Tag Archives: #inflation

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
Adf

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
Adf

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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QE Will Wane

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Some pundits have come to believe
That sometime before New Year’s Eve
The Fed will explain
That QE will wane
Though others are sure they’re naïve

So, let’s listen to what the Fed
Has very consistently said
Without hard statistics,
Not simple heuristics,
The idea of tapering’s dead

As a new week begins, all eyes are turning to the central bank conclaves scheduled for the latest clues in monetary policy activity.  Recall last week, the Bank of Canada surprised almost everyone by explaining they would reduce the amount of QE by 25% (C$1 billion/week) as they see stronger growth and incipient inflationary pressures beyond the widely discussed base effects that are coming soon to a screen near you.  This has clearly inspired the punditry, as evidenced by a recent survey of economists carried out by Bloomberg, showing more than 60% of those surveyed expect the Fed to begin to taper QE before the end of this year.  When the same questions were asked in March, less than 50% of those surveyed expected a tapering this year.  Obviously, we have seen a run of very strong survey data, as well as a very strong payroll report at the beginning of this month.  In addition, the vaccine rate has increased substantially, with the combination of these things leading to significantly upgraded economic forecasts for the US this year.

And yet, everything we have heard from Chairman Powell and the rest of the FOMC has been incredibly consistent; they are not even thinking about thinking about tapering monetary policy and will not do so until substantial further progress toward their goals of maximum employment and average inflation of 2.0% are achieved.  In addition, Powell has promised to communicate very clearly, well in advance, that changes are in the offing.  While we have had two strong employment reports in a row, the combined job gains remain a fraction of the 10 million that Powell has repeatedly explained need to be regained.  Arguably, we will need to see NFP numbers north of 750K for the next 6-9 months before the Fed is even close to their target and will consider taking their foot off the proverbial accelerator.

Of course, there is one thing that could force earlier action by the Fed, inflation rising more quickly than anticipated.  As of now, the Fed remains unconcerned over price rises and have made it clear that while the data for the next several months will be rising quickly, it is a transitory impact from the now famous base effects caused by the Covid induced swoon this time last year.  Even then, given the new framework of average inflation targeting, rather than a hard numeric target, a few more months of above 2.0% core PCE will hardly dissuade them from their views as they have nearly a decade of lower than 2.0% core PCE to offset.

But what if inflation is more than a transitory event?  While the plural of anecdote is not data, it certainly must mean something when every week we hear from another major consumer brand that prices will be rising later this year.  Personal care products, food and beverages have all been tipped for higher prices this year.  The same is true with autos and many manufactured goods as the consistent rise in input prices (read commodities) is forcing the hands of manufacturers.  While it is true that, by definition, core PCE removes food & energy prices, to my knowledge, neither toothpaste nor Teslas are core purchases.

The medium-term risk appears to be that inflation runs, not only hotter than the Fed expects, but hot enough that they begin to become uncomfortable with its impact.  While the natural response would be to simply raise rates, given Jay’s effective promise not to raise rates until 2023, as well as the fact that the Treasury can ill afford higher interest rates (nor for that matter can the rest of the economy given the amount of leverage that is outstanding), the Fed may well find themselves in quite a bind later this year.  One cannot look at the price of copper (+1.9% today, 25.6% YTD), aluminum (+1.2%, 21.1%) or iron ore (+0.4%, 16.0%) without considering that those critical inputs, neither food nor energy, are going to drive price pressures higher.  And, by the way, food and energy prices have been rocketing as well (Corn +38% YTD, Wheat +13.1%, Soybeans +18.2%, WTI +26.1%).  Chairman of the Fed may not be that attractive a position by the time Powell’s term ends in February.

Turning to the markets, if I had to characterize them in a theme, it would be idle.  Equity markets are generally flat to lower with the odd exception in Asia (Nikkei +0.4%, Hang Seng -0.4%, Shanghai -1.0%) and Europe (DAX -0.2%, CAC 0.0%, FTSE 100 0.0%).  US futures are also noncommittal this morning, with the NASDAQ (-0.3%) the only one having really moved.

In the bond market, the rally we had seen over the past three weeks has stalled and is starting to cede some ground.  For instance, Treasuries (+3.7bps) are leading the way higher but we are seeing higher yields throughout Europe (Bunds +2.3bps, OATs +2.5bps, Gilts +3.0bps) and even saw gains overnight in Australia (+1.8bps) and Japan (+0.5bps).  Historically, that would have seemed to be a risk-on phenomenon, but given the lack of equity strength, this feels a lot more like an inflationary call.

While the metals space is strong today, oil is actually softer (-1.7%) as concerns over the rampant spread of Covid in India and other emerging markets undermines the vaccine news in the West.

