Two central banks managed to shock The market by walking the walk The Old Lady jacked By fifteen, in fact Banxico then doubled the talk So, now that it’s all said and done C bankers, a new tale have spun The virus no longer Is such a fearmonger Inflation’s now job number one Talk, as we all know, is cheap, but from the two largest central banks, that’s mostly what we got. While Chairman Powell got a positive market response from his erstwhile hawkish comments initially, yesterday investors started to rethink the benefits of tighter monetary policy and decided equity markets might not be the best place to hold their assets. This is especially true of those invested in the mega-cap tech companies as those are the ones that most closely approximate an extremely long-duration bond. So, the NASDAQ’s -2.5% performance has been followed by weakness around the globe and NASDAQ futures pointing down -0.9% this morning. As many have said (present company included) the idea that the Fed will be aggressively tightening monetary policy in the face of a sharp sell-off in the stock market is pure fantasy. The only question is exactly how far stocks need to fall before they blink. My money is on somewhere between 10% and 20%. Meanwhile, Madame Lagarde continues to pitch her view that inflation remains transitory and that while it is higher than the target right now, by next year, it will be back below target and the ECB’s concerns will focus on deflation again. So, while the PEPP will indeed be wound down, it will not disappear as it is always available for a reappearance should they deem it necessary. And in the meantime, they will increase the APP by €40 billion/month while still accepting Greek junk paper as part of the mix. Even though inflation is running at 4.9% (2.6% core) as confirmed this morning, they espouse no concern that it is a problem. Perhaps the most confusing part of this tale is that the EURUSD exchange rate rallied on the back of a more hawkish Fed / more dovish ECB combination. One has to believe that is a pure sell the news result and the euro will slowly return to recent lows and make new ones to boot. One final word about the major central banks as the BOJ concluded its meeting last night and…left policy unchanged as universally expected. There is no indication they are going to do anything different for a long time to come. However, when you step away from the Big 3 central banks, there was far more action in the mix, some of it quite surprising. First, the BOE did raise the base rate by 15 basis points to 0.25% and indicated that it will be rising all throughout next year, with expectations that by September it will be 1.00%. The MPC’s evaluation that omicron would not derail the economy and price pressures, especially from the labor market, were reaching dangerous levels led to the move and the surprise helped the pound rally as much as 0.7% at one point. Earlier yesterday, the Norges Bank raised rates 25bps, up to 0.50%, and essentially promised another 25bp rise by March. Then, in the afternoon, Banco de Mexico stepped in and raised their overnight rate by 0.50%, twice the expected hike and the largest move since they began this tightening cycle back in June. It seems they are concerned about “the magnitude and diversity” of price pressures and do not want to allow inflation expectations to get unanchored, as central bankers are wont to say. Summing up central bank week, the adjustment has been significant from the last round of meetings with inflation clearly now the main focus for every one of them, perhaps except for Turkey, where they cut the one-week repo rate by 100 basis points to 14.0% and continue to watch the TRY (-7.0%) collapse. It is almost as if President Erdogan is trying to recreate the Weimar hyperinflation of the 1920’s without the war reparations. Will they be able to maintain this inflation fighting stance if global equity markets decline? That, of course, is the big question, and one which history does not show favorably. At least not the current crop of central bankers. Barring the resurrection of Paul Volcker, I think we know the path this will take. This poet is seeking his muse To help him define next year’s views Thus, til New Year’s passed Do not be aghast My note, you’ll not have, to peruse Ok, for my final note of the year, let’s recap what has happened overnight. As mentioned above, risk is under pressure after a poor performance by equity markets in the US. So, the Nikkei (-1.8%), Hang Seng (-1.2%) and Shanghai (-1.2%) all fell pretty sharply overnight. This morning, Europe has also been generally weak, but not quite as badly off as Asia with the DAX (-0.65%) and CAC (-0.7%) both lower although the FTSE 100 (+0.3%) is bucking the trend after stronger than expected Retail Sales data (+1.4%). Meanwhile, Germany has been