Tag Archives: #NFP

Growing Disdain

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There is now a silver haired queen
Whose role since she came on the scene
Has been to explain,
With growing disdain,
Inflation is still unforeseen
 
Her minions, as well, all campaign
To make sure the message is plain
Though prices are rising
They won’t be revising
Their plans, or so said Philip Lane
 
There is a growing disconnect between the ECB and the rest of the world’s central banks.  While the transitory narrative has been increasingly taken out back and shot, the ECB will not let that story die.  Just today, ECB Chief Economist Philip Lane defended the ECB stance, explaining, “If we look at the situation over the medium term, the inflation rate is still too low, below our 2% target.  This period of inflation is very unusual and temporary, and not a sign of a chronic situation.  The situation we are in now is very different from the 1970’s and 1980’s.”  [author’s emphasis]  In other words, in case Madame Lagarde’s comments from last week that the ECB is “very unlikely” to raise rates next year, were not clear, the ECB is telling us that their mind is made up and there will be no policy tightening in the foreseeable future.
 
In fairness, raising interest rates will not convince Russia to pump more natural gas through the pipelines to help mitigate the dramatic rise in prices there.  Nor will it help build new semiconductor fabs to alleviate that shortage.  However, what it might do is reduce demand for many things thus easing supply constraints and perhaps encouraging prices to fall.  After all, that is exactly what tighter monetary policy is supposed to do.  The problem with that logic, though, is that there isn’t a central banker on the continent that is willing to risk slowing down growth in order to address rapidly rising prices.  The politics of that move would likely bring more rioters into the streets.  Once again, central banks’ vaunted independence is shown to be a sham.  They are completely political and beholden to the government in charge at any given time.
 
And so, we are left with a situation where prices continue to rise throughout the world while the two largest economic areas, the US and Eurozone, maintain the easiest monetary policy in history.  Yes, I know the Fed said it would begin to reduce its QE purchases, but even if they do reduce purchases by $15 billion / month, they are still going to expand their balance sheet by a further $420 billion and interest rates are still at zero.  There remains virtually zero chance that inflation is going to fade as long as the current incentive structure remains in place. 
 
Speaking of the Fed, Friday’s NFP data was substantially better than expected with job growth rising 531K and revisions higher for the previous two months of an additional 235K.  The Unemployment Rate fell to 4.6% and wages continue to climb smartly, +4.9% Y/Y.  (Of course, on a real basis, that is still negative given the current 5.4% CPI with expectations that on Wednesday, the latest release will jump to 5.9%.)  However, Chairman Powell has indicated that the Fed believes there is still a great deal of slack in the labor market, based on the Participation Rate remaining well below pre-pandemic levels, and so raising rates prematurely would be a mistake.  Summing it all up, there is no reason to believe that either US or ECB monetary policy is going to be changing anytime soon, regardless of the data.
 
The question at hand, then, is what will this mean for markets in general and the dollar in particular?  As long as new, excess liquidity continues to flood the markets, there is little reason to believe that the ongoing bull market in equities, commodities, real estate, and bonds is going to end.  While history has shown that rising inflation will eventually hurt both bonds and stocks, we are not yet at that point, and quite frankly don’t appear to be approaching it that rapidly.  Though there remains a small cadre of old-timers (present company included) who have a difficult time accepting current valuations as normal and who have actually lived through inflationary times, the bulk of the market participants do not carry that baggage and so are unencumbered by negative thoughts of that nature.  But, as an example of how inflation can degrade equity markets, from Q4 1968 through Q1 1980, the S&P 500 fell 1% in nominal terms while inflation averaged 7.1% per year with a high print of 14.8%.  The point is that the last time we had an inflation situation of the current magnitude, holding equities did not solve the problem.  As George Santayana famously told us back in 1905, “Those who cannot remember the past are condemned to repeat it.”
 
With this in mind, let us take a look at markets and the week ahead.  Aside from the ECB comments this morning, arguably the most impactful news from the weekend was the story that Elon Musk is planning to sell $20 billion worth of stock in order to pay his upcoming tax bill.  Not surprisingly Tesla’s stock is lower by nearly 6% on the news and it seems to have put a damper on all equity activity.  After all, if Tesla isn’t going higher, certainly nothing else can have value!
 
Looking at equity markets, Asia (Nikkei -0.35%, Hang Seng -0.4%, Shanghai +0.2%) were mixed but leaning weaker.  That is an apt description of Europe as well (DAX -0.2%, CAC +0.2%, FTSE 100 -0.1%) although overall, the movement has not been that significant.  US futures, meanwhile, are little changed although NASDAQ futures are slightly lower while the other two major indices are edging higher.
 
Bonds, on the other hand, are all under pressure with Treasuries (+2.8bps) leading the way although this was after a major rally on Friday that saw the 10-year yield fall 7bps and a total of 15bps since the FOMC last Wednesday.  But European sovereigns, too, are all lower with yields rising (Bunds +2.0bps, OATs +2.1bps, Gilts +2.9bps).  Perhaps bond investors are beginning to register their concern over the inflation story.
 
On that front, commodity prices are rebounding off the lows seen last week led by energy with oil (+1.25% and back over $82/bbl) and NatGas (+1.1%) both having good days.  The rest of the space, though, is more mixed with copper (+0.2%) and tin (+0.4%) both firmer this morning, while aluminum (-0.2%) and iron ore (-3.25%) are both suffering.  Precious metals are little changed although Friday saw a sharp rally in the barbarous relic.  And yes, the cryptocurrency space is rocking today as well.
 
As to the dollar, it has had a mixed performance this morning with both gainers and losers across the G10 and EMG spaces.  In the G10, NZD (+0.6%) is the clear leader as the government is talking of ending the draconian lockdown measures by the end of the month.  In fact, we saw similar behavior in the EMG currencies as THB (+0.8%) and IDR (+0.5%) rallied on similar news.  On the flip side, BRL (-0.8%) continues to decline despite the central bank being one of the most aggressive in its rate hike path having raised the SELIC rate from 2% in March to 7.75% last month with expectations growing for yet another hike in December.  Of course, inflation is running at 10.25% there, so real yields remain firmly negative.
 
On the data front, this is inflation week with both the PPI and CPI on the docket.
 

Tuesday

NFIB Small Biz Optimism

99.5

 

PPI

0.6% (8.6% Y/Y)

 

-ex food & energy

0.5 (6.8% Y/Y)

Wednesday

Initial Claims

263K

 

Continuing Claims

2050K

 

CPI

0.6% (5.9% Y/Y)

 

-ex food & energy

0.4% (4.3% Y/Y)

Friday

JOLTS Job Openings

10.4M

 

Michigan Sentiment

72.5

Source: Bloomberg
 
Of course, the Fed doesn’t care about CPI as its models work better with core PCE, which also happens to be designed to be permanently lower.  The rest of us, however, know better and recognize the pain.  We have a number of Fed speakers on the calendar this week as well, with Chairman Powell headlining 9 planned appearances.  My sense is that there will be a strenuous effort to press the storyline that inflation may take a little longer to fall back, but don’t worry, it will fall again.
 
If pressed, I would say the dollar is far more likely to continue to grind higher, but that any movement will be slow.  While Treasury yields are not supportive right now, the reality is that amid major currency bonds, Treasuries continue to offer the best combination of yield and liquidity so remain in demand.  I think that along with the need for other economies to buy dollars to buy energy will maintain the bid in the buck.
 
