You have to be mighty impressed The bond market’s not even stressed Although CPI Has reached a new high One wonders if yields are repressed Clearly, there is only one story of import these days, and that is whether or not inflation is transitory. Chairman Powell and his minions have spent the last several months harping on this idea, and although there was a time when several FOMC members seemed to get nervous and wanted to discuss tapering QE, it seems highly likely that next week’s FOMC meeting will focus on the fact that “substantial progress” has not yet been made toward the Fed’s goals of maximum employment and 2% average inflation. Well, at least on the goal of maximum employment. It seems pretty clear that they have made some progress on the inflation front. While the headline Y/Y print of 5.0% was clearly impressive, and the highest since August 2008, personally, I am more impressed with the core M/M print of 0.7% as that is not impacted by what happened during the pandemic. And the fact that this followed last month’s 0.9% print could indicate that inflation is becoming a bit less transitory. But the Fed has done a wonderful job of selling its story. One has to believe that Chairman Powell could not have wanted a better outcome than yesterday’s market price action with the S&P 500 making new highs while the bond market rallied sharply with the 10-year yield falling 6 basis points to 1.43%. For a moment, let us try to unpack this price action. On the one hand, it is easy to understand the equity rally as the decline in nominal yields alongside the rising recorded inflation has led to a dramatic fall in real yields. One view, which many utilize, is that real 10-year yields are simply the 10-year yield less the current headline CPI rate. Of course, right now, that comes to -3.57%, a level only seen a handful of times in the past, all of which occurred during significant inflationary periods in the 1970’s and early 1980’s. Negative real yields are a boon for stocks, but historically are awful for the dollar and yet the dollar actually rallied slightly yesterday. It seems to me that a more consistent outcome would require the dollar to decline sharply from here. After all, even using Bund yields, currently -0.284%, and Eurozone CPI (2.0%), one sees real yields in the Eurozone far higher (-2.284%) than here in the US. Something seems amiss. Something else to consider is bond positioning. There continues to be a great deal of discussion pointing to the bond market rally as a massive short squeeze. Last week’s CFTC data was hardly indicative of that type of movement, although we will learn more this afternoon. However, there is another place where both hedge funds and retail investors play, the ETF market, and when it comes to bond speculation, TLT is the product of choice. Interestingly, more than 37% of the shares outstanding have been shorted in this ETF, a pretty good indication that there were a lot of bets for a higher yield. But the word is that a significant portion of these shorts were closed out yesterday, on the order of $7 billion in short covering in total, which would certainly explain the sharp rally in the bond market. This begs the question, is the price action technical in nature rather than a reflection of the views that inflation is truly transitory? The problem with this question is we will not be able to answer it with any certainty for at least another three to four months. But for now, the Fed has the upper hand. In fact, there doesn’t seem to be any reason for them to adjust policy next week at all. Why taper if the current policy mix is working? Speaking of policy mixes that seem to be working, I would be remiss if I didn’t mention that the ECB meeting yesterday resulted in exactly…nothing. Policy was left unchanged, Madame Lagarde promised to continue to buy assets at a faster pace than the first quarter, and then she spent an hour in her press conference saying virtually nothing. It may have been her finest performance in the role. The bond market seems to have made up its mind that the Fed is correct although there remain many pundits who disagree. I expect that we will be continuing this discussion all summer long and with every high CPI print, you can look for the punditry to pump up the volume of their critiques of the Fed. However, we need only see one dip in the data for the Fed to claim victory and move on from the inflation discussion. Next month’s CPI report will truly be important as the base effects will have disappeared. Last year, the June M/M CPI was 0.5%. If inflation is truly with us, we need to see M/M in June 2021 to be at least that high, if not a repeat of the 0.6%-0.8% numbers we have been seeing lately. Between now and then we will see a number of price indicators including the Fed’s favorite core PCE. For the past several months, every price indicator has been high and surprising on the high side. The next months’ worth of data will be very important to both the Fed and the markets. Enjoy the ride. With two of the three key near-term catalysts now out of the way, all eyes will turn to next Wednesday’s FOMC meeting. But that leaves us 4 sessions to trade in the interim. Right now, with the fed narrative of transitory inflation dominating, it is easy to expect continued risk-on market performance. Interestingly, that was not actually the case in Asia as the Nikkei (0.0%) was flat and Shanghai (-0.5%) fell although the Hang Seng (+0.35%) managed to close higher on the day. Europe, however, got the memo and is green across the board (DAX +0.4%, CAC +0.7%, FTSE 100 +0.5%). US futures, too, are picking up buyers as they all trade 0.25% or so higher at this hour. Meanwhile, in the bond market, Treasury yields have backed up 1.3bps, which looks far more technical than fundamental. After all, they have fallen 18 bps in the past week, a rebound is no surprise. However, European sovereign markets were closed before the bond party really started yesterday afternoon and they are in catch up mode today. Bunds (-2.0bps) and OATS (-2.1bps) are performing well, but nothing like Gilts (-4.6bps), nor like the PIGS, all of which are seeing yield declines of at least 4bps. Commodity prices are generally higher led by oil (WTI +0.5%) with the industrial metals all performing well (Cu +1.9%, Fe +1.0%, Sn +0.6%) although despite the dramatic decline in yields, gold (-0.5%) continues to underperform. That feels like it is going to change soon. Finally, in FX markets, the dollar is king of the G10, rising against all of its counterparts here with NZD (-0.4%) and SEK (-0.4%) leading the way down. While the kiwi price action appears to be technical after having seen a decent rally lately, Sweden’s krona continues to suffer from its lower CPI print yesterday, once again delaying any idea that they may need to tighten policy in the near term. The rest of the bloc is softer, but the movement has been far less impressive. What makes that price action interesting is the fact that EMG currencies have actually had a much better performance with IDR (+0.4%), KRW (+0.4%) and TRY (+0.4%) all showing modest strength. In Turkey, FinMin comments regarding the divergence between CPI and PPI were taken somewhat hawkishly. In Seoul, a BOK governor mentioned the idea that one or two rate hikes should not be seen as tightening given the current record low level of interest rates (currently 0.50%). However, it seems the market would see 50bps of tightening as tightening. And lastly, the rupiah continues to benefit from foreign buying of bonds with inflows rising for a third consecutive week. Data this morning brings Michigan Sentiment (exp 84.4) and careful attention will be paid to the inflation expectation readings, with the 1yr expected at 4.7%. Remember, the Fed relies on those well-anchored inflation expectations, so if they are rising here, that might cause a little indigestion in Washington. At this stage, just as we are seeing the bond market rally ostensibly on short covering, my sense is the dollar is behaving in the same way. The data and rates would indicate the dollar should fall, but it continues to grind higher right now. In the end, “the fundamentals things apply, as time goes by”1, and right now, they all point to a weaker dollar. Good luck, good weekend and stay safe Adf 1. Apologies to Wilson Dooley
Tag Archives: #Lagarde
Out of Gas
