Tag Archives: #narrative

Do Not Be Afraid

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Said Jay, “you must listen to me”

And not to the numbers you see

Do not be afraid

Inflation will fade

So, keep up the stock buying spree!

Last week’s FOMC meeting seems to have been an inflection point in the recent market narrative which has resulted in a great many conflicting thoughts about the future.  The dichotomy of the meeting was the virtual absence of discussion on current high inflation readings juxtaposed with the Dot Plot forecasts on interest rates rising in 2023.  Arguably, the Dot Plot reflects the participants’ growing concern that inflation is rising, and that the FOMC will need to address that situation.  One could argue that this dichotomy has been the underlying cause for the increased volatility evident in markets, with sharp gains and losses seen across bonds, equities and currencies.

This afternoon, Chairman Powell will once again regale us with his views as he testifies before the House Select Subcommittee on the Coronavirus Crisis.  His prepared testimony was released yesterday afternoon with some key comments.  “Inflation has increased notably in recent months.  As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”  That pretty much sums up the Fed view and confirms that there is very little concern about inflation over time.  

Yesterday we also heard from three other Fed speakers, NY’s Williams, Dallas’ Kaplan and St Louis’ Bullard, with slightly different messages.  Williams, a permanent voter, remains adamant that it is too soon to consider adjusting policy, although he is willing to discuss the idea of tapering.  Meanwhile, both Kaplan and Bullard, both non-voters, are far more interested in getting the tapering talk off the ground as both see the economy picking up pace and have evidenced concern about overheating areas in the economy.  One can surmise from these comments that both of them are amongst the ‘dots’ above 1.0% for 2023.  In fact, Bullard admitted that he was a 0.6% ‘dot’ for 2022 in comments last week.  

Looking ahead, we have a long list of Fed speakers this week, with Mester, a hawkish non-voter, and Daly, a dovish voter, also set to comment today.  It almost appears as though voting members have been given a set of marching (speaking?) orders to which they are to adhere that express no concern over prices and the need to continue with current policy for the foreseeable future, while non-voting members have no such restrictions.  This is a very different dynamic than what we have become used to seeing, where everybody on the committee was saying the same thing.  Perhaps this is Powell’s solution to being able to maintain the policy he wants while having the Fed overall avoid criticism for groupthink.  But groupthink remains the base case, trust me.

During this period of policy adjustments, or at least narrative adjustments, investors have found themselves without their previous strong signals that all asset prices will rise and that havens serve little purpose.  Instead, we have seen a much choppier market in both stock and bond prices as previously long-held convictions have come into question. The most notable change has been in the shape of the yield curve, which has flattened dramatically.  For instance, the 2yr-10-yr spread, which had reached a high above 160 basis points in early April has seen a decline from 137 to below 110 and a rebound back to 122 in the past three sessions.  Other than March 2020, during the initial Covid confusion, there has not been movement of that nature since President Trump was elected in 2016.  And that was a one-day phenomenon.  At this point, the volatility we are experiencing is likely to continue until a new narrative takes hold.  As to today’s session, so far, we are seeing a modest bond rally with yields softer in Treasuries (-1.7bps after a 5bp rally yesterday) and European sovereigns (Bunds -0.4bps, OATs -1.4bps, Gilts -0.5bps) all slightly firmer on the day.  

Meanwhile, equity markets are also somewhat confused.  Last night, for instance, the Nikkei (+3.1%) rebounded sharply after the BOJ explained they had restarted their ETF buying program on Monday, so all was right with the world.  The Hang Seng (-0.6%) didn’t get that message but Shanghai (+0.8%) did despite rising short-term interest rates in China.  Those climbing rates appear to be a function of quarter end demand for bank funding that is not being supplied by the PBOC.  My sense is once July comes those rates will drift back down.  Europe, has had a more mixed equity session after a nice rally yesterday, with both the DAX and CAC flat on the day and the FTSE 100 (+0.3%) rising a bit, but weakness in the peripheral markets of Spain and Italy, with both of those lower by about 0.5%.  US futures are virtually unchanged at this hour as market participants seem to be awaiting Mr Powell.

