We’ll Be Behind

The Chair and the Vice-Chair both said
Before we raise rates at the Fed
We’ll taper our buying
While we’re verifying
If growth can keep moving ahead

So, don’t look at forecasts ‘cause we
Care only for hard stats we see
Thus, we’ll be behind
The curve, but you’ll find
Inflation we’ll welcome with glee

The Fed has made clear they are driving the bus looking only in the rearview mirror.  This is a pretty dramatic change in their modus operandi.  Historically, given the widespread understanding that monetary policy works with a lag of anywhere from 6 months to 1 year, the Fed would base policy actions on their forecasts of future activity.  This process was designed to prevent inflation from rising too high or allowing growth to lag too far from trend.  One of the problems they encountered, though, was that they were terrible forecasters, with their models often significantly understating or overstating expectations of future outcomes.

So, kudos to Chairman Powell for recognizing they have no special insight into the future of the economy.  It is always difficult for an institution, especially one as hidebound as the Federal Reserve, to recognize its shortcomings.  This does beg the question, though, if they are going to mechanically respond to data with policy moves, why do they even need to be involved at all?  Certainly, an algorithm can be programmed to make those decisions without the added risk of making policy errors. Instead, the Fed could concentrate on its role as banking supervisor, an area in which they have clearly fallen behind.  But I digress.

Back in the real world, this change, which they have been discussing for some time, is truly important.  It seems to be premised on the idea that measured inflation remains far below their target, so running the economy ‘hot’ is a desirable way to achieve that target.  And running the economy hot has the added benefit of helping to encourage maximum employment in the economy, their restated goal on that half of the mandate.  It also appears to assume that they have both the tools, and the wherewithal to use them, in case inflation gets hotter than currently expected.  It is this last assumption that I fear will come back to haunt them.  But for now, this week’s CPI data did nothing to scare anybody and they are feeling pretty good.

One other thing they both made clear was that the timing of any rate hike was absolutely going to be after QE purchases are completed.  So, the tapering will begin at some point, and only when they stop expanding the balance sheet will they consider raising the Fed Funds rate.  Right now, the best guess is late 2023, but clearly, since they are data driven, that is subject to change.

There is a conundrum, though, in the markets.  Despite this very clear policy direction, and despite the fact that bond investors are typically quite sensitive to potential inflation, Treasury yields have seemingly peaked for the time being and continue to slide lower.  Certainly, the auctions this week, where the Treasury issued $120 billion in new debt were all well received, so concerns over a buyer’s strike were overblown.  In fact, overnight data showed that Japanese buyers soaked up nearly $16 billion in bonds, the largest amount since last November.  But, depending on how you choose to measure real interest rates, they remain somewhere between 0.0% and -1.0% based on either Core or Headline CPI vs. the 10-year.  Traditionally, headline has been the measure since it represents everything, and for a bond investor, they still need to eat and drive so those costs matter.

Summing this all up tells us 1) the Fed is 100% reactive to data now, so overshooting in their targets is a virtual given; 2) interest rates are not going to rise for at least another two years as they made clear they will begin tapering their QE purchases long before they consider raising interest rates; and 3) the opportunity for increased volatility of outcomes has grown significantly with this new policy stance since, by definition, they will always be reactive.  To my mind, this situation is one where the current market calm is very likely preceding what will be a very large storm.  If central banks handcuff themselves to waiting for data to print (and remember, hard data is, by definition, backwards looking, generally at least one month and frequently two months), trends will be able to establish themselves such that the Fed will need to respond in a MUCH greater manner to regain control.  Markets will not take kindly to that situation.  But that situation is not yet upon us, so the bulls can continue to run.

And run they have, albeit not as quickly as they have been recently.  In Asia overnight, it was actually a mixed performance with the Nikkei (+0.1%) eking out a small gain while the Hang Seng (-0.4%) and Shanghai (-0.5%) both stumbled slightly.  Europe, on the other hand, is all green with gains ranging between 0.2% and 0.4% across the major markets.  US futures are actually looking even better, with gains of 0.45%-0.6% at this hour.  Earnings season started yesterday, and the big banks all killed it in Q1, helping the overall market.