Though prices are forecast to rise The Treasury market implies That Jay has it right And this is the height Inflation will reach at its highs Instead, once the base effects pass Inflation will run out of gas So there is no need For Powell to heed The calls to halt QE en masse This morning we finally get to learn about two of the three potential market catalysts I outlined on Monday, as the ECB announces their policy decision at 7:45 EDT with Madame Lagarde speaking at a press conference 45 minutes later. And, as it happens, at 8:30 EDT we will also see the May CPI data (exp 0.5% M/M, 4.7% Y/Y headline; 0.5% M/M, 3.5% Y/Y ex food & energy). Obviously, these CPI prints are far higher than the Fed target of an average of 2.0% over time, but as we have been repeatedly assured, these price rises are transitory and due entirely to base effects therefore there is no need for investors, or anybody for that matter, to fret. And yet…one cannot help but notice the rising prices that we encounter on a daily basis and wonder what the Fed, and just as importantly, the bond market, is thinking. Perhaps the most remarkable aspect of the current inflation discussion is that despite an enormous amount of discussion on the topic, and anecdotes galore about rising prices, the one market that would seem to be most likely to respond to these pressures, the Treasury market, has traded in exactly the opposite direction expected. Yesterday, after a very strong 10-year auction, where the coverage ratio was 2.58 and the yield fell below 1.50%, it has become clear that bond investors have completely bought into the Fed’s transitory story. All of the angst over the massive increases in fiscal spending and huge growth in the money supply have not made a dent in the view that inflation is dead. Recall that as Q1 ended, 10-year yields were up to 1.75% and forecasters were falling all over themselves to revise their year-end expectations higher with many deciding on the 2.25%-2.50% area as a likely level for 10-year yields come December. The economy was reopening rapidly and expectations for faster growth were widespread. The funny thing is that those growth expectations remain intact, yet suddenly bond investors no longer seem to believe that growth will increase price pressures. Last week’s mildly disappointing NFP report is a key reason as it was the second consecutive report that indicated there is still a huge amount of labor slack in the economy and as long as that remains the case, wage rises ought to remain capped. The counter to that argument is the heavy hand of government, which is both increasing the minimum wage and paying excessive unemployment benefits thus forcing private companies to raise wages to lure workers back to the job. In effect, the government, with these two policies, has artificially tightened the labor market and historically, tight labor markets have led to higher overall inflation. The last bastion of the inflationists’ views is that the recent rally in Treasuries has been driven by short-covering and that has basically been completed thus opening the way for sellers to reemerge. And while I’m sure that has been part of the process, my take, also anecdotal, is that fixed income investors truly believe the Fed at this time, despite the Fed’s extraordinarily poor track record when it comes to forecasting literally anything. As an example, two weeks ago, I was playing golf with a new member of my golf club who happened to be a portfolio manager for a major insurance company. We spent 18 holes discussing the inflation/deflation issue and he was 100% convinced that inflation is not a problem. More importantly, he indicated his portfolio is positioned for that to be the case and implied that was the house view so his was not the only portfolio so positioned. This helps explain why Treasury yields are at 1.49%, 25 basis points lower than on April 1. However, it also means that while today’s data, whatever it is, will not be conclusive to the argument, as the summer progresses and we get into autumn, any sense that the inflation rate is not heading back toward 2.0% will likely have major market consequences. Stay tuned. As to the ECB, it seems highly unlikely that they will announce any policy changes this morning with the key issue being their discussion of the pace of QE purchases. You may recall that at the April meeting, the key words were, “the Governing Council expects purchases under PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year.” In other words, they stepped up the pace of QE to roughly €20 billion per week, from what had been less than €14 billion prior to that meeting. While the data from Europe has improved since then, and reopening from pandemic induced restrictions is expanding, it would be shocking if they were to change their view this quickly. Rather, expectations are for no policy change and no change in the rate of QE purchases for at least another quarter. The inflationary impulse in the Eurozone remains far lower than in the US and even though they finally got headline CPI to touch 2.0% last month, there is no worry it will run away higher. Remember, too, there is no way the ECB can countenance a stronger euro as it would both impair its export competitiveness as well as import deflation. As long as the Fed continues to buy bonds at the current rate you can expect the ECB to do the same. In the end, we can only wait and see what occurs. Until then, a brief recap of markets shows that things have continued to trade in tight ranges as investors worldwide await this morning’s news. Equity markets in Asia were very modestly higher (Nikkei +0.3%, Shanghai +0.5%, Hang Seng 0.0%) and in Europe the movement has been even less pronounced (DAX +0.1%, CAC -0.1%, FTSE 100 +0.3%). US futures are mixed as well with the three major indices within 0.2% of closing levels. Bond markets, after a strong rally yesterday, have seen a bit of profit taking with Treasury yields edging higher by 0.8bps while Europe (Bunds +1.0bps, OATs +1.6bps, Gilts +0.7bps) have moved up a touch more. But this is trader position adjustments ahead of the news, not investors making wholesale portfolio changes. Commodity markets are mixed with crude oil (+0.1%) barely higher while precious metals (Au -0.5%, Ag -0.4%) are under a bit of pressure. Base metals, however, are seeing more selling pressure (Cu -1.5%, Al -0.2%, Sn -0.7%) while foodstuffs are mixed as wheat is lower though corn and soybeans have edged higher. Finally, in the FX market, the G10 is generally mixed with very modest movement except for one currency, NOK (-0.5%) which has fallen sharply after CPI data came out much lower than expected thus relieving pressure on the Norgesbank to tighten policy anytime soon. In the EMG bloc, ZAR (+0.6%) is the leading gainer after its C/A surplus was released at a much stronger than expected 5.0% indicating finances in the country are improving. But away from that, things have been much less exciting as markets await today’s data and ECB statements. In addition to the CPI data this morning, as it is Thursday, we will see Initial Claims (exp 370K) and Continuing Claims (3.65M). Interestingly, those may be more important data points as the Fed is clearly far more focused on employment than on inflation. But they will not be sensational, so will not get the press. FWIW my money is on a higher than expected CPI print, 5.0% or more with nearly 4.0% ex food & energy. However, even if I am correct, it is not clear how big a market impact it will have beyond a very short-term response. In the end, if Treasury yields continue to fall, I believe the dollar will follow. Good luck and stay safe Adf
So Slyly
The stock market’s feeling some pains
As word is that capital gains
Will soon be taxed highly
As Biden, so slyly
Pays tribute to John Maynard Keynes
It can be no surprise that the Biden administration has begun to float trial balloons regarding higher tax rates as they were a key plank in Biden’s presidential campaign. Given the remarkable amount of money that this administration seems to want to spend, there needs to be some additional revenue to help pay for things, although the gap between the spending plans and forecast revenue enhancements remains extremely wide. For instance, while the mooted price tag for the American Jobs Plan, the latest proposal, is on the order of $2.3 trillion, the estimated revenues of the capital gains tax rise is somewhere in the $500 billion to $1 trillion zone. That’s still a pretty big gap that needs to be filled. Of course, we know that the Treasury will simply borrow the difference, and based on current form, the Fed will buy most of that. Who knows, maybe MMT really does work, and everything will work out fine.
Investors, though, seeing the world through a slightly different prism than policymakers, may decide that while the extraordinary equity market rally has been lots of fun, it might be time to take some money off the table. When the first headlines about a doubling of capital gains taxes hit the tape, US markets fell about 1.3% and finished lower on the day. Now, we are still a long way from those tax laws being enacted, but do not be surprised if equity markets have more difficulty making new highs going forward. After all, if the government is going to tax away your gains, the risk/reward equation will change for the worse. (While on the subject of taxes, there was a rumor that the Treasury was talking about 70% marginal tax rates on Bitcoin and other cryptocurrency gains. It should be no surprise they suffered as well.)
Attempting, us all, to assure
Lagarde said, t’would be “premature”
To taper our buying
Since we are still trying
To help the recovery endure
Yesterday’s other big story was the ECB meeting where, while policies were left unchanged as expected, there was a great deal of anticipation that Madame Lagarde might offer some hints as to the structural reforms due to be announced in June, or even give a bit more guidance on the current situation within the PEPP. Alas, the information quotient from this meeting was pretty limited. Lagarde insisted that increased buying in the PEPP, which was a key outcome from the March meeting, would remain in place, although the pace of purchases does not seem to have increased all that much. Yet when asked directly about the probability of tapering those purchases, Lagarde was adamant that it was “simply premature” to discuss that subject.
What is becoming apparent at the ECB is that there is a growing divide between the hawks and doves regarding how policy should evolve. The Frugal four are clearly seeing improved economic activity and the beginnings of rising prices while the more profligate southern countries continue to lag in both economic activity and rate of vaccinations. It is becoming clear that a single monetary policy is no longer going to be efficient for both groups of countries simultaneously. When Super Mario was ECB President, he simply ran roughshod over the hawks, but then he had the policy chops to do so on his own. It remains to be seen if Madame Lagarde will have the same ability. The upshot is that we could be looking at some more volatility in Eurozone markets if the hawks start speaking in concert and do not back Lagarde. We shall see.