dealing with soaring inflation (PPI 19.2%, a new historic high) and weakening growth expectations as the IFO (92.6) fell to its lowest level since January and is trending sharply lower. US futures are also pointing lower at this hour. Bond markets, meanwhile, are generally firmer although Treasury yields are unchanged at this time. Europe, though, has seen declining yields across the board led by French OATs (-2.6bps) and Bunds (-1.8bps) with the peripherals also doing well. Gilts are bucking this trend as well, with yields unchanged this morning. In the commodity space, oil (-1.75%) is leading the energy sector lower along with NatGas (-1.9%), but metals markets are going the other way. Gold (+0.5%, and back above $1800/oz) and silver (+0.7%) feel more like inflation hedges this morning, and we are seeing strength in the industrial space with copper (+0.45%), aluminum (+2.1%) and tin (+1.8%) all rallying. Lastly, looking at the dollar, on this broad risk-off day, it is generally stronger vs. its G10 counterparts with only the yen (+0.2%) showing its haven status. Otherwise, NZD (-0.5%) and AUD (-0.4%) are leading the way lower with the entire commodity bloc under pressure. As to the single currency, it is currently slightly softer (-0.1%) but I believe it has much further to run by year end. In the EMG bloc, excluding TRY’s collapse, the biggest mover has actually been ZAR (+0.6%) after it reported that the hospitalization rate during the omicron outbreak has collapsed to just 1.7% of cases being admitted. This speaks to the variant’s less pernicious symptoms despite its rapid spread. Other than that, on the plus side KRW (+0.25%) benefitted from central bank comments that they would continue to support the economy but raise rates if necessary. On the downside, CLP (-0.4%) is opening poorly as traders brace for this weekend’s runoff presidential election between a hard left and hard right candidate with no middle ground to be found. However, beyond those moves, there has been much less activity. There is no economic data today and only one Fed speaker, Governor Waller at 1:00pm. So, the FX market will once again be seeking its catalysts from other markets or the tape. At this point, if risk continues to be shed, I expect the dollar to continue to recoup its recent losses and eventually make new highs. As I mention above, this will be the last daily note for 2021 but the FX Poet will return with his forecasts on January 3rd, 2022, and the daily will follow afterwards. To everyone who continues to read, thank you for your support and I hope everyone has a happy and healthy holiday season. Good luck, good weekend and stay safe Adf
Investors seem somewhat concerned
That risk, in all forms, has returned
Thus, stocks are backsliding
While Jay is deciding
If QE should soon be adjourned
With the FOMC beginning its two-day meeting this morning, and PPI data due at 8:30am, it is clear that investors are taking a more precautionary view of the world today. Certainly, yesterday’s US equity market price action, where the major indices all closed on their session lows, has not helped sentiment, nor has the current market narrative of imminently tighter policy from the Fed. As such, it should be no great surprise that risk assets across the board are under pressure while more traditional havens have found some support.
But let us ask ourselves, is this current market (not Fed) narrative realistic? Again, I would contend the market expectations for tomorrow are that the Fed will double the pace of its QE tapering come January, which will have them finish QE by the end of March. And it is easy to see the merits of the argument given the persistence and magnitude of price gains seen over the past twelve to fifteen months. This is especially so given there is no obvious reason to believe prices will decline other than the economists’ mantra that supply will be created to fill the demand. (While this is certainly true in the long run, as Keynes pointed out back in 1923, in the long run we are all dead, so timing matters here.)
However, there are counterarguments also being made that will carry weight, especially with the political bent of the current administration. Specifically, the maximum employment piece of the Fed mandate, which Mr Powell highlighted last year when announcing the Fed’s new policy initiatives, remains an open question. It appears that the current Fed view is that NAIRU (full employment) is reached when the Unemployment Rate reaches 3.8%. The November NFP report showed Unemployment has declined to 4.2%, as measured, and recall that pre-pandemic, the Unemployment Rate had fallen to 3.5%, its lowest point in half a century. Thus, the new view is that full employment will only be reached at near historic lows. Yet, is that maximum employment in the current vernacular?