As to the dollar, it is generally, but not universally, weaker this morning.  In the G10, AUD (+0.6%), NZD (+0.3%) and CAD (+0.3%) are the leaders, with all benefitting from the metals rally, which has been sufficient to offset weaker oil prices for the Loonie.  On the downside, NOK (-0.1%) is clearly feeling a bit of pressure from oil, although 0.1% hardly makes a statement.  EMG currencies are showing the same type of price action with TRY (+1.2%) the leading gainer as it rebounds from near-record lows amid hopes the tension with the US will be temporary.  Away from the lira, TWD (+0.5%) rallied on concerns that the Taiwanese government would be pressured by the US with respect to its currency and competition concerns.  We saw similar, but lesser pressure on KRW (+0.4%).  Meanwhile, the modest declines seen in HUF (-0.2%) and MXN (-0.1%) define the other side of the spectrum.

Clearly, the FOMC meeting is the highlight of the week, but there is other important data as well, including the BOJ tonight.

Today Durable Goods 2.5%
-ex transport 1.6%
Tuesday Case Shiller Home Prices 11.8%
Consumer Confidence 112.0
Wednesday FOMC Decision 0.00% – 0.25%
IOER 0.12%
Thursday Initial Claims 550K
Continuing Claims 3.59M
GDP Q1 6.9%
Personal Consumption 10.3%
Friday Personal Income 20.0%
Personal Spending 4.2%
Core PCE 1.8%
Chicago PMI 64.2
Michigan Sentiment 87.5

Source: Bloomberg

The end of the week is where all the action will be, assuming Chairman Powell doesn’t shake things up Wednesday afternoon.  Core PCE is forecast to print at its highest level since February 2020, but if you recall the CPI data, it was a tick higher than forecast as well.  Of course, for now, it doesn’t matter.  This is all transitory.

Nothing has changed my opinion with respect to the relationship between the dollar and the 10-year Treasury yield.  While it is not actually tick for tick, if yields do back up, I would look for the dollar to find its footing in the near term.  I know the dollar bears are back in force, but we need to see a break above the 1.2350 level in the euro to really turn the tide in my view.  Otherwise, we are simply at the bottom of the dollar’s range.

Good luck and stay safe
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Not If But When

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Eight years ago, when Chairman Ben
Suggested t’was not if but when
The Fed would reduce
Its purchase, profuse,
Of bonds, traders sold bonds, bought yen

But these days when taper’s discussed
The bond market doesn’t seem fussed
The reason could be
There’s now nobody
The market invests with its trust

Yesterday’s CPI data printed a tick higher than forecast indicating that, yes, prices are rising relative to last year.  The headline print of 2.6% was the beneficiary of a substantial rise in energy prices compared to last year, but the core price index indicated that both goods and services prices are rising in price.  One data point is not enough to make any claims in either direction, but it will certainly keep the discussion going for a while.  The market response was somewhat counterintuitive as by the end of the day, 10-year Treasury yields had fallen 6 basis points and the dollar was softer amid modestly firmer equity prices.  While the link between the dollar and Treasuries remains intact, the question is why would bonds rally (yields decline) if inflation was rising?

One possible answer is that the market had gotten far ahead of itself with respect to pricing in rising inflation.  Historically, inflation takes time to manifest itself as prices on many things are sticky, meaning they remain stable for a time amid broad pressures and then shift in a relatively large step, rather than a gradual daily or weekly increase.  We are all familiar with the situation when an item regularly purchased suddenly rises in price to catch up to the broad underlying price pressures.  But when taken over the totality of all goods purchased, while any given good or service may see prices rise in discrete steps, the index moves up in a relatively smooth manner.  This fact is why yesterday’s data are interesting, because the headline jump of 0.6% M/M certainly tests the definition of smooth.  Consider that a monthly increase of 0.6% would result in annual inflation of 7.4%, a level that even the Fed would consider too hot.  FYI, yesterday’s core print, which was actually 0.34%, would represent 4.2% core CPI over a year.  So, yes, the base effects were instrumental in the much higher Y/Y data, but the monthly increases were pretty high in any accounting.

And yet, the bond market ultimately rallied all day, having touched 1.7% in early European trading and closing the session at 1.615%.  If this wasn’t a classic case of buy the rumor, sell the news, I don’t know what is.  And, as we have seen consistently all year, the dollar dutifully followed yields lower while equity markets ultimately rallied, although the euphoria over the value trade seems to be waning.

Perhaps of more interest is the fact that we have now had 3 key central bankers, two from the ECB, Knot and Villeroy, and the Fed’s Bullard all start to discuss the idea of tapering bond purchases.  This seems incongruous given the adamant claims on both sides of the pond that current monetary policy is necessary and appropriate to ensure the respective economies return to form.  And yet each of these discussed how tapering of QE could begin before the year is out.  You may recall that Bullard wanted to tie the idea of tapering to the level of vaccinations in the economy, indicating that when 75% of the population is vaccinated, it could be time to start slowing purchases with the implication being the economy would then be able to stand on its own two feet.