Away from those stories, though, the market this morning is ostensibly focused on the better than expected PMI data that we have seen around the world. Starting with Australia last night, and on to Japan and most of Europe and the UK, the big gainer was Services PMI, which is back above 50 everywhere except Japan, which printed at 48.3. But Australia, the Eurozone and the UK are all back in expansionary territory as anticipation of the great reopening takes hold. In this regard, the Japanese data makes sense as the nation is about to impose lockdowns again for the next two weeks in Tokyo, Kyoto and two other prefectures, closing bars and restaurants and banning public gatherings.
In addition to the PMI data, UK Retail Sales was quite strong, rising 4.9% M/M ex fuel, as were Japanese Department Store Sales (+21.8%). With all of this positive data, it can be no surprise that the dollar is under pressure this morning, but it is a bit surprising that equity markets in Europe are under pressure (DAX -0.3%, CAC -0.2%, FTSE 100 -0.4%) and sovereign bond yields are softer (Bunds -1.3bps, OATs -1.2bps, Gilts -0.7bps). While buy the rumor, sell the news is always a viable thought process, it strikes me that there were no rumors of this type of economic strength.
Finishing the market recap, commodities are firmer (WTI +0.5%, Au +0.1%, Cu +0.8%), which syncs well with the dollar’s weakness. In the G10 space, the dollar is softer versus the entire spectrum of currencies, with EUR (+0.3%) and GBP (+0.3%) leading the way while JPY (+0.1%) is the laggard today. In the EMG space, RUB (+0.6%) is the leading gainer after the Bank of Russia raised their base rate by 0.50% to 5.00% in a surprise as only 25bps was expected. Away from that, the CE4 are all following the euro higher and then commodity currencies are also edging higher, but by much lesser amounts (ZAR +0.2%, MXN +0.2%). There are a few decliners here, TRY (-0.2%), INR (-0.1%) but the size of the move is indicative of the lack of general interest. Certainly, both those nations have been suffering more significantly with Covid lately, and it would not be a surprise to see both currencies continue to lag until that situation changes.
On the data front this morning, New Home Sales (exp 885K) is the major number, although preliminary PMI data (61.0 Mfg, 61.5 Services) is also due. In the US, though, there is far more focus on ISM than PMI. With the Fed coming up next week, there is no Fedspeak to be had, so as we head into the weekend, it is reasonable to expect a quiet session. Equity futures are currently slightly in the green, roughly 0.15%, so perhaps the gut reaction to the tax news has passed and won’t have an impact. But the one thing of which we can be certain appears to be that higher taxes are on the way. That is a double whammy for equities as higher corporate tax rates will reduce earnings while higher cap gains taxes will encourage selling before those taxes come into effect.
In the end, though, nothing has changed the underlying market driver, the 10-year Treasury. If yields there continue to slide, the dollar will remain weak across the board. If they reverse, look for the dollar to rebound. Next week, after the Fed, we see Core PCE data on Friday. Currently, that is forecast to rise 1.8%. a high side surprise there could well shake things up with regard to views on tapering with a corresponding impact on all markets. But until the Fed on Wednesday, it seems we are in for some slow times.
Good luck, good weekend and stay safe
Adf
Powell Won’t Waver
The story last quarter was prices
Would rise, leading up to a crisis
So, bond markets dropped
The dollar, she popped
And gold bugs all made sacrifices
But now a new narrative line
Explains that inflation’s benign
So, bonds are in favor
As Powell won’t waver
While dollars resume their decline
All year long the market story has been driven by the yield on the 10-year Treasury bond. Ever since the run-off elections in Georgia in the beginning of January, market anticipation has been for significant growth in the US on the heels of increased vaccination rates and increased fiscal stimulus. In Q1, Treasury yields rose dramatically, touching as high as 1.77% at their top toward the end of March. Meanwhile, the dollar, which had been slated to decline all year, rallied versus every emerging market currency and all but CAD, GBP and NOK in the G10.
But, as of the first of this month, the world appears to be a different place, as Treasury bonds have rallied driving yields lower and supporting equity and commodity markets. At the same time, the dollar has come under broad-based pressure and reversed a large portion of its Q1 gains.
Currently, the narrative appears to be along the following lines: US GDP growth in 2021 is going to be spectacular, well above 6.0% and its strongest since 1984. Inflation, meanwhile, will print at higher levels for Q2 purely as a result of base effects, but will then resume its long-term downtrend and the Fed will be required to continue to support the economy aggressively in order to meet their goals. By the way, the Fed’s newly articulated goal is for maximum employment, not full employment, and they have promised to become completely reactive, waiting for hard data to confirm positive results in employment and wages, before considering any efforts to rein in rising prices.
Equity markets still love the story as the implication is that interest rates will not be rising at all this year, nor next year for that matter, at least in the front end of the curve. Treasury markets, which appeared to get a little panicked in Q1 have reverted to form and seem to be pricing one of two things; either less impressive economic growth, or anticipation that the Fed will expand QE or YCC as Powell and friends seek to prevent any significant rise in yields. Meanwhile, the dollar is falling again, gold is rising and commodity prices (the one true constant) remain firm.
Have we reached economic nirvana? Some skepticism might be in order given the myriad issues that can undermine this narrative. The primary issue is, of course, another wave of Covid spreading throughout the US and the world. As the virus mutates, it is not clear that the current vaccines are going to be effective preventatives to new strains. While the vaccination progress in the US and UK has been excellent, with 40% and 50% of their respective populations receiving at least the first dose, the same cannot be said elsewhere in the world. In fact, the newsworthy item of the day is that India reported 315,800 new cases just yesterday! Alongside Brazil and Turkey, these three nations, with a combined population of nearly 1.7 billion find themselves in the midst of another serious wave of infection. Remember that a huge part of the reopening and growth narrative is the ending of the pandemic. It is still too early to make that claim, and so, perhaps a bit early to count the 2021 GDP growth figures as a given.
However, there is a second issue of note that cannot be ignored, and that is the inflation story. While it is clear that the Fed has convinced themselves inflation is not a concern, that the elevated readings that are almost certain to come over the next three months will be ‘transitory’, there is a case to be made that rising inflation may have a more lasting impact.
Consider that oil prices have risen dramatically from their levels this time last year and continue to trend higher. Now, while the Fed looks at core prices, ex food & energy, the reality is that rising energy prices feed into everyday items beyond the cost of filling your gas tank. Given that virtually everything produced and consumed requires energy to create, eventually higher energy prices feed into the cost of all those products. It can be even more direct for services such as shipping, where energy price surcharges are common. But just because something is labeled a surcharge doesn’t mean it hasn’t raised the price of the item consumed. The point is, rising energy prices and rising commodity prices in general, are leading to higher input costs which will eventually lead to higher prices. We continue to see the evidence in data like PPI and the price indices in the PMI and ISM data.
And these are just the two largest known issues. Less probable, but potentially highly significant, we could see increased tension in US-China relations, with a stepped-up trade war, or even a confrontation over the situation in Taiwan. Neither can one rule out more mischief from Russia, or Middle Eastern strife that could easily impact the supply of oil and hence its price. The point is, it seems early to declare that the worst is behind us and price securities and risk as though that is the case.
Market activity today is relatively muted as investors and traders await the latest word(s) from Madame Lagarde and the ECB. Expectations are there will be no changes to policy, but the real hope is that she will give clearer guidance on their plans going forward. You may recall at the last meeting they expressed some dismay that bond yields had risen as much as they had and promised to increase PEPP purchases. Since then, while they have increased those purchases, the amount of increase has been less than impressive and yields in Europe, while not rising further, have not returned to previous lower levels. At the same time, as US yields have fallen back more than 20bps from their recent highs, the euro (+0.2%) has resumed its climb and is back above 1.20 for the first time since early March. One thing we know is that the ECB can ill afford a stronger euro, so some type of response may be forthcoming.