The Fed’s policy review used the terms “broad-based and inclusive” to describe maximum employment, by which they were considering not merely the statistical headline, but the makeup of the data when broken down by various subcategories, notably race. That November report indicated that the Unemployment rate for minorities was 6.7%, considerably higher than for the white cohort which saw Unemployment of just 3.7%. That disparity is at the heart of the question as to whether the Fed believes its employment mandate has been fulfilled.
You will not be surprised to know that there is vocal advocacy by some that the ratio that currently exists reflects bias and the Fed must do more to alleviate the problem, even at the expense of higher inflation. Nor would you be surprised that others make the case that rising inflation is a greater burden on the lower and middle classes, so seeking those last few jobs results in a significantly worse outcome for all, especially those for whom the policies are intended to help.
The point is it is not a slam-dunk that the Fed is going to be as aggressively hawkish as the current market narrative claims. While Chairman Powell clearly indicated that the pace of tapering would increase, do not be surprised if it rises from $15B/month to $20B or $25B/month rather than the baseline market assumption of $30B/month. If that is the case, then another repricing in markets will be coming, with risk assets getting a reprieve while the dollar is likely to suffer. While this is not my base case, I would ascribe at least a 30% probability to the idea that tomorrow’s FOMC is less hawkish than currently priced. Stay on your toes.
In the meantime, here is what has been happening since you all went home last evening. As mentioned, risk is under pressure with Asian equity markets (Nikkei -0.7%, Hang Seng -1.3%, Shanghai -0.5%) all following the US markets lower while European markets opened in a similar vein. However, it appears that recent omicron news regarding the efficacy of current vaccinations with respect to moderating illness has begun to turn sentiment around and we now see both the DAX and CAC flat on the day while the FTSE 100 (+0.4%) has risen, embracing the new omicron news along with better than expected employment data from the UK (Unemployment fell to 4.2% with Weekly Earnings rising 4.9%). Alas, US futures remain lower despite that Covid news, led by the NASDAQ (-0.6%).
Bond markets, which had earlier been modestly firmer (yields lower) have reversed course on the omicron news and we now see Treasury yields (+1.9bps) rising alongside the European sovereign market (Bunds +1.5bps, OATs +1.2bps, Gilts +2.3bps). It seems market participants continue to be whipsawed between concerns over tighter policy and positive omicron news.
Commodity prices, too, have begun to reverse course as early session declines have now been erased with oil (0.0%) back to flat on the day from a nearly 1% decline a few hours ago. While NatGas (-2.6%) in the US remains stable and under $4/mmBTU, the situation in Europe remains dire with prices rising another 3.6% as ongoing concerns over Nordstream 2 pressure the situation. In the metals’ markets, there is mostly red with precious (Au -0.1%) softer and base (Cu -0.1%, Al -0.7%) also under pressure. Agricultural products are falling as well today.
The dollar is on its back foot this morning as positivity permeates the markets with only NOK (-0.15%) softer in the G10, still feeling the lingering pain of oil while we see CHF (+0.35%) and EUR (+0.3%) lead the way higher. Much of this movement, I believe, is position related as there has been little data or commentary to drive things, and the broader dollar gains that we have seen over the past months are seeing some profit-taking ahead of the FOMC and ECB meetings in the event that my case above for a more dovish outcome occurs. Remember, too, given the market’s long dollar positioning, even a hawkish Fed could see a ‘sell the news’ result.
EMG currencies are showing similar trends with TRY (-3.3%) the true outlier as the lira quickly melts on ongoing policy concerns. But elsewhere, HUF (+0.8%) has gained as the central bank reduced its QE purchases and expectations of further rate hikes are rampant. CZK (+0.5%) is also benefitting from hawkish central bank news as the head there explained he saw rates closer to 4.0% than 3.0% next year (current 2.75%). After those stories, there is much less movement overall.
