Opening Move

Forty trillion yen
Kishida’s opening move?
Or his legacy?

While it has been quite a week in the FX markets, and in truth, markets in general, it appears that both traders and investors are now tired and price volatility has ebbed.  While inflation remains topic #1 in most discussions, that poor horse has been beaten into submission at this point.  We already know that it is running hotter than most forecasts and that its composition is broadening.  This means the idea that Covid related issues, like used car prices or lumber prices, which have spiked (and in the case of lumber receded somewhat) due to supply chain issues is clearly no longer the only factor.  In fact, wages are beginning to rise substantially and with higher commodity prices, input costs continue to climb (see PPI) which is rapidly feeding into retail costs.  And it doesn’t appear this is set to slow anytime soon, despite the wishful comments by every central banker and finance minister around.  So, what’s a country to do?

Well, if you’re Japan, this is the perfect time to…spend more money!  And so, last night it was reported that new PM, Fumio Kishida, will be proposing a ¥40 trillion stimulus package in order to help support growth.  The rationale is that GDP is forecast to have contracted in Q3, rather than following in the footsteps of other major nations which all saw varying levels of growth.  Meanwhile, this being Japan, the home of the permanent deflationary impulse, one ought not be surprised at the fact that the BOJ and the government completely dismiss the recent PPI data (8.0% in October, a full point above expectations) as transitory given the decision that this will shore up the government’s approval rating.  And anyway, all the forecasts point to a still subdued 0.1% Y/Y CPI reading next week so there should be nothing to worry about.  After all, economic forecasts for inflation have been spot on around the world lately!

Since the last week of September, when USDJPY broke out of a six-month long trading range, the yen has fallen nearly 5%.  I believe that the BOJ is extremely encouraging of this movement as it has been a tacit policy goal since the initiation of Abenomimcs in 2012, when the BOJ really went all-in on its QE initiative in an effort to defeat deflation.  One thing for the Japanese to consider, though, is that history shows getting a little inflation is a very hard thing to do.  Once that genie is out of the bottle, it tends to be far more unruly than anticipated.  For Japan’s sake, I certainly hope that the PPI data is the outlier, but the risk of a policy mistake seems to be growing.  And after all, central bank policy mistakes are all the rage now (see Federal Reserve), so perhaps Kuroda-san just wants to feel like a member of the club.  At any rate, this morning the yen appears to be readying for the next leg lower and I would not be surprised at a move toward 116.75 before it’s all over.

But truthfully, there is not much to tell beyond that.  As mentioned, there is still a lot of discussion regarding inflation and its various causes and effects.  One thing to keep in mind is that history has shown the currencies of nations with high inflation tend to fall over time.  And this does not have to be hyperinflation, merely inflation running hotter than its peers.  Consider Italy, pre euro, where inflation averaged 5.4% and the currency regularly depreciated to offset the growth in prices.  In fact, the entire economic model was based on a depreciating currency to maintain the country’s industrial competitiveness.  The same can be seen in Turkey today, where each higher than expected CPI print leads to further lira weakness.

The point is, while Japan may not be able to create inflation, it is abundantly clear that we have done so in the US.  And when push comes to shove, if/when the Fed has to implement policy to support financial stability, they will be faced with the “impossible trinity” where of the three markets in question, stocks, bonds and the dollar, they will support the first two and allow the dollar as the outlet valve.  This means that eventually, a much weaker dollar is likely on the cards, not in the next several months, but very possibly within the next 2 years.  For payables hedgers, especially with the dollar showing short term strength, it may be an excellent time to consider longer term protection.  USD puts are very cheap these days.  Let’s talk.

Ok, so what do I mean by dull markets?  Well, equities are mostly higher, but generally not by very much.  In Asia, the Nikkei (+1.1%) was the big winner on the stimulus news, but both the Hang Seng (+0.3%) and Shanghai (+0.2%) were only modestly better on the night.  In Europe too, the movement has been relatively modest with the UK (FTSE 100 -0.4%) even falling on the day although the other major markets (DAX +0.1%, CAC +0.4%) are a bit firmer.  US futures are also pointing higher, with gains on the order of 0.2% across the board.

Bond markets are mixed as Treasuries (+2.2bps) are softer after yesterday’s holiday, but European sovereigns are all seeing modest yield declines (Bunds -0.9bps, OATs -0.6bps, Gilts -0.9bps).  That said, the peripheral markets also selling off a bit with Italian BTPs (+2.8bps) and Greek GGBs (+3.1bps) leading the way lower.