Commodity markets are following suit, with some gainers (Au +0.2%, Ag +0.2%, Al +0.1%), some losers (WTI -0.7%, Soybeans -0.7% and Fe -3.2%) and many with little overall movement.  In a market that has lost its direction with respect to both growth and inflation expectations, or at least one which is re-evaluating those expectations, it should be no surprise there is a hodgepodge of price movements.

The dollar, however, is broadly firmer on the day, with GBP (-0.35%) the weakest performer in the G10 as traders await Thursday’s BOE meeting and their latest discussion on the inflation situation in the UK.  This will be BOE Chief Economist Andy Haldane’s last meeting, and he is expected to make some hawkish noises, but thus far, the rest of the committee has not been aligned with him.  Right now, the market is not looking for him to receive any support, hence the pound’s ongoing weakness, but if we do hear some hawkishness from another member or two, do not be surprised if the pound jumps back up.  As to the rest of the G10, losses range from 0.1%-0.25% and are all a reflection of the dollar’s strength, rather than any idiosyncratic stories here.  

Emerging market currencies are also broadly softer this morning, with a mix of laggards across all three blocs.  HUF (-0.5%), ZAR (-0.5%, THB (-0.45%) and MXN (-0.35%) reflect that this is a dollar and Fed story, not an EMG one.  The one exception to this rule is TRY (+1.0%) as hopes for an early lifting of Covid restrictions and a modest rise in Consumer Confidence there has underpinned the lira.

On the data front, we see Existing Home Sales (exp 5.72M) this morning at 10:00, but that seems unlikely to excite the market.  Rather, I expect limited movement until Chairman Powell speaks this afternoon.  

For now, volatility is likely to be the norm as the market adjusts to whatever the new narrative eventually becomes.  The inflation debate continues to rage and when Core PCE is released later this week, there will be more commentary.  However, it will require high inflation readings into the autumn to change the Fed’s stance, in my view, and until then, the idea that the Fed is considering tighter policy is likely to support the dollar for now.  However, that doesn’t mean further strength necessarily, just not any real weakness.

Good luck and stay safe

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Contracted, Not Grown

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There once was a continent, grand
Whose culture and history fanned
Both science and art
Which helped to jumpstart
Expansion across all the land

But lately the data has shown
That Europe’s contracted, not grown
This bodes ill for those
Who purchased euros
As markets take on a new tone

Entering 2021, one of the highest conviction trades amongst the analyst and investment community was that the dollar would decline sharply this year.  After all, it fell broadly and steadily in 2020 from the moment it peaked in mid-March on the initial pandemic fears.  But the narrative that developed was that the Fed would be the king of all monetary easers, pumping so much liquidity into markets that the surfeit of dollars would simply drive the value of the greenback lower vs. all its main counterparts.  Adding to the tale was the election of Joe Biden as president, and the belief that he would be able to enact massive stimulus to help reflate the economy, thus adding fiscal stimulus to the Fed’s already humongous monetary efforts.  The pièce de résistance was the Georgia runoff elections, when the Democrats gained effective control of the Senate, and so all of these dreams seemed destined to come true.

However, there was always one conundrum that never made sense, at least to me, and that was the idea that the dollar would decline while the US yield curve steepened.  The thesis was that all the fiscal stimulus would result in massive Treasury issuance (check), which would result in higher yields as the market had trouble absorbing all that debt (partial check) and then the dollar would decline sharply (oops).  The problem is that historically, as the US yield curve steepens, the dollar typically rallies.

The other quibble with this narrative was that it seemed to ignore the facts on the ground in Europe.  It was never realistic to believe that the ECB would sit back and allow the euro to rally sharply without responding.  And of course, that is exactly what we have seen.  In the past three weeks, we have heard from numerous ECB speakers, including Madame Lagarde, that the exchange rate is quite important in their deliberations.  The proper translation of that comment into English is, if the euro keeps rallying, we will directly respond via further easing or even intervention if necessary.  Remember, Europe can ill afford a strong euro from both a growth and inflationary perspective, and they will do all they think they can to prevent it from coming about.

At the same time, there is another issue that the dollar bears seemed to neglect, the pathetic state of affairs in the Eurozone economy, as well as the vast incompetence displayed throughout the continent with respect to the inoculation of their populations with the new Covid vaccines. Based on current trends, the US and UK will have vaccinated 75% of their respective populations by the end of 2021.  Italy, Germany and France are looking at 2024 at the earliest to achieve the same milestone.  Ask yourself how beneficial that will be for the Eurozone economy if the current lockdowns remain in place for the next 2-3 years.