Data this morning showed the NFIB Small Business Optimism Index edge slightly higher to 98.4 while PPI (exp 9.2%, 7.2% ex food & energy) is due at 8:30. If the market takes hold of the latest omicron news, I would expect the equity market to turn around, but also the dollar as less Covid worries allows the Fed to be more hawkish. But really, all eyes are on tomorrow afternoon, so don’t look for too much movement in either direction today.
Good luck and stay safe
It turns out the internet can
Stop working, though that’s not the plan
Thus, to be succinct
The people who linked
Their lives to it found nothing ran
Under the heading, ‘It’s amusing today but could be much worse’, it seems there is a downside to all the conveniences we were promised if we just linked all the mundane features of life to the internet so the IoT could work its magic. When the IoT stops working, so do all those mundane features, like door locks using Ring, and Roomba® vacuums and smart refrigerators and washing machines. And so, yesterday, when Amazon Web Services crashed for upwards of 9 hours along the East Coast, many people and businesses learned just how reliant they were on a single private company (albeit a big one) for maintaining the status quo of their lives. Do not be surprised if the question arises as to whether the ‘cloud’ has become too important for the private sector to manage by itself and needs to be regulated as a utility going forward.
With omicron somewhat less feared
The bulls feel the way has been cleared
To add to positions
Which led to conditions
Where price rises were engineered
Markets, however, were completely unconcerned with any hiccups regarding the cloud and bulled ahead with spectacular gains yesterday as the NASDAQ led the way rising more than 3.0%. While this author’s view is risk appetite is more closely correlated to views on / concerns over the tapering of QE and tighter Fed policy, the narrative has been very focused on omicron and the news that it seems to be more widespread but far less virulent and therefore will have a lesser impact on the recovering economy. At least, that’s what the punditry is saying this morning as an explanation for yesterday’s massive risk-on rally.
And perhaps, that is an accurate viewpoint. Perhaps last week’s selloff was entirely due to the uncertainty over just how impactful omicron would be on the global economy. The problem is that doesn’t pass the smell test. Consider that if omicron was really going to result in another wave of economic closures, the central bank response would likely be adding still more liquidity to the global system, much of which would find its way into equities. In contrast, tighter monetary policy that reduces overall liquidity would have the opposite effect. As such, it seems to me that sharp declines are more likely on fear of less liquidity than fear of the latest virus variant. So, while markets are still pricing rate hikes for next year, they have clearly come to grips with the current expected pace of those hikes. Now, if inflation continues to rip higher, and we see the latest CPI print on Friday, the sanguinity over the pace of rate hikes could well disappear. Remember that there are many ‘fingers of instability’ weaving throughout the market construct, among them massive leverage and extremely high equity valuations. Risk is a funny thing, it often isn’t a concern until, suddenly, it is the only concern. Risk asset markets, while continuing to ascend, are also doing so on less and less breadth. Again, I would contend that hedging remains a critical activity for the corporate set.
Looking around markets today, yesterday’s euphoria, while evident in Asia overnight, has not made its way to Europe. Japan’s Nikkei (+1.4%) led the way in Asia despite GDP data printing at a much lower than expected -3.6% in Q3. It seems to me any idea that the BOJ will consider reducing its support for the economy is misplaced. If anything, I would anticipate increased support as the nation tries to dig itself out of its latest economic hole. As to the rest of Asia, the Hang Seng (+0.1%) lagged as its tech sector continues to be undermined by Xi’s ongoing crackdown on Chinese tech behemoths, but Shanghai (+1.1%) with far less tech exposure, did fine.