Commodities are actually the one market where there is still some real volatility as oil (-2.1%) leads the way lower alongside NatGas (-2.8%), although there is weakness in gold (-0.6%) and copper (-0.4%), all of which have had strong weeks.  Frankly, this feels like some position closing after a positive outcome rather than the beginning of a new trend.  In fact, if anything, what we have seen this week is commodity prices breaking out of consolidations and starting higher again.  Agriculturals are little changed and the other industrial metals like Al (+1.1
%) and Sn (+0.6%) are actually a bit better bid.  In other words, there doesn’t appear to be a cogent theme today.

As to the dollar, mixed is the best adjective today.  In the G10, we have several gainers led by the pound (+0.2%) as well as several laggards led by SEK (-0.4%).  The thing is, there is very little to hang your hat on with respect to stories driving the activity.  Neither nation published any data and there haven’t been any comments of note either.  In the EMG space, PHP (+0.6%) is the leading gainer on the strength of equity market inflows as well as central bank comments indicating they will seek to allow the market to determine the exchange rate.  On the downside, RUB (-1.0%) is falling sharply on the back of oil’s sell-off and rising geopolitical tensions with Russia complaining about NATO activity near its borders.  Between those two extremes, however, the movement is limited and pretty equal on both sides in terms of the number of currencies rising or falling.  Last night, Banxico raised rates by 25bps, as widely expected and the peso is weaker this morning by -0.25% alongside oil’s decline.

Data-wise, JOLTS Jobs (exp 10.3M) and Michigan Sentiment (72.5) are both 10:00 numbers, but neither seems likely to move markets.  NY Fed president Williams speaks at noon, so perhaps there will be something there, but I doubt that too.

For now, the dollar’s trend is clearly higher in the short term, especially if we continue to see Treasury yields climb.  However, as mentioned above, I think the medium-term story can be far more negative for the greenback, so consider that as you plan your hedging for 2022 and beyond.

Good luck, good weekend and stay safe
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Raring to Spend

Japan’s new PM
Fumio Kishida is
Raring to spend yen

The LDP elected Fumio Kishida as its new president, thereby assuring him of the job of Japan’s 65th Prime Minister.  Relacing Yoshihide Suga, Kishida-san has a tall task ahead of him in leading the nation back to a growth trajectory.  In addition, he must face the voters by November as well as rally his supporters in an upper house election next year.  Apparently, his plan is…spend more money!  He has promised to spend tens of trillions of yen (hundreds of billions of dollars equivalent) in order to help resuscitate the Japanese economy and bolster the middle class.

As refreshing as it is to have a new administration, it seems as though the policy playbook continues to consist of a single page…spend more yen.  Perhaps something will change in Japan, but it seems unlikely.  Rather, the nation will continue to struggle with the same macroeconomic issues that have plagued it for the past decades; excess debt driving slower growth amid an aging population.  The yen (+0.1%) has stabilized this morning but appears to be trending pretty sharply lower.  While support (USD resistance) is strong at 111.65-85, should we breech that level, a move toward 115.00 appears quite reasonable as well as likely.

As energy prices rise higher
Most governments seek a supplier
Of power that will
Completely fulfil
The orders that they all desire

In other news, it is becoming abundantly clear that the combination of energy policies that have been enacted recently are not having the desired outcome, assuming that outcome is to develop clean energy in abundance.  This is made evident by the dramatically rising prices of things like natural gas in Europe (+400% since 1Mar21) and the US (+130% YTD) and coal (+160% YTD).  Of course, the latter is rarely considered ‘clean’ but it is reliable.  And that is the crux of the matter.  Reliability of both wind and solar power has been called into question lately and reliance on baseload power sources like coal, which Europe, China, and India have in abundance, and NatGas, which they don’t, is driving policy decisions.

For instance, China is mulling energy price hikes for industry in an effort to reduce demand.  And if that doesn’t work, they will raise prices for residential users.  Go figure, a communist nation using price signals to adjust behavior!  At any rate, the immediate impact is likely to be downgraded growth prospects for China’s economy as rising energy prices will lead to rising export prices, lower exports, and lower growth.  We have already seen Chinese equity markets under pressure recently as the energy situation worsens.  Shanghai (-1.8%, -5.5% in past two weeks) is leading the way lower amid growing concern that Evergrande is not the biggest problem impacting China.  At some point, I expect the renminbi is going to suffer a bit more than its recent price action has shown.  Slowing growth and continued monetary expansion are going to add a great deal of pressure to the currency as it may be the only outlet available for the economy.  I fear it could be a “long cold lonely winter” in China this year.