Speaking of central banks, yesterday’s big surprise came from north of the border as the Bank of Canada, while leaving policy on hold, changed their tune on the timing for the end of QE. They brought forward their tapering timeline and the market brought forward the rate hike timeline in response. It seems that the employment situation in Canada has returned far closer to pre-Covid levels than in the US, with more than 90% of the jobs lost having been regained. While CAD has given up 0.1% this morning, this is after a nearly 1.0% rise yesterday in the wake of the BOC announcement.
A quick look at equity markets around the world shows that Asia had a pretty good session (Nikkei +2.4%, Hang Seng +0.5%, Shanghai -0.25%) while Europe is all green and has been steadily climbing all day (DAX +0.45%, CAC +0.6%, FTSE 100 +0.1%). US futures, however, are ever so slightly softer, down about 0.15% across the board, although this was after solid rallies yesterday afternoon. Meanwhile, bond markets are under the barest of pressures with yields edging higher in the US (+0.5bps) and Europe (Bunds +0.4bps, OATs +0.8bps, Gilts -0.4bps), really showing a market waiting for the next piece of data.
Energy prices are under modest pressure this morning (WTI -0.5%), as are precious metals (Au -0.3%, Ag -0.6%) and industrials (Cu 0.0%, Zn -0.2%, Al -0.2%).
It can be little surprise that the dollar is mixed this morning, given the lack of a coherent market theme, although there are some modest surprises. NOK (+0.25%) for example is stronger in the face of weaker oil prices. Meanwhile NZD (-0.3%) is the weak link in the G10, on the back of market internals and stop-loss selling. EMG currencies have a few more substantial movers with RUB (+1.25%) the leading gainer by far after President Putin’s state of the nation address focused entirely on domestic issues rather than feared saber rattling. This encouraged bond buying and strength in the ruble. On the other end of the spectrum is TRY (-0.8%) which has seen further investor outflow after reports that the US administration is prepared to raise the issue of the Armenian genocide and put further pressure to isolate President Erdogan. However, away from those two movers, the rest of the bloc is +/- 0.2% or less.
Aside from the ECB meeting, the US data slate brings Initial Claims (exp 610K), Continuing Claims (3.6M), Leading Indicators (1.0%) and Existing Home Sales (6.11M). Clearly the Claims data is the most important of the bunch with a strong number possibly helping to halt the Treasury rally and potentially support the dollar. We are in the Fed quiet period, so no speakers there.
The rest of the day will take its tone from Madame Lagarde, but if she is less than forceful, I would expect the current trend (modestly lower yields, modestly higher equities and modestly weaker dollar) to continue.
Good luck and stay safe
Adf
As Much As They Want
Said Madame Lagarde with some jaunt
“They can test us as much as they want”
We’ve exceptional tools
And we still make the rules
These are words that could come back to haunt
If there were any questions as to the key driver in the markets, Madame Lagarde answered them tacitly this morning in a televised interview. The number one driver of all things financial continues to be the yield on the 10-year Treasury bond and its knock-on effects for other markets. Hence, when asked about the rising yields in the European sovereign markets, where similar to the Treasury market, yields are broadly at or near one-year high levels, she uttered what almost seemed like a challenge, “They can test us as much as they want. We have exceptional circumstances to deal with at the moment and we have exceptional tools to use at the moment, and a battery of those. We will use them as and when needed in order to deliver on our mandate and deliver on our pledge to the economy.” While this doesn’t quite rise to Signor Draghi’s famous “whatever it takes” comment, it is certain that Lagarde was trying for the same impact.
Perhaps, however, something is lost in the translation from Italian to French, as the bond market stifled a collective yawn at her comments and yields continue to climb higher this morning, albeit not quite as dramatically as yesterday. So, a quick tour of European bond markets shows yields on the Bunds, OATs and Gilts all about 1 basis point higher, following right along with Treasury yields which are 2.2bps above yesterday’s close as I type. While there is no doubt that this move higher in yields is getting a bit long in the tooth, and it would not be surprising to see a short-term respite, the underlying drivers, which remain a combination of anticipated excess new supply and rising prices, are still very much in place. In fact, later today apparently President Biden is going to introduce his newest spending bill with a $2.25 trillion price tag. This merely adds fuel to that fire of excess supply expectations.
There is one other thing that seems to belie the image of strength put forth by Lagarde, as well as by Chair Powell; the fact that they both go out of their way to explain that if when the time ever comes that they are actually going to slow down monetary injections, let alone actually reverse them, they will do so only after having given ample warning well in advance of such actions. In other words, they remain terrified that taper tantrums are going to occur if they ever stop expanding their balance sheet, with a resulting decline in asset prices. Now, the one thing that is abundantly clear, especially in the US, is that while there is a great deal of Fedspeak about achieving maximum employment, the Fed’s key indicator is the S&P 500. Thus, a falling stock market will bring about a change in Fed policy faster than anything else. However, it seems to me advance notice of tapering would not change the market reaction, merely its timing, so it is not clear what benefit they see in the idea.
Nonetheless, it remains the working thesis of central banks everywhere, that they must give significant forward guidance in order to be effective. Yet once the market perceives an inflection point in that guidance, it is going to react immediately, even if the promised policy change is not until some future date. My personal belief is that central banks would be far better off simply changing policies as they deem necessary without forward guidance and allow markets to find a new equilibrium after the policy change. But that is a radical idea in today’s world.
In any case, there has been nothing new to change the ongoing narrative which remains the reflationary story is driving yields higher and the dollar along with them. meanwhile, equity prices are beginning to struggle in the face of those rising yields as fixed income has started to become a viable alternative investment to equities, and the discount factor for future growth continues to point to lower current prices. Thus, while markets this morning are taking a pause on their recent trajectory, with the dollar modestly softer along with most equity markets and commodities, much of this can be attributed to the fact that it is month and quarter end (and fiscal year end for many Asian nations), so recent positions may be reduced for balance sheet purposes.
So, let’s take a look at markets today. Equity markets in Asia were mostly under pressure with the Nikkei (-0.9%), Hang Seng (-0.7%) and Shanghai (-0.4%) all weaker on the close. Europe has seen a more mixed picture as the DAX (0.0%) has recovered from mild early losses, but the CAC (-0.2%) and FTSE 100 (-0.3%) are both feeling a bit of pressure. US futures, meanwhile, continue their bipolar activities, this time with the NASDAQ (+0.65%) rising while the DOW (-0.2%) is under the gun. However, remember that much rebalancing is likely to be seen again today given the calendar, so do not be surprised if there are short-term reversals to recent trends.
As to commodities, oil prices (-0.4%) are a touch softer this morning while gold (+0.1%) and silver (+0.25%) seem to have stabilized for the time being. The base metal story is more mixed with Cu (+0.7%) on the day, but the rest of the main trading metals generally softer by a similar amount.
Finally, the dollar is under some pressure today, although given its run over the past week, this appears merely to be a short-term corrective. In the G10, NOK (+0.5%) is the leading gainer, despite oil’s modest decline, as the market continues to look at the Norwegian economy and forecast Norgesbank may be the first G10 bank to raise interest rates. Inflation pressures appear to be building in the country and growth remains on the upswing. Away from the krone, the rest of the bloc is firmer by between 0.2% and 0.3% with modest impact from CPI data across Europe showing prices rising compared to February, but a tick less than forecast in the major countries. The one exception is JPY (-0.25%) which is simply cratering of late and has now declined about 7.5% in 2021. It appears that we are beginning to see an increase in unhedged Treasury buying by Japanese investors, with the 10-year yield spread now above 165 basis points, a level that historically has seen significant interest from the Japanese investment community. In fact, if drawing a long-term trend line from its recent peak in early 2017, USDJPY appears to be breaking higher with a target of 112.00 a very real near-term possibility.
Regarding EMG currencies, there is general strength there as well, led by ZAR (+0.7%) and RUB (+0.6%) which have been two of the overall better performers for the week. But in a broader sense, we are seeing modest reversals of what had been EMG currency weakness for the past week or more.