Europe, on the other hand, is under a bit of pressure this morning with the DAX (-0.6%) leading things lower followed by the CAC (-0.3%) while the FTSE 100 is little changed on the day. The big news in Germany is that Angela Merkel is officially out as Chancellor and Olaf Scholz was sworn in as the new leader of the nation. I don’t envy his situation as energy prices are rising sharply and Germany is entirely reliant on Russia and Vladimir Putin for the natural gas necessary to stay warm this winter, while their export-led economy is so tightly tied to China’s performance, that the ongoing slowdown there will soften growth prospects. But then again, as a Social Democrat, maybe that is exactly the position Scholz relishes.
Finally, US markets remain in euphoria mode with futures all pointing higher by another 0.4% at this hour with the S&P 500 less than 1% from its all-time high.
The bond market, this morning, is showing no clarity whatsoever. Treasury yields, after backing up 5bps yesterday, are actually lower by 0.8bps despite the positive look from equities. Bunds and OATs are little changed while Gilts (-1.4bps) are showing the most strength. Perhaps of more interest are the PIGS, where yields are rising sharply (Italy +3.2bps, Greece +4.9bps) after comments from Latvian ECB member, Martin Kazaks, that there was little reason to continue with additional QE once PEPP expires in March. I suspect the Greeks and Italians would have a different opinion!
Last week, commodity prices were under huge pressure, led by oil, which cratered in the wake of the Thanksgiving holiday. This morning, WTI (+0.75%) and Brent (+1.0%) are continuing their strong rebound with both grades more than 12% off their recent lows. NatGas (+3.9%), too, is rebounding but has much further to go to reach the peaks seen in October. Metals market, on the other hand, are having a less interesting day with gold (+0.1%) and copper (+0.1%) just edging up a bit.
Turning to the dollar, it is broadly, but not universally weaker this morning with NOK (+0.6%) leading the way on the back of oil’s rebound, although the rest of the G10 gainers are far less impressive (AUD +0.2%, CAD +0.1%). There are some laggards as well with GBP (-0.35%) falling after news that PM Johnson is about to impose new travel restrictions in the country. Now, if the UK combines tightening monetary policy, at which the BOE has hinted, with omicron inspired restrictions, that is clearly a recipe for slowing growth, and a weaker pound and FTSE. In fact, the pound has fallen to its lowest level in almost exactly 12 months this morning. In the EMG space, only TRY (-1.3%) is really falling and that story is consistent. On the plus side, though is THB (+0.6%), RUB (+0.4%) and ZAR and MXN (both +0.35%) as the commodity sector continues to perform well while Thailand powered ahead on reduced omicron fears. So, the UK is reacting one way while the Thai government is going in the opposite direction!
On the data front, yesterday’s productivity and labor cost data were even more awful than forecast and Consumer Credit rose far less than anticipated and barely 56% as quickly as September. This morning brings only the JOLTs report (exp 10469K) which means that with the lack of Fed speakers, the FX market will look elsewhere for drivers. As long as risk remains in vogue, I expect the dollar to remain under some pressure, but if the European equity impulse comes here, look for the dollar to recoup its losses before the day is over.
Good luck and stay safe
The omicron variant seems
No longer to haunt people’s dreams
Thus, stocks are advancing
And markets financing
The craziest, wildest schemes
So, risk is no longer taboo
As narrative changes ensue
Chair Powell’s regained
Control, and contained
The fallout from his last miscue
Risk appetite is remarkably resilient these days as evidenced not only by yesterday’s US equity rally, but by the follow-on price action in Asia last night as well as Europe this morning. In fact, it seems the rare market that has not rallied at least 2% this morning. Naturally, this raises the question as to what is driving this sudden return to bullishness? Is it a widening view that the omicron variant is not going to result in more draconian government lockdowns? Well, based on the news that NYC has imposed new restrictions on people, requiring vaccinations for everyone aged 5 and older to enter any public building, that may not be the case. Perhaps the news that Austria has established fines of €600 for the first time someone is found not to be vaccinated with an increasing scale and jail time in that person’s future if they do not correct the situation, is what is easing concern.