Of course, it’s not just China where energy prices are rising, they are higher everywhere.  I’m sure you see it when you refill your gas tank, or when you pay your electric bill.  And this is a problem for economic growth as higher energy costs feed into product and service pricing directly, as well as reduce the amount of disposable income available for spending by the population.  Higher prices and slower growth (i.e. stagflation) are a very real risk, and by some measures have already arrived.

Beyond the direct discomfort we all will feel from its impacts, the policy questions are critical.  Consider, last time stagflation was upon us, then Fed Chairman Paul Volcker raised interest rates sharply in order to attack the inflation issue driving the US economy into a severe double-dip recession.  Oh yeah, the S&P 500 fell nearly 30% over the two-year period.  But ask yourself if, given the current zeitgeist as well as the current makeup of the Fed, there is any possibility that Chairman Powell (or his successor) will attack inflation in the same way.  It seems highly unlikely that would be the case.  Rather, it is a virtual certainty that the focus will be on the ‘stag’ part of the term and more money printing and spending will be recommended.  After all, given the increasing acceptance of the MMT mindset, that’s all that needs to be done.  Remember, policies matter, and if policies are designed to achieve short-term goals at the expense of longer-term needs, the ultimate outcome tends to be poor.  As in China, the currency is likely to be the relief valve for the economy which is what informs my view of longer-term USD weakness.  However, for now, the dollar is following 10-year Treasury yields, which seem to be trending higher, albeit not today when they have fallen 4.2 basis points.

Summing it all up, rising energy prices are starting to have deleterious effects on all parts of the global economy and the financial market implications are only going to grow.  In addition, the policy actions going forward are critical, and the chance of a policy error seem to grow daily.  The idea of short-term pain for long-term gain is obsolete in the year 2021.  Be prepared for more problems in the future.

Ok, a quick run around markets shows that after yesterday’s sharp US equity sell-off, Japan (Nikkei -2.1%) followed suit as did Shanghai although the Hang Seng managed to rally 0.7%.  Europe, on the other hand has decided that central banks will come to the rescue, as we are seeing a nice rebound from yesterday’s price action (DAX +1.1%, CAC +1.2%, FTSE 100 +1.0%).  US futures, too, are higher led by the NASDAQ (+1.0%) as declining yields are helping out.

But are yields really declining?  The fact that the bond market has bounced slightly after a dramatic 1-week decline is hardly a sign of a rebound.  Rather, it is normal trading activity.  While the trend remains for higher yields, today, all of Europe has seen yields slide on the order of 2 basis points alongside the Treasury yield declines.  This feels very much like a lull in the action, not a top/bottom in the market.

Commodity prices are behaving in a similar manner as oil (-0.8%) and NatGas (-1.2%) are leading the way lower, consolidating what has been an impressive rally.  Metals prices are mixed with gold (+0.6%) rebounding but base metals (Cu -0.4%, Al -0.2%, Sn -0.6%) all sliding.  Agricultural prices are mixed as the overall session seems to be one of position adjustments after a big move.

As to the dollar, it is mixed, albeit slightly firmer if anything.  In the G10, NOK (-0.35%) is falling alongside oil prices with NZD (-0.3%) the next worst performer on weakening commodity prices.  JPY (+0.1%) and CHF (+0.1%) are both modestly firmer, but here, too, things seem more position oriented than trend worthy.  EMG currencies are mixed with an equal number of gainers and losers, but the notable thing is that the biggest movers have only seen price adjustments of 0.3% or less.  In other words, there are precious few stories here to think about.

There is no data of note this morning, but we do hear from a lot of central bankers, notably Chairman Powell alongside Lagarde, Kuroda and Bailey (BOE) at an ECB forum.  We also hear from Harker, Daly and Bostic, but the narrative remains tapering is coming in November, and none of these three will be able to change that narrative.

In truth, I would have expected the dollar to soften today given the bond market, so the fact it remains reasonably well bid is a sign that there is further strength in this move.  The euro is pushing to critical technical support at 1.1650, a break of which is likely to see a much sharper decline.  Hedgers, keep that in mind.

Good luck and stay safe
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