Bond yields, meanwhile, are continuing to slide, with Treasuries (-1.9bps) continuing to show the way to virtually all Western bond markets.  Bunds (-1.6bps), OATs (-2.0bps ) and Gilts (-2.7bps) are rallying as well despite the generally upbeat economic news.  There was, however, one negative release, where the German economic Institutes have cut their GDP forecast by 1.0%, to 3.7%, after the third wave and concomitant lockdowns.

Oil prices, which have had a huge runup this week, have slipped a bit, down 0.5%, but the metals markets are all in the green with Au (+0.6%), Ag (+0.6%), Cu (+1.5%) and Al (+0.25%) all in fine fettle.

It can be no surprise that with Treasury yields lower and commodity prices generally higher, the dollar is under further pressure this morning.  In the G10, the commodity bloc is leading the way with NZD (+0.25%), CAD (+0.2%) and AUD (+0.2%) all performing well.  There are a few laggards, but the movement there is so small, it is hardly a sign of anything noteworthy.  The euro, for instance, is lower by 0.1%, truly unremarkable.  In the EMG bloc, RUB (-1.2%) is the biggest mover, suffering on the news that the Biden Administration is slapping yet more sanctions on Russia for their election meddling efforts.  After that, HUF (-0.4%) has suffered as the central bank maintains its rate stance despite quickening inflation readings.  On the plus side, ZAR (+0.65%) and MXN (+0.3%) are the leading gainers, both clearly benefitting from the commodity story today.

One thing to watch here is the technical picture as despite the slow-motion decline in the dollar since the beginning of the month, it is starting to approach key technical support levels with many traders looking for a breakout should we breach those levels.  We shall see, but certainly if Treasury yields continue to slide, the dollar is likely to slide further.

We have a bunch of data today led by Initial Claims (exp 700K), Continuing Claims (3.7M), Retail Sales (+5.8%, +5.0% ex autos) and then Empire Manufacturing (20.0), Philly Fed (41.5), IP (2.5%) and Capacity Utilization (75.6%).  The Retail Sales data is based on the second stimulus check being spent, and the Claims data is assuming strength based on the NFP from last month.    We also hear from a bunch more speakers, but Powell and Clarida are done, so it would be surprising to see anything new from this group of three.

All told, nothing has changed my view that as goes the 10-year Treasury yield, so goes the dollar.  That will need to be proven wrong consistently before we seek another narrative.

Finally, I will be taking a few, very needed, days off so there will be no poetry until I return on Thursday April 22.

Good luck, good weekend and stay safe
Adf

Not If But When

Eight years ago, when Chairman Ben
Suggested t’was not if but when
The Fed would reduce
Its purchase, profuse,
Of bonds, traders sold bonds, bought yen

But these days when taper’s discussed
The bond market doesn’t seem fussed
The reason could be
There’s now nobody
The market invests with its trust

Yesterday’s CPI data printed a tick higher than forecast indicating that, yes, prices are rising relative to last year.  The headline print of 2.6% was the beneficiary of a substantial rise in energy prices compared to last year, but the core price index indicated that both goods and services prices are rising in price.  One data point is not enough to make any claims in either direction, but it will certainly keep the discussion going for a while.  The market response was somewhat counterintuitive as by the end of the day, 10-year Treasury yields had fallen 6 basis points and the dollar was softer amid modestly firmer equity prices.  While the link between the dollar and Treasuries remains intact, the question is why would bonds rally (yields decline) if inflation was rising?

One possible answer is that the market had gotten far ahead of itself with respect to pricing in rising inflation.  Historically, inflation takes time to manifest itself as prices on many things are sticky, meaning they remain stable for a time amid broad pressures and then shift in a relatively large step, rather than a gradual daily or weekly increase.  We are all familiar with the situation when an item regularly purchased suddenly rises in price to catch up to the broad underlying price pressures.  But when taken over the totality of all goods purchased, while any given good or service may see prices rise in discrete steps, the index moves up in a relatively smooth manner.  This fact is why yesterday’s data are interesting, because the headline jump of 0.6% M/M certainly tests the definition of smooth.  Consider that a monthly increase of 0.6% would result in annual inflation of 7.4%, a level that even the Fed would consider too hot.  FYI, yesterday’s core print, which was actually 0.34%, would represent 4.2% core CPI over a year.  So, yes, the base effects were instrumental in the much higher Y/Y data, but the monthly increases were pretty high in any accounting.