At this point, arguably, it is too early to truly understand the nature of the omicron variant and its level of virulence, although it is clearly highly transmissible. Early indications are that it is not as deadly but also that none of the currently approved vaccines does much with respect to preventing either infection or transmission of this variant. However, global equity investors have clearly spoken and decided that any potential issues are either likely to be extremely short-term or extremely mild.
Perhaps this renewed risk appetite has been whetted by the idea that the Fed’s tapering will be a net positive for the market. On the surface, of course, that doesn’t seem to accord with the idea that it has been the Fed’s (and ECB’s) largesse of adding constant liquidity to the system that has been the major support for the equity rally. I’m sure you all have seen the graph that shows the growth in the Fed’s balance sheet overlain on the price action in the S&P 500, where the two lines are essentially the same. So, if more central bank liquidity has been the key driver of higher stock prices, how can reduced liquidity and threats(?) or indications of higher interest rates coming sooner help support stocks. That seems to run contra to both that thesis as well as the idea that inflation is good for stocks, with the second idea suffering from the concept that tighter monetary policy is designed to fight inflation.
But maybe, that is the key. For the cognitive dissonant equity bull, loose policy and high inflation are good for equity markets because loose policy will keep the economy growing faster than inflation can reduce real returns. On the other hand, tighter policy will fight inflation thus allowing lower nominal returns to remain competitive on a real basis. Or something like that. Frankly, it has become extremely difficult to understand the ever-changing rationales of equity bulls. But that doesn’t mean they haven’t been right for a long time now, despite changes in underlying macroeconomic trends.
From its peak on November 22, to its bottom Friday, the S&P 500 fell about 5.25%, not even a correction, as defined in the current vernacular. That requires a 10% pullback. So, for all intents and purposes, this bull market has done nothing more than pause for a few days and is apparently trying to regain all its lost ground as quickly as possible. Remember this, though, trees do not grow to the sky, nor do markets rally forever. There continue to be numerous red flags as to the performance of equities; notably potentially tighter monetary policy, extremely high valuations, narrowing breadth of index performance and questions over future earnings growth amongst others. And any of these, as well as the many potential issues that are not even currently considered, can be a catalyst for a more significant risk-off event. In fact, the situation in the Treasury market, the curve is flattening quite rapidly, seems to be one clear warning that the future may not be as rosy as currently priced by the stock market. Do not take for granted that risk appetite will remain this robust indefinitely and plan accordingly.
But today that is not a concern! Risk is ON and in a big way. After yesterday’s US rally, we saw all green in Asia (Nikkei +1.9%, Hang Seng +2.7%, Shanghai +0.2%) and Europe (DAX +2.1%, CAC +2.2%, FTSE 100 +1.2%) with US futures all higher between 1.0% (DOW) and 1.8% (NASDAQ). In other words, all is right with the world! Interestingly, one of the stories making the rounds today is about yesterday’s Chinese reduction in the RRR, but that was literally yesterday’s news, well known throughout the entire session. I feel like there is something else driving things.
As to the bond market, while prices have fallen slightly, the movement is a lot less than would be expected given the strength of the equity rally. Treasury yields are higher by just 0.2bps while Bunds (+1.5bps), OATs (+0.9bps) and Gilts (+2.4bps) are all responding a little more in line with what would normally be expected. Data from Europe was slightly better than forecast with German IP (2.8%) and ZEW Expectations (29.9) both showing the economy there holding up better despite the ongoing lockdowns. Asian bonds also saw yields climb a bit making the process nearly universal.
Commodity prices are following the risk narrative with oil (+2.8%) rallying sharply for the second consecutive day and now trading nearly 15% off the lows seen Thursday! NatGas (+2.2%) is rebounding but still well below its highs seen in early October, while metals prices are all higher as well led by Cu (+0.7%) and Al (+1.2%) although both gold (+0.25%) and silver (+0.3%) are a bit firmer as well.