Good luck and stay safe
Adf
 

Their Latest Excuse

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While prices worldwide keep on rising
Most central banks are still devising
Their latest excuse
For why money, loose,
Is still the least unappetizing

On Wednesday Chair Powell explained
That QE would slowly be drained
Then Thursday the Bank
Of England helped sank
Gilt yields, leaving traders bloodstained

Now Friday’s arrived and we’re all
Concerned that a Payrolls curveball
Could quickly defuse
The new dovish views
With hawks back for their curtain call

If you sell stuff in the UK, or hold assets there, I sure hope you’ve hedged your currency exposure.  In what can only be described as shocking, the Bank of England left policy on hold yesterday after numerous hints from members, including several explicitly from Governor Andrew Bailey, that something needed to be done about rising inflation. The combination of rising inflation prints, rising inflation forecasts and comments from BOE members had the market highly convinced that a 0.15% base rate hike was coming yesterday, with the idea it would then allow the central bank to hike further in 25 basis point increments with futures pointing to the base rate at 1.00% come next December.  But it was not to be.  Instead, in a 7-2 vote, the BOE left policy rates unchanged and will continue its current QE program which has £20 billion left to buy to reach their target.

The result was a massive repricing of markets as interest rates tumbled across the entire curve and the pound tumbled along side them.  In what is perhaps the most brazen lie audacious statement from a major central banker lately, Bailey explained in a Bloomberg TV interview that it was “not our job to steer markets.”  Seriously?  That is all every central banker ever tries to do.  If financial stability is one of the goals enumerated for central banks, the BOE failed dismally yesterday.  Tallying up the impact shows that 10-year Gilt yields fell 13 basis points (and another 4.1 this morning), OIS markets saw the 1-year interest rate decline 20 basis points and the pound fell 1.4% yesterday and a further 0.5% this morning.  It was ugly.

Perhaps the lesson to learn here is that as central banks around the world try to adjust monetary policy going forward, there are going to be a lot more bumps along the way, with market expectations being left unfulfilled and severe market reactions accordingly.  Forward guidance, which has become a critical tool for central banks over the past decade plus is no longer going to be as effective.  When Ben Bernanke highlighted the idea in 2009, it was thought to be a great addition to the central bank toolkit, the ability to adjust markets without adjusting policy.  And while that may have been true when monetary policy was being eased for years, it turns out that forward guidance is a bit more difficult to handle in the other direction.  Market volatility, across all markets, is likely to increase over the next couple of years as the coordinated central bank activities we have become used to seeing disappear.  Consider that while the Fed, ECB, BOJ and BOE have all pushed back on raising rates soon, the Norgesbank, BOC, RBNZ, RBA and a host of emerging market central banks are starting the process or already well along the way.

Turning to this morning’s data, if you recall, the last two NFP numbers were quite disappointing, with both coming in well below expectations.  The only thing we know about the labor market is that we don’t really know what is going on there anymore.  Clearly, based simply on the JOLTS data we know there are more than 10 million job openings in the country.  (That is also made obvious whenever you leave your home and see all the help wanted signs in store windows.)  But despite clearly rising wages, it has thus far not been enough to entice many people back into the labor force.  So, the Unemployment Rate remains far higher than it was pre-pandemic, but there are plenty of jobs available.  In this situation I feel for the Fed, as there is no clarity available with conflicting data rampant.  At any rate, here are the forecasts heading into the release:

Nonfarm Payrolls 450K
Private Payrolls 420K
Manuacturing Payrolls 30K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%

Source: Bloomberg

One interesting thing is that excluding the pandemic stimulus checks, the current Y/Y Earnings data is the highest since the series began in 2006.  And worse still, it is lagging CPI by at least a half-point.  My sense is that we are likely to see another weaker than expected number as the kinks in the labor market have not yet been worked out.

Ok, a quick look at markets shows that Asia had a rough go of it last night (Nikkei -0.6%, Hang Seng -1.4%, Shanghai -1.0%) as continued concerns over the Chinese property market weigh on the economy there while Japan looks more like position adjustment ahead of the weekend.  Europe, on the other hand, is doing much better (DAX +0.15%, CAC +0.6%, FTSE 100 +0.55%) despite much weaker than expected IP data from both Germany (-1.1%) and France (-1.3%) in September.  Too, Eurozone Retail Sales (-0.3%) badly missed expectations in September, but revisions helped ameliorate some of those losses.  Regardless, I would argue that the weak data has encouraged investors and traders to believe that all the talk of tightening to address inflation is ebbing.  Meanwhile, US futures, which had spent the bulk of the evening essentially unchanged are now higher by about 0.25%.

Bond yields are generally lower again this morning with most European sovereigns seeing declines of around 1 basis point except for Gilts, pushing 4bps.  Treasuries, which had seen softer yields earlier in the session have now turned around and edged lower (higher yields) but are still less than a basis point different from yesterday’s close.

Commodity prices also had a wild session yesterday with oil initially rallying $2/bbl before abruptly reversing and falling $5/bbl to close back below $80 for the first time in a month.  Given that backdrop, this morning’s 0.6% rise seems less interesting and it is still below $80.  NatGas (-0.5%) has slipped this morning, while the rest of the commodity complex is showing no trends whatsoever, with both gainers and losers.  Like every other market, traders are trying to come to grips with the new central bank situation.

The one consistency has been the dollar, which rallied yesterday and is continuing today.  In the G10, the pound (-0.5%) is the worst performer but we are seeing weakness in AUD (-0.4%), CHF (-0.4%) and NOK (-0.35%) as well with the entire bloc under pressure.  NOK is clearly still being impacted by yesterday’s oil moves while the others seem to be feeling the heat from suddenly more dovish thoughts regarding policy.  In the EMG space, PHP (+0.55%) is the outlier, rallying on comments from the central bank that it will continue to support the economy and news that the Covid infection rate has been falling.  Otherwise, the bulk of the bloc is in the red led by ZAR (-0.45%), PLN (-0.4%) and MXN (-0.35%).  Of these, the most noteworthy is PLN, where the central bank, which had just been touting its hawkish bona fides, has completely reversed and indicated that further rate hikes may not be necessary.  This seems odd given inflation is running at 6.8%, and forecast to top 8.0% next year, while the base rate was just raised to 1.25%.  It feels to me like PLN could fall further.

So, for now, we all await the payroll data and then get to reevaluate our views and expectations of Fed actions.  Nothing has changed my view that inflation will continue higher and nothing has changed my view that growth is going to slow.  So, while the Fed may begin to taper, I still believe they will stop before the end.  However, for now, the Fed is the most hawkish dove out there, so the dollar can continue to rally.

Good luck, good weekend and stay safe
Adf

A Gordian knot

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Now, what if inflation is not
As transit’ry as Powell thought?
And what if there’s slowing
Instead of more growing?
Would that be a Gordian knot?

Well, lately the bond market’s view
Appears to be, in ‘Twenty-two
Inflation will soar
Much higher before
The Fed figures out what to do

The Fed has been pushing the transitory inflation narrative for quite a while now, but lately, they have been struggling to get people to accept it at face value.  You can tell this is the case because pretty much every third story in any newsfeed is about rising prices in some product or service.  Commodities are particularly well represented in these stories, especially energy, as oil, NatGas and coal have all seen dramatic price rises in the past month or so.  It is also important to understand that despite the durm und strang regarding the continued use of coal as an energy source, it remains the largest source of electricity worldwide.  I bring this up because the situation in China is one where the country is restricting energy use due to a lack of coal available to burn.  (Perhaps one of the reasons for this is the Chinese, in a snit over Australia calling them out as to the origins of Covid-19, banned Australian coal imports.)

From an inflation perspective, this has the following consequences: less coal leads to less electricity production which leads to restrictions on electricity use by industry which leads to reduced production of everything.  Given China’s importance in the global supply chain for most products, less production leads to shortages and, presto, higher prices.  And this is not going to end anytime soon.  Much to the Fed’s chagrin, they can print neither coal nor NatGas and help mend those broken supply chains.  Thus, despite their (and every other central bank’s) efforts to repeal the laws of supply and demand, those laws still exist.  So, just as April showers lead to May flowers, less supply leads to higher prices.