On the data front, ADP Employment (exp 550K) is the first part of the employment picture this morning with some whisper numbers growing for the NFP on Friday to over 1 million new jobs as the economy reopens. We also see Chicago PMI (61.0), which should show continued growth in the manufacturing sector. Overnight, Chinese PMI data (Composite 55.3) was much better than expected and indicates that the Chinese economy has moved past the Lunar New year lull. There are no Fed speakers, but really, people will be focused on the new spending package, and more importantly, the indications of how it will be funded. The less tax discussion, the likelihood of the bigger negative impact on the bond market.
As to the dollar today, the current trend remains clearly higher, but with month-end rebalancing taking place here as well, a touch of further weakness is quite viable on the day.
Good luck and stay safe
Adf
Tempting the Fates
What everyone now can assume
Is Jay and his friends in the room
Will never raise rates
Thus, tempting the fates
In search of a ne’er ending boom
Well, that’s that! To anyone who thought that the Fed was concerned over rising back-end yields and a steeper yield curve, Chairman Powell made it abundantly clear that it is not even on their radar. No longer will the Fed be concerned with mere forecasts of economic strength or pending inflation. As in the Battle of Bunker Hill, they will not “…fire until they see the whites of [inflation’s] eyes”. “Until we give a signal, you can assume we are not there yet,” Powell explained when asked about the timing of tapering asset purchases and tightening policy. It would seem that is a pretty clear statement of intent on the Fed’s part, to maintain the current policy for years to come.
To recap, the Fed raised their forecasts for GDP growth to 6.5% in 2021, 3.3% in 2022 and 2.2% in 2023, while increasing their inflation forecasts (core PCE) to 2.2%, 2.0% and 2.1% respectively for the same years. Finally, their view on unemployment adjusted to 4.5% this year with declines to 3.9% and 3.5% in ’22 and ’23. All in all, they have quite a rosy view of the future, above trend growth, full employment and no inflation. I sure hope they are correct, but I fear that the world may not turn out as they currently see it through their rose-tinted glasses. The market’s biggest concern continues to be inflation, which, after decades of secular decline, appears to be at an inflection point for the future. This can be seen in the bond market’s reaction to yesterday’s activities.
Prior to the FOMC statement, (which, by the way, was virtually verbatim with the January statement, except for one sentence describing the economic situation), risk was under pressure as equity markets were slipping, 10-year Treasury yields were rallying to new highs for the move and the dollar was firming up. But the statement release halted those movements, and once the press conference got underway, Powell’s dovishness was evident. This encouraged all three markets to reverse early moves and stocks closed higher, bonds flat and the dollar softer. It seems, there was a great deal of positive sentiment at that time.
However, over the ensuing 16 hours, there has been a slight shift in sentiment as evidenced by the fact that the 10-year Treasury is now down 2/3’s of a point with the yield higher by 8 basis points, rising to 1.72%. This is the highest yield seen since January 2020, pre-pandemic, but certainly shows no sign of stopping here. In fact, 30-year Treasuries now yield 2.5%, their highest level since July 2019, and here, too, there is no evidence that the move is slowing down. If anything, both of these bonds appear to be picking up speed in their race to higher levels. Meanwhile, TIP yields are climbing as well, but not quite as quickly taking the 10-year breakeven to 2.31%. In other words, that is the market forecast for inflation. FYI, this is the highest level in this measure since May 2013. As mentioned above, it appears there is a secular change in inflation on the way.
Perhaps what makes this most remarkable is the dramatic difference in the Fed’s stance and that of some other major central banks. On the one hand, Madame Lagarde informed us last week that the ECB would be speeding up their PEPP purchases to counter the effect of rising yields. Again, this morning she explained, “what we are responding to is a yield increase that could get ahead of the expected economic recovery.” On the other hand, the Norges Bank, while leaving rates on hold at 0.00% this morning predicted it would start raising rates in the “latter half” of this year, far sooner than previous expectations. Meanwhile, in the emerging markets, we have an even more aggressive story, with the Banco Central do Brazil raising the overnight SELIC rate by a more than expected 0.75% last night, as despite Covid continuing to ravage the country and the economy stuttering, inflation is starting to move higher at a faster pace.
The point here is that after almost a full year of synchronous monetary policy around the world, things are starting to change at different rates in different places. The one thing almost certain to follow from this change in policies is that market volatility, across all asset classes, is likely to increase. And since most markets either get measured in dollars, or versus dollars, and the inherent volatility in the US bond market is increasing, we may soon be testing central bank limits of control, especially the Fed’s. After all, if the 2yr-10-yr spread widened to 2.75%, a level it has reached numerous times in the past, will the Fed remain sanguine on the subject? Will the stock market implode? Will the dollar race higher? These are the questions that are likely to be on our lips going forward. The fun is just beginning as the Fed embarks on its new policy roadway.
With all that in mind, what is this morning’s session doing? Based on the different central bank activities, things are performing as one would expect. The initial warm glow following the FOMC meeting followed into Asia with gains in most major markets there (Nikkei +1.0%, Hang Seng +1.3%, Shanghai +0.5%) although Australia’s ASX 200 fell 0.7% during the session. Meanwhile, Lagarde’s comments, reiterating that the ECB would be buying more bonds has encouraged equity investors in Europe with gains across the board led by the DAX (+1.2%), although the rest of the set are far less impressive (CAC +0.25%, FTSE 100 +0.1%). However, US futures tell a different story, as the rising long bond yields are continuing to have a severe impact on the NASDAQ with futures there -1.0% and dragging SPX (-0.3%) down with it although DOW futures have actually edged higher by 0.2%. This is the ongoing rotation story, out of growth/big tech and into value and cyclical stocks.
In the bond market, the damage is severe with Treasuries leading the way followed by Gilts (+5.5bps) as the market awaits the BOE meeting results, and then much smaller rises in yields on the continent (Bunds +2.6bps, OATs +1.9bps, Italian BTPs +1.7bps) as traders recognize that the ECB is going to prevent a dramatic decline there.
Perhaps the most surprising outcome this morning is in the commodity bloc, where virtually all commodity prices are lower, albeit not by too much. Oil (-0.3%), gold (-0.5%) and copper (-0.3%) are uniformly under pressure. This could be a response to the Fed’s benign inflation forecasts, but I think it is more likely a response to the dollar’s strength.
Speaking of the dollar, it is mostly stronger this morning, recouping the bulk of yesterday afternoon’s losses. In the G10, only AUD (+0.25%) is higher of note after the employment report released overnight showed far more strength than expected (Unemployment Rate fell to 5.8%). But otherwise, the rest of the bloc is under pressure, once again led by SEK (-0.45%) and CHF (-0.35%), with both currencies seeing outflows on the back of higher USD yields. In the EMG bloc, TRY (+2.0%) has just jumped higher after the central bank there surprised the market and raised rates by 2.0% rather than the 1.0% expected. So, like Brazil, despite economic concerns, inflation is rearing its ugly head. However, beyond that, last night saw strength in KRW (+0.6%) after the BOK indicated they will not allow excessive market volatility (read declines) in the wake of the FOMC meeting. And that was really the extent of the positives. On the downside, PLN (-0.9%) is the laggard, as the market is concerned over additional Covid closures slowing any comeback and encouraging easier monetary policy further into the future than previously thought. The rest of the CE4 are in similar, if not as dire straits this morning as the euro’s softness is undermining the whole group. As to LATAM, the peso is starting the day unchanged and the rest of the continent has not yet opened.
On the data front, today brings Initial Claims (exp 700K), Continuing Claims (4.034M), Philly Fed (23.3) and Leading Indicators (0.3%). In addition, we hear from the BOE, with no policy change expected, and then Chairman Powell speaks around noon at the BIS conference. My guess is that there will be a great deal of interest in what he has to say and if he tries to walk back the idea that the Fed is comfortable with the yield curve steepening as quickly as it is. One thing to recognize is that markets can move much faster than anticipated when given a green light. With the 10-year yield currently at 1.737%, a move to 2.0% by the end of the month is quite realistic. And my sense is that might raise a few eyebrows at the Mariner Eccles building.
