A Kettle of Hawks

There once was a kettle of hawks
Who regularly gave earnest talks
When prices would rise
They would then surmise
T’was time to forget Goldilocks

But now they’re a bevy of doves
The type every borrower loves
Who, if prices rose
Would never propose
That they would give rates, up, a shove

While today’s activity roster includes the Bank of England rate decision (no change) and QE target (possible change), I want to review yesterday’s Fedspeak as I believe it is crucial to continue our understanding of the policy evolution.

Three Fed regional presidents spoke; Chicago’s Mike Evans, a known dove; Boston’s Eric Rosengren, historically slightly more hawkish than centrist; and Cleveland’s Loretta Mester, historically one of the most hawkish Fed members.  All three made clear that they are unconcerned over the almost certain rise in inflation in the short-term, with all three convinced this is a ‘transitory’ phenomenon that will work itself out by the end of 2022.  Rosengren was particularly colorful in his description as he compared his view of general price increases upcoming to the situation right at the beginning of the pandemic shutdowns regarding toilet paper.  “My view is that this acceleration in the rate of price increases is likely to prove temporary,” he said.  He continued, “Toilet paper and Clorox were in short supply at the outset of the pandemic, but manufacturers eventually increased supply, and those items are no longer scarce.  Many of the factors raising prices this spring are also likely to be similarly short-lived.”

Now, I don’t know about you, but I would beg to differ with his assessment, specifically on the two items he mentioned, toilet paper and Clorox.  While there is no question that both items are readily available today as opposed to the situation twelve months ago, it is also very clear that the prices of both items have risen substantially.  In fact, my anecdotal evidence from the local Shop-Rite is that prices of these two items have risen at least 35% in the past twelve months, and there is no evidence that these prices are going to decline anytime soon.  After all, as a manufacturer, why would you reduce prices if customers are still buying your product?  So, while supply has improved, it has done so at the expense of higher prices.  In my book, this is the very definition of inflation.

Regarding the topic of tapering, Evans was dismissive of the idea at all and surprisingly, Mester showed no interest in the discussion in the near term.  Rosengren, however, did indicate that it was possible the situation by the end of this year could warrant a discussion, although he would sooner halt purchases of mortgage bonds than Treasuries as he mentioned the possibility that housing prices could get ‘frothy’.  Ya think?  A quick look at the recent Case Shiller House Price Index shows it has risen by nearly 12% in the past year nationwide, the fastest level since March 2006, right in the middle of the housing bubble whose bursting caused the GFC.  Perhaps this is what is meant by “frothy” in Chairman Powell’s eyes.

From London, the market’s awaiting
The Old Lady’s econ re-rating
While wondering if
She’ll offer a sniff
Of when QE might start abating

The UK’s post-pandemic growth trajectory has been far closer to the US than of the EU as PM Johnson’s government has done an excellent job of getting a large proportion of its population inoculated allowing for a reopening of the economy.  Recent data has been strong and as more restrictions are eased; prospects continue to be relatively bright.  Not dissimilar to the Fed’s situation, the Bank of England will find themselves raising their GDP growth forecasts while maintaining their ongoing monetary policy support.  Or will they?  There is talk in the market that the BOE may well discuss the initial timing of tapering purchases while they upgrade their forecasts.  Precedent was set last week when the Bank of Canada did just that, not merely discussing tapering, but actually cutting the amount of purchases by 25%.  Will the BOE follow suit?

Analyst expectations are that they will not change policy at all and explain it in the same manner as the Fed, that while inflation in the near-term may rise above their 2.0% target, this will be a temporary phenomenon and is no cause for concern.  However, any hint that tapering may be coming sooner than the current program’s target end date later this year is likely to be quite supportive of the pound, so keep that in mind.  That said, ahead of the meeting, the pound is essentially unchanged on the day at 1.3900.

Stronger growth forecasts, as well as strong earnings numbers, continue to support equity markets, although while they are not falling, rallies have been modest at best.  In fact, there is growing concern that the tech sector, which has clearly been the leader in the post pandemic equity rally, is starting to falter more seriously.  Last night saw gains in the Nikkei (+1.8%) and Hang Seng (+0.8%) but a modest decline in Shanghai (-0.2%) on its return from Golden Week.  Europe, despite strong German Factory Orders (+3.0%) and Eurozone Retail Sales (+2.7%) has been unable to make any real headway (DAX 0.0%, CAC 0.0%, FTSE 100 +0.2%).  US futures are similarly lackluster, with all three major indices higher by 0.1% at this hour.  Could it be that economic and earnings strength is fully priced in at these levels?