The difference in the past week or so is that bond markets worldwide have started to cotton on to the idea that inflation is not transitory after all.  Yields have been rising and curves steepening, but even the front end of yield curves, where central banks have the most impact, have seen yields rise.  So, a quick look at global bond markets today shows yields higher in every major market around the world.  Treasuries (+1.1bps) have not moved that far overnight but are higher by 12bps in the past week.  Gilts (+4.8bps) on the other hand, have seen real selling in today’s session, also rising 12bps in the past week, but on a lower base (10-year Gilts yield 1.125% vs. 1.58% for Treasuries.)  And the same situation prevails in Bunds (+2.6bps, +6.6bps in past week), OATs (+2.5bps) and the rest of Europe.  Asia is not immune to this with even JGB’s (+1.2bps, +4bps in past week) selling off.  The point is that bond investors are starting to recognize that inflation may be more persistent after all.  And if the Fed loses control over their narrative, they have much bigger problems.  Forward guidance remains a key monetary policy tool, arguably more important that the Fed Funds rate these days, so if that is no longer effective, what will they do?

Needless to say, risk attitudes are starting to change somewhat as concern grows that almost the entire central banking community, certainly the Fed and ECB, will be too slow to react to very clear inflation signals.  In this situation, financial assets will definitely suffer.  Keep that in mind as you look ahead.

OK, next we need to look to this morning’s NFP report as that has been a key element of the recent market inactivity.  Investors are looking for confirmation that the Fed is going to begin tapering next month and have certainly been encouraged by both the ADP Employment number as well as yesterday’s much lower than expected Initial Claims data.  Here’s what current median forecasts look like:

Nonfarm Payrolls 500K
Private Payrolls 450K
Manufacturing Payrolls 25K
Unemployment Rate 5.1%
Average Hourly Earnings 0.4% (4.6% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.8%

Source: Bloomberg

Powell explained that as long as this report was not terrible, he felt the tapering would begin.  Interestingly, the range of forecasts is 0K to 750K, a pretty wide range of disagreement as to how things might play out.  Certainly, a number like last month’s 235K could throw a wrench into the tapering process.  Personally, my take is slightly weaker than median, but not enough to change the taper idea.

On a different note, I cannot help but look at the Average Hourly Earnings forecasts and wonder how any Fed speaker can argue that wages aren’t growing rapidly.  Absent the Covid induced gyrations, 4.6% is the highest number in the series by far going back to early 2007.  Again, this speaks to persistent inflationary pressures, not transient ones.

But we will know shortly how things turn out, so a quick recap before then shows that equity markets had a good session in Asia (Nikkei +1.3%, Hang Seng +0.55%, Shanghai +0.7%) but are less giddy in Europe (DAX -0.1%, CAC -0.4%, FTSE 100 0.0%).  Meanwhile, US futures are essentially unchanged ahead of the data.

We’ve already discussed the bond market selloff and cannot be surprised that commodity prices are mostly higher led by oil (+0.8%) and NatGas (+0.1%), but also seeing strength in gold (+0.3%).  Industrial metals are having a rougher go of it (Cu -0.3%, Al -0.4%) and Ags are a bit firmer this morning with all three major grains higher by about 0.55%.

As to the dollar, it is mixed this morning ahead of the data with the largest gainer NOK (+0.4%) on the back of oil’s strength, while SEK (+0.3%) is also firmer although with no clear driver other than positioning ahead of the data.  On the downside, JPY (-0.15%) continues under pressure as higher US yields continue to attract Japanese investors.

EMG currencies have seen a more negative session with PLN (-0.6%), TRY (-0.5%) and RUB (-0.5%) all under pressure and the APAC bloc mostly falling, albeit not quite as far.  The zloty story seems to be concerns over a judicial ruling that puts Poland further at odds with the EU which has been sufficient to offset the boost from yesterday’s surprise rate hike.  In Turkey, a story that President Erdogan is “cooling” on his view toward the central bank governor seems to have markets nervous while in Russia, rising inflation and limited central bank response has investors concerned despite oil’s rally.

There are no Fed speakers on the calendar today so it will all be about the NFP number.  Until then, don’t look for much, and afterwards, there is typically a short burst of activity and a slow afternoon.  I don’t think the big trend of dollar strength has ended by any means, but it is not clear today will see much of a gain.

Good luck, good weekend and stay safe
Adf

Resolute

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The narrative is resolute
That though prices did overshoot
They’re certain to fall
And that, above all,
The Fed’s in control, absolute

However, concern is now growing
That growth round the world’s started slowing
Though Friday’s report
On jobs was the sort
To help the bull market keep going

Clearly, my concerns over a weak payroll report were misplaced as Friday’s data was strong on every front, although perhaps too strong on some.  Nonfarm payrolls grew a robust 943K with net revisions higher of 119K for the past two months.  The Unemployment Rate crashed to 5.4%, down one-half percent, and Average Hourly Earnings rose 4.0% Y/Y.  It is the last of these that may generate some concern, at least from the perspective of the transitory inflation story.

While it is unambiguously good news for the working population that their wages are rising, something that has been absent for the past two decades, as with Newton’s first law (every action has an equal and opposite reaction) the direct result of rising wages tends to be rising prices.  So, while getting paid more is good, if the things one buys cost more, the net impact may not be as positive.  And in fact, consider that while the 4.0% annual rise is the highest (excluding the distortions immediately following the  Covid-19 lockdowns) in the series since at least the turn of the century, when compared to the most recent CPI data (you remember, 5.4%) we find that the average employee continues to fall behind on a real basis.

When discussing inflation, notice that the Fed harps on things like used car prices or hotel prices as the key drivers of the recent rise in the data.  They also tend to explain that commodity prices play a role, and that is something they cannot control.  But when was the last time Chairman Powell talked about rapidly rising wages or housing prices as an underlying cause of inflation?  In fact, when asked about whether the Fed should begin tapering mortgage-backed securities purchases sooner because of rapidly rising house prices, he claimed the Fed’s purchases have no impact on house prices, but rather it was things like the temporary jump in lumber prices that were the problem.  Oh yeah, and see, lumber prices have fallen back down so there is nothing to worry about.

Of course, wages are not part of CPI directly.  Rising wages are reflected in the rising prices of everything as companies both large and small find it necessary to raise prices to maintain their profitability.  Certainly, there are some companies that have more pricing power than others and so are quicker to raise prices, but in the end, rising wages result in one of two things, higher prices or lower margins, and oftentimes both.  In the broad scheme of things, neither of these outcomes is particularly positive for generating real economic growth, which is arguably the goal of all monetary policies.

Consider, to the extent rising wages force companies to raise the price of their product or service, the result is an upward bias in inflation that is independent of the price of oil or lumber or copper.  In fact, one of the key features of the past 40 years of disinflation has been the fact that labor’s share of the economic pie has fallen substantially compared to that of capital.  This has been the result of the globalization of the workforce as the addition of more than 1 billion new workers from developing nations was sufficient to keep downward pressure on wages.

Arguably, this has also been one of the key reasons corporate profit margins have risen and stock prices along with them.  Now consider what would happen if that very long-term trend was in the process of reversing.  There is a likelihood of rising prices of goods and services, otherwise known as inflation.  There is also a likelihood of a revaluation of equity prices if margins start to decline. And nothing helps margins decline like rising labor costs.

Consider, also, this is the sticky type of inflation, exactly the opposite of all the transitory claims.  This is the widely (and rightly) feared wage-price spiral.  I am not saying this is the current situation, at least not yet, but that things are falling into place that could easily result in this outcome.

Now put yourself in Chairman Powell’s shoes.  Prices have begun rising more rapidly as companies respond to rising wage pressures.  The employment situation has been improving more rapidly so there is less concern over the attainment of that part of your mandate.  But…the amount of leverage in the system is astronomical with government debt running at record high levels (Federal government at 127%) and all debt, including household and corporate at 400% of GDP.  Do you believe that the economy can withstand higher interest rates of any substance?  After all, in order to tackle inflation, real rates need to be positive.  What do you think would happen if the Fed raised rates to 6%?  And this is my point as to why the Fed has painted themselves into the proverbial corner.  They cannot possibly respond to inflation with their “tools” because the negative ramifications would be far too large to withstand.  It is also why I don’t’ believe the Fed will make any substantive policy changes despite all the tapering talk.  They simply can’t afford to.