The one possible saving grace for this view is that the Fed responds more aggressively to any steepening of the yield curve.  While Europe cannot afford for the euro to rise, the US cannot afford for interest rates to rise, at least not very much.  While yields have clearly risen from their summer lows, they remain extremely accommodative.  However, if yields should start to rise further, say because inflation starts to accelerate, the Fed seems destined to stop that move, either explicitly, via YCC, or tacitly via extending and expanding QE such that they absorb all the new Treasury issuance and prevent yields from rising.  Of course, this will result in much deeper negative real yields which, in my view, will be what leads to the dollar’s eventual decline.  Given Europe’s much duller inflationary pulse, it will be much harder for the ECB to drive real yields in Europe as low as in the US.  But that is a story for the second half of 2021, not the first.

Which brings us to today’s activity.  The discussion above was prompted by the much weaker than expected Eurozone Retail Sales data released this morning, with December’s monthly growth at 2.0% and the Y/Y number at just 0.6%, half of expectations.  And this was before the extended and expanded lockdowns in January.  It is increasingly evident that the Eurozone is in its second recession in just over a year, again, hardly a rationale to buy its currency.  Which makes it completely unsurprising that the euro has declined yet again, -0.4%, and breaking below the psychological 1.20 level.  For those keeping track, this is he fourth consecutive day of declines and it is pretty easy to look at a chart and see a downtrend developing.  In fact, since its peak on January 7, the euro is down a solid 3%.

But the dollar is performing well against all its G10 brethren, and most EMG counterparts as well.  SEK (-0.6%) and NOK (-0.5%) are the worst performers with the latter somewhat surprising given that oil (+0.75%) continues to rally.  It seems that both these countries are seeing doubts over their ability to inoculate their populations from Covid similar to the Eurozone, so it should not be surprising that their currencies decline.  The same is true of CAD (-0.25%) where the current trend for vaccinations shows it will take a full ten years to vaccinate 75% of Canada’s population!  I imagine the pace will increase, but it does demonstrate the futility so far.  CAD, however, has not been as weak as the euro given the benefits from the rising oil price seem to be offsetting some of its other problems.

In the Emerging markets, ZAR (-0.8%) is the worst performer today, falling on a combination of broad dollar strength and concerns over the possibility of a debt crisis as the nation’s debt/GDP ratio has climbed rapidly to 80%, and with its still high yields, debt service ability is becoming a bigger problem.  Of course, there is also a new strain of Covid, first identified there, that has increased virulence and is working against the economy.  With the euro lower, it is no surprise that the CE4 have followed it down, and we are also seeing weakness in MXN (-0.6%), again, after central bank comments indicating possible rate cuts in the future.  On the flipside, TRY (+0.5%) is the star performer today, continuing to gather interest given its world-beating interest rate structure and promises from the central bank to maintain those yields.

While I skipped over both equity and bond markets today, it is only because there was precious little movement in most cases and certainly no discernible trend.

On the data front, yesterday saw better than expected ADP Employment and ISM Services prints, once again highlighting the differences between the US and Europe.  This morning brings a raft of data as follows: Initial Claims (exp 830K), Continuing Claims (4.7M), Nonfarm Productivity (-3.0%), Unit Labor Costs (4.0%) and Factory Orders (0.7%).  With Payrolls tomorrow, all eyes will be on the Initial Claims number, but it is hard to believe any print will change market sentiment.

Finally, the BOE met this morning and left policy unchanged, as expected.  However, they did tell banks to start preparing for negative interest rates going forward.  While they claim the policy is not imminent, it seems unlikely that they are asking banks to prepare for a low probability event.  Despite significant evidence that negative rates do not help the economy, although they do help stock prices, the BOE looks like it is going to ignore that and go there anyway.  The only analyses that showed NIRP was beneficial was produced by the central banks that are operating under NIRP.  This cannot be good for the pound over time.

For the day, the dollar is starting to gain momentum to move higher, and I think a slow continuation of this move is likely.