As to the dollar, follow the yields. If they continue to rise, so will the dollar. If they stop, I expect the dollar will as well.
Good luck and stay safe
Adf
Central Banks Fear
The one thing that’s been crystal clear
Is yields have exploded this year
The question at hand
Since this wasn’t planned
Is what, most, do central banks fear?
For Jay and the FOMC
The joblessness rate is the key
For Christine its growth
And prices, as both
Refuse to respond to her plea
While the bond market has taken a respite from its headlong rush to higher yields, there is no evidence we have seen the top. Rather, it feels very much like the market has positioned itself for the next leg higher in yields, potentially to kick off after tomorrow’s FOMC meeting. If you recall, the last Fedspeak on the topic was by Chairman Powell and he was essentially dismissive of the issue as a non-event. The consistent story has been that higher yields in the back end of the curve is a sign that the economy is picking up and they are doing their job properly, in other words it is a vote of confidence in the Fed. And he was unambiguous in his discussion regarding the potential to tighten policy; it ain’t gonna happen for at least two to three more years, which is their timeline as to when the employment situation will recover to pre-Covid levels. Remember, Powell has been explicit that he will not be satisfied until another 10 million jobs have been created and filled.
It has been this intense focus on the employment situation that has driven the Fed narrative that neither inflation or higher yields are of consequence for now or the foreseeable future. Thus, all the positive US data, both economic and vaccine related, has served to increase expectations of a strong economic rebound consistently supported by front end interest rates remaining at zero.
But the interplay between rising yields and the speed of the recovery remains open to question. In addition, there is the question of just how high yields can go before the Treasury gets uncomfortable that financing all this deficit spending is going to become problematic. After all, if yields continue to rise, at some point the cost of carrying all the debt is going to become quite painful for the government.
In fact, it is this issue that has been a key feature of many forecasts of market behavior for the rest of this year and next; at some point, probably sooner rather than later, the Fed is going to step in and cap yields. But what if the Treasury is looking at this problem from a different perspective, not what actual yields are, but the size of their debt service relative to the economy? On that measure, despite a more than doubling of Treasury debt outstanding since 2007, interest expense is currently a smaller percentage of GDP than it was back then. It is important to remember that Treasury debt matures monthly, not just T-bills, but also old notes and bonds, and when those notes and bonds were issued, ZIRP didn’t exist so many carry coupons much higher than the current replacements. The upshot is that debt service costs have been declining despite the growth in the nominal amount of debt outstanding and are forecast to continue declining for the next 3 years according to the CBO. So, maybe, Jay is serious that he is unworried about the current level of yields in the 10-year bucket and beyond.
If this thesis is correct, the implications for other markets going forward are significantly different than I believe many are currently considering. For instance, a further rise in yields will start to have a significant negative impact on equity prices as all of the discounted cash flow models that currently assume zero rates forever to justify the current level of valuations will come crashing back to reality and there will be a realization that price-earnings multiples are unsustainable at current levels. As well, the dollar bearish theme will likely get destroyed, as it is predicated on the idea that real yields will decline with rising inflation and capped yields. If yields are not capped, but instead respond to rising inflation expectations by going higher unchecked, the dollar will be a huge beneficiary. Precious metals? They will suffer, although base metals should hold their own as growth will support demand and supply continues to be lacking, especially new supply. And I would be wary of EMG debt as that rising dollar will wreak havoc on emerging market economies.
Perhaps it is the last thing that will cause the Fed to blink, since if the rest of the world slides into another recession amid increased demand for dollars, history has shown the Fed will ease policy to halt that slide. Of course, for the past thirty years, any significant decline in the US equity market has been sufficient to get the Fed to ease policy, with Q4 2018 the most recent pre-pandemic episode. But that means those valuations will compress, at least somewhat, before the Fed responds.
Add it all up and we have the opportunity for significantly more volatility in markets going forward, something hedgers need to heed.
As to today, ahead of the Retail Sales release this morning, and of course the FOMC tomorrow, markets are continuing in their quiet consolidation overall, though with a modest risk-on bias.
Equity market screens are all green with gains in Asia (Nikkei +0.5%, Hang Seng +0.7%, Shanghai +0.8%) and Europe (DAX +0.5%, CAC +0.1%, FTSE 100 +0.5%) pretty solid everywhere. US futures are showing gains in the NASDAQ (+0.5%), but little movement in the other two indices.
Bond markets are also quietly higher, with very modest yield declines in Treasuries (-0.5bps), Bunds (-0.5bps) and Gilts (-1.0bp). In fact, looking at my screen shows only Italian BTP’s (+1.9bps) and Greek 10-years (+2.8bps) falling as both nations impose stricter lockdowns. Even JGB’s (-1.0bp) are a bit firmer as market participants await the BOJ’s policy framework Friday.
Commodity prices are under a bit of pressure this morning with oil (-1.3%) leading the way but base metals pretty much all lower as well. As to the precious metals, they are little changed on the day and are the market with, perhaps, the keenest interest in the Fed meeting tomorrow. If yields are going to continue to climb unabated, gold and silver will decline.
Finally, the dollar is having a mixed session as well, with a pretty equal split of gainers and losers against the greenback. In the G10, SEK (+0.3%) and CHF (+0.3%) lead the way higher although both appear to be continuing a consolidation move of the past week. On the downside, GBP (-0.3%) is the laggard after the EU brought new legal action against the UK on a Brexit related matter. As to the rest of the space, the movements have been even smaller and essentially irrelevant.
In Emerging Markets, TRY (+0.8%) is the leading gainer as bets grow that the central bank will be raising rates later this week. Next in line was KRW (+0.6%) which benefitted from large net inflows into the bond market, but after that, things are much less interesting. On the downside, while there are a number of currencies that have declined this morning, the movements, all 0.2% or less, just don’t need a rationale, they are simply trading activity.
Data wise, we see Retail Sales this morning (exp -0.5%, 0.1% ex autos) a far cry from last month’s stimulus check induced jump of 5.3%. We also see IP (0.3%) and Capacity Utilization (75.5%) a little later, but the reality is that if Retail Sales is uninteresting, markets are likely to continue to drift until tomorrow’s FOMC meeting.
For today, there seems very little likely to occur, but beware the Fed, if they really are going to allow yields to rise further, we could see some real changes in viewpoint for both equity markets and the dollar.
Good luck and stay safe
Adf
Our Fear and Our Dread
Said Madame Lagarde, don’t misread
The fact that our PEPP has lost speed
The quarter to come
A good rule of thumb
Is twice as much is guaranteed
This morning, though, markets have said
That’s just not enough to imbed
The idea your actions
Of frequent transactions
Will offset our fears and our dread
As we walk in this morning, there is a distinct change in tone in the markets from yesterday. It seems that the initial impressions of yesterday’s two big events, the ECB meeting and the 30-year auction, were fleeting, and fear, once again, has taken over.
A quick recap shows that ECB President Lagarde, in responding to the growing questions about the reduced pace of ECB PEPP purchases, promised to significantly increase them during the next quarter. While she refused to quantify ‘significantly’, the analyst community is moving toward the idea that means at least doubling the weekly purchase amounts to ~€25 billion. At the same time, we heard from several ECB members this morning that this action did not presage increasing the size of the PEPP, which still has approximately €1 trillion in firepower remaining. Lagarde emphasized the flexible nature of the program and explained that varying the speed of purchases is exactly why that flexibility was created. However, despite today’s comments, Lagarde also assured us that, if necessary, the ECB could recalibrate the program, which is lawyer/central bank speak for increase the size.
The market liked what it heard, and the result was a bond rally on both sides of the Atlantic. Several hours later, the results of the Treasury’s 30-year auction were released and, while not fantastic, were also not as disastrous as the 7-year auction from two weeks ago. In the end, bond yields basically ended the day flat, equities rallied, and the dollar was under pressure all day. Risk had regained its allure and the bulls were back in command.
