In Germany, and too, in Spain
The people are feeling the pain
Of prices exploding
And therefore corroding
Their standards of living again
Meanwhile from the ECB’s halls
The comments from those know-it-alls
Show lack of concern
As each of them spurn
The idea of future pratfalls
In trading, ‘the trend is your friend’ is a very common sentiment and an idea backed with strong evidence. One can think of this as analogous to Newton’s first law, i.e. a body in motion stays in motion. So, when the price action in some market has been heading in one direction over time, it tends to continue in that direction. This is the genesis of the moving average as a trading tool as the moving average is what defines the trend. I highlight this because the concept is not restricted to trading but is also evident in many other price series, notably inflation. When one looks at the history of inflation, it tends to trend in one direction for quite some time with major reversals relatively infrequent. That is not to say a reversal cannot occur, but if one does, it tends to be the result of a long period of adjustment, not a quick flip of direction.
And yet, when listening to both Fed and ECB speakers lately, they would have you believe that the currently entrenched trend higher for prices is the aberration and that in a matter of months they will be back to their old concerns about deflation being the biggest problem for the economy. One has to wonder at what evidence they are looking to come to that determination as certainly the recent data does not point in that direction. Just this morning Spanish CPI (5.6%) printed at the highest level since 1992 while Italian PPI (25.3%) printed at the highest level in its history. From Germany, we have seen CPI prints from several of its states (Hesse 5.3%, Baden Wuerttemberg 4.9%, Bavaria 5.3%, Saxony 5.0%) with the national number (exp 5.5%) due at 8:00 this morning.
Still, none of this seems to be having an impact on the thoughts of ECB members with Lagarde, Schnabel, Villeroy and de Cos all out explaining that this is a temporary phenomenon and that by the middle of next year CPI will be back at their 2.0% target or lower. Maybe it will be so, but as Damon Runyon so aptly explained, “The race is not always to the swift, nor the battle to the strong; but that is the way to bet.” In other words, looking at the current trends, it seems far more likely that inflation remains high than suddenly turns around lower. The biggest problem the central banks have now is that it has become common knowledge that inflation is rising, which means that individual behaviors are adjusting to a new price regime. And if you listen to the central bank thesis that inflation expectations are a critical input, then they are really in trouble as inflation expectations are clearly rising.
At least the Fed has begun to discuss the idea of removing accommodation, although the Omicron variant of Covid may given them pause, but in Europe, it is not even on the table. A discussion point that has been raised numerous times lately is the idea of a central bank policy error, either raising rates prematurely to battle phantom inflation or waiting too long to tighten policy and allowing inflation to become more entrenched. While my money is on the latter, it is very clear that the ECB, at least, and still many Fed members, are far more concerned with the former. Perhaps they are correct, and all these rising prices will quickly dissipate, and that would be great. However, I am not counting on that outcome, nor should anyone else at this point until there is ANY proof the Fed or ECB are correct.
Meanwhile, Friday’s dramatic events seem to have been erased from memory as while there are still headlines regarding the Omicron variant, the collective market view appears to be that it is not going to result in another wave of lockdowns and therefore the economic impact will be relatively minor. As such, we are seeing a reversal of fortune across most markets from their Friday price action. It should be no surprise that the biggest change comes from oil (+4.75%) which has recouped about one-third of its losses and seems set to continue rebounding. After all, if the consensus is that Omicron is not going to have much of an impact, then the supply/demand story hasn’t changed and that bodes well for oil prices moving higher. Elsewhere in the commodity space NatGas (+7.4%) is rising sharply on the back of colder than normal weather, while metals prices (Au +0.1%, Ag +0.5%, Cu +1.7%, Al +1.2%) are all rebounding as well.
In the equity markets, Asia never got a chance to sell off like Europe and the US on Friday so caught up (down?) with the Nikkei (-1.6%) leading the way although the Hang Seng (-1.0%) also suffered. Shanghai traded flat for the day. Europe, however, which sold off sharply on Friday, with many markets down more than 4%, has rebounded somewhat this morning (DAX +0.7%, CAC +1.1%, FTSE 100 +1.2%) although these markets are obviously well lower than Thursday’s closing levels. Finally, US equities sold off sharply in Friday’s abbreviated session, with all three indices down about 2.3% but this morning futures are all rebounding as well, up between 0.6% and 0.8%.
Bonds saw the most dramatic move on Friday, with Treasury yields tumbling 16 basis points while European yields all fell as well, albeit less dramatically. This morning, with risk back in vogue, bonds are back under pressure with Treasuries (+6.8bps) leading the way but all of Europe (Bunds +2.7bps, OATs +1.5bps, Gilts +3.9bps) also seeing higher yields.
It should come as no surprise that the dollar is also reversing some of Friday’s price action with the commodity bloc doing well (SEK +0.4%, CAD +0.3%, AUD +0.3%) while the financials are under modest pressure (EUR -0.2%). This movement is nothing more than a reaction to the Friday movement. EMG currencies are seeing similar price action with the best performers the commodity bloc here (RUB +0.9%, ZAR +0.7%) while weakness has been seen in TRY (-3.45%) and CLP (-0.7%). The former continues to suffer from President Erdogan’s comments about never raising interest rates to fight inflation while the peso is reacting to early polls showing the leftist, Gabriel Boric, leading ahead of the runoff presidential election in 3 weeks.
It is a week full of data culminating in Friday’s payroll report although it starts out slowly.
|Tuesday||Case Shiller Home Prices||19.35%|
|ISM Prices Paid||85.8|
|Fed Beige Book|
|Average Hourly Earnings||0.4% (5.0% Y/Y)|
|Average Weekly Hours||34.7|
In addition to all that data, we hear from Chairman Powell (and Secretary Yellen) in front of the Senate and House on Tuesday and Wednesday as well as eight more Fed speakers during the week. If I were a betting man, I would expect that the broad message will continue to be that while inflation is not a long-term problem, it is appropriate to continue to normalize monetary policy now. And that will be the message right up until markets force them to make a choice by either selling off sharply and forcing an end to policy tightening or running to new highs dragging inflation expectations, as well as inflation, along with them.
Meanwhile, the dollar remains beholden to the latest whims. If tightening is back on the table, then look for the dollar to resume its uptrend. However, if Omicron, or something else, causes a change in the message, the dollar seems likely to pull back smartly.
Good luck and stay safe