Ok, on to the markets.  One of the notable things overnight was the flash crash in the price of gold, which tumbled $73 as the session began on a huge sell order in the futures market, although has since regained $54 and is currently down 1.1% from Friday’s close.  The other things was the release of Chinese CPI (1.0%) and PPI (9.0%), both of which printed a few ticks higher than expected.  Obviously, there is not nearly as much pass-through domestically from producer to consumer prices in China, but that tends to be a result of the fact that consumption is a much smaller share of the Chinese economy.  However, higher prices on the production side, despite the government’s efforts to stop commodity speculation and hoarding, does not bode well for the transitory story.  And while discussing EMG inflation readings, early this morning we saw Brazil (1.45% M/M) and Mexico (5.86% Y/Y) both print higher than forecast results.  Certainly, it is no surprise that both central banks are in tightening mode.

A quick peak at equity markets showed Asia performed reasonably well (Nikkei +0.3%, Hang Seng +0.4%, Shanghai +1.0%) although Europe has been struggling a bit (DAX -0.2%, CAC -0.1%, FTSE 100 -0.4%).  US futures, meanwhile, are either side of unchanged with very modest moves.

Treasury yields have given back 2 basis points from Friday’s post-NFP surge of 7.5bps, although there are many who continue to believe the short-term down trend has been ended.  European sovereigns are also rallying a bit, with Bunds (-1.3bps), OATs (-1.3bps) and Gilts (-3.5bps) leading a screen that has seen every European bond rally today.

Commodity prices are perhaps the most interesting as oil prices have fallen quite sharply (-4.0%) with WTI back to $65.50/bbl, its lowest level since late May.  This appears to be a recognition of the growth of the Delta variant and how more and more nations are responding with another wave of lockdowns and restrictions on movement, thus less travel and overall economic activity.  As such, it should be no surprise that copper (-1.5%) is lower or that the metals space as a whole is under pressure.

Interestingly, the dollar is not showing a clear trend at all today, with gainers and losers about evenly mixed and no particularly large moves.  In the G10, NOK (-0.3%) is the laggard, clearly impacted by oil’s decline, but away from that, the mix is basically +/- 0.1%, in other words, no real change.  In the emerging markets, ZAR (+0.3%) is the leader, although this appears more to be a response to its sharp weakness last week than to any specific news.  And that is the only EMG currency that moved more than 0.2%, again, demonstrating very little in the way of new information.

Data this week brings CPI amongst a bunch of lesser numbers:

Today JOLTS Jobs Openings 9.27M
Tuesday NFIB Small Biz Optimism 102.0
Nonfarm Productivity 3.2%
Unit Labor Costs 0.9%
Wednesday CPI 0.5% (5.3% Y/Y)
-ex food & energy 0.4% (4.3% Y/Y)
Thursday Initial Claims 375K
Continuing Claims 2.88M
PPI 0.6% (7.1% Y/Y)
-ex food & energy 0.5% (5.6% Y/Y)
Friday Michigan Sentiment 81.2

Source: Bloomberg

At this point, the response to the CPI data will be either of the following; a high number will be ignored (transitory remember), and a low number will be proof they are correct.  So, while we may all be suffering, the narrative will have no such problems!

There are a handful of Fed speakers this week as well, with the two most hawkish voices (Mester and George) on the calendar.  Right now, the narrative has evolved to tapering is part of the conversation and Jackson Hole will give us more clarity.  The market is pricing the first rate hike by December 2022 based on the recent commentary.  We shall see.  Until then, I don’t anticipate a great deal as many desks will be thinly staffed due to summer vacations.  Just be careful if you have a large amount to execute.

Good luck and stay safe
Adf

A New Endeavor

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A trend that is growing worldwide
Shows policy’s been modified
From lower forever
To a new endeavor
That tapering must be applied

But what if the jobless report
Frustrates and the number falls short?
Will traders respond
By buying the bond?
Or will sellers keep holding court?

While today is a summer Friday, which typically holds little excitement except for the anticipation of the weekend, there is a bit more at stake this morning with the release of the July NFP report at 8:30.  Given that we appear to be reaching an inflection point in policymaking circles, today’s data could either cement the changes that seem to be coming, or it could throw cold water on the entire process and take us back to square one.

The one thing that we have heard consistently over the past several weeks is that there is a growing desire by a widening array of FOMC members to begin tapering asset purchases.  While Chairman Powell has not yet indicated he is ready, and a key lieutenant, Governor Lael Brainerd, was forceful in her views that it was way too early to do so, at least six or seven other members are ready to roll, with the latest being vice-chair Clarida and SF President Daly.  But all of this tightening talk is predicated on the idea that not only has the inflation part of their mandate been achieved (gotten out of hand really), but that they have made progress on the employment part.

This brings us to today’s report.  Since December, when the number was negative amid the second wave of the Covid outbreak, we have seen the following numbers: 233K, 536K, 785K, 269K, 583K, 850K. Historically, all of those numbers would be seen as strong, but obviously, given the 20 million job losses at the beginning of the lockdown last year, those numbers represent a very different situation now.  A rudimentary look at the pattern would have you believe that today’s print, expected at 858K, is more likely to come at a much lower number, something like 250K-300K.  Frankly, the thing that has me concerned is that the monthly survey is taken during the week that contains the 15th of the month.  A quick look back at the weekly Initial Claims data for that week in July shows it was a surprisingly high 424K, a relatively high level given the prior trend.  So, it could well be that a quirk in the data may result in a disappointing headline number.  Remember, too, that the ADP Employment number was a MUCH weaker than expected 330K, so another potential sign of impending weakness.  My point is that there is a very real opportunity for a negative surprise this morning.

The question is; if we do get a negative surprise, will markets ignore it?  Or will they reevaluate their current belief set that tapering is on the way?  As it happens, there are no Fed speakers scheduled for today, so it is not obvious that anyone will be able to clarify things in that situation.

Ahead of the number, markets continue to demonstrate their belief that tighter monetary policy is coming to the US.  This is made evident by the dollar’s continuing strength, with the euro (-0.25%) testing the 1.18 level and stronger vs. all of its G10 and most of its EMG counterparts.  It is evident in the continued backing up in Treasury yields, which after trading as low as 1.1275% Wednesday ahead of the Clarida comments, are now higher by 3.3 basis points this morning and trading back at 1.26%.  While this is hardly “high” in a broad sense, the recent movement does demonstrate a clear trend

Equity markets seem to be somewhat less concerned, as yesterday, once again, US markets traded to new all-time highs.  European markets are all modestly in the green this morning and only China, which continues to attack its own companies (the latest being Moutai, the food delivery service that is mooted to be fined >$1 billion for no apparent reason), has seen any real weakness in this space.  But equity investors will continue to claim TINA until yields have really made a comeback.  And despite the modest declines we have seen in bond prices today, we have actually seen negative yielding debt rise further, to $16.9 trillion, as of yesterday, hardly a sign of tighter policy.

So, overall, we are mostly given mixed signals by markets and policymakers and need to sort things out for ourselves.  The first thing to do is look at what is expected this morning

Nonfarm Payrolls 858K
Private Payrolls 709K
Manufacturing Payrolls 26K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $23.0B

Source: Bloomberg

Between the widening spread of the delta variant, which is clearly disrupting supply chains around the world as well as causing more lockdowns and thus slowing economic activity, and the statistical noise and patterns, I have a feeling we are going to get a pretty bad number.  A print below 500K, which is my guess, is likely to force at least some rethinking of the timing for tapering.  Remember, while the Fed has admitted that some progress toward their goals has been achieved, their standard of “substantial further progress” remains “a ways away” according to Chairman Powell’s last comments.  A low print today will certainly delay the tapering talk.

In that event, how can we expect markets to respond?  Well, as the equity market sees all news as good news, it will clearly rally under the guise of easy money for longer.  Bond markets are also likely to push higher with yields slipping as concerns over a taper in the near-term dissipate.  But arguably, the biggest mover will be the dollar, which I believe has rallied sharply on the tapering talk, and if/when that fades, the short-term case for being long dollars will fade with it.