And yet, the bond market ultimately rallied all day, having touched 1.7% in early European trading and closing the session at 1.615%.  If this wasn’t a classic case of buy the rumor, sell the news, I don’t know what is.  And, as we have seen consistently all year, the dollar dutifully followed yields lower while equity markets ultimately rallied, although the euphoria over the value trade seems to be waning.

Perhaps of more interest is the fact that we have now had 3 key central bankers, two from the ECB, Knot and Villeroy, and the Fed’s Bullard all start to discuss the idea of tapering bond purchases.  This seems incongruous given the adamant claims on both sides of the pond that current monetary policy is necessary and appropriate to ensure the respective economies return to form.  And yet each of these discussed how tapering of QE could begin before the year is out.  You may recall that Bullard wanted to tie the idea of tapering to the level of vaccinations in the economy, indicating that when 75% of the population is vaccinated, it could be time to start slowing purchases with the implication being the economy would then be able to stand on its own two feet.

This morning, Banque de France Governor Villeroy de Galhau explained that there could be an evolution in monetary policy at the ECB, which while remaining accommodative would shift the burden back to the APP (the original QE plan) from PEPP, which will ostensibly run its course in March 2022.  Last week, Knot, the Dutch Central Bank president expressed his view that the current expectations of robust growth in the second half of the year could be a signal to begin tapering asset purchases.  Now, understand that there were members from both central bank committees pushing back on the idea, but the fact remains that there is some consideration of tapering.  Today, we hear from Chairman Powell again, but we will not hear from Madame Lagarde until her press conference after the ECB meeting next week.

Adding up the disparate facts is quite difficult.  On the one hand, we have the first trial balloons floated regarding tapering of asset purchases as a response to the forecasts for extremely robust growth this year.  On the other hand, the market appears to have indicated that, at least for now, the idea of much faster growth leading to much higher inflation has run its course.  It strikes me that the market is unlikely to worry too much about these trial balloons until they hear from Powell and/or Lagarde.  Until then, it appears that a short period of higher inflation readings is on the cards and unless they really start to spike, that is unlikely to have a big impact on either equities or bonds.

Speaking of equities, yesterday saw the S&P 500 close at yet another new all-time high with the NASDAQ pushing back to within 1% of its February record.  Clearly, there is no inflation scare there.  Rather, all eyes are turning to the first earnings releases due today.  Overnight saw the Nikkei slide (-0.4%) but elsewhere in Asia equities rallied (Hang Seng +1.4%, Shanghai +0.5%).  European markets are mixed with the DAX (-0.1%) lagging while both the CAC (+0.4%) and FTSE 100 (+0.3%) continue to grind higher.  Apparently, Villeroy’s comments about tapering have not been seen as a danger.  US futures are modestly higher at this point, just 0.2% or so as the market bides its time ahead of Powell’s comments at noon.

In the bond market, after a big rally yesterday, the 10-year has seen yields back up slightly, by 1.1 bps, although European bonds are all looking at modest yield declines (Bunds -1.0bps, OATs -1.2bps, Gilts -0.3bps).  It has become pretty clear that the rush higher in yields has stalled for now, with important implications for all the other markets, especially the dollar.

Oil prices are continuing their recent rebound, with WTI +1.6%, although the price action in the metals markets remains confusing.  Precious metals rallied sharply yesterday but are little changed this morning.  Base metals continue to trade both ways with Cu (+1.1%) leading the way higher, but Al (-0.3%) lagging.  It all seems very much like a consolidation period ahead of the next leg higher.

As to the dollar, after sliding all day yesterday alongside Treasury yields, it is continuing lower this morning.  The leading gainer is NZD (+0.8%) which has rallied based on the market’s interpretation that standing pat by the RBNZ last night was actually hawkish, which has helped drag AUD (+0.65%) higher as well.  Oil is supporting NOK (+0.45%) but the rest of the moves are far less significant.  EMG currencies are also performing well this morning, led by KRW (+0.85%) and TRY (+0.5%).  The won was a beneficiary of the generally falling dollar as well as foreign inflows into the KOSPI.  TRY, on the other hand, simply offers yields that are too high to resist for certain investors, despite rising inflation there.

