participation Rate remaining well below pre-pandemic levels, and so raising rates prematurely would be a mistake.  Summing it all up, there is no reason to believe that either US or ECB monetary policy is going to be changing anytime soon, regardless of the data.
 
The question at hand, then, is what will this mean for markets in general and the dollar in particular?  As long as new, excess liquidity continues to flood the markets, there is little reason to believe that the ongoing bull market in equities, commodities, real estate, and bonds is going to end.  While history has shown that rising inflation will eventually hurt both bonds and stocks, we are not yet at that point, and quite frankly don’t appear to be approaching it that rapidly.  Though there remains a small cadre of old-timers (present company included) who have a difficult time accepting current valuations as normal and who have actually lived through inflationary times, the bulk of the market participants do not carry that baggage and so are unencumbered by negative thoughts of that nature.  But, as an example of how inflation can degrade equity markets, from Q4 1968 through Q1 1980, the S&P 500 fell 1% in nominal terms while inflation averaged 7.1% per year with a high print of 14.8%.  The point is that the last time we had an inflation situation of the current magnitude, holding equities did not solve the problem.  As George Santayana famously told us back in 1905, “Those who cannot remember the past are condemned to repeat it.”
 
With this in mind, let us take a look at markets and the week ahead.  Aside from the ECB comments this morning, arguably the most impactful news from the weekend was the story that Elon Musk is planning to sell $20 billion worth of stock in order to pay his upcoming tax bill.  Not surprisingly Tesla’s stock is lower by nearly 6% on the news and it seems to have put a damper on all equity activity.  After all, if Tesla isn’t going higher, certainly nothing else can have value!
 
Looking at equity markets, Asia (Nikkei -0.35%, Hang Seng -0.4%, Shanghai +0.2%) were mixed but leaning weaker.  That is an apt description of Europe as well (DAX -0.2%, CAC +0.2%, FTSE 100 -0.1%) although overall, the movement has not been that significant.  US futures, meanwhile, are little changed although NASDAQ futures are slightly lower while the other two major indices are edging higher.
 
Bonds, on the other hand, are all under pressure with Treasuries (+2.8bps) leading the way although this was after a major rally on Friday that saw the 10-year yield fall 7bps and a total of 15bps since the FOMC last Wednesday.  But European sovereigns, too, are all lower with yields rising (Bunds +2.0bps, OATs +2.1bps, Gilts +2.9bps).  Perhaps bond investors are beginning to register their concern over the inflation story.
 
On that front, commodity prices are rebounding off the lows seen last week led by energy with oil (+1.25% and back over $82/bbl) and NatGas (+1.1%) both having good days.  The rest of the space, though, is more mixed with copper (+0.2%) and tin (+0.4%) both firmer this morning, while aluminum (-0.2%) and iron ore (-3.25%) are both suffering.  Precious metals are little changed although Friday saw a sharp rally in the barbarous relic.  And yes, the cryptocurrency space is rocking today as well.
 
As to the dollar, it has had a mixed performance this morning with both gainers and losers across the G10 and EMG spaces.  In the G10, NZD (+0.6%) is the clear leader as the government is talking of ending the draconian lockdown measures by the end of the month.  In fact, we saw similar behavior in the EMG currencies as THB (+0.8%) and IDR (+0.5%) rallied on similar news.  On the flip side, BRL (-0.8%) continues to decline despite the central bank being one of the most aggressive in its rate hike path having raised the SELIC rate from 2% in March to 7.75% last month with expectations growing for yet another hike in December.  Of course, inflation is running at 10.25% there, so real yields remain firmly negative.
 
On the data front, this is inflation week with both the PPI and CPI on the docket.
 

Tuesday

NFIB Small Biz Optimism

99.5

 

PPI

0.6% (8.6% Y/Y)

 

-ex food & energy

0.5 (6.8% Y/Y)

Wednesday

Initial Claims

263K

 

Continuing Claims

2050K

 

CPI

0.6% (5.9% Y/Y)

 

-ex food & energy

0.4% (4.3% Y/Y)

Friday

JOLTS Job Openings

10.4M

 

Michigan Sentiment

72.5

Source: Bloomberg
 
Of course, the Fed doesn’t care about CPI as its models work better with core PCE, which also happens to be designed to be permanently lower.  The rest of us, however, know better and recognize the pain.  We have a number of Fed speakers on the calendar this week as well, with Chairman Powell headlining 9 planned appearances.  My sense is that there will be a strenuous effort to press the storyline that inflation may take a little longer to fall back, but don’t worry, it will fall again.
 
If pressed, I would say the dollar is far more likely to continue to grind higher, but that any movement will be slow.  While Treasury yields are not supportive right now, the reality is that amid major currency bonds, Treasuries continue to offer the best combination of yield and liquidity so remain in demand.  I think that along with the need for other economies to buy dollars to buy energy will maintain the bid in the buck.
 
Good luck and stay safe
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