Tag Archives: #minutes

On the Brink

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Most pundits worldwide seem to think
The Fed is now right on the brink
Of both raising rates
And having debates
On how soon the BS should shrink

And so, today’s Minutes are key
To see if the FOMC
Has made up its mind
That they’re now behind
The curve, and need hurry QT

I am old enough to remember the last time the Fed decided that they wanted to shrink their balance sheet and normalize policy, way back in 2018.  As I recall, when first mooted, then Fed Chair Janet Yellen (she of Treasury Secretary fame) described the process of the gradual reduction as ‘like watching paint dry.’  Who knew drying paint was so exciting!  Of course, she couldn’t bring herself to even start the process.  Ultimately, the combination of slowly raising the Fed Funds rate and simultaneously reducing the size of the balance sheet (which all occurred on Powell’s watch) led to a declining stock market throughout Q4 2018 with the largest Christmas Eve sell-off ever seen in stocks as the culmination of the events.  Two days later, Chairman Powell explained he was just kidding, and tighter monetary policy was a thing of the past.

But that was then.  It’s different this time!

Actually, it’s not.  In fact, what we have learned from observing markets for many years is that it is never different.  While the catalysts may change, market responses remain pretty much the same time and again.  So, here we are three years later with the Fed’s balance sheet having more than doubled in the intervening period, equity markets having made 70 record highs in the past twelve months and the 10-year bond yielding half what it was back then. Inflation is raging, as opposed to the situation back then, and GDP, while higher than back then, has clearly peaked and is reversing some of the pandemic-induced policy giddiness.  But human nature is still the same.  Greed and fear remain the constants and investor and trader responses to policy decisions are pretty cut and dried.  You can be confident that if longer date interest rates rise, whether in a steepening or flattening yield curve, the rationale for the mega cap stocks to maintain their value is going to diminish quickly.  And as they are the ‘generals’ of the equity market rally, when they start to fall, so will everything else, including the indices.  Ask yourself how long the Fed, whose members are virtually all multi-millionaires and hold large equity portfolios, are going to sit by and allow the stock market to correct just because some Austrian school monetary hawks believe in sound money.  Exactly.

However, we have not yet reached the point where the markets have started to decline substantially, as, of course, the Fed has not yet started to even raise interest rates, let alone shrink the balance sheet.  But that is the growing consensus view amongst the punditry, that today’s FOMC Minutes from the December meeting are going to reveal the level of interest to begin that part of policy normalization.  Many analysts continue to highlight the fact that inflation is becoming such a problem that the Fed will be forced to stay the course this time.  I wish it were so, but strongly believe that history has shown they will not.  Rather, they will change the inflation calculations and continue to explain that the alternative is worse.

Yesterday, Minneapolis Fed President Neel Kashkari, the most dovish of all FOMC members, explained that he believes the Fed Funds rate needs to rise 0.50% this year as, “…inflation has been higher and more persistent than I had expected.”   It is comments such as this that have the analyst community convinced the Fed is really going to tighten this time.  But we have heard these before as well.  This is not to say that the Minutes won’t hint at QT, they very well could do so.  However, when the rubber meets the road and risk assets are falling sharply in price, the Fed will exhibit its underlying Blepharospasm, and tighter policy will be a thing of the past (as will a stronger dollar!)

Now, leading up to the Minutes, let’s take a look at what happened last night.  In the wake of a bit of equity market schizophrenia in the US, we have seen a mixed picture.  Yesterday saw the NASDAQ fall sharply (there’s that concern over higher rates) while the Dow managed to rally.  Overnight saw the Nikkei (+0.1%) bide its time but the Hang Seng (-1.6%) and Shangahi (-1.0%) both suffer on a combination of the ongoing property sector problems as well as more lockdowns in country.  Europe, on the other hand, has managed to stay in the green (DAX +0.6%, CAC +0.5%, FTSE 100 +0.2%) after PMI Services data was released a little bit softer than forecast, but still seen as quite positive.  In a way, this was a ‘bad news is good’ idea as softening growth means the ECB doesn’t need to respond to Europe’s very high inflation readings so dramatically.  Alas, US futures are flat except for NASDAQ futures, which are lower by -0.4%.

In the bond market, while yesterday saw an early sell off in Treasuries, it was mostly unwound by the end of the day and this morning yields are little changed at 1.645%.  As to Europe, yesterday also saw Gilt yields rally sharply, 12.5 bps, but they have consolidated today, falling 1bp while the rest of the continent has seen much less movement.  Clearly, there is far less concern over ECB activity than either Fed or BOE.

As to the commodity space, oil (+0.3%) is edging higher and NatGas (+2.3%) is firming on the cold weather in the Northeast.  (Of course, compared to what happened in Kazakhastan, where the government was kicked out by the president because of high energy prices, this seems rather tame!)  Metals prices are mixed with gold (+0.2%) still hanging around $1800, while copper (-0.6%) is clearly less enamored of the current economic situation.

Finally, the dollar is under modest pressure this morning, with SEK (+0.5%) the leading G10 gainer after printing the strongest PMI data around, while JPY (+0.4%) has simply rebounded from its very sharp decline yesterday, although it remains in a very clear downtrend for now.  the rest of the G10 is modestly firmer vs. the dollar at this hour, but nothing to write home about.

In the EMG space, ZAR (+0.9%) is the leader, also seeming to benefit on the back of last week’s liquidity induced decline and seeing a rebound.  We are also seeing strength in PHP (+0.7%) and CZK (+0.6%) with the latter benefitting from expectations for further rate hikes while the former benefitted from a much lower than expected CPI print of just 3.6%.  Meanwhile, on the downside, IDR (-0.4%) was the worst performer as the infection rate rose sharply and KRW (-0.25%) fell after North Korea launched another ballistic missile and rejected further talks with the US.

On the data front, ADP Employment (exp 410K) leads this morning and then the Minutes are released at 2:00pm.  Aside from the Minutes, there are no speakers scheduled, so the dollar will need to take its cues from other markets.  Keep an eye on the 10-year as a continued rally in yields should see further dollar strength.