The only data today is the Fed’s Beige Book, to be released at 2:00, but aside from Powell at noon, we hear from four other Fed speakers including vice-chairman Clarida at 3:45 this afternoon.  Come Friday, the Fed will enter their quiet period ahead of the next FOMC meeting, so it seems everyone wants to get their thoughts aired ahead of that.

In the end, the dollar remains beholden to 10-year Treasury yields, so we could be in for a period of very limited movement, if Treasuries have found a new home.  Unless we hear something new from the Chairman today, I expect we are looking at a period of quiet for the next two weeks.  The calm before the storm.

Good luck and stay safe
Adf

A Simple Statistic

There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic

But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided

The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning.  At that time, CPI will be released with the following median forecasts according to Bloomberg:

CPI MoM 0.5%
-ex food & energy MoM 0.2%
CPI YoY 2.5%
-ex food & energy YoY 1.5%

The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018.  As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high.  After all, last month CPI YoY printed at 1.7%, so this is a big jump.  We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs.  Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.

Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA.  My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data.  What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation.  And I can’t help but notice how the price of things that I buy seem to continue to rise as well.  While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning.  Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price.  Certainly not gasoline, and even tech items cost more.  If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.

Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future.  In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all.  If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.

Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices.  We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities.  Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance.  Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year.  The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions.  Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low.  However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.

Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon.  This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality.  In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.

As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus.  So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.

Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets.  The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder.  We also saw yields rise in Australia overnight.

Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains.  Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way.  In other words, pretty much every market is waiting for CPI to take their cues.

FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data.  This is especially odd given oil’s gains in the session.  But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number.  EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.

The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week.  Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option.  While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.

At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver.  If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck.  These days, it is truly binary.

Good luck and stay safe
Adf

Prices Are Rising

While Jay and the Fed are persuaded
Inflation won’t soon be upgraded
The press keeps advising
That prices are rising
How long can rate hikes be evaded?

Chairman Powell gave yet another interview this weekend, this time to a national audience on 60 Minutes last night.  A cynic might believe that the Chairman is concerned the Fed’s message, inflation is still quite low and will not present any problems, is not getting across to the general public.  While those of us in the financial markets are well aware of everything he utters, his fame amongst the general populace is far less significant.  (After all, I’m pretty certain he doesn’t have either an Instagram or TikTok presence!)  The problem for the Fed if they are unable to get their message across is that people might start to believe their own eyes what they read in the papers and lately, that is not synching well with the Fed’s message.  The number of stories on inflation has been inflating along with a clearly growing interest by the general population, at least as evidenced by the number of Google searches on the subject.  The fear here is that all of this talk of rising prices might result in a change in inflation expectations by the general population, and according to the Fed’s models, that is when inflation starts to rise.

The Fed is not the only central bank in this position as evidenced by comments this morning from Banca’d’Italia, and ECB Executive Board Member, Fabio Panetta’s comments, “We cannot be satisfied with inflation at 1.2% in 2022 and 1.4% in 2023.”  Here, too, the concern is over too low inflation although, in fairness, the inflationary impulse on the Continent is far less consistent than in the US.

One need not look too deep beneath the surface to find a viable explanation for this lack of concern over rising prices.  Clearly the ongoing need for central banks to continue to monetize purchase government debt issuance in order to support the government in power economy is the catalyst.  And there is no better rationale for a central bank to continue QE than a strong belief that inflation is too low along with a commitment to raise it.

That cynic might also question the timing of this 60 Minutes interview as it was aired just two days before the CPI data is to be released.  We are all aware that CPI prints for the next several months will be quite a bit higher than the Fed’s 2.0% target as the base effects from the initial impacts of the Covid-inspired lockdowns are now the comparison.  The month-on-month rate of CPI in March 2020 was -0.4% with it declining to -0.8% in April 2020.  Given the very real increases in price pressures we have observed in the past months, you can be sure that CPI tomorrow, currently expected at 0.5% M/M, 2.5% Y/Y will be quite high.  All told, Powell and the Fed will have to work overtime in order to ensure their message on inflation gets across, because if the general population starts to anticipate rising prices, even though the Fed ‘has tools’ to combat inflation, given the fragility of the economy, their ability to use those tools is highly suspect.  Inflation, once it gets rolling, has a history of being more persistent than desired, and as much as the Fed claimed to fear deflation, I’m pretty sure they are not looking forward to having to fight inflation either.  Especially as that would require actions that will slow the economy down, meaning they will be an easy political target for both sides of the aisle.