**BOE leaves policy unchanged, as expected**

Bond markets, on the other hand, are holding their own overall.  While Treasury yields are unchanged on the day, they slid 2.5bps yesterday and are now closer to their recent lows than highs.  In Europe, sovereigns are showing the smallest of rallies with yields in both Bunds and OATs lower by 0.5bps while Gilt yields are unchanged.  At this point, it appears that bond traders and investors are starting to believe the central banks regarding the idea of transitory inflation.  While that would be a wonderful outcome, I fear that there is far more permanent inflation scenario unfolding.

Commodity prices are mixed this morning with oil (-0.75%) soft but metals, both base and precious firmer.  In fact, iron ore has reached record high levels, rising 6.5% this week, and approaching $200/ton.  Again, rising input prices are not disappearing.

As to the dollar, it is generally softer this morning, albeit not substantially so.  In the G10, CHF (+0.4%) is the leading gainer but the European currencies are all solidly higher, between 0.2% and 0.3%, although the pound’s move occurred just since the BOE announcement.  However, commodity currencies have underperformed here and are little changed on the day.

In the emerging markets, THB (-0.45%) was the laggard after the central bank left rates on hold amid a surge in reported Covid infections.  KRW (-0.25%) was next worst as there were a surprisingly large amount of equity outflows from the KOSPI.  On the positive side, IDR (+0.8%) was the biggest mover as Indonesia saw significant equity inflows as well as increased interest in the carry trade.  ZAR (+0.7%) is benefitting from the rise in gold (+0.25%) as well as the metals complex generally.  Otherwise, while gains have been broad-based, they have been shallow.

This morning’s data brings Initial Claims (exp 538K), Continuing Claims (3.62M), Nonfarm Productivity (4.3%) and Unit Labor Costs (-1.0%).  However, all eyes are turned to tomorrow’s NFP report, which despite a slightly softer than expected ADP Employment number yesterday (742K, exp 850K), has seen the forecast rise to essentially 1.0 million.

Treasury bond yields have lost their mojo for now and have been able to ignore any signs of imminent inflation.  It seems that the Fed chorus of transitory inflation is having the desired impact and preventing yields from running away higher.  As long as Treasury yields remain under control, especially if they drift lower, then the dollar will remain under modest pressure.  So far, nothing has occurred to change that equation.

Good luck and stay safe
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The Feathers of Hawks

It seems like the feathers of hawks
Turn whiter when each of them talks
On Monday, Loretta
Said policy betta
Stay easy for pumping up stocks

For those of you not familiar with a word ladder, it is a type of puzzle where you start with a word, Hawk, for example, and change one letter in each step, while maintaining the order of the letters, to form another word and keep doing so until you arrive at the desired second word.  The object is to complete this task in as few moves as possible.  In this way, this morning’s task is to use a word ladder to turn hawk into dove (one possible answer below).

Once upon a time, in the economic community, there were two schools of thought as to how monetary policy would best serve a nation.  There were hawks, who believed that Ludwig von Mises and Friedrich Hayek had identified the most effective way for central banks to behave; namely minimalist activity and allowing the markets to work.  The consequences of this policy view were that economic cycles would exist but would be moderated naturally rather than allowing bubbles to inflate and interest rates would be set by the intersection of supply and demand.  On the other side of the debate were the doves, whose hero was John Maynard Keynes (although Stephanie Kelton of MMT fame is quickly rising up the ranks) and who believed that an activist central bank was the most effective.  This meant constant monetary interventions to support demand, alongside fiscal interventions to support more demand.  As to the consequences of this policy, like unsustainable debt loads, or rising inflation, they were seen as ephemeral and unimportant.

But that was soooo long ago, at least a full year.  In the interim, Covid-19 appeared as a deadly and virulent disease. While we have learned that it is particularly dangerous for the elderly and for those with comorbidities, there is also another group which has basically been made extinct, monetary hawks in public policy positions.  For the longest time, the two most hawkish members of the FOMC were Kansas City’s Esther George and Cleveland’s Loretta Mester.  However, at the very least, Ms. Mester has now shown that she coos like a dove as per her comments yesterday about US monetary policy, “We’re going to be accommodative for a very long time because the economy just needs it to get back on its feet.