Good luck and stay safe
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Compelled

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Just last week the narrative spoke
And told us the world would soon choke
On dollars they held
Thus, would be compelled
To sell them, ere they all went broke

But funnily, this week it seems
The selling had reached its extremes
So, shorts are now squeezed
And traders displeased
As they now must look for new themes

It had been the number one conviction trade entering 2021, that the dollar would sell off sharply this year.  In fact, there were some who were calling for a second consecutive year of a 10% decline in the dollar versus its G10 counterparts, with even more gains in some emerging market currencies.  The market, collectively, entered the new year short near record amounts of dollars, riding the momentum they had seen in Q4 of last year and looking for another few percentage points of decline.  Alas, one week into the year and things suddenly seem quite different.

The first thing to highlight is that while a few percent doesn’t seem like much of a move, certainly compared to equities or bitcoin, the institutional trading community, consisting of hedge funds and CTA’s, lever up their positions dramatically.  In fact, 10x capital is quite common, with some going even further.  So, that 2% move on a 10x leverage position results in a 20% gain, certainly very respectable.  The second thing to highlight is that if a short-term trading reversal is able to cause this much angst in the trading community, conviction in the trade must not have been that high after all.

But let us consider what has changed to see if we can get a better understanding of the market dynamics.  Clearly, the biggest change was the run-off election in Georgia, which had been expected to result in at least one seat remaining in Republican hands, and thus a Republican majority in the Senate.  This outcome of a split government was seen to be a general positive for risk, as it would prevent excessive increases in debt financed stimulus, thus force the Fed to maintain low US interest rates.  And of course, we all know, that low rates should undermine the currency.

But when the Democrats won both seats, and the Senate effectively flipped, the new narrative was that there would be massive stimulus forthcoming, encouraging the reflation trade.  The thing is, the reflation trade is part and parcel of the steepening yield curve trade based on the significant amount of new Treasury debt that would need to be absorbed by the market, with the result being declining prices and higher Treasury yields.  (One thing that I never understood about the weak dollar trade in this narrative was the idea that a steeper yield curve would lead to a weaker dollar, when historically it was always the other way around; steep curve => strong dollar.)

Last week, of course, we saw Treasury yields back up 20 basis points in the back end of the curve, exactly what you would expect in a reflation trade.  And so, it cannot be surprising that the dollar has found a bottom, at least in the short-term, as higher yields are attracting investors.  But what does this say about the future prospects for the dollar?

My thesis this year has been the dollar will decline on the back of declining real yields in the US, which will be driven by rising inflation and further Fed support.  Neither the US, nor any G10 country for that matter, can afford for interest rates to rise as they continue to issue massive amounts of debt, since higher rates would ultimately bankrupt the nation.  However, inflation appears to be making a comeback, and not just in the US, but in many places around the world, specifically China.  Thus, the combination of higher inflation and capped yields will result in larger negative real rates, and thus a decline in the dollar.  Last week saw real yields rise 15 basis points, so the dollar’s rally makes perfect sense.  But once the Fed makes it clear they are going to prevent the back end of the curve from rising, the dollar will come under renewed pressure.  However, that may not be until March, unless we see a hiccup in the equity market between now and then.  For now, though, as long as US yields rise, look for the dollar to go along for the ride.

Of course, higher US yields and a stronger dollar do not encourage increased risk appetite, so a look around markets today shows redder screens than that to which we have become accustomed.  The exception to the sell-off rule was Tokyo, where the Nikkei (+2.35%) rallied sharply as the yen continues to weaken.  Remember, given the export orientation of the Japanese economy, a weaker yen is generally quite positive for stocks there.  The Hang Seng (+0.1%) managed a small gain, but Shanghai (-1.1%), fell after inflation data from China showed a much larger rebound than expected with CPI jumping from -0.5% to +0.2%.  Obviously, that is not high inflation, but the size and direction of the move is a concern.

European markets, however, are all underwater this morning, with the DAX, CAC and FTSE 100 all lower by 0.5%.  US futures are pointing down as well, between 0.4%-0.6% to complete the sweep.  Bond markets are modestly firmer this morning, with Treasury yields slipping 1.5 bps, while Bunds, OATS and Gilts have all seen yields fall just 0.5bps.  Do not be surprised that yields for the PIGS are rising, however, as they remain risk assets, not havens.