Good luck and stay safe
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Somewhat Misleading

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The latest inflation’ry reading
Showed price rises kept on proceeding
But bond markets jumped
While dollars were dumped
This movement seems somewhat misleading

The two market drivers yesterday were exactly as expected, the CPI report and the FOMC Minutes.  The funny thing is it appears the market’s response to the information was contrary to what would have been expected heading into the session.

Starting with CPI, by now you are all aware that it continues to run at a much hotter pace than the Fed’s average 2.0% target.  Yesterday’s results showed the M/M headline number was a tick higher than forecast at 0.4%, as was the 5.4% Y/Y number.  Ex food & energy, the results were right on expectations at 4.0%, but that is cold comfort.  Here’s a bit of bad news though, going forward for the next 5 months, the monthly comps are extremely low, so the base effects (you remember those from last year, right?) are telling us that CPI is going to go up from here.  Headline CPI is almost certain to remain above 5.0% through at least Q1 22 and I fear beyond, especially if energy prices continue to rise.  The Social Security Administration announced that benefits would be increased by 5.9% next year, the largest increase in 20 years, but so too will FICA taxes increase accordingly.

The initial market movement on the release was perfectly logical with the dollar bouncing off its lows while Treasury yields backed up.  Given the current correlation between those two, things made sense.  However, that price action was relatively short-lived and as the morning progressed into the afternoon, the dollar started to slip along with yields.  Thus, leading up to the Minutes’ release, the situation had already turned in an unusual direction.

The Minutes explained, come November,
Or possibly late as December
The time will have come
Where QE’s full sum
Ought fade like a lingering ember

The Minutes then confirmed what many in the market had expected which was that the taper is on, and that starting in either mid-November or mid-December the Fed would be reducing its monthly asset purchases by $15 billion ($10 billion less Treasuries, $5 billion less mortgages).  This timeline will end their QE program in the middle of next year and would then open the way for the Fed to begin to raise rates if they deemed it necessary.

Oddly enough, the bond rally really took on legs after the Minutes and the dollar extended its losses.  So, while the correlation remains intact, the direction is confusing, at least to this author.  Losing the only price insensitive bond buyer while the government has so much debt to issue did not seem a recipe for higher bond prices and lower yields.  Yet here we are.  The best explanation I can offer is that investors have assessed that less QE will result in slowing growth and reduced inflationary pressures, so much so that there is the beginning of talk about a recession in the US early next year.  Alas, while I definitely understand the case for slowing growth, and have been highlighting the Atlanta Fed’s GDPNow trajectory lower, there is nothing about the situation that I believe will result in lower inflation, at least not for quite a while yet.  Thus, a bond market rally continues to seem at odds with the likely future outcome.

Of course, there is one other possible explanation for this behavior.  What if, and humor me here for a moment, the Fed doesn’t actually follow through with a full tapering because equity prices start to fall sharply?  After all, I am not the only one to have noticed that the Fed’s reaction function seems to be entirely based on the level of the S&P 500.  Simply look back to the last time the Fed was trying to remove policy accommodation in 2018.  You may recall the gradual reduction in the size of their balance sheet as they allowed bonds to mature without replacing them while simultaneously, they were gradually raising the Fed funds rate.  However, by Christmas 2018, when the equity market had fallen 20% from its highs, Chairman Powell pivoted from tightening to easing policy thus driving a reversal higher in stocks.  Do you honestly believe that a man with a >$100 million portfolio is going to implement and maintain a policy that will make him poorer?  I don’t!  Hence, I remain of the belief that if they actually do start to taper, still not a given in my mind, it won’t last very long.  But for now, the bond market approves.

Thus, with visions of inflation dancing in our heads, let’s look at this morning’s market activity.  Equity markets are clearly of the opinion that everything is under control, except perhaps in China, as we saw the Nikkei (+1.5%) put in a strong performance and strength throughout most of Asia.  However, the Hang Seng (-1.4%) and Shanghai (-0.1%) were a bit less frothy.  Europe, though, is all in on good news with the DAX (+0.8%), CAC (+0.9%) and FTSE 100 (+0.7%) having very positive sessions.  This has carried over into the US futures market where all three major indices are higher by at least 0.6% this morning.

Bonds, meanwhile, are having a good day as well, with Treasury yields sliding 0.7bps after a nearly 5bp decline yesterday.  In Europe, given those markets were closed during much of the US bond rally, we are seeing a catch-up of sorts with Bunds (-3.7bps), OATs (-3.1bps) and Gilts (-1.6bps) all trading well as are the rest of Europe’s sovereign markets.

On the commodity front, pretty much everything is higher as oil (+1.25%), NatGas (+2.1%) and Uranium (+21.7%!) lead the energy space higher.  Metals, too, are climbing with gold (+0.4%), copper (+0.7%) and aluminum (+3.4%) all quite firm this morning.  Not to worry, your food is going up in price as well as all the major agricultural products are seeing price rises.

As to the dollar, it is almost universally lower this morning with only two currencies down on the day, TRY (-0.9%) and JPY (-0.15%).  The former is suffering as President Erdogan fired three more central bankers who refuse to cut interest rates as inflation soars in the country and the market concern grows that Turkey will soon be Argentina.  The yen, on the other hand, seems to be feeling the pressure from ongoing sales by Japanese investors as they seek to buy Treasury bonds with much higher yields than JGBs.  However, away from those two, the dollar is under solid pressure against G10 (SEK +0.9%, NOK +0.8%, CAD +0.55%) and EMG (THB +0.7%, IDR +0.7%, KRW +0.6%).  Broadly speaking, the story is much more about the dollar than about any of these particular currencies although commodity strength is obviously driving some of the movement as is positive news in Asia on the Covid front where some nations (Thailand, Indonesia) are easing restrictions on travel.

