While prices in Europe are leaping
According to Christine’s bookkeeping
She’s got “every reason”
To keep on appeasin’
The ECB doves who are sleeping

So, rather than look to the Fed
She’s focused on China instead
Where they just cut rates
As growth there stagnates
And Covid continues to spread

One has to wonder exactly what Christine Lagarde is looking at when she makes comments like she did this morning.  Specifically, she said the following in a radio interview in France, [emphasis added] “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might, but we have started to respond and we, of course, stand ready to respond with monetary policy if figures, data, facts, require it.”  Remember, the ECB has a single mandate, achieving price stability which they define as 2% inflation over the medium term.  With this in mind, let me recount this morning’s data, which clearly has Madame Lagarde nonplussed: German Dec PPI +5.0% M/M and +24.2% Y/Y, the highest figures ever in the history of German record keeping back to 1949.  Eurozone Dec CPI +0.4% M/M and 5.0% Y/Y, also the highest since the creation of the Eurozone.  I realize I am a simple FX salesman, but to my uneducated eye, those indications of inflation seem somewhat above 2.0%.  Perhaps mathematics in France is different than here in the US, but I would challenge Madame Lagarde to explain a bit more carefully why, despite all evidence to the contrary, she thinks the ECB is acting in accordance with their mandate.  I suspect there are about 83 million people in Germany who may be wondering the same thing.

Certainly, traders do not believe her or her colleagues when they say, as Pablo Hernandez de Cos did “an increase in interest rates is not expected in 2022.”   De Cos is the head of the Spanish central bank and a Governing Council member and clearly not a hawk.  Yet, the OIS market in Europe is pricing in 0.20% of rate hikes by the end of 2022 (the ECB has been moving in 10 basis point increments), so two rate hikes.  I also realize that there appear to be many econometric models around that are forecasting a return to much lower inflation within the next twelve months, certainly those are the models the central banks themselves are using.  It seems that the real question is at what point will the central banks, specifically the Fed and ECB, recognize that their models may not be a very accurate representation of reality?  And I fear the answer is, never!

Perhaps Madame Lagarde was channeling Yi Gang, the PBOC’s Governor, although the situation on the ground in China is clearly different than that in Europe.  For instance, after cutting two important interest rates last Friday, the PBOC cut two different interest rates last night, the 1-year loan prime rate by 0.10% down to 3.70%, and the 5-year rate was cut by 5 basis points to 4.60%.  China continues to struggle with their zero covid policy.  They continue to fall behind the curve there as the omicron variant is so incredibly transmissible.  But what is clear is that China is growing increasingly concerned over the pace of growth in the economy and so the PBOC has begun to act even more aggressively.  While 5 and 10 basis point moves may not seem like a lot, given how infrequently the PBOC has been willing to cut interest rates, they are an important signal to market participants that support is at hand.  This was made clear by the equity markets last night where the Hang Seng, home to so many property companies, exploded higher by 3.4% although Shanghai’s market was quite subdued, actually slipping 0.1%.

In the end, it is clear that global synchronicity is not an appropriate way to think about the current macroeconomic situation.  Given the dramatically different ways that different nations approached the Covid pandemic, it should be no surprise that there are huge differences in rates of growth and inflation around the world.  The hedging implications of this outcome are that it will require more specific analysis of each country in which there is an exposure to determine the best way to mitigate risks there.

With that in mind, let us take a look at markets this morning.  Despite Shanghai’s lackluster performance, the rest of Asia was actually quite solid with the Nikkei (+1.1%) rounding out the top markets.  Europe, on the other hand, has been less positive with the DAX (+0.1%) edging higher while both the CAC (-0.1%) and FTSE 100 (-0.1%) are slipping a bit.  I guess more promises of ongoing policy ease were not enough to overcome the soaring inflation story on the continent.  US futures are all pointing higher at this hour, with NASDAQ (+0.9%) leading the way although that index has fallen by 10% from its highs, so has more room to catch up.

Looking at the bond market, I can’t help but wonder if we have seen peak hawkishness earlier this week, at least for the Fed.  After the long weekend, we saw the 10-year Treasury yield trade up to 1.88%, but since then it has slipped back with today’s price action seeing yields fall an additional 2.7 basis points and placing us 4bps off those highs.  Now, this could simply be a short-term correction, but with the Fed announcement next week, it really does feel like the market has gotten way ahead of itself.  At this point, the only way next week’s FOMC could be seen as hawkish would be if they actually raised rates, something to which I ascribe a zero probability.  One other thing to recall is that recent surveys continue to show a large contingent of fund managers believe that inflation is transitory which implies that they are likely to take advantage of the current rise in yields and prevent things from running away.

On the commodity front, oil (-0.4%) has stopped running higher, although this pause seems much more like a consolidation than a change in views.  NatGas (-1.5%) is also a bit softer today in both the US and Europe as seasonal or higher temperatures continue to reduce marginal demand.  Turning to metals markets, gold (-0.2%) is slightly softer this morning, but overall, despite rising interest rates, has held up quite well lately and remains well above the $1800/oz level.  Interestingly, silver (0.0% today +4.6% this week) seems to be having a much better time of things and technically looks to have broken out higher.  Arguably, this information blends well with the thought that bond yields may have peaked, but we shall see.

As to the dollar, it is mixed this morning with both gainers and losers in both the G10 and EMG spaces.  The funny thing is, other than RUB (-0.6%) which is leading the way lower today on the back of threats of more substantial sanctions in the event Russia does invade the Ukraine, the rest of the story is much harder to pin down.  For instance, from a news perspective Bank Indonesia met last night and left rates on hold, as expected, but indicated that it would begin normalizing monetary policy in March, returning its RRR to its pre-covid levels, but the rupiah only rose 0.2%.  In fact, today’s leading gainer is ZAR (+0.75%), but given the dearth of either data or news, the best bet here seems to be a response to precious metals strength.  One other thing to remember is that despite easing by the PBOC, the renminbi continues to edge higher.  Frankly, I see no reason for it to weaken anytime soon, especially with my view the dollar will be suffering going forward.

On the data front, Initial Claims (exp 225K), Continuing Claims (1563K), Philly Fed (19.0) and Existing Home Sales (6.43M) are on the calendar.  Remember, Empire Manufacturing was a huge bust earlier this week, so watch the Philly Fed number for any indication of weakness and slowing growth here at home.  In fact, it is that scenario that will allow the Fed to remain on the dovish side, although I fear it will not slow down the inflation train.

If there are any inklings that the Fed is not going to be as hawkish as had seemed to be believed just a few days ago, I expect that the dollar will come under further pressure.  In fact, in order to change that view we will need to see a very hawkish outcome from next Wednesday’s FOMC, something I do not anticipate.  Payables hedgers, I fear the dollar may be near its peak, so don’t miss out.

Good luck and stay safe
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