In the commodity space, oil is under modest pressure, -0.65%, while gold is essentially unchanged, although I cannot ignore Friday’s 2.5% decline, and would point out it fell another 1.5% early in today’s session before rebounding.  Since I had highlighted Bitcoin’s remarkable post-Christmas rally, I feel I must point out it is down 17% since Friday, with some now questioning if the bubble is popping.

Finally, the dollar continues its grind higher, with commodity currencies suffering most in the G10 (NOK -1.1%, NZD -0.7%, AUD -0.6%) as well as the pound (-0.6%) which is feeling the pain of Covid-19 restrictions sapping the economy.  In the EMG space, we are also seeing universal weakness, with the commodity focused currencies under the most pressure here as well.  So, ZAR (-1.0%), MXN (-0.85%) and BRL (-0.8%) are leading the pack lower, although there were some solid declines out of APAC (IDR -0.75%, KRW -0.7%) and CE4 (PLN -0.75%, HUF -0.7%).

On the data front, this week brings less info than last week, with CPI and Retail Sales the highlights:

Tuesday NFIB Small Biz 100.3
JOLTs Job Openings 6.5M
Wednesday CPI 0.4% (1.3% Y/Y)
-ex food & energy 0.1% (1.6% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 785K
Continuing Claims 5.0M
Friday Retail Sales 0.0%
-ex autos -0.2%
PPI 0.3% (0.7% Y/Y)
-ex food & energy 0.1% (1.3%)
Empire Manufacturing 5.5
IP 0.4%
Capacity Utilization 73.5%
Business Inventories 0.5%
Michigan Sentiment 80.0

Source: Bloomberg

Aside from that, we also will hear a great deal from the Fed, with a dozen speakers this week, including Powell’s participation in an economics webinar on Thursday.  Last week, you may recall that Philadelphia’s Patrick Harker indicated he could see a tapering in support by the end of the year, but the market largely ignored that.  However, if we hear that elsewhere, beware as the low rates forever theme is likely to be questioned, and the dollar could well find a lot more support.  The thing is, I don’t see that at all, as ultimately, the Fed will do all they can to prevent higher yields.  For now, the dollar has further room to climb, but over time, I do believe it will reverse and follow real yields lower.

Good luck and stay safe
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A New Paradigm

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Awaiting a new paradigm
The market is biding its time
Will Brexit be hard?
Or will Ms. Lagarde
Do something that’s truly sublime?

And what of next week and the Fed?
Are traders now looking ahead?
Will Jay make a change?
And thus rearrange
The views that are now so widespread

Come with me now, on a trip down memory lane.  Back to a time when hope (for a vaccine) sprung eternal, the blue wave was cresting, and investors were sidling up to the all-you-can-eat risk buffet with a bottomless appetite.  You remember, November.  Reflation was on the menu, along with a massive fiscal stimulus bill; progress was concrete with respect to Brexit negotiations; and the prospect of another wave of government shutdowns, worldwide, was just a gleam in petty tyrants’ politicians’ eyes.  Well, it turns out that those expectations were somewhat misplaced.  While we did, indeed, get that vaccine announcement, with the milestone first injection made today in the UK, many of those views turned out differently than expected.  As we are all aware, there was no blue wave in the US election.  Regarding Brexit, it appears that the time has finally come for the leaders of both sides to sit down and hash things out.  This morning brought news that Boris and Ursula will be meeting tomorrow to see if they can agree on what each side is willing to accept as their top negotiators have clearly reached their limits.

As to risk appetite, certainly November was beyond impressive, with massive risk rallies in equities around the world while haven assets, notably Treasuries and gold, suffered significant losses.  Since then, however, the euphoria has been far less prevalent, with some sessions even winding up in the red.  Lockdowns?  Alas, those have returned in spades, with seemingly new orders each and every day by various governmental authorities around the world.

The upshot of this mixture of news is that the market is now searching for the next big thing.  Don’t misunderstand, the 2021 conviction trades remain on the table.  Thus, expectations for a much weaker dollar, huge returns in emerging markets, both bonds and stocks, and continued strength in the US market are rife.  Just not right now.  The short-term view is more muddled which is why the price action we are currently experiencing is so mixed and until that new view develops, choppy markets with no net directional movement is the most likely outcome.  For instance, let’s look at today’s activity, which is a perfect example of the situation.