The global central bank community is all-in on the idea that ZIRP, NIRP and QE are the new normal, and as long as equity markets around the world continue to rally, they are not going to change their views.  In a related note, the BOJ is in the midst of continuing its policy review and the question of how they should describe their ETF purchases has come up.  It seems that while a number of board members would like to pare back the purchases, they are unwilling to explain that for fear the market would misinterpret their adjustments as a policy change and the result would be a sharp equity market sell-off.  And we know that cannot be tolerated!

The point is, no matter which central bank you consider, they have all reached the point where their previous actions have resulted in fragile markets and they appear to have lost the ability to change policy.  In other words, there is no end in sight to easy money, inflation be damned.

Which, of course, is exactly what we saw yesterday in markets, as equities rallied in the US, with all three major indices closing at new all-time highs.  Asian markets mostly followed through with the Nikkei (+0.4%), Hang Seng (+0.5%) and Shanghai (+2.0%) all nicely firmer, although Australia’s ASX (-0.9%) couldn’t find any love.  And perhaps, that is the story in Europe, as well, this morning, with various shades of red painting the screen.  The DAX (-0.5%) is the worst performer, with both the CAC (-0.1%) and FTSE 100 (-0.1%) more pink than red.  As to US futures, they find themselves in the unusual position of being negative at this hour, but only just, with all three indices looking at losses of between 0.1% and 0.2%.

Bond markets are clearly in more of a risk-off mood than a risk-on one, with Treasury yields lower by 2.2bps this morning and more than 4bps lower than the peak seen yesterday.  European markets have seen less movement, with yields in the major markets all down less than one basis point, hardly a strong signal, although notably, Italian 10-year yields, at 0.502%, have traded to a new historic low level.  Excitement over the prospect that Super Mario can fix Italy remains high.

On the commodity front, oil’s early gains have reversed, and it is now essentially flat on the day, although it remains within pennies of the highs set early this morning above $58/bbl.  Gold (+0.7%) is rebounding strongly, from the lows seen last Tuesday, with silver (+1.3%) even stronger.  Of course, all these non-fiat currency plays pale in comparison to Bitcoin (+17%) which exploded higher as the progenitor of one bubble (a certain EV maker in California) explained it bought $1.5 billion worth of Bitcoin for its Treasury reserves.

With this type of price action in commodities, as well as with the ongoing conversion of US monetary hawks into doves, it should not be surprising that the dollar is lower this morning, pretty much across the board.  In the G10 space, CHF and JPY are leading the way higher (+0.6% each) as investors seem to be running for havens not called the dollar.  But the euro (+0.45%) has also gained nicely and any thoughts that January’s price action was anything other than a short-term correction are now quickly fading away.  It will be interesting to see how the market responds to tomorrow’s CPI data, as that has the opportunity, if it prints higher than forecast, to alter views on real interest rates.  I have maintained that declining real yields will undermine the dollar, but I have to admit, I didn’t expect it to happen this early in the year.

EMG currencies are also firm this morning, led by ZAR (+0.6%) and RUB (+0.5%), on the back of commodity price rises, but with a pretty uniform strength throughout the CE4 and LATAM.  The one exception is BRL (-0.3%), the worst performing currency in the world this morning, as a lower than expected CPI print for January has traders shedding the belief that the central bank may be forced to raise rates any time soon.

On the data front, NFIB Small Business Optimism printed lower than last month and worse than expected at 95.0, not a good sign for the economy, but probably a boost for the view that more stimulus is coming.  At 10:00, we see JOLTs Job Openings (exp 6.4M), although that tends to be ignored.

The only Fed speaker today is St Louis’ Bullard, whose tendencies before Covid-19 were dovish, and he certainly hasn’t changed his views.  As such, and given that the market seems to have rejected the notion of a further USD correction higher, it looks like the dollar’s downtrend is getting set to resume.