It will come as no surprise that the dollar is somewhat softer this morning given the environment as we see AUD (+0.7%), CAD (+0.5%) and NOK (+0.4%) all benefit from firmer commodity prices while the euro (-0.25%) is actually the laggard on the day, despite the rally in equities there. Perhaps the single currency is gaining some haven characteristics. In the emerging markets, TRY (+0.7%) is the leading gainer followed by THB (+0.6%) and BRL (+0.5%). One can simply recognize the extreme volatility in the lira given the ongoing policy missteps, so a periodic rally should be no surprise. As to the baht, it seems buyers are looking for China’s RRR cut to support the Chinese economy and by extension the Thai economy as well. Brazil is a more straightforward commodity story I believe. On the downside, CZK (-0.4%) and HUF (-0.3%) are the laggards as traders express mild concern that the central banks there may not keep up with rising inflation when they meet this week and next.
On the US data front, Nonfarm Productivity (exp -4.9%) and Unit Labor Costs (+8.3%) lead along with the Trade Balance (-$66.8B) at 8:30. One cannot help but look at the productivity and labor cost data and wonder how equity markets can continue to rally. Those seem to point to the worst of all worlds. As to the Fed, they are in their quiet period ahead of next Wednesday’s meeting, so nothing to report there.
While I may not agree with its underpinnings, risk is clearly in vogue this morning and I don’t see any reason for that to change today. In general, I would look for the dollar to continue to soften slightly, but also see limited scope for a large move. All eyes have turned to the Fed next week and will be anxiously awaiting Chair Powell’s explanations for whatever moves they make.
Good luck and stay safe
There once was a narrative told
Explaining the Fed still controlled
The market’s reaction
Thus, making sure stocks ne’er got sold
But that was before Omicron
Evolved and put more pressure on
The future success
Of Fed’ral largesse
With no real conclusion foregone
So, later this morning we’ll hear,
When Janet and Jay both appear,
In front of the Senate
If they’ve still the tenet
That all will be well by next year
Perhaps all is not right with the world. At least that would be a conclusion easily drawn based on market activity this morning. Once again, risk is being shed rapidly and across the board. Not only that, but the market is completely rethinking the idea of tighter monetary policy by the Fed with the growing conclusion that it is just not going to happen, at least not on the timeline that had been assumed a few short days ago.
It seems that the Omicron variant of Covid is proving to be a bigger deal in investor’s eyes than had been originally assumed. When this variant was first identified by South African scientists, the initial belief was it was more virulent but not as acute as the Delta variant. So, while it was spreading quite rapidly, those who were infected displayed milder symptoms than previous variants. (If you think about the biology of this, that makes perfect sense. After all, every organism’s biologic goal is to continue to reproduce as much as possible. If a virus is so severe that its host dies, then it cannot reproduce very effectively. Thus, a more virulent, less severe strain is far more likely to remain in the world than a less virulent, more deadly strain, which by killing its hosts will die off as well.)
In the meantime, financial markets have been trying to determine just what type of impact this new strain is going to have on economies and whether it will induce another series of lockdowns slowing economic activity, or if it will be handled in a different manner. And so far, there is no clear conclusion as evidenced by the fact that we saw a massive sell-off in risk assets Friday, a major rebound yesterday and another sell-off this morning. If pressed, I would expect lockdowns to come back into vogue as despite questions over their overall efficacy, their imposition allows government officials to highlight they are ‘doing something’ to prevent the spread. Additional bad news came from the CEO of Moderna, one of the vaccine manufacturers, when he indicated that the nature of this variant would likely evade the vaccines’ defense.
So, story number one today is Omicron and how this new Covid variant is going to impact the global economy. Ironically, central bankers around the world must be secretly thrilled by this situation as the focus there takes the spotlight off their problem, rapidly rising inflation.