If I am wrong, and we get a strong number then the taper talk will intensify.  This should lead to further bond weakness (higher yields), a dollar rally and likely test of the key euro support at 1.1704, and … an equity rally since that is what stocks seem to do.

Good luck, good weekend and stay safe
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Dire Straits

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The Vice-Chair explained he foresees
A time when the Fed, by degrees
Will taper their buying
Of bonds while they’re trying
To offset the spread of disease

Soon after they finish that deed
Most members already agreed
To raise interest rates
Unless dire straits
In markets don’t let them succeed

Fed Vice-Chair Richard Clarida certainly surprised markets yesterday with his speech as he laid out his reasoning that the tapering of the Fed’s current QE purchases will occur sooner than many had previously expected.  While he started out with the caveat that the Fed will not be responding to forecasts, but rather to actual economic outcomes, he then proceeded to forecast the exact sequence of events that will occur and create the proper environment for the Fed to first, taper bond purchases and second, eventually raise interest rates.  The market response was immediate, with the bond market selling off sharply, the dollar rallying and equity markets ceding early gains alongside most commodity prices.  After all, a tighter Fed is not nearly as supportive of risk assets, but neither does it imply lower interest rates.  It is also worth noting that coincident with the release of the text of his speech was the release of the ISM Services number which printed at a much higher than expected, and record level, 64.1.  So, a positive data print and a hawkish Fed speaker were sufficient to change a lot of opinions.

But not this author’s, at least not yet.  My baseline view continues to be that the Fed remains in an extremely difficult position where inflation continues at much higher levels than which they expected or with which they are comfortable, but the employment market remains far away from their restated goal of maximum employment.  As well, as Clarida noted yesterday, and as has been repeated by numerous other Fed speakers, they promise they are not going to move on forecasts or survey data, but instead wait for actual numbers (read the NFP data and core PCE) to achieve their preferred levels before altering policy.  This means that tomorrow’s NFP data will be scrutinized even more closely than usual, as Clarida’s comments yesterday imply that even more FOMC members are ready to move.

One problem with the early taper thesis is that the data may not meet the FOMC’s requirements, at least not in the near term.  For instance, yesterday’s ADP Employment release printed at 330K, less than half the expected 690K and basically one-third of the forecasts for NFP tomorrow.  While the month to month correlation between the two data points is not perfect (0.784 over the past 5 years) it is certainly high enough to imply a strong relationship between the two.  The point is that if tomorrow’s NFP number disappoints, which cannot be ruled out, and assuming that the Fed is true to their word regarding waiting for actual data to reach their preferred levels, it would certainly suggest a delay to the tapering story.  Keep in mind, as well, that the Citi Economic Surprise Index, which measures actual releases vs. forecasts, remains in negative territory, implying that the economy is slowing further rather than extending gains seen earlier in the year.  In fact, after the much worse than expected GDP print last week, it appears that growth is already slipping back toward pre-Covid trends of 1.5% – 2.0%.  Oh yeah, none of this includes the impact of the delta variant, which has resulted in numerous lockdowns around the world and augers still slower growth.

On the flip side, though, is the fact that we have seen an increasing number of FOMC members start to accept the idea that tapering will soon be appropriate.  In addition to Clarida, yesterday we also heard from SF Fed President Daly, an avowed dove, who said, “Fed will do something on asset purchases end ’21 / early ’22.”  By my count, that makes at least six different FOMC members who have indicated tapering is coming soon.  Of this group, Clarida is by far the most important, but if even the doves like Daly are coming round to that view, tapering cannot be ruled out.

To taper or not remains the $64 trillion question for all markets, and while the recent trend of the narrative seems to be pushing in that direction, without support from ongoing improvements in employment data (after all, inflation is well through their target), it will still come to naught.

One last thing on inflation.  As the Fed tries to retake the narrative from the market, be prepared for a new description of inflation.  No longer will it be transitory, but rather, perhaps, tolerable.  In other words, they will accept that it is running hotter than their target and make the excuse that it is far more important to get the nation back to work first, at which point they can use those vaunted tools they frequently mention to address rapidly rising prices.

With all this in mind, the next question is, how will these changes impact the markets?  Yesterday’s price action is likely to be a very good case study if the data continues to support an early tapering of purchases.  Any interruption in the flow of money into the capital markets will be felt by both equities and bonds in the same way, they will fall in price, while the dollar is very likely to find a lot of support vs. both G10 and EMG counterparts.  As to commodities, my inclination is that the past year’s rally will pause, at the very least, but given they remain massively undervalued vs. other asset classes, they likely still have some upside.

On to today.  Overnight price action was mixed with the Nikkei (+0.5%) rising somewhat while Chinese shares (Hang Seng -0.8%, Shanghai -0.3%) were under pressure as stories about the next sectors to feel the wrath of regulators (sin stocks) were rampant with those falling and dragging the indices with them.  fortunately, they represent a much smaller portion of the market than the tech sector, so will have a smaller negative impact if that is, indeed, the situation.  Europe is mixed this morning (DAX +0.1%, CAC +0.35%, FTSE 100 -0.2%) as the morning data was inconclusive and investors there are far more concerned with the Fed than anything else.  As to US futures, they are all modestly higher this morning, about 0.2%.

Bond markets are showing the difference between central bank policy this morning with Treasuries consolidating yesterday’s declines and unchanged on the day, while European sovereigns (Bunds -1.0bps, OATs -1.2bps) continue to see support from an ECB that is nowhere near tightening policy.  Gilts (+2.0bps) on the other hand, are selling off a bit as the BOE meeting, just ending, revealed several things.  First, they are prepared to go to negative interest rates if they need to.  Second, they will continue their current QE pace of £3.4 billion per week, and third, that they expect inflation to reach 4.0% in Q4 of this year.  They did, however, explain that if things proceed as expected, some tightening, read higher interest rates, may be appropriate.  while the initial move in the GBP was a sharp jump higher, it has already retraced those steps and at +0.2% is only modestly up on the day.

Commodity prices are mixed with oil consolidating after yesterday’s rout and unchanged on the day.  In fact, the same is true of precious and most base metals, as traders are trying to figure out their next move, so likely waiting for tomorrow’s data.

And the dollar, interestingly, is modestly softer vs. the G10 this morning, but that is after a strong rally yesterday in the wake of the Clarida speech.  The commodity bloc is leading the way (AUD +0.35%, NOK +0.3%, NZD +0.25%) despite the lack of commodity price action.  And this also sems to ignore the 6th lockdown in Melbourne since the pandemic began last year, as the delta variant continues to wreak havoc around the world.  The rest of the G10 though, has seen much less movement.  In the emerging markets, PHP (-1.0%) was by far the worst performer overnight as the covid caseload soared to record numbers and concerns over growth expanded.  After that, TRY (-0.6%) is the next worst, as President Erdogan came out with calls for a rate cut despite rampant inflation.  However, away from those two currencies, movement has been on the order of +/- 0.2%, indicating nothing very special.  Essentially, these markets have ignored Clarida.  One last thing to note here is yesterday, the central bank of Brazil raised its SELIC rate by 1.0% to 5.25%, as inflation is exploding there.  However while BRL has been modestly stronger over the past several sessions, this was widely priced in so there was no big movement.

Data-wise, today brings Initial Claims (exp 383K), Continuing Claims (3255K) and the Trade Balance (-$74.2B), none of which seem likely to change any opinions.  Rather, at this point, all eyes are on tomorrow’s NFP data.  We also hear from two Fed speakers, Governor Waller and Minneapolis President KashKari, who is arguably the most dovish of all.  certainly if he starts talking taper, then the die is cast.  We shall see.

As I said, if tapering is on the cards, the dollar will likely test its highs from March/April, so be prepared.