Aahh, the good old days. This morning, it is almost as though Madame Lagarde never said a word, or perhaps said too many. Bond markets are selling off sharply, with 10-year Treasury yields higher by 7 basis points and above 1.60%, while European sovereigns are weaker across the board, led by UK gilts (+5.4bps), but with most continental bonds showing yield gains of 2.0-3.0 basis points. So, what happened to all the goodwill from yesterday?
Perhaps that goodwill has fled from fears of rising inflation after President Biden (sort of) laid out his plan for vaccinating the entire nation by May and reopening the economy by summer. Many analysts have pointed to the massive increase in savings and combined that with the newest stimulus checks to come (as soon as this weekend according to Treasury Secretary Yellen) and forecast a huge spending surge, significant economic growth and rising inflation. After all, the Atlanta Fed’s GDPNow forecast is at 8.35%, which while slightly lower than a few weeks ago, is still an extremely rapid pace for the US economy. This pundit, however, questions whether or not that spending surge will materialize. Historically, after a deeply shocking financial event like we have just experienced, behaviors tend to change, with the most common being a tendency to maintain a higher savings ratio. As such, expectations for a massive consumer boom may be a bit optimistic.
Or, perhaps the goodwill has disappeared after further crackdowns by Chinese authorities on its most successful companies, with TenCent now under the gun, receiving fines and being reined in following their efforts to crush Ant Financial. The Hang Seng certainly felt it, falling 2.2% overnight, although Shanghai (+0.5%) and the Nikkei (+1.7%) were still euphoric from yesterday’s US equity rally. Rapidly rising Brazilian inflation (5.2% vs. 3.0% target) could be the cause, as concerns now increase that the central bank, when it meets next week, will be raising rates 0.50% to battle that, despite the economic weakness and ongoing Covid related stresses.
There is, however, one other potential cause of the bond market’s poor performance, which I believe is leading to the general risk-off attitude; but it is a sort of inside baseball issue. The Supplementary Leverage Ratio (SLR) is part of bank regulation that was designed to insure banks would remain stable during hard times and not need to be bailed out, a la 2008. However, during the initial stresses of the Covid crisis, the Fed suspended the need for banks to count Treasury securities and bank reserves as part of that ratio, thus allowing banks to hold more of those assets on their books while remaining within the regulations. But this exemption is due to expire on March 31, which means banks either need a LOT more equity capital, or they need to shrink their balance sheet by selling off those excess Treasuries. And, of course, selling Treasuries is much easier and exactly what we have seen in the past two weeks. If the Fed does not give further guidance on this issue, and lets it expire, bonds probably have further to fall. Ironically, that doesn’t seem to fit with what the Fed really wants to happen, as the higher yields would result in tighter financial conditions, especially if equity markets sold off in sync. So, my guess is the Fed blinks and rolls the exemption over for at least 6 months, but until we know, look for bouts of selling in bonds and all the ensuing market reactions that come with that.
Just like today’s, where European markets are lower (DAX -0.6%, CAC -0.1%, FTSE 100 -0.1%) although in the latter two cases not by much and US futures are also lower, especially the tech laden NASDAQ (-1.4%) although also SPX (-0.4%).
Commodity prices are also under a bit of pressure with oil (-0.25%) slipping a bit as well as precious (gold -1.0%) and base (copper -1.25%) metals. In fact, today is also seeing weakness throughout the agricultural sector, with declines of the 0.75%-1.75% range across the board.
And what of the dollar, you ask? Stronger across the board, with yesterday’s leading gainers showing the way lower today. NZD (-0.75%), SEK (-0.7%) and CHF (-0.7%) are in the worst shape, but in truth, the entire G10 is under pretty significant pressure with only CAD (-0.15%) showing any signs of holding up as Canadian government bond yields rise right along with US yields.
Emerging market currencies are also under significant pressure this morning, led by TRY (-1.5%) but seeing MXN (-1.3%) and ZAR (-1.0%) also suffering greatly. In fact, all of LATAM and the CE4 are under significant pressure today but then all of them had seen substantial strength yesterday. In fact, the two-day movement in many of these currencies is virtually nil. Their futures will depend on a combination of the ongoing evolution of US interest rates and their unique domestic situation. If rising inflation is ignored in order to support these economies, look for much further weakness in that nation’s currency. In other words, there is every chance that the dollar gains strength broadly against this bloc in the next several months.
On the data front, today brings PPI (exp 2.7%, 2.6% core) and Michigan Sentiment (78.5). Certainly, that PPI data looks like inflation is in the pipeline, but the relationship between PPI and CPI is not nearly as strong as you might think, with just a 0.079% correlation over the past 5 years, although it does have a stronger relationship to core PCE (0.228%). But if history is any guide, the market will not be flustered by any print at all.
So, today is shaping up as risk-off with both bonds and stocks selling and no commentary from the Fed coming. Just like yesterday’s risk appetite fed stronger currencies, it appears the opposite is true today. I don’t expect to see substantial further gains, but a modest continuation of the dollar rally does feel like it is in the cards.
Good luck, good weekend and stay safe
Adf
On Edge
Two fears have the market on edge
Inflation that many allege
Will drive bond yields higher
Thus, causing a dire
Result, pushing stocks off the ledge
But right now, the bulls rule the roost
As inflation has not been produced
So, Jay and Christine
Have no need to wean
The market from QE’s large boost
Yesterday morning’s CPI release was a touch softer than expected, thus helping to abate fears of the much-mooted inflationary surge arriving soon. (PS, it is clear that starting next month the CPI data will be much higher, given the year over year comps, with the key question being will that continue through the summer and beyond.) In the meantime, bond investors, who had clearly been concerned over the rising inflation story, relaxed a bit and bought more Treasuries. The result was that the early morning rise in yields was unwound. Of course, the other big news yesterday was the 10-year Treasury auction which was received by the market with general aplomb. While there was a 1 basis point tail, the bid-to-cover ratio at 2.37 was right in line with recent averages. One little hiccup, though, was indirect bidders (usually foreign governments) continued their declining participation, falling to 56.8%, with the implication that natural demand for Treasuries is truly sinking. This latter point is critical because, given the amount of new money the Treasury will need to borrow this year and going forward, it will increase pressure on the Fed to absorb more (i.e. increase QE), or yields will definitely climb.
However, that apparently, is a story for another day. Equity markets reveled in the low inflation print and modest bond market rally, while the dollar fell pretty much across the board, reversing all of its early gains.
Which brings us to this morning’s ECB meeting, where the question is not about a change in policy, as quite clearly no policy change is in the offing, but rather about the ECB’s utilization and reaction function of its current policy programs. While sovereign yields have stabilized for the past several sessions, the fact remains that they have not fallen back anywhere near the levels seen at the beginning of the year. The question market participants have is exactly what will constitute a tightening in financial conditions that might bring a response.
As mentioned yesterday, the ECB has been consistently underutilizing the PEPP compared to recent months, with weekly purchases falling to a net €12 billion despite the rise in yields. So, it would seem that the ECB does not believe the current yield framework is a hindrance to the economy. However, you can be sure that Madame Lagarde will field several questions on the topic at this morning’s press conference as market participants try to determine the ECB’s pain threshold. The last we heard on the topic was that they were carefully watching the market with some of the more dovish members calling for a more active stance to prevent a further climb in yields.
And remember, the ECB is not only focused on sovereign yields, but on the exchange rate as well, which is also officially a key indicator. With the US inflation story getting beaten back, and US yields slipping, the euro’s concomitant rise will not be welcome. Now, we remain well below the early January highs in the single currency, but if the euro has bottomed, and more importantly starts that long-term rise that is so widely expected, the ECB will find themselves in yet another sticky situation. These, however, are stories for a future date, as today the euro is firmly in the middle of recent ranges while sovereign yields are slipping a bit.
With two potential landmines behind us, risk appetite has been reawakened, with asset purchases across virtually all classes. For instance, overnight saw equity market strength across the board (Nikkei +0.6%, Hang Seng +1.65%, Shanghai +2.4%) although Europe’s early gains have mostly diminished and markets are little changed ahead of the ECB (DAX -0.1%, CAC +0.1%, FTSE 100 -0.35%). US futures, though, are largely booming, led by the NASDAQ (+1.9%) but seeing solid gains in the other indices as well.