On the data front, this morning brings the weekly Initial (exp 320K) and Continuing (2.67M) Claims numbers as well as PPI (8.7%, 7.1% ex food & energy).  PPI tends to have less impact when it is released after CPI, so it seems unlikely, unless it is a big miss, to matter that much.  However, it is worth noting that Chinese PPI (10.7%) printed at its highest level since records began in 1995 while Korean import and export prices both rose to levels not seen since the Asian financial crisis in 1998.  The point is there is upward price pressure everywhere in the world and more of it is coming to a store near you.

We hear from six more Fed speakers today, but it would be quite surprising to have any change in message at this point.  To recap the message, inflation is proving a bit stickier than they originally thought but will still fade next year, they will never allow stock prices to fall, inflation expectations remain anchored and tapering will begin shortly.

While I still see more reasons for the dollar to rally than decline, I believe it will remain linked to Treasury yields, so if those decline, look for the dollar to follow and vice versa.

Good luck and stay safe
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To Taper’s Ordained

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The Minutes on Wednesday explained
That QE would still be sustained
But ere this year ends
Some felt that the trends
Implied that, to taper’s, ordained

But ask yourself this, my good friends
What happens if tapering sends
The stock market down
Will they turn around
And restart QE as amends?

Remember all the times the Fed tried to tell the world that their current policy stance, notably the massive amount of QE purchases, were not the driving force in the equity market?  Stock market bulls played along with this as well, explaining that historically high valuation measures were all appropriate given the huge corporate profit margins, and had nothing to do with the Fed’s suppression of interest rates along the entire yield curve.  The bulls would point to 30-year interest rates below 2.00% and explain that when you discounted future cash flows at such low levels, it was only natural that stock valuations were high.  The fact that it was the Fed that was simultaneously buying up all the net Treasury issuance, and then some, thus driving rates artificially lower, as well as promising to do so for the foreseeable future was seen as a minor detail.

Perhaps that detail was not as minor as the bulls would have you believe!  Yesterday, the FOMC Minutes were released and the part that garnered all the attention was the discussion on the current asset purchase framework and how it might change in the future.

“Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met. At the same time, most participants remarked that this standard had been achieved with respect to the price- stability goal. (my emphasis) A few participants noted, however, that the transitory nature of this year’s rise in inflation, as well as the recent declines in longer-term yields and in market-based measures of inflation compensation, cast doubt on the degree of progress that had been made toward the price-stability goal since December.”

So, it seems they are in sync on the fact that the employment situation has room to run, and they don’t want to act too early because of that.  But what I find more interesting is that they can use the term ‘price stability’ when discussing inflation running in the 4.0%-5.0% range.  As well, it is apparent that many of the committee members are drinking their own Kool-Aid on the transitory story.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year because they saw the Committee’s “substantial further progress” criterion as satisfied with respect to the price-stability goal and as close to being satisfied with respect to the maximum employment goal. Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year because they saw prevailing conditions in the labor market as not being close to meeting the Committee’s “substantial further progress” standard or because of uncertainty about the degree of progress toward the price-stability goal.” (my emphasis)

But this was the money line, the clear talk that most of the committee expected tapering to begin before the end of the year.  While we have not yet heard any of the three key leaders (Powell, Williams and Brainerd) say they were ready to taper, it seems that most of the rest of the committee is on board.  Jackson Hole suddenly became much more interesting, because if Powell discusses tapering as likely to occur soon, it will be a done deal.  But if he doesn’t explain that tapering is coming soon, it is possible that we see four dissents, at the next meeting.  And how about this for a thought, what if those three are the only votes to stand pat, and the other six voting members want to start the taper?  That would truly be unprecedented and, I think, have major negative market ramifications.  I don’t expect that to occur, but after everything that has occurred over the past 18 months, I wouldn’t rule out anything anymore.

At any rate, the tapering talk remains topic number one in every market, and one cannot be surprised that the market’s reaction has been a clear risk-off response.  Equity markets around the world are lower, substantially so in Europe; bond markets are rallying as risk is jettisoned; commodity prices are falling, and the dollar is king!

So, let’s take a tour and see where things are.  Starting in Asia, we saw equities decline throughout the region with the Nikkei (-1.1%), Hang Seng (-2.1%) and Shanghai (-0.6%) all under pressure.  But the real pressure was felt in Korea (KOSPI -1.9%) and Taiwan (TAIEX -2.7%).  In fact, the only markets in the region to hold their own were in New Zealand.  Turning to Europe, it is a uniform decline with the DAX (-1.6%), CAC (-2.5%), and FTSE 100 (-2.0%) all falling sharply, with the lesser known indices also completely in the red.  I guess the prospect of less Fed largesse is not seen as a positive after all.  Meanwhile, ahead of this morning’s opening, US equity futures are all sharply lower, on the order of 0.75%.

Turning to the bond market, the prospect of less Fed buying is having an interesting outcome, bonds are rallying.  Of course, this is because Treasuries remain the ultimate financial safe-haven trade and as investors flee risky assets, bonds are the natural response.  So, 10-year Treasury yields have fallen 3.5bps, and we are seeing yields decline in the European market as well, at least those countries that are deemed solvent.  So, Bunds (-1.4bps), OATs (-1.1bps) and Gilts (-3.4bps) are all seeing demand.  Yields for the PIGS, however, are unchanged to higher on the day.

Commodity prices are uniformly lower, except for gold, which is essentially unchanged on the day.  Oil (-3.7%) leads the way down, but we are seeing weakness in base metals (Cu -3.3%) as well as the Agricultural space (Wheat -1.5%, Soybeans -1.2%).

Finally, the dollar is on top of the world this morning, as investors are buying dollars to buy bonds, or so it seems.  In classic risk-off fashion, only the yen (+0.1%) has managed to hold its own vs. the dollar as the rest of the G10 bloc is weaker led by NOK (-0.95%) and AUD (-0.95%).  NZD (-0.7%) and CAD (-0.7%) are also suffering greatly given the commodity weakness story.  But do not ignore the euro (-0.15%) which while it hasn’t moved very far, has managed to finally trade below the key 1.1704 support level, and is set, in my view, to head much lower.

