A Wrong Turn

In Europe, the reading today
For CPI led to dismay
With prices still rising
Lagarde’s now revising
The timing for QE’s decay

Then later this morning we’ll learn
If Jay has a cause for concern
Should payrolls be strong
It will not be long
Til stock markets take a “wrong” turn

There seem to be three stories of note today with varying impacts on market behavior, and in the end, they are all loosely tied together.  Starting in Europe, CPI printed at a higher than forecast 5.0% in December, rising to a historic high for the Eurozone as currently constituted.  While energy prices were the largest driver of the data, even excluding those, CPI rose 2.6%, well above the current ECB target.  Given the series of remarkable energy policy blunders that have been made by the Europeans, one has to believe that it will be many more months before energy inflation has any chance of abating.  And as long as the continent remains reliant on Russia for its natural gas supplies, it will almost certainly be held hostage across other issues.  Remember, too, the more money spent on energy, where those funds leave the continent as they don’t really produce much of their own, the less money available for things like manufacturing and consumption of other goods.

The problem for the ECB is that the specter of slowing growth conflicts with their alleged desire to reduce QE and allow policy to “normalize”.  As we see in virtually every nation, the tension between addressing inflation and stifling growth is the crux of central bank decision making.  Madame Lagarde finds herself between the proverbial rock and hard place here.  As things currently stand, I fear the Eurozone is going to find itself in a position dangerously close to stagflation as the year progresses.  Do not be surprised if there are some major electoral changes this year.  PS, none of this is actually very good for the single currency, so keep that in mind as well.  While it has seemed to have stabilized over the past two months, another leg lower feels like it is still on the cards.  What Will Christine Do? History shows that central banks almost always err on the side of higher inflation, so do not be surprised if that is the case here as well.

Turning to the States, it is payroll day with the following forecasts:

Nonfarm Payrolls 447K
Private Payrolls 405K
Manufacturing Payrolls 35K
Unemployment Rate 4.1%
Average Hourly Earnings 0.4% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.9%

Source: Bloomberg

With the market and investors still absorbing what seemed to be an even more hawkish set of FOMC Minutes than anticipated, where they extensively discussed QT, this has all the trademarks of a ‘good news is bad’ set-up, such that a strong print (>600K) will result in a bond and stock market sell-off as investors flee duration assets.  Remember, too, the ADP number printed at 807K, nearly double expectations and the highest since May21.  Since that release, forecasts have risen by about 50K and whispers even more.  The point is that if US data really starts to show significantly more strength, expectations are going to grow for more rate hikes this year as well as a quicker pace of allowing the balance sheet to shrink.  And that, my friends, will not be a good look for risky assets.

There once was a firm, Evergrande
In China, that bought tons of land
In order to build
Apartment blocks filled
With people, but now must disband

The problem for China is they
Explained, when this firm went astray
Twas under control
And they would cajole
Investors, their sales, to delay

Finally, before we move on to today’s markets, I would be remiss if I didn’t point out a change of tone from China overnight, one that was not officially announced but is true nonetheless.  You may remember back in September when we first heard about China Evergrande and the fact that the second largest property developer in that country, and the most indebted, was having trouble repaying its loans.  Initially there was talk by the doomsayers that this was China’s Lehman moment, and everything would unravel quickly.  Of course, that did not happen, although what we have seen since is a slower unraveling of that company and many others in the sector.  It turns out that when your business model is premised on borrowing excessive amounts of money to build apartment blocks in ghost cities, there could be problems down the line.

At any rate, the PBOC was adamant that everything was under control and that, anyway, China Evergrande’s borrowings weren’t that big compared to China’s GDP.  (That always sounded an awful lot like Bernanke’s comments regarding subprime mortgages.)  More recently, the PBOC imposed three ‘red lines’ regarding the ability of property developers to borrow money as they were really trying to squeeze the speculation out of the property market, but without causing the bubble to actually burst, simply deflate.  These rules, though, meant that Evergrande, and the other very weak companies in the space, suddenly had no source of funding.  Well, last night it was discovered that the PBOC has actually instructed banks to lend to property companies more aggressively.  Apparently the PBOC’s red lines have as much value as Qaddafi’s or Obama’s, in other words, none.  It can be no surprise that the PBOC has reversed course given the potential problems that exist in the Chinese property sector.  Just beware as things there remain opaque and in flux, although I doubt the renminbi is set to move dramatically soon.

Ok, quickly, after yesterday’s US equity fizzle, where markets slid slightly, Asia was mostly the same although the Hang Seng (+1.8%) did manage to rally sharply after it became clear Evergrande would get more funding.  Europe has done essentially nothing, despite a generally weak mix of data (German IP -0.2%, French IP -0.4%) as investors seem to be waiting for the payroll number to assess the Fed’s actions.  US futures are little changed at this hour as well.

We are seeing similar lack of activity in the bond market as here, too, investors await the payroll numbers.  Yesterday saw essentially no change in the 10-year Treasury yield although shorter maturity bonds did see yields rise a couple of ticks as the market continues to look for rate hikes sooner rather than later.  Europe is also biding its time to see what comes from NFP, with no major markets having moved even 1 basis point from yesterday’s levels.

Oil prices continue to rise (+0.75%) with WTI now above $80/bbl for the first time in two months.  But we are seeing strength throughout this space with NatGas (+1.4%) and Uranium (+3.5%) showing all energy is bid.  In fairness, the Uranium story is squarely on the back of the uprising in Kazakhastan where some 40% of global uranium is mined.)  On the metals front, both precious (Au +0.2%, Ag +0.2%) and base (Cu +0.3%, Al +0.5%, Zn +2.7%) are all in favor with only agricultural prices under pressure today.

As to the dollar, it is somewhat softer but not universally so.  SEK (+0.4%) and NOK (+0.3%) are the leading gainers in the G10 with oil helping the latter while the former continues to benefit from perceptions of still strong economic activity despite the latest wave of omicron.  However, other than these, movement is 0.1% or less in either direction, signifying absolutely nothing.  EMG currencies, though, have definitely seen more strength with ZAR (+0.7%), RUB (+0.7%) and CLP (+0.5%) all responding positively to the commodity rally.

And that is really it for the day.  My take on the NFP data is that good news (i.e. a strong print) will be a negative for risk assets as estimates will be that the Fed needs to move that much quicker to alleviate the inflation pressures.  That means a classic risk-off scenario of stronger dollar, stronger yen and weaker equities.  Bonds, however, are likely to see curve flattening more than higher rates, as the front end will be sold aggressively while the back lags appreciably.

Good luck, good weekend and stay safe