On the bond front, Treasury yields are lower by 1.9 basis points, back to 1.50%, while we are seeing more modest declines in the major European bond markets, on the order of 0.5bps for all of them.
Oil prices are firmly higher (WTI +1.2%) as is the entire energy complex. Metals prices, too, are rising with both precious and base seeing a resumption of demand. Meanwhile agricultural prices are generally moving up in sync. Once again, to the extent that commodity price rises are a harbinger of future inflation, the signs are clearly pointing in that direction.
The dollar, meanwhile, which reversed yesterday’s early gains to close lower across the board, has continued in that direction with further losses this morning. CHF (+0.5%) leads the way in the G10, which given the fact it had been the biggest loser over the past month, falling more than 5.6%, should be no surprise. But the rest of the bloc is seeing gains in the commodity focused currencies with AUD (+0.45%), NZD (+0.4%) and CAD (+0.3%) next in line. Perhaps the biggest surprise is that NOK (0.0%) is not along for the ride.
EMG currencies are also broadly firmer led by BRL (+1.6%) which is following on yesterday’s 2.5% rally as the central bank has been actively intervening to stem the real’s recent weakness. Concerns remain over rising inflation, and expectations for rising policy rates are growing there, which would likely support the currency even more. But we are seeing strength in ZAR (+1.0%), CLP (+1.0%) and MXN (+0.65%) as well, clearly all benefitting from the commodity story. However, virtually the entire bloc is firmer given today’s increasing risk-on attitude.
Aside from the ECB meeting, with the statement published at 7:45 and the press conference at 8:30, we see Initial Claims (exp 725K), Continuing Claims (4.2M) and the JOLTs Job Openings survey (6.7M). Again, no Fed speakers so look for the dollar to follow risk attitude and the movement in real yields. Those are both pointing toward a lower dollar as the day progresses, and I see no reason to fight that absent comments from a surprising source. Unless Madame Lagarde fumbles the press conference, look for this little risk bounce to continue.
Good luck and stay safe
Adf
Powell’s Dismay
The ECB’s Christine Lagarde
Is finding that markets are hard
As bond yields keep climbing
She needs more pump priming
Or Europe will truly be scarred
Meanwhile in the US today
The 10-year sale gets underway
A sloppy result
Just might catapult
More QE, to Powell’s dismay
Markets have had a relatively uneventful evening as participants await some important new information. The first clue will come this afternoon when the results of the US 10-year bond auction are released. Remember, this interest rate is arguably the most important rate in the world, as it serves as the basis for trillions of dollars of debt in both the public and private sectors. And while the on-the-run 10-year bond is probably the single most liquid security in the world, its recent volatility belies that statement. In fact, this morning, ahead of the auction, we are seeing selling pressure with the yield rising 3.3 basis points to 1.56%, within spitting distance of its recent highs and up a pretty remarkable 65 basis points year-to-date.
The reason today’s auction of $38 billion is being so keenly watched is that two weeks ago, the 7-year note auction was flat out awful, with a long tail and low indirect interest. This means that there wasn’t really that much demand, especially from investors, as opposed to the primary dealers who are forced to bid. That auction served as the catalyst for the 15-basis point rise in the 10-year the last week of February. You may recall that coincided with a 100-point decline in the S&P 500 and commensurate declines in equity markets around the world.
And that is why this is seen as so critical. With the knowledge that the House is voting on the $1.9 trillion stimulus bill today, and it will certainly pass along a party-line vote, investors recognize that there is going to be a lot more issuance upcoming. After all, the government will need to borrow a lot of money to fund that stimulus. If this benchmark auction goes poorly, meaning it doesn’t generate substantial bidding interest outside the primary dealers, we could well be in for another sharp decline in equity markets as the bond market sells off further. Remember, too, the Fed is in its quiet period so will not be able to make comments in order to support the market.
Yesterday saw an impressive rebound by equity markets around the world after a serious bout of selling almost everywhere. A good result today is likely to help keep that going, but a poor auction will almost certainly show that yesterday was the proverbial “dead cat bounce.” And folks, if the auction goes poorly, look for the dollar to make new highs against pretty much every currency, especially emerging market counterparts., but the G10 too.
Which brings us to the ECB and Madame Lagarde. Today is the first day of the ECB’s March meeting and the market is putting pressure on them as well. As Treasury yields have climbed, so too have European government bond yields, with, for instance, 10-year bund yields 30 basis points higher on the year, albeit still firmly in negative territory at -0.30%. But the question being raised is why the ECB hasn’t been more active with its PEPP program during this yield rally. After all, we have heard from a number of different ECB members that they are closely monitoring sovereign yields and they explicitly told us that was a key benchmark for them. And yet, their net purchases through the PEPP have declined during the past several weeks to €14.8 billion a week, down from the more than €18 billion they had been purchasing previously. So, clearly, they have the capacity to do more. Why then haven’t they been more active? At this point, nobody really knows, and you can be certain that at tomorrow’s press conference it will be a hot topic.
Of course, it may be that they want to leave themselves extra ammunition in the event the Treasury auction goes poorly and there is another bond market rout. But that is a far more cynical stance than I would attribute to any central bank. The risk for the ECB is that European sovereign yields begin to rise faster than Treasury yields both crimping economic support and simultaneously supporting the euro. And the one thing we know is the ECB wants a weaker euro, in fact they desperately need a weaker euro to help their exporting economies as well as to try to stoke their much-desired inflation. As Ricky Ricardo used to say, ‘Christine, you got some ‘splainin’ to do!’
So, as we await the results of the auction, let’s take a quick tour of the overnight price action. The best description of markets is mixed, with modest overall activity. In the equity space, the Hang Seng (+0.5%) led the way on the high side, while both the Nikkei and Shanghai were essentially flat on the session. Australia’s ASX 200, meanwhile, fell 0.8%. As I said, mixed. The story is no different in Europe with the CAC (+0.6%) the leader with the DAX (+0.3%) doing fine but the FTSE 100 (-0.2%) slipping back a bit. And so, it cannot be surprising that US futures are behaving in the same manner, with NASDAQ (-0.3%) suffering while DOW (+0.25%) is slightly higher and SPX futures are little changed.
Other than the Treasury market, the yield picture is also mixed, with major European bond markets +/- 0.5bps or less. This looks like a market biding its time for the two big stories to come. Intrigue continues to build in Japan where the results of the BOJ’s review will be announced at their meeting next week and we have heard from Kuroda-san that there will be no change in the 10-year yield curve target while a key deputy, Amamiya-san, has left the door open to a widening of that 0.20% range around 0.0%.
In the commodity world oil (+0.5%) is firmer, but just looking at the products, that modest rally is not universal. Metals are mixed (that word keeps coming up) with copper and aluminum both higher while tin and zinc are lower. Precious metals are modestly softer as well after a huge rally yesterday.
And finally, the dollar is the one thing not really mixed, but rather broadly higher this morning. Against the G10, only NOK (0.0%) has managed to hold its own on the back of the oil rally, while CHF (-0.4%) and JPY (-0.3%) are both suffering on what appears to be their lagging interest rate performance. In the EMG bloc, TRY (+0.5%) is the only gainer of note, however, its movement appears to be positioning related rather than fundamental. On the downside, there is a broad range of weaker currencies across all three main geographies, although none is weaker by more than 0.3%. Again, it appears that traders are biding their time for news.
On the data front, today is CPI day with expectations for a 0.4% M/M (1.7% Y/Y) headline rise and a 0.2% M/M (1.4% Y/Y) ex food & energy print. Based on the past 9 months, I would expect the odds are for a beat on the high side as we have seen in 6 of those readings. And then it’s the auction. We remain in the Fed’s quiet period, so look for the dollar to meander this morning and take its cues from the auction like every other market starting at 1:00pm when the results are released. My money is on a less than stellar auction, higher yields, lower stocks and a stronger dollar. We shall see.
Good luck and stay safe
Adf
fxpoetry 