In the EMG space, ZAR (-1.3%) is the leading decliner, falling alongside the commodity complex.  KRW (-0.7%) has given back all of yesterday’s gains as equity outflows continue to dominate the market there, but we are seeing weakness across the board with most currencies falling between 0.3%-0.6% purely on the dollar’s overall strength.

On the data front, this morning brings the weekly Initial Claims (exp 364K) and Continuing Claims (2.8M) as well as Philly Fed (23.1) and Leading Indicators (+0.7%).  There’s no scheduled Fedspeak, but what else can they say after yesterday’s Minutes anyway?  If you recall, Monday’s Empire Mfg was quite weak, so I would not be surprised to see Philly follow suit.  In fact, I think the biggest problem the Fed is going to have is that the data is rolling over and looking like a slowing economy, despite high inflation.  If they keep seeing economic weakness, are they really going to taper into a weakening economy?  They may start, but I doubt they get two months in before they stop, especially if equities continue to revalue (fall).  As to the dollar, for now, I like its prospects and suspect that we are going to trade to levels not seen since June of last year.

Good luck and stay safe
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T’won’t be a Disaster

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The Minutes explained that the Fed

Continues, when looking ahead

To brush off inflation

And seek job creation

Though prices keep rising instead

Meanwhile, there’s a new policy






That came from Lagarde’s ECB





T’won’t be a disaster





If prices rise faster





So, nothing will stop more QE





There is no little irony in the fact that the one-two punch of the Fed and ECB reconfirming that ‘lower for longer’ remains the driving force behind central bank policy has resulted in a pretty solid risk-off session this morning.  After all, I thought ‘lower for longer’ was the driver of ongoing risk appetite.





However, that is the case, as yesterday the FOMC Minutes essentially confirmed that while there are two camps in the committee, the one that matters (Powell, Clarida, Williams and Brainerd) remain extremely dovish.  Inflation concerns are non-existent as the transitory story remains their default option, and although several members expressed they thought rates may need to rise sooner than their previous expectations, a larger group remains convinced that current policy is appropriate and necessary for them to achieve their goals of average 2% inflation and maximum employment.  Remember, they have yet to achieve the undefined ‘substantial further progress’ on the jobs front.  Funnily enough, it seems that despite 10 years of undershooting their inflation target, there are several members who believe that the past 3 months of overshooting has evened things out!  Ultimately, my take on the Minutes was that the market’s initial reaction to the meeting 3 weeks ago was misguided.  There is no hawkish tilt and QE remains the norm.  In fact, if you consider how recent data releases have pretty consistently disappointed vs. expectations, a case can be made that we have seen peak GDP growth and that we are rapidly heading back toward the recent trend levels or lower.  In that event, increased QE is more likely than tapering.





As to the ECB, the long-awaited results of their policy review will be released this morning and Madame Lagarde will regale us with her explanations of why they are adjusting policies.  It appears the first thing is a change in their inflation target to 2.0% from ‘below, but close to, 2.0%’.  In addition, they are to make clear that an overshoot of their target is not necessarily seen as a problem if it remains a short-term phenomenon.  Given that last month’s 2.0% reading was the first time they have achieved that milestone in nearly 3 years, there is certainly no indication that the ECB will be backing off their QE programs either.  As of June, the ECB balance sheet, at €7.9 trillion, has risen to 67.7% of Eurozone GDP.  This is far higher than the Fed’s 37.0% although well behind the BOJ’s 131.6% level.  Perhaps the ECB has the BOJ’s ratio in mind as a target!





Adding up the new policy information results in a situation where…nothing has changed.  Easy money remains the default option and, if anything, we are merely likely to hear that as central banks begin to try to tackle issues far outside their purview and capabilities (climate change and diversity to name but two) there is no end in sight for the current policy mix. [This is not to say that those issues are unimportant, just that central banks do not have the tools to address them.]





But here we are this morning, after the two major central bank players have reiterated their stance that no policy changes are imminent, or if anything, that current ultra-easy monetary policy is here to stay, and risk is getting tossed aside aggressively.





For instance, equity markets around the world have been under significant pressure.  Last night saw the Nikkei (-0.9%), Hang Seng (-2.9%) and Shanghai (-0.8%) all fall pretty substantially.  While the Japanese story appears linked to the latest government lockdowns imposed, the other two markets seem to be suffering from some of the recent actions by the PBOC and CCP, where they are cracking down on international equity listings as well as the ongoing crackdown on freedom in HK.  European bourses are uniformly awful this morning with the DAX (-1.7%) actually the best performer as we see the CAC (-2.25%) and FTSE 100 (-1.9%) sinking even further.  Even worse off are Italy (-2.7%) and Spain (-2.6%) as investors have weighed the new information and seemingly decided that all is not right with the world.  As there has been no new data to drive markets, this morning appears to be a negative vote on the Fed and ECB.  Just to be clear, US futures are down uniformly by 1.4% at this hour, so the risk-off attitude is global.





Turning to the bond market, it should be no surprise that with risk being jettisoned, bonds are in high demand.  Treasury yields have fallen 6.5bps this morning, taking the move since Friday to 21bps with the 10-year now yielding 1.25%, its lowest level since February.  Is this really a vote for transitory inflation?  Or is this a vote for assets with some perceived safety? My money is on the latter.  European sovereigns are also rallying with Bunds (-4.1bps), OATs (-2.7bps) and Gilts (-4.8bps) all putting in strong performances.  The laggards here this morning are the PIGS, where yields are barely changed.





In the commodity space, yesterday saw a massive reversal in oil prices, with the early morning 2% rally completely undone and WTI finishing lower by 1.7% on the day (3.6% from the peak).  This morning, we are lower by a further 0.4% as commodity traders are feeling the risk-off feelings as well.  Base metals, too, are weak (Cu -1.75%, Al -0.3%, Sn -0.4%) but gold (+0.7%) is looking quite good as real yields tumble.