For instance, after yesterday’s higher than expected CPI prints in Spain and Germany, one cannot be surprised that the Eurozone’s CPI printed this morning at 4.9%, the highest level since the Eurozone was born in 1997, and far higher than any of the 40 economist forecasts published. Madame Lagarde wasted no time explaining that this was all temporary and that by the middle of next year inflation would be back to its pre-pandemic levels, but it seems fewer and fewer people are willing to believe that story. Do not mistake the run to the relative safety of sovereign bonds as a vote of confidence in the central bank community. Rather that is simply seen as a less risky place to park funds than the equity market, which by virtually every measure, remains significantly overvalued.
This leads to the third major story of the day, the upcoming testimony by Chairman Powell and Treasury Secretary Yellen in front of the Senate Banking Committee. The pre-released opening comments focus on Omicron and how it can be a risk for both growth and inflation thus once again trying to divert attention from Fed policies as a problem by blaming exogenous events beyond their control. Of course, this story will resolve itself starting at 10:00, so we will all listen in then.
Ok, with all that as prelude, a quick tour of markets shows just how much risk is in disfavor this morning. Overnight in Asia we saw broad weakness (Nikkei -1.6%, Hang Seng -1.6%) although once again Shanghai was flat. Europe is completely in the red (DAX -1.45%, CAC -1.25%, FTSE 100 -1.0%) and US futures are also pointing lower (DOW -1.2%, SPX -1.0%, NASDAQ -0.5%).
Meanwhile, bond markets are ripping higher with Treasuries (-5.1bps) leading the way as yields fall back to levels last seen in early September. In Europe, Bunds (-2.1bps), OATs (-2.2bps) and Gilts (-4.0bps) are all seeing demand pick up with the rest of the Continent all looking at lower yields despite rising inflation. Fear is clearly a powerful motivator. Even in Asia we saw JGB’s (-1.9bps) rally as did Australian and New Zealand paper.
Commodity markets are having quite a day with some really mixed outcomes. Oil (-2.5%) is back in the red after yesterday’s early morning rebound faded during the day, and although oil did close higher, it was well of the early highs. NatGas (-5.0%) is falling sharply, which at this time of year is typically weather related. On the other hand, gold (+0.5%) is bouncing from yesterday and industrial metals (Cu +1.4%, Al +1.6%, Sn +2.7%) are in clear demand. It seems odd that on a risk-off day, these metals would rally, but there you have it.
Finally, the dollar can only be described as mixed this morning, with commodity currencies under pressure (NOK -0.4%, CAD -0.25%) while financial currencies (EUR +0.5%, CHF +0.5%, JPY +0
4%) are benefitting on receding expectations for a tighter Fed. PS, I’m sure the risk off scenario is not hurting the yen or Swiss franc either.
Emerging market currencies are demonstrating a broader based strength with TRY (-1.6%) really the only major loser as further turmoil engulfs the central bank there and expectations for lower interest rates and higher inflation drive locals to get rid of as much lira as possible. Otherwise, PLN (+0.8%) is leading the way higher as expectations for the central bank to raise rates grow with talk now the rate hike will be greater than 50 basis points. But MYR (+0.8%) and CZK (+0.75%) are also showing strength with the ringgit simply rebounding after a 10-day down move as bargain hunters stepped in, while the koruna has benefitted from hawkish comments from the central bank governor. It appears that most EMG central banks are taking the inflation situation quite seriously and I would look for further rate hikes throughout the space.
Aside from the Powell/Yellen testimony, this morning brings Case Shiller House Prices (exp 19.3%), Chicago PMI (67.0) and Consumer Confidence (111.0). As well, two other Fed speakers, Williams and Clarida, will be on the tape, but it is hard to believe they will get much notice with Powell front and center.
The dollar appears to be back following the interest rate story, which means that if expectations of Fed tightening dissipate, the dollar will likely fade as well, at least versus the financial currencies. Commodities have a life of their own and will continue to dominate those currencies beholden to them. The tension between potential slower growth and rising inflation has not been solved, and while my view is the Fed will allow inflation to burn still hotter, keep in mind that if they do act to tighten policy, the dollar should find immediate support.
Good luck and stay safe
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