Good luck and stay safe
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One possible answer:  I would love to see others
Hawk
Hark
Hare
Have
Hove
Dove

Much Could Be Gained

Today’s jobs report is the theme
About which most traders will scheme
If strong, bulls will buy
Just like last July
If weak, you can bet they’ll all scream

But yesterday there was some news
About a Fed President’s views
Ms. Mester explained
That much could be gained
If price hikes the Fed could perfuse

Yes folks, it’s payrolls day so let’s get that out of the way quickly. Here are the current consensus estimates as per Bloomberg:

Nonfarm Payrolls 145K (whisper 125K)
Private Payrolls 130K
Manufacturing Payrolls 3K
Unemployment Rate 3.7%
Average Hourly Earnings 0.2% (3.2% Y/Y)
Average Weekly Hours 34.4
Participation Rate 63.2%
Trade Balance -$54.5B

Census hiring explains the relatively wide gap between nonfarm and private payrolls, and it is important to understand that these numbers represent a downtick from the trends we have seen during the past several years. But it is also important to remember that a nonfarm number greater than 100K is deemed sufficient to prevent the Unemployment Rate from rising as population growth in the US slows. Given how poor the data has been this week, while official forecasts at most institutions haven’t fallen much, the trading community is definitely looking for a weaker number.

In the event the data is weak, I expect the dollar to decline as the market starts to price in more than a 25bp cut for the end of this month (currently an 85% probability), but I think the initial reaction to equities could be a rally as the reflex of lower rates leading to higher stock prices kicks in. Alas, for stock bulls, I fear the situation is starting to turn to the data is getting weak enough to indicate an imminent recession which will not be good for equity markets. Of course, a strong print should see both the stock market and the dollar rally, while Treasuries sell off. As an aside, 10-year Treasury yields have fallen 37 basis points since September 13! That is a huge move and a very good indicator of just how quickly sentiment has shifted regarding the Fed’s activity later this month.

But there was something else yesterday that I think was not widely noticed, yet I believe is of significant importance. Cleveland Fed President Loretta Mester, one of the two most hawkish members of the FOMC (KC’s Esther George is the other) spoke yesterday and said she thought, “adopting a band for the Fed’s inflation objective makes sense for communications reasons, as it allows some scope to run inflation a bit higher in the band during good times while allowing the target for price gains to be lower during downturns when interest rates are near zero.” This is hugely significant because if a Fed hawk is now comfortable allowing inflation to run above target, something that hawks specifically fight, it means that the FOMC is much more dovish than previously assumed. And that means that we are likely to head toward ZIRP much sooner than many had thought.

This is clearly an impediment to further dollar strength, as one of the pillars of the strong dollar view has been the idea that the FOMC would maintain relatively tighter monetary policy than other central banks. Of course, as we have already seen, other central banks are not sitting around, waiting for Godot, but acting aggressively already. For example, after the RBA cut rates last week, last night the Reserve Bank of India cut rates by 25bps while lowering GDP forecasts. As inflation remains modest in India, you can bet that there will be further cuts to come. The FX impact was on a day when the dollar lost ground against virtually all EMG counterparts, INR actually weakened by 0.15%.

Away from these stories, Brexit is still Brexit with Boris flitting around Europe trying to close the loop. Though not yet able to get a deal agreed in Brussels, he seemingly is having success at home in getting enough of Parliament to back him to get his deal passed. And that is important for the EU, because given the previous failure of Teresa May to get her deal passed, the EU is wary that anything to which they agree will still be voted down. But if Boris can show his deal will get enacted in the UK, it would be a powerful argument for the EU to blink.

And that’s really it folks. The dollar is generally softer this morning against both G10 and EMG currencies with KRW the biggest gainer (+0.8%) on excitement over prospects for the Fed to cut rates which encouraged profit taking after a two-week 2+% decline. But it’s all about payrolls this morning. We do hear from three more Fed speakers today, with Chairman Jay on the hustings in Washington this afternoon. That will give the market plenty of time to have absorbed the data.

For my money, I fear a much worse NFP number, something on the order of 50K. The data has been too weak to expect something much better in my view.

Good luck and good weekend
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No Magical Date

March 1st is no magical date
Said Trump, while investors fixate
On whether a deal
On trade will be sealed
By then, or if tariffs can wait

After a day where there was mercifully little discussion of the ongoing trade negotiations, they have come back to the fore. Yesterday, President Trump indicated that the March 1st deadline for a deal was now far more flexible than had previously been indicated. Based on the reports that there has been substantial progress made so far, it seems a foregone conclusion that tariffs will not be rising on March 2nd. However, key issues remain open, notably the question of forced technology transfer and IP theft. Of course, as the Chinese maintain that neither one of those things currently occur, it is difficult for them to accept a resolution and change their methods. On the flip side, both Trump and Xi really need a deal to remove a major economic concern as well as to demonstrate their ability to help their respective nations.