As to the dollar, in the G10 space, commodity currencies are falling sharply (NZD -0.75%, AUD -0.7%, CAD -0.6%, NOK -0.6%) while havens are rallying (CHF +0.9%, JPY +0.8%).  The euro (+0.45%) is firmer as well, which given the remarkable slide in USD yields seems long overdue.





Emerging market currencies are seeing similar behavior with the commodity bloc (MXN -0.75%, RUB -0.5%) sliding along with a number of APAC currencies (THB -0.65%, KRW -0.6%, MYR -0.5%).  It seems that Covid is making a serious resurgence in Asia and that has been reflected in these currencies.  On the plus side, the CE4 are all firmer this morning as they simply track the euro’s performance on the day.





On the data front, our last numbers for the week come from Initial (exp 350K) and Continuing (3.35M) Claims at 8:30 this morning.  Arguably, these numbers should be amongst the most important given the Fed’s focus on the job situation.  However, given the broad risk off sentiment so far, I expect sentiment will dominate any data.  There are no further Fed speakers scheduled this week, which means that the FX markets are likely to take their cues from equities and bonds.  Perhaps the correlation between yields and the dollar will start to reassert itself, which means if the bond market rally continues, the dollar has further to decline, at least against more haven type currencies.  But if risk continues to be anathema to investors, I expect the EMG bloc to suffer more than the dollar.





Good luck and stay safe





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			Tapering Talk
		


				

			Posted on  by 		

			


		

		
Despite all the tapering talk

The market did not walk the walk

Now sovereigns worldwide

Have seen their yields slide

While stocks are where people all flock


Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing?  That was so two days ago.  With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion.  Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion.  Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals.  In other words, tapering is still a long way in the future.


This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so.  Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals.  Do not be misled into believing the Fed is on the cusp of removing accommodation.  They are not!


A quick look at yesterday’s data highlights why they are still a long way off.  While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth.  As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever.  But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem.  Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.


Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon.  While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.


Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing.  The interesting thing is the contrast between the data from Asia and that from Europe.  It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5.  While a slight decline from the previous month, it is still well into growth territory.  However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7.  There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.


European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end.  As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength.  Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact.  While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.


Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening.  The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.


Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.


Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%).  Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there.  Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day.  US futures are all modestly higher at this point, by roughly 0.25%.


As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps.  But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads.  The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.


Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer.  However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.


Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above.  In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May).  But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4.  In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.


On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00.  Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.


Nothing has changed my view that as go 10-year yields, so goes the dollar.  If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain.  If, however, yields reverse higher, the dollar will find its footing immediately.


Good luck, good weekend and stay safe

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			Retrogression
		


				

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To taper or not is the question

Resulting in much indigestion

For traders with views

The Minutes were cues

The Fed’s ready for retrogression


“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”  This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity.  Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.


No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything.  So, is this really as hawkish as the commentariat would have us believe?  Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report.  Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy.  Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time.  Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).


The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis.  That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”


Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do.  The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion.  In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco.  Of that group, Chicago’s Evans and SF’s Daly are uber-dovish.  Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all.  This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months.  Do not get overexcited about the Fed tapering.


Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive.  Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released.  Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session.  In other words, it was hardly a rout based on the Minutes.  The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit.  Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.


As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%.  But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps.  This is hardly the sign of a market preparing for a Fed change of heart.  European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps).  Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.


Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%).  However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions.  The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day.  Agricultural products, though, maintain their bids with small gains across the board.


Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April.  This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.


Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes.  Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%).  Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night.  However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.


Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%).  All of these are benefitting from the broad based, but mild, dollar weakness.  The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.


Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0).  Then at 10:00 we see Leading Indicators (1.3%).  On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.


Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment.  Look for the dollar to drift lower on the day.


Good luck and stay safe

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			Inflation Be Damned
		


				

			Posted on  by 		

			


		

		
The Minutes revealed that the Fed

Cares not about outlooks, instead

Inflation be damned

They now are programmed

To wait until growth is widespread


There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh?  Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time.  We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around.  And that’s great!  Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis.  Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive.  And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come.  A cynic might think that those central banks don’t actually believe their own forecasts.


Yesterday’s FOMC Minutes revealed this exact situation.  “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.”  In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates.  On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves.  After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”


It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations.  For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano.  I’ve been sitting on that volcano for many, many years.  It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices.  Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever.  And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.


Thus, the conundrum.  Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue.  Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy.  But every central bank has essentially promised they will be falling behind the curve to fight the current battle.


So, let’s follow this line of thought to some potential conclusions.  Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse.  Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation.  (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!)  Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money.  Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter?  This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B.  And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below).  Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.


So, with that in mind, let’s take a quick tour of the markets.  Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day.  In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher.  As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.


As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs.  European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point.  A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year!  Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget.  Imagine what would happen if yields there rose, even 100 basis points.  And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.


Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector.  And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline.  But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.


In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today.  Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week.  As described above, inflation s clearly not going to be a major policy driver in most economies for now.  But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.


On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon.  But what can the Fed tell us that we don’t already know?


As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well.  And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.


Good luck and stay safe

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			Suspicions
		


				

			Posted on  by 		

			


		

		
Fed staffers relayed their suspicions

That ease in financial conditions

Could lead to distress

Which could make a mess

For Powell and all politicians


But Jay heard the story and said

The risks when we’re looking ahead

Are growth is too slow

Inflation too low

So, money still pours from the Fed


Yesterday’s Fed Minutes left us with a bit of a conundrum as there appears to be a difference of opinion regarding the current state of the economy and financial markets between the Fed staffers and their bosses.  The bosses, of course, are the 19 members of the FOMC, 7 governors including the Chair and vice-Chair and the 12 regional Fed presidents.  The staffers are the several thousand PhD economists who work for that group and develop and run econometric models designed, ostensibly, to help better understand the economy and predict its future path.  On the one hand, based on the Fed’s prowess, or lack thereof, in forecasting the economy’s future path, it is understandable how the bosses might ignore their staffers.  When looking at past Fed forecasts, they are notoriously poor at determining how the economy is progressing, seemingly because the models upon which they rely do not represent the US economy very well.  On the other hand, the willful blindness exhibited by the bosses with respect to the current financial conditions is disqualifying, in itself, of trusting their views.  As I said, quite the conundrum.