This morning, Banque de France Governor Villeroy de Galhau explained that there could be an evolution in monetary policy at the ECB, which while remaining accommodative would shift the burden back to the APP (the original QE plan) from PEPP, which will ostensibly run its course in March 2022.  Last week, Knot, the Dutch Central Bank president expressed his view that the current expectations of robust growth in the second half of the year could be a signal to begin tapering asset purchases.  Now, understand that there were members from both central bank committees pushing back on the idea, but the fact remains that there is some consideration of tapering.  Today, we hear from Chairman Powell again, but we will not hear from Madame Lagarde until her press conference after the ECB meeting next week.

Adding up the disparate facts is quite difficult.  On the one hand, we have the first trial balloons floated regarding tapering of asset purchases as a response to the forecasts for extremely robust growth this year.  On the other hand, the market appears to have indicated that, at least for now, the idea of much faster growth leading to much higher inflation has run its course.  It strikes me that the market is unlikely to worry too much about these trial balloons until they hear from Powell and/or Lagarde.  Until then, it appears that a short period of higher inflation readings is on the cards and unless they really start to spike, that is unlikely to have a big impact on either equities or bonds.

Speaking of equities, yesterday saw the S&P 500 close at yet another new all-time high with the NASDAQ pushing back to within 1% of its February record.  Clearly, there is no inflation scare there.  Rather, all eyes are turning to the first earnings releases due today.  Overnight saw the Nikkei slide (-0.4%) but elsewhere in Asia equities rallied (Hang Seng +1.4%, Shanghai +0.5%).  European markets are mixed with the DAX (-0.1%) lagging while both the CAC (+0.4%) and FTSE 100 (+0.3%) continue to grind higher.  Apparently, Villeroy’s comments about tapering have not been seen as a danger.  US futures are modestly higher at this point, just 0.2% or so as the market bides its time ahead of Powell’s comments at noon.

In the bond market, after a big rally yesterday, the 10-year has seen yields back up slightly, by 1.1 bps, although European bonds are all looking at modest yield declines (Bunds -1.0bps, OATs -1.2bps, Gilts -0.3bps).  It has become pretty clear that the rush higher in yields has stalled for now, with important implications for all the other markets, especially the dollar.

Oil prices are continuing their recent rebound, with WTI +1.6%, although the price action in the metals markets remains confusing.  Precious metals rallied sharply yesterday but are little changed this morning.  Base metals continue to trade both ways with Cu (+1.1%) leading the way higher, but Al (-0.3%) lagging.  It all seems very much like a consolidation period ahead of the next leg higher.

As to the dollar, after sliding all day yesterday alongside Treasury yields, it is continuing lower this morning.  The leading gainer is NZD (+0.8%) which has rallied based on the market’s interpretation that standing pat by the RBNZ last night was actually hawkish, which has helped drag AUD (+0.65%) higher as well.  Oil is supporting NOK (+0.45%) but the rest of the moves are far less significant.  EMG currencies are also performing well this morning, led by KRW (+0.85%) and TRY (+0.5%).  The won was a beneficiary of the generally falling dollar as well as foreign inflows into the KOSPI.  TRY, on the other hand, simply offers yields that are too high to resist for certain investors, despite rising inflation there.

The only data today is the Fed’s Beige Book, to be released at 2:00, but aside from Powell at noon, we hear from four other Fed speakers including vice-chairman Clarida at 3:45 this afternoon.  Come Friday, the Fed will enter their quiet period ahead of the next FOMC meeting, so it seems everyone wants to get their thoughts aired ahead of that.

In the end, the dollar remains beholden to 10-year Treasury yields, so we could be in for a period of very limited movement, if Treasuries have found a new home.  Unless we hear something new from the Chairman today, I expect we are looking at a period of quiet for the next two weeks.  The calm before the storm.

Good luck and stay safe
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A Simple Statistic

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There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic

But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided

The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning.  At that time, CPI will be released with the following median forecasts according to Bloomberg:

CPI MoM 0.5%
-ex food & energy MoM 0.2%
CPI YoY 2.5%
-ex food & energy YoY 1.5%

The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018.  As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high.  After all, last month CPI YoY printed at 1.7%, so this is a big jump.  We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs.  Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.

Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA.  My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data.  What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation.  And I can’t help but notice how the price of things that I buy seem to continue to rise as well.  While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning.  Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price.  Certainly not gasoline, and even tech items cost more.  If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.

Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future.  In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all.  If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.

Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices.  We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities.  Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance.  Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year.  The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions.  Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low.  However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.

Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon.  This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality.  In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.

As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus.  So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.

Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets.  The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder.  We also saw yields rise in Australia overnight.

Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains.  Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way.  In other words, pretty much every market is waiting for CPI to take their cues.

FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data.  This is especially odd given oil’s gains in the session.  But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number.  EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.

The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week.  Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option.  While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.

At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver.  If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck.  These days, it is truly binary.

Good luck and stay safe
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