Good luck and stay safe
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Jay Powell’s Story

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This weekend the Chinese reported
That PMI growth has been thwarted
This likely implies
They’ll increase the size
Of stimulus, when all is sorted

Meanwhile, as the week doth progress
Investors will need to assess
If Jay Powell’s story
About transitory
Inflation means more joblessness

The conventional five-day work week clearly does not apply to China.  On a regular basis, economic data is released outside of traditional working hours as was the case this past weekend when both sets of PMI data, official and Caixin (targeting small companies), were reported.  And, as it happens, the picture was not very pretty.  In fact, it becomes easier to understand why the PBOC reduced the reserve requirement for banks several weeks ago as growth on the mainland is quite evidently slowing.  The damage can be seen not only in the headline manufacturing numbers (PMI 50.4, Caixin 50.3) but also in the underlying pieces which showed, for example, new export orders fell to 47.7, well below the expansion/contraction line.

While it is one of Xi’s key goals to wean China from the dominance of exports as an economic driver, the reality is that goal has come nowhere near being met.  China remains a mercantilist, export focused economy, where growth is defined by its export sector.  The fact that manufacturing is slowing and export orders shrinking does not bode well for China’s economy in the second half of the year.  To the extent that the delta variant of Covid is responsible for slowing growth elsewhere in the world, apparently, China has not escaped the impact as they claim.

However, in today’s upside-down world, weakening Chinese growth is seen as a positive for risk assets.  The ongoing ‘bad news is good’ meme continues to drive markets and this weaker Chinese data was no exception.  Clearly, investors believe that the Chinese are going to add more stimulus, whether fiscal or monetary being irrelevant, and have responded by snapping up risk assets.  The result was higher equity prices in Asia (Nikkei +1.8%, Hang Seng +1.1%, Shanghai +2.0%) as well as throughout Europe (CAC +0.8%, FTSE 100 +0.95%, DAX +0.1%) with the DAX having the most trouble this morning.  And don’t worry, US futures are all higher by around 0.5% as I type.

But it was not just Chinese equities that benefitted last night, investors snapped up Chinese 10-year bonds as well, driving yields lower by 5bps as expectations of further policy ease are widespread in the investment community there. That performance is juxtaposed versus what we are witnessing in developed market bonds, where yields are actually slightly firmer, although by less than 1 basis point, as the risk-on attitude encourages investors to shift from fixed income to equity weightings.

Of course, all this price action continues to reflect the fact that the Fed, last week, was not nearly as hawkish as many had expected with the tapering question remaining wide open, and no timetable whatsoever with regard to rate movement.  And that brings us to the month’s most important data point, Non-farm Payrolls, which will be released this Friday.  At this early point in the week, the median forecast, according to Bloomberg, is 900K with the Unemployment Rate falling to 5.7%.

Given we appear to be at an inflection point in some FOMC members’ thinking, I believe Friday’s number may have more importance than an August release would ordinarily demand.  Recall, the recent trend of US data has been good, but below expectations.  Another below expectations outcome here would almost certainly result in a strong equity and bond rally as investors would conclude that the tapering story was fading.  After all, the Fed seems highly unlikely to begin tapering into a softening economy.  Last week’s GDP data (6.5%, exp 8.5%) and core PCE (3.5%, exp 3.7%) are just the two latest examples of a slowing growth impulse in the US.  That is not the time when the Fed would historically tighten policy, and I don’t believe this time will be different.

There is, however, a lot of time between now and Friday, with the opportunity for many new things to occur.  Granted, it is the beginning of August, a time when most of Europe goes on vacation along with a good portion of the Wall Street crowd and investment community as a whole, so the odds of very little happening are high.  But recall that market liquidity tends to be much less robust during August as well, so any new information could well lead to an outsized impact.  And finally, historically, August is one of the worst month for US equities, with an average decline of 0.12% over the past 50 years.

Keeping this in mind, what else has occurred overnight?  While bad news may be good for stock prices, as it implies lower rates for even longer, slowing growth is not an energy positive as evidenced by WTI’s (-1.8%) sharp decline.  Interestingly, gold (-0.25%) is not benefitting either, as arguably the reduced inflation story implies less negative real yields.  More surprisingly, copper (+0.7%) and Aluminum (+0.6%) are both firmer this morning, which is a bit incongruous on a weaker growth story.

As to the dollar, it is broadly weaker, albeit not by much, with G10 moves all less than 0.2% although we have seen some much larger gains in the EMG space.  On top of that list sits ZAR (+1.15%) and TRY (+1.1).  The former is quite surprising given the PMI data fell by a record amount to 43.5, 14 points below last month’s reading as rioting in the wake of the Zuma arrest had a huge negative impact on business sentiment and expectations.  Turkey, on the other hand, showed a solid gain in PMI data, which bodes well for the economy amid slowing growth in many other places.  After those two, the gains were far more modest with HUF (+0.5%) and RUB (+0.35%) the next best performers with both the forint and the ruble benefitting from more hawkish central bank comments.

Obviously, it is a big data week as follows:

Today ISM Manufacturing 60.9
ISM Prices Paid 88.0
Construction Spending 0.5%
Tuesday Factory Orders 1.0%
Wednesday ADP Employment 650K
ISM Services 60.5
Thursday Initial Claims 382K
Coninuing Claims 3260K
Trade Balance -$74.0B
Friday Nonfarm Payrolls 900K
Private Payrolls 750K
Manufacturing Payrolls 28K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $22.0B

Source: Bloomberg

Beyond the data, surprisingly, we only hear from three Fed speakers as many must be on holiday.  But at this point, the market is pretty sure that it is only a matter of time before the Fed starts to taper, so unless they want to really change that message, which I don’t believe is the case, they can sit on the sidelines for now.  of course, that doesn’t mean they are going to taper, just that the market expects it.

While the dollar is opening the week on its back foot, I don’t expect much follow through weakness, although neither do I expect much strength.  I suspect many participants will be biding their time ahead of Friday’s report unless there is some exogenous signal received.

Good luck and stay safe
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Crucial Advice

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The Chinese Department of Price

Is proffering crucial advice

Don’t think about hoarding

It won’t be rewarding

And don’t make us speak to you twice!

There really is such a thing as the Department of Price in China.  It is part of the National Development and Reform Commission, the Chinese economic planning agency, although I have to admit it sounds more like something from Atlas Shrugged than a real agency.  But soaring commodity prices during the past year have become quite the problem for China, resulting in rising inflation and shortages of inputs for their manufacturers.  Apparently, President Xi is not pleased with this result and so this obscure (absurd?) government agency is now tasked with preventing prices from rising across a range of commodities.  Their tactics include threats against buyers deemed to be hoarding, against speculators in commodity trading firms and against manufacturers for passing on rising input costs to their final customers.  While one cannot help but chuckle at the futility of this effort (prices of things in demand will rise or shortages will result) it also highlights just how much of a concern inflation is to the Chinese and helps explain the recent PBOC action regarding FX reserves in order to stop/reverse the renminbi’s recent strength.  While a stronger renminbi would help ease inflationary pressures, its impact on exports, especially with input prices rising, was just too much to take.  For the foreseeable future, you can expect USDCNY to rise in a slow and steady manner.

Along with the FOMC

Investors are anxious to see

The payroll release

With forecast increase

To offset last month’s perigee

Turning to today’s news, markets remain quiet and rangebound ahead of this morning’s NFP report.  Last month’s abysmal outcome, just 266K new jobs, hugely below the nearly one million expected has increased the concern today.  While yesterday’s ADP Employment report was spectacular at 978K, last month it was nearly 750K and we still got that huge surprise.  Estimates this morning range from 335K to 1000K which tells us that nobody really knows, and none of the econometric models out there are well tuned to the current economic circumstances.  Here are the current median forecasts according to Bloomberg:

Nonfarm Payrolls 674K
Private Payrolls 610K
Manufacturing Payrolls 25K
Unemployment Rate 5.9%
Average Hourly Earnings 0.2% (1.6% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.8%
Factory Orders -0.3%

Following yesterday’s ADP report, the dollar, which had been drifting higher, got a huge boost and rallied strongly versus all its counterparts.  In addition, we saw sharp declines in precious metals prices and more modest declines in bond prices (yields on the 10-year rose about 4bps).  Arguably, that is exactly what one would expect with news that the US economy is growing more rapidly than previously thought.  But that begs the question for today, has the market already priced in a much larger number and so become subject to some serious profit-taking on a ‘sell the news’ meme?  My sense is that we will need to see a very large number, something on the order of 1.3 million to continue yesterday’s price action in markets.  Anything less, even if above the median forecast, will likely be seen as toppish and given it is a summer Friday, traders will be quick to square up positions.