This was made a little clearer yesterday when the FOMC Minutes showed that the staff had indicated the following:


The staff provided an update on its assessments of the stability of the financial system and, on balance, characterized the financial vulnerabilities of the U.S. financial system as notable. The staff assessed asset valuation pressures as elevated. In particular, corporate bond spreads had declined to pre-pandemic levels, which were at the lower ends of their historical distributions. In addition, measures of the equity risk premium declined further, returning to pre-pandemic levels. Prices for industrial and multifamily properties continued to grow through 2020 at about the same pace as in the past several years, while prices of office buildings and retail establishments started to fall. The staff assessed vulnerabilities associated with household and business borrowing as notable, reflecting increased leverage and decreased incomes and revenues in 2020. Small businesses were hit particularly hard. [author’s emphasis].


And yet, after hearing the staff reports, neither the FOMC statement nor Chairman Powell at the ensuing press conference referred to elevated asset values or financial system vulnerabilities.  Rather, those, and most other concerns, were described as moderate, while explaining that downside outcomes to inflation still dominated their thinking.  In the intervening 3 weeks, we have seen Treasury yields rise 30 basis points in the 10-year and inflation breakevens rise 22 basis points.  In other words, it is beginning to appear as though the Fed and the market are watching two different movies.  The risk to this scenario is that the Fed can fall dangerously behind the curve with respect to keeping the economy on their preferred path, and may be forced to dramatically shift policy (read raise rates) if (when) it becomes clear rising inflation is not a temporary phenomenon.  Now, while it is likely to take the Fed quite a while to recognize this discrepancy, I assure you, when it occurs and the Fed feels forced to act, the market response will be dramatic.  But for now, that is just not on the cards.  If anything, as we continue to hear from various Fed speakers, there is no indication they are going to consider tighter policy for several years to come.


In the meantime, there is no reason to suspect that market participants will change their short-term behavior, so ongoing manias will continue.  Just be careful with your personal accounts.  Remember, when things turn, return OF capital is far more important than return ON capital!


Now to today’s session.  Once again, the traditional risk memes are a bit confused this morning.  Equity markets have not had a good session with Asia mostly lower (Nikkei -0.2%, Hang Seng -1.6%, although Shanghai reopened with a gain, +0.5%).  European markets are also under pressure (DAX -0.1%, CAC -0.4%, FTSE 100 -0.9%) despite the fact that today marks the beginning of the disbursement of EU-wide support funded by EU-wide bond issuance.  You may remember last July when, to great fanfare, the EU agreed a €750 billion joint debt issuance, to be backed by all members.  Well, we are now seven months later, and they are finally starting to disburse the funds.  And do not seek respite in US futures markets as they are all lower by between 0.25% (DOW) and 0.8% (NASDAQ).


What is interesting is that despite the equity market weakness, bond markets are falling as well.  It appears that growing concerns over rising inflation are outweighing the risk aversion theme.  Thus, 10-year Treasury yields are higher by 1.9bps this morning and we are seeing even larger rises in some European markets (Gilts +4.1bps, OATs +2.6bps, Bunds +1.8bps).  So, I ask you, which market is telling us the true risk story today?


Perhaps if we look to commodities we will get a hint.  Alas, the information here is muddled at best.  Oil prices continue to rise, up another 0.3% this morning, as up to 4 million barrels of daily production in Texas and the Midwest have been shut in because of the winter storms.  That is 36% of US production, and clearly making an impact. Meanwhile, base metals have been mixed with Aluminum higher and Copper lower.  Precious metals?  Mixed as well with gold (+0.4%) rebounding from a couple of really bad sessions while silver (-0.75%) continues to slide.


Thus far, making a claim as to the risk sense of markets is essentially impossible.  So, now we turn to the dollar.  If tradition is a guide, the dollar’s broad weakness, lower vs. all G10 counterparts and many EMG ones as well, would indicate a risk on session.  But if investors are moving into risky assets, why are stocks under uniform pressure? Perhaps they are all moving their money into Bitcoin (+0.2% today, +11.2% in the past week).


But back to the fiat world where we see GBP (+0.6%) as the leading G10 gainer which appears to be a result of traders expecting the UK to recover much faster than Europe given the relative success of their Covid vaccination program.  But even the worst performers, CAD and JPY are higher by 0.15% this morning.  NOK (+0.4%) seems to be benefitting from the ongoing oil rally, and the rest of the bloc may be beginning to see the resumption of the dollar short trade.


EMG currencies are a bit more mixed, with most APAC currencies softening overnight, but LATAM and CE4 currencies benefitting from the dollar’s overall softness.  CLP (+0.5%) leads the way on the strength of rising copper prices, with ZAR (+0.45%) following closely behind.


Yesterday’s US data was surprisingly good, with Retail Sales exploding higher by 5.3% on a monthly basis (I guess the most recent stimulus checks were spent!) and PPI jumping by a full percent, to a still low 1.7%, which may well foreshadow the future of CPI.  We also saw strong IP and Capacity Utilization data.  This morning brings Initial Claims (exp 770K), Continuing Claims (4.425M), Housing Starts (1660K), Building Permits (1680K) and Philly Fed (20.0) all at 8:30. We also have two more Fed speakers, the hyper dovish Lael Brainerd and a more middle of the road dove Rafael Bostic.


Wrapping it all up shows a weak dollar, weak bond prices and weak stock prices.  It feels like at least one of these needs to adjust its trajectory for the day to make any sense, but as of now, I am not willing to bet which.  As far as the FX market goes, we appear to be rangebound for now, although any eventual break still feels like it will be for a lower dollar.