Equity markets around the world are softer, but not aggressively so.  Asian markets sold off modestly last night (Nikkei -0.3%, Hang Seng -0.75%, Shanghai -0.3%), but look simply to be consolidating what have been impressive gains since the beginning of November.  European markets are also a bit softer this morning, led by the CAC (-0.65%) although the DAX (-0.3%) and FTSE 100 (-0.4%) are drifting lower as well.  We did see some data from Europe, with ZEW readings from Germany turning out bi-polar (Expectations were strong at 55.0, Current Situation was weak at -66.5), thus showing how financial markets continue to focus on the post-covid economy while ignoring the current situation.  Meanwhile, US futures are all pointing a bit lower, between 0.4%-0.5%, after a mixed performance yesterday.  In other words, all that risk appetite from last month appears to have been satisfied for now, although we are, by no means, seeing serious risk reduction.

In the bond market, surprisingly, 10-year Treasury yields have actually edged higher by 0.7bps this morning, despite the modest risk-off theme, whereas in Europe, we see marginal yield declines across Germany, France and the UK. Bonds from the PIGS, however, are definitely feeling a little stress as they are trading with yields nearly 2bps higher than yesterday.  And that is a bit surprising given that Thursday, the ECB is going to announce their latest expansion of monetary policy, thus guaranteeing to buy yet more debt from these nations.  (We will cover the ECB tomorrow).

Commodities?  Well, gold has been rocking since its nadir on November 30, having rebounded more than 6% since then, and while unchanged on the day, remains in a short-term uptrend.  Oil, meanwhile, is ever so slightly softer this morning, just 0.5%, but also remains in its powerful uptrend, which has seen it rally more than 33% since its nadir on November 2nd.  In fact, metals and energy overall remain well bid and in strong uptrends.  Clearly, they are looking ahead to stronger growth (or possibly higher inflation) once the pandemic finally fades.

And lastly, the dollar, which can best be described as mixed today, remains the linchpin for many market expectations in 2021.  Remember this; given the dollar’s place in the world economy, as the financing vehicle of choice, a too strong dollar is generally associated with broad economic underperformance.  As debt loads worldwide have exploded, even at remarkably low interest rates, the need for foreign issuers, whether private or government, to acquire dollars to service that debt is perpetual.  When the dollar is strong, it crimps the ability of those foreign debtors to both invest and repay the outstanding debt, with investment suffering.  So, while a strong dollar may signal growth in the US economy, given that the US economy now represents only about 20% of the global economy, well down from its previous levels, and that trade continues to represent such a small portion of the US economy, just 12%, these days, a strong dollar simply hurts foreign economies without the previous benefits of knock-on global growth.  This is the key link between the views of a weaker USD and strong EMG performance next year, the two are tightly linked on a fundamental basis.

But as for today, the proper description of the dollar would be mixed.  In the G10, SEK (-0.45%) and GBP (-0.45%) are the leading decliners, with the latter clearly under pressure from the ongoing concerns over Brexit while the former seems to be feeling the sting of hints from the Riksbank that ZIRP will remain longer than previously expected.  On the plus side, the gains are less impressive, with CHF (+0.2%) the leader, while the euro has edged higher by 0.1%.  However, trying to explain a movement that small is a waste of time.

EMG currencies, on the other hand, are showing a little life, led by ZAR (+0.55%) and RUB (+0.5%) as commodity prices continue to hold the bulk of their gains.  INR (+0.5%) also had a good evening after the FinMin there explained that there would be no reduction in fiscal support for the economy for the foreseeable future, and that the government would continue to work with the RBI to insure a return to sustainable growth.  On the downside, KRW (-0.3%) is the laggard after the president there urged people to cancel holiday plans and stay home.

On the data front, NFIB Small Business Optimism fell to 101.4, a bit weaker than expected, but given the stories of closures around the nation, this cannot be that surprising.  A little later we get Nonfarm Productivity (exp 4.9%) and Unit Labor Costs (-8.9%), although neither is likely to excite the market.  There are no speakers on the docket, so the dollar will be taking its cues from the equity markets in all likelihood.  Right now, with futures pointing lower, that implies the dollar may have a bit of a rebound coming.  However, until that new narrative forms, I don’t anticipate too much movement.

Good luck and stay safe
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