Obviously, the FOMC is watching this data closely.  Recall, their stated goal is maximum employment and they continue to harp on the 8.1 million jobs that have not yet been replaced due to the Covid shutdown as well as the 2 million jobs that would have otherwise been created based on trend growth prior to the shutdown.  The point is that, given the transitory inflation pressures theme that has been universally repeated by every FOMC member, the Fed seems very likely to maintain the current policy settings for a while yet.  So, while today’s number is important for the market’s understanding of the current situation, I don’t believe there is any number that will change Fed policy.  At least no large number.  On the flipside, a second consecutive weak number might just encourage discussion that the current QE is not sufficient.  It will certainly raise eyebrows and cause a great deal of angst at the next FOMC meeting in two weeks’ time.

At this point, however, there is nothing we can do but wait.  A recap of the overnight activity shows that equity markets had minimal movements with no major index moving more than 0.4% (Nikkei -0.4%) and US futures essentially unchanged at this time.  Bond markets are exhibiting the same lack of direction, with movements less than 1 basis point ahead of the release across Treasuries and European sovereigns.  Commodity prices, after yesterday’s spectacular declines in the precious metals of more than 2%, have stabilized with oil drifting slightly higher (WTI +0.3%), and metals and agricultural prices either side of unchanged.

Finally, the dollar has also been ranging with no G10 currency having moved more than 0.2% from yesterday’s closing level and an even spread of gainers and losers.  In other words, everyone is biding their time here.  EMG currencies have displayed a bit more weakness, but much of that is due to last night’s APAC session where most currencies fell in response to the ADP number, just like everything else did during yesterday’s NY session.  Looking at the EEMEA currencies, only PLN (-0.4%) is showing any type of noteworthy movement and that mostly appears to be a reaction to the fact it has been amongst the best performers over the past month, having gained more than 3.0%, and so is subject to more profit-taking.  In other words, every market is simply biding its time ahead of the release.

Away from the payroll report, Chairman Powell does speak this morning, but the focus is on climate change, not monetary policy, so it seems unlikely we will learn very much.  And after this, the Fed is in its quiet period ahead of the meeting, so we are left to our own devices to determine what will happen.

My sense is we will see a strong showing today, maybe 750K as well as a revision up to last month’s data, which was abnormally weak given other indicators, but I am hard pressed to see the dollar repeat yesterday’s gains.  Rather, consolidation into the weekend seems the most likely outcome.

Good luck, good weekend and stay safe

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To Make Jay Concerned

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On Friday the payroll report
Surprised folks by coming up short
Is growth really slowing?
Or else, is this showing
A government data distort?

This morning, though, all eyes have turned
To metals and stuff that is burned
As those prices soar
They seem to have more
Potential to make Jay concerned

With all that anticipation leading up to the payroll report on Friday, it sure turned out differently than expected.  You may recall that the median forecast for the headline number was a cool million new jobs, with a survey range from 700K to 2.1 million.  The result, 266K plus a reduction of 140K from the previous month was, in a word, awful.  In fact, it was the largest statistical miss since the data began.  Now, the analyst community is busy trying to figure out what went wrong.

There are a couple of possible answers, each with its own implications.  The simplest explanation is that the combination of exiting from an unprecedented, government-imposed economic shutdown is not easily modeled and when combined with the vagaries of seasonal adjustments to the data, analysts’ models were simply wrong.  It is important to remember that the seasonal adjustments in this data stream are quite large relative to the reported data, so this is quite a viable explanation.

A second possible explanation, and one favored by the current administration, is that the data shows the economy needs more government support as too many people are falling through the cracks.  On the other hand, the business community continues to complain how difficult it is to hire qualified employees, especially in the service sector, as the ongoing government unemployment largesse is paying more than many low paying service sector jobs.  (The story of the entire workforce of a Dollar General store upping and quitting en masse is the quintessential symbol of this concept.)  Another facet of this argument is the skills mismatches that exist as, for example, erstwhile airline staff may not be able to analyze data for an IT firm, effectively resulting in a hiring need and unemployed worker at the same time.

While skills mismatches certainly exist, they always have, arguably one way for businesses to obtain staffing is to pay more for the roles in question.  The risk in that strategy is, especially for small businesses, increased labor costs will force companies to raise prices at the risk of losing business.  Based on Friday’s report, this is clearly not yet the default choice of the small business owner.  Odds are, though, especially as demand for all products and services increases with the reopening of the economy more generally, that this is going to be the outcome.  Higher wages to get workers and higher prices for goods and services.

Occam’s Razor suggests that the first explanation, data uncertainty, is the most likely cause for Friday’s massive statistical miss.  However, don’t expect the other two arguments to disappear as they are each very compelling for the currently competing political narratives.  Ultimately, we will find out more through the data for the rest of this month and get to do this all over again in June.

On the topic of rising prices, though, this morning has much more to offer, specifically in the commodity space.  The big weekend news has been about a cyberattack on Colonial Pipeline, which happens to be the largest pipeline for oil products like gasoline and diesel, to the East Coast.  With the pipeline shut, (apparently the pipeline can still carry the products, but the company cannot track how much fuel is being consumed, and thus charge accordingly), gasoline and product prices are rising, dragging up oil prices as well (WTI +0.5%).  But of more interest is the metals sector where prices are exploding higher.  Not only are precious metals (Au +0.45%, AG +1.25%) higher, but industrial base metals are really rocking (Fe +5.1%, Cu +2.6%, Al +1.9%, Ni +0.8%).  This is, of course, one of the key features of the inflation is coming narrative, sharply rising commodity prices will work their way into the price of stuff.  But inflation is a measure of the ongoing change in prices over time.  The Fed’s argument is that these prices will have an impact in the short run, but unless commodity prices continue rise year after year, the effect will be ‘transitory’.

The counter to the Fed’s argument is that we are currently embarking on the beginning of a commodity super-cycle, a price phenomenon where prices trend in one direction for many years on end, often 10-15 years.  If this argument is correct, and the prices of copper and iron ore are just beginning their climb, then the Fed is going to find themselves with a whole lot of trouble in the future.  But right now, it is merely dueling forecasts and narratives, so nothing is clear.

With all the excitement in commodities, things are pretty quiet in the financial markets.  Equity markets in Asia were a bit higher (Nikkei +0.55%, Hang Seng 0.0%, Shanghai +0.25%) while European bourses are mixed (DAX -0.25%, CAC -0.2%, FTSE 100 +0.15%).  US futures are also mixed with Dow (+0.3%) continuing last week’s rally while NASDAQ (-0.25%) continues to feel pain from the ongoing rotation out of tech.

Bond markets are not buying the inflation narrative at this point with Treasuries (-0.5bps) seeing slightly lower yields while Bunds and OATs are essentially unchanged on the day.  The only real mover is the Gilt market (+1.7bps) which has rallied after weekend elections failed to give the Scottish National Party a majority in the Scottish Parliament and thus the prospect of a referendum to allow Scotland to leave the UK seems to be pushed back.