Good luck and stay safe

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			Blue Wave at Last
		


				

			Posted on  by 		

			


		

		
Psephologists have now decided

The run-off election provided

A blue wave at last

So laws can be passed

Republicans view as misguided


The market responded by sellin’

The 10-year, with traders foretellin’

Inflation to come

As Powell stays mum

While financing Treasury’s Yellen


While the election results from Georgia are not yet final, the indications at this time are that the Democratic party won one of the seats with the second one still too close to call.  However, the market has already made its decision, that both seats flipped to the Democrats and that the Senate will now be split 50:50, which means that the Vice President will be able to cast the deciding vote.  The clear implication is that, while hardly a mandate, the Democrats will control both the executive and legislative branches and be able to implement a great deal of their agenda.  In other words, the blue wave high tide has finally crested.


The initial reaction to this news has been seen in the sell-off of the 10-year Treasury, where the yield has risen to 1.02% as I type, its first foray above 1.00% since March 19th, during the first days of the Covid-19 market panic.  The reflation trade is back in vogue, with expectations now that the new administration will be aggressively adding fiscal stimulus, thus increasing Treasury issuance significantly and ultimately steepening the yield curve as demand for long-dated Treasuries will not be able to keep pace with the new supply.  However, given the already record levels of debt outstanding, the government simply cannot afford for interest rates to rise too far, as if they do, interest payments will soak up an ever-increasing proportion of available revenues.  It is for this reason that I continue to believe the Fed will increase their current activity, and whether tacitly, by expanding QE and extending the maturity of purchases, or explicitly, by setting a yield target, implement Yield Curve Control (YCC).


At the same time, the Fed has made it abundantly clear that higher inflation is of no concern to the committee.  The latest proof comes from Chicago Fed President Charles Evans, who explained to us yesterday, “Frankly, if we got 3% inflation, that would not be so bad.  It is very difficult to imagine out of control inflation, even with the large debt that fiscal authorities have been running up.”   Perhaps, as a Regional Fed President, he simply lacks imagination.  After all, just yesterday, almost at the same time he was recounting his views, the ISM Prices Paid index printed at 77.6, well above expectations and at a level seen only twice, briefly, in the past decade.  There is a strong correlation between this index and PPI, so the idea that inflation pressures are building is hardly unimaginable.


Which brings us back to the prospects for the dollar, as well as other markets.  While yields have climbed today, the prospect of inflation rising more rapidly and real rates falling further into negative territory still informs my view that the dollar has further to decline.  This will become more obvious when the Fed steps in to prevent the rise in nominal yields, which I am confident will occur sooner rather than later.  Again, while I don’t anticipate a dollar collapse, as other central banks will fight to prevent such an outcome, further dollar weakness is in the cards.


Speaking of other central banks fighting the dollar’s weakness, last night the PBOC started to do just that by establishing the CNY fix at a weaker renminbi rate than anticipated.  Since August 1st, CNY has appreciated by nearly 8% vs. the dollar, which for an economy that remains heavily reliant on exporting for GDP growth, is a growing problem.  As the PBOC makes no bones about directing the value of the currency, you can expect that they will be actively managing the renminbi’s value going forward in an effort to prevent too much further strength.  But, as long as both nominal and real yields remain positive in China, that will attract significant capital flows and continue to pressure the renminbi higher.


So, what has all this news done to other markets?  Well, most of Europe is ecstatic at the election outcome, at least that seems to be the case based on the rallies seen in equity markets there.  The FTSE 100 (+2.3%) is leading the way, but we are seeing strong gains in the DAX (+0.9%) and CAC (+0.8%) as well, despite the fact that the PMI Services data disappointed across the board.  The story in Asia was more mixed with the Nikkei (-0.4%) and Australia (-1.1%) underwhelmed by the outcome, although the Hang Seng (+0.2%) and Shanghai (+0.6%) both wound up in the green.  As to US futures, as I type, they are a mixed bag, with DOW futures higher by 0.2%, SPU’s lower by 0.4% while NASDAQ futures are down 2.0%.  The latter’s decline are a response to the election results as concerns grow that Big Tech will now be in the crosshairs of Congress for more regulation if not outright dismemberment.


While we have already discussed the Treasury market, European government bonds are mostly softer today as well, with yields rising as much as 4bps in the UK, although German bunds are unchanged on the session.


Another inflationary impulse comes from oil, where yesterday the Saudis surprised the market by unilaterally cutting production by 1 million barrels/day helping to take WTI above $50/bbl for the first time since late February.  If this rally continues, look for gasoline prices to creep higher, one of the key sentiment indicators regarding the perception of inflation.


And finally, the dollar remains broadly under pressure this morning, with NOK (+0.75%) the leading gainer in the G10 on the back of the oil rally, although both AUD (+0.6%) and NZD (+0.65%) are also having a good day as both commodity prices gain and they serve as a proxy for Asian growth.  Meanwhile, the euro (+0.35%) is trading at new highs for the move and back to levels not seen since April 2018.


Emerging market currencies are universally higher this morning, led by PLN (+0.85%), MXN (+0.8%) and HUF (+0.8%).  Those stories are easy to see, with oil helping the peso, while the CE4 currencies are tracking the euro’s strength.  Asian currencies, while all firmer, did not show nearly the enthusiasm, with gains between 0.1% and 0.2%, but of course, the election results were not fully known during their session.


On the data front, this morning brings ADP Employment (exp 75K) as well as Factory Orders (0.7%) and the PMI Services index (55.2).  Then, this afternoon, we see the FOMC Minutes of the December meeting, one where they disappointed many folks by not easing further. The first thing to note is that after yesterday’s ISM data, the ADP forecast increased from 50K.  Clearly, the manufacturing sector remains in better shape than expected.  At the same time, the Minutes ought to be interesting as perhaps we will learn more about attitudes regarding any prospects for what could change policy.  Of course, given the world was a different place then, and as Evans explained, inflation is of no concern, the real question from the Minutes will be what will the Fed do next to ease further.


As to the dollar, it is hard to see a short-term path in any direction other than lower, but I continue to expect the decline to be slow and orderly.