One of the things that appears to be on the agenda is a Chinese pledge to maintain a stable yuan going forward, rather than allowing the market to determine its value. Looking back, it is ironic that the IMF allowed the yuan to join the SDR in 2016 to begin with, given that it continues to lack a key characteristic for inclusion in the basket; the ability to be “freely usable” to make payments for international transactions. And while the PBOC had been alleging that they were slowly allowing more market influence on the currency in their efforts to internationalize it, the results of the trade talks seem certain to halt whatever progress has been made and likely reverse some portion of it. It should be no surprise that the yuan strengthened on the back of these reports with the currency rallying 0.8% since yesterday morning. If currency control is part of the deal, then my previous views that the renminbi will weaken this year need to be changed. Given the continued presence of financial controls in China, if they choose to maintain a strong CNY, they will be able to do so, regardless of what happens in the rest of the world.

Meanwhile, away from the trade saga, the ongoing central bank activities remain the top story for markets. This has been made clear by comments from several central bankers in the past 24 hours. First, we heard from Cleveland Fed President Mester who, unlike the rest of the speakers lately, indicated that she expects rates to be higher by the end of the year. her view is that 3.00% is the neutral rate and that while waiting right now makes sense, the growth trajectory she expects will require still higher rates. However, while the FX market paid her some attention, it is not clear that the equity market did. Two things to note are that she is likely the most hawkish member of the Fed to begin with, and she is not a voting member this year, so will not be able to express her views directly.

Remember, too, that at 2:00 this afternoon, the FOMC Minutes of the January meeting will be released. Market participants and analysts are all very interested to see the nature of the conversation that led to the remarkable reversal from ‘further rate hikes are likely, to ‘patience is appropriate for now’ all while economic data remained largely unchanged. Until that release, most traders will be reluctant to add to any positions and movement is likely to be muted.

Across the pond, ECB Member Peter Praet continues to discuss the prospect of rolling over TLTRO’s which begin coming due in June of next year. Remember, one of the key issues for the Eurozone banks who availed themselves of this funding is that once the maturities fall below one year, it ceases to be considered long term funding and impacts bank capital ratios. Banks will then either have to call in loans that were made on the basis of this funding, or raise loan interest rates, or see their profits reduced as they pay more for their capital. None of these situations will help Eurozone growth. So, despite claims that banks must stand on their own, and TLTRO’s will only be rolled over if there is a monetary policy case to be made, the reality is that it is quite clear the ECB will roll these loans over. If they don’t, it will require the restarting of asset purchases or some other easing measure.

Once again, I will highlight that given the current growth and inflation trajectories in the Eurozone, there is a vanishingly small probability that the ECB will allow policy to get tighter than its current settings, and a pretty large probability that they will ease further. This will not help the euro regardless of the Fed’s actions. Yesterday saw the euro rally on the back of the updated trade story, but that has been stopped short as the market begins to accept the idea that the ECB is not going to tighten policy at all. Thus, this morning, the euro is unchanged.

The final story of note is, of course, Brexit, where the most recent word is that PM May is seeking to get a subtle change in the EU stance on the backstop plan thus allowing a new vote, this time with a chance of passing. The pro-Brexit concern is that the current form of the backstop will force the UK to be permanently attached to the EU’s trade regime with no say in the matter, exactly the opposite of what they voted for. May is meeting with EU President Juncker today, and it is quite possible that the EU is starting to feel the pressure of the ramifications of a no-deal Brexit and getting concerned. The Brexit outcome remains highly uncertain, but the FX implications remain the same; a Brexit deal will help the pound rally initially, while a no-deal Brexit will see a sharp decline in Sterling. Yesterday there was hope for the deal and the pound rallied. This morning, not so much as the pound has given back half the gain and is down 0.2% on the day.

Elsewhere, the dollar has been mixed with gainers and losers in both the G10 and the EMG blocs as everybody awaits the Minutes, which is the only data for the day. It is hard to believe there will be much movement ahead of them, and afterwards, it will depend on what they say.

Good luck
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