The outcome of the Scottish vote helped the pound as well, with GBP rallying 0.9% this morning, far and away the best performer in the FX markets.  Amid broad-based dollar weakness, the pound’s performance still stands out.  Next in line, in the G10, is AUD (+0.5%) which is a clear beneficiary of the rise in commodity prices.  In fact, iron ore is Australia’s largest commodity export.  NZD and CAD (both +0.2%) are lesser beneficiaries and the rest of the block, save JPY (-0.2%) is slightly firmer.  The yen seems to be suffering from the latest poll showing PM Suga’s popularity continuing to slide and bringing some uncertainty to the situation there with an election due by the end of the year.

Asian currencies were the big beneficiary in the EMG space led by KRW (+0.7%), IDR (+0.6%) and CNY (+0.3%).  The story there continues to be the anticipated strong growth rebound combined with the dollar’s weakness.  Remember, Chairman Powell has essentially promised that US rates are going to remain at zero regardless of what happens for at least another year.  As it happens, TWD (+0.3%) has traded to its strongest level since 1997, as the robust economic situation, plus the huge demand for semiconductors has more than offset any geopolitical concerns.

Data this week is back-loaded as follows:

Tuesday NFIB Small Biz Optimism 100.8
JOLTs Job Openings 7.5M
Wednesday CPI 0.2% (3.6% Y/Y)
-ex food & energy 0.3% (2.3% Y/Y)
Thursday Initial Claims 495K
Continuing Claims 3.64M
PPI 0.3% (5.8% Y/Y)
-ex food & energy 0.4% (3.7% Y/Y)
Friday Retail Sales 1.0%
-ex autos 0.9%
IP 1.0%
Capacity Utilization 75.1%
Michigan Sentiment 90.1

Source: Bloomberg

Obviously, CPI will be very interesting, as will Retail Sales.  We also hear from 13 more Fed speakers this week, all of whom are certain to repeat the mantra that the economy needs more support and they will not be changing policy anytime soon.  Remember, inflation is transitory…until it’s not.

The dollar is starting the week off on the back foot.  If we continue to hear Fed speakers insist that policy is not going to change, and we continue to see inflationary consequences rise, the dollar will weaken further.  In the end, 10-year Treasury yields remain the key number to watch.  As long as they remain within the recent range, the dollar is likely to remain soft.  If they should break higher, though, watch out.

Good luck and stay safe
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An Untimely End

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Should risk appetite ever fall
The asset price rally could stall
And that could portend
An untimely end
To trust in the Fed overall

Yesterday afternoon the Fed released their annual financial stability report.  In what may well be the most unintended ironic statement of all time, on the topic of asset valuations the report stated, “However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.” [Author’s emphasis.]  Essentially, the Fed seems to be trying to imply that for some reason, having nothing to do with their policy framework, asset prices have risen and now they are in a vulnerable place.  But for the fact that this is very serious, it is extraordinary that they could make such a disingenuous statement.  The reason asset prices are elevated is SOLELY BECAUSE THE FED CONTINUES TO PURCHASE TREASURIES VIA QE AND FORCE INVESTORS OUT THE RISK CURVE TO SEEK RETURN.  This is the design of QE, it is the portfolio rebalance channel that Ben Bernanke described a decade ago, and now they have the unmitigated gall to try to describe the direct outcome of their actions as some exogenous phenomenon.  If you wondered why the Fed, and truly most central banks, are subject to so much criticism, you need look no further than this.

In Europe, a little-known voice
From Latvia outlined a choice
The ECB may
Decide on one day
In June, and then hawks will rejoice

In a bit of a surprise, this morning Latvian central bank president, and ECB Governing Council member, Martins Kazaks, explained that the ECB could decide as early as their June meeting to begin to scale back PEPP purchases.  His view was that given the strengthening rebound in the economy as well as the significant progress being made with respect to vaccinations of the European population, overall financial conditions may remain favorable enough so they can start to taper their purchases.  This would then be the third major central bank that is on the taper trail with Canada already reducing purchases and the BOE slowing the rate of weekly purchases, although maintaining, for now, the full target.

This is a sharp contrast to the Fed, where other than Dallas Fed president Kaplan, who is becoming almost frantic in his insistence that it is time for the Fed to begin discussing the tapering of asset purchases, essentially every other FOMC member is adhering to the line that the US economy needs more monetary support and any inflation will merely be transitory.  As if to reaffirm this view, erstwhile uber-hawk Loretta Mester, once again yesterday explained that any inflation was of no concern due to its likely temporary nature, and that the Fed has a long way to go to achieve its new mission of maximum employment.

A quick look at the Treasury market this morning, and over the past several sessions, shows that the 10-year yield (currently 1.577%, +0.7bps on the day) seems to have found a new equilibrium.  Essentially, it has remained between 1.54% and 1.63% for about the last month despite the fact that virtually every data release over that timespan has been better than expected.  Thus, despite a powerful growth impulse, yields are not following along.  It is almost as if the market is beginning to price in YCC, which is, of course, exactly the opposite of tapering.  Given the concerns reflected in the Financial Stability Report, maybe the only way to prevent that asset price decline would be to cap yields and let inflation fly.  History has shown bond investors tend to be pretty savvy in these situations, so do not ignore this, especially because YCC would most likely result in a sharply weaker dollar and sharply higher commodity and equity prices.

This morning the market will see
The labor report, NFP
Expecting one mill
The Fed’s likely, still,
To say they’ll continue QE

Finally, it is payroll day with the following current expectations according to Bloomberg:

Nonfarm Payrolls 1000K
Private Payrolls 938K
Manufacturing Payrolls 57K
Unemployment Rate 5.8%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%

The range of forecasts for the headline number is extremely wide, from 700K to 2.1 million, just showing how little certainty exists with respect to econometric models more than a year removed from the initial impact of Covid-induced shutdowns.  As well, remember, even if we get 1 million new jobs, based on Chairman Powell’s goal of finding 10 million, as he stated back in January, there are still another 7+ million to find, meaning the Fed seems unlikely to respond to the report in any manner other than maintaining current policy.  In fact, it seems to me the bigger risk today is a disappointing number which would encourage the Fed to double down!  We shall learn more at 8:30.

As to markets ahead of the release, Asian equities were mixed (Nikkei +0.1%, Hang Seng -0.1%, Shanghai -0.65%) although Europe is going gangbusters led by Germany’s DAX (+1.3%), with the CAC (+0.3%) and FTSE 100 (+0.8%) also having good days.  German IP data (+2.5% M/M) was released better than expected and has clearly been a catalyst for good.  At the same time, French IP (+0.8% M/M) was softer than expected, arguably weighing on the CAC.

Away from Treasuries, European sovereign bonds are all selling off as risk appetite grows, or so it seems.  Bunds (+1.0bps) and OATs (+2.8bps) are feeling pressure, although not as much as Italian BTPs (+4.8bps).  Gilts, on the other hand, are little changed on the day.

Commodity prices continue to rally sharply, at least in the metals space, with gold (+0.3%, +1.5% yesterday), silver (+0.1%, +3.5% yesterday), copper (+2.6%), aluminum (+1.0%) and nickel (+0.2%) all pushing higher.  Interestingly, oil prices are essentially unchanged on the day.

Lastly the dollar is mixed on the session, at least vs. the G10.  SEK (+0.35%) is the leading gainer on what appears to be positive risk appetite, while NZD (-0.25%) is the laggard after inflation expectations rose to a 3-year high.  The other eight are all within that range and split pretty evenly as to gainers and losers.

EMG currencies, though, are showing more positivity with only two small losers (ZAR -0.25%, PLN -0.15%) and the rest of the bloc firmer.  APAC currencies are leading (KRW +0.4%, INR +0.35%, TWD +0.3%) with all of them benefitting from much stronger than forecast Chinese data. We saw Caixin PMI Services rise to 56.3 and their trade balance expand to $42.85B amid large growth in both exports and imports.  Models now point to Chinese GDP growing at 9.0% in 2021 after these releases.

At this point, we are all in thrall to the NFP release later this morning.  The dollar response is unclear to me, although I feel like a strong number may be met with a falling dollar unless Treasury yields start to climb.  Given their recent inability to do so, I continue to believe that is the key market signal to watch.

Good luck, good weekend and stay safe
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