Good luck and stay safe

Adf

			

	
	



				
					


	

		

			Dreams All Come True
		


				

			Posted on  by 		

			


		

		
The Minutes explained that the Fed

Was actively looking ahead

Twixt yield curve control

And guidance, their goal

Might not be achieved, so they said


This morning, though, payrolls are due

And traders, expressing a view

Continue to buy

Risk assets on high

Here’s hoping their dreams all come true!


In the end, it can be no surprise that the Fed spent the bulk of their time in June discussing what to do next. After all, they had to be exhausted from implementing the nine programs already in place and it is certainly reasonable for them to see just how effective these programs have been before taking the next step. Arguably, the best news from the Minutes was that there was virtually no discussion about negative interest rates. NIRP continues to be a remarkable drag on the economies of those countries currently caught in its grasp. We can only hope it never appears on our shores.


Instead, the two policies that got all the attention were forward guidance and yield curve control (YCC). Of course, the former is already part of the active toolkit, but the discussion focused on whether to add an outcome-based aspect to their statements, rather than the more vague, ‘as long as is necessary to achieve our goals of stable prices and full employment.’ The discussion centered on adding a contingency, such as; until inflation reaches a certain level, or Unemployment falls to a certain level; or a time-based contingency such as; rates will remain low until 2023. Some would argue they already have that time-based contingency in place, (through 2022), but perhaps they were leading up to the idea it will be longer than that.


The YCC discussion focused on research done by their staff on the three most well-known instances in recent history; the Fed itself from 1942-1951, where they capped all rates, the BOJ, which has maintained 10-year JGB yields at 0.0% +/- 0.20%, and the RBA, which starting this past March has maintained 3-year Australian yields at 0.25%. As I mentioned last week in “A New Paradigm” however, the Fed is essentially already controlling the yield curve, at least the front end, where movement out to the 5-year maturities has been de minimis for months. Arguably, if they are going to do something here, it will need to be in the 10-year or longer space, and the tone of the Minutes demonstrated some discomfort with that idea.


In the end, my read of the Minutes is that when the FOMC meets next, on July 29, we are going to get a more formalized forward guidance with a contingency added. My guess is it will be an Unemployment rate contingency, not a time contingency, but I expect that we will learn more from the next set of Fed speakers.


Turning to today, as the market awaits the latest payroll report, risk assets continue to be on fire. The destruction in so many areas of the economy, both in the US and around the world, is essentially being completely ignored by investors as they continue to add risk to their portfolios amid abundant central bank provided liquidity. Here are the latest median forecasts as compiled by Bloomberg for today’s data:






Nonfarm Payrolls
3.06M




Private Payrolls
3.0M




Manufacturing Payrolls
438K




Unemployment Rate
12.5%




Average Hourly Earnings
-0.7% (5.3% Y/Y)




Average Weekly Hours
34.5




Participation Rate
61.2%




Initial Claims
1.25M




Continuing Claims
19.0M




Trade Balance
-$53.2B




Factory Orders
8.7%




Durable Goods
15.8%




-ex Transport
6.5%






Because of the Federal (although not bank) holiday tomorrow, the report is being released this morning. It will be interesting to see if the market responds to the more timely Initial Claims data rather than the NFP report if they offer different messages. Remember, too, that last month’s Unemployment rate has been under much scrutiny because of the misclassification of a large subset of workers which ultimately painted a better picture than it might otherwise have done. Will the BLS be able to correct for this, and more importantly, if they do, how will the market interpret any changes. This is one reason why the Initial and Continuing Claims data may be more important anyway.


But leading up to the release, it is full speed ahead to buy equities as yesterday’s mixed US session was followed by strength throughout Asia (Nikkei +0.1%, Hang Seng +2.85%, Shanghai +2.1%) and in Europe (DAX +1.6%, CAC +1.3%, FTSE 100 +0.6%). US futures are also higher, between 0.4%-0.8%, to complete the virtuous circle. Interestingly, once again bond yields are not trading true to form on this risk-on day, as yields in the US are flat while throughout Europe, bond yields are declining.


But bonds are the outlier here as the commodity space is seeing strength in oil and metals markets and the dollar is under almost universal pressure. For example, in the G10, NZD is the leading gainer, up 0.6%, as its status as a high beta currency has fostered buying interest from the speculative crowd betting on the recovery. But we are also seeing NOK and SEK (both +0.5%) performing well while the euro (+0.3%) and the pound (+0.3%) are just behind them. The UK story seems to be about the great reopening that is due to occur starting Saturday, when pubs and restaurants as well as hotels are to be allowed to reopen their doors to customers. The fear, of course, is that this will foster a second wave of infections. But there is no doubt there is a significant amount of pent up demand for a drink at the local pub.


In the EMG bloc, the ruble is today’s winner, rising 1.2% on the back of oil’s continued rebound. It is interesting, though, as there is a story that Saudi Arabia is having a fight with some other OPEC members, and is close to relaunching a full-scale price war again. It has been the Saudis who have done the lion’s share of production cutting, so if they turn on the taps, oil has a long way to fall. Elsewhere in the space, INR (+0.8%) and ZAR (+0.75%) are having solid days on the back of that commodity strength and recovery hopes. While the bulk of the space is higher, IDR has had a rough session, in fact a rough week, as it has fallen another 0.65% overnight which takes its loss in the past week near 2.0%. Infection rates continue to climb in the country and investors are becoming uncomfortable as equity sales are growing as well.


So, this morning will be a tale of the tape. All eyes will be on the data at 8:30 with the odds stacked for a strong risk session regardless of the outcome. If the data shows the recovery is clearly strengthening, then buying stocks makes sense. On the other hand, if the data is disappointing, and points to a reversal of the early recovery, the working assumption is the Fed will come to the rescue quite quickly, so buying stocks makes sense. In this worldview, the dollar is not seen as critical, so further dollar weakness could well be in our future.


Good luck and stay safe

Adf