But CPI is tomorrow’s release, despite the fact that there are no less than ten stories on major media sites on the subject today.  In the meantime, markets are starting the week generally on their back foot, with risk definitely under some pressure today.  Equity markets in Asia, for instance, were all red (Nikkei -0.8%, Hang Seng -0.9%, Shanghai -1.1%) while European markets have been more mixed, but the mix is flat to down (DAX +0.1%, CAC 0.0%, FTSE 100 -0.4%).  US futures markets are also pointing slightly lower, with all three major indices off by about 0.15% as I type.

Bond market activity has been fairly quiet, with the 10-year Treasury yield unchanged on the day, although we are seeing very modest gains (yield declines) in most of Europe (Bunds -1.3bps, OATs -1.5bps).  Gilts are the lone exception here, with yields rising 1.0 basis point as the UK economy, despite a surprise spring snowstorm, welcomes the reopening of pubs for outdoor drinking/dining.  As the UK economy reopens, there is a great deal of focus on the £150 billion of savings that have accrued during the lockdown and how much of that will be quickly spent.  After all, that represents nearly 7% of GDP in the UK, and obviously, if spent would have a remarkable impact on growth there.

Commodity prices show oil rebounding from its recent lows (WTI +1.1%) as it pushes back to $60/bbl.  Metals prices, however, have been far more mixed with precious largely unchanged, and base metals showing both gains and losses (Cu -0.4%, Al +0.2%).

Finally, the dollar is edging lower this morning in general, but by no means universally.  G10 markets are led by GBP (+0.4%) on the economy reopening news and corresponding growth in confidence there, as well as JPY (+0.4%) which some will attribute to haven demand as equity markets suffered in Asia overnight, but I might attribute to Hideki Matsuyama’s fantastic win at the Masters yesterday.  On the downside, SEK (-0.25%) is the weakest of the bunch, which looks more like position trading than fundamentally driven activity.

EMG currencies are also mixed this morning, but most of the movement remains modest at best.  HUF (+0.6%) is the leading gainer followed by RUB (+0.3%) and PLN (+0.3%).  The HUF seems to be rallying on the news that the central bank will be buying the soon to be issued government green bonds as part of their QE exercise, helping to add demand there.  As to the other two, given the euro’s modest climb, it is no surprise to see EEMEA currencies rise.  On the downside, it is all APAC currencies that fell last night, led by INR (-0.4%) and KRW (-0.35%), which were victims of local equity market disposals by international investors.

Data wise, there is important information beyond tomorrow’s CPI as follows:

Today Monthly Budget Statement -$658B
Tuesday CPI 0.5% (2.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Wednesday Fed Beige Book
Thursday Initial Claims 700K
Continuing Claims 3700K
Retail Sales 5.5%
-ex autos 4.8%
Empire Manufacturing 18.8
Philly Fed 40.0
IP 2.5%
Capacity Utilization 75.6%
Business Inventories 0.5%
Friday Housing Starts 1600K
Building Permits 1750K
Michigan Sentiment 89.0

Source: Bloomberg

So, there is much to learn this week, especially on Thursday, although if the CPI data is large enough, it is likely to dominate conversation for a while.  The FOMC is back on tour this week with ten more speakers, including Chairman Powell on Wednesday, across at least 15 different venues.  I expect there will be a great deal of effort downplaying any thoughts that inflation is making a permanent comeback and that current policy is perfect for right now.

In the end, though, the dollar remains beholden to the Treasury bond, as do most markets, and so all eyes will continue to be on its movement going forward.  Strong data that pushes it to its recent high yield at 1.75% or beyond will result in the dollar rallying.  On the other hand, if the data goes the other way, look for the dollar to retreat a bit further.

Good luck and stay safe
Adf

Central Banks Scoff

In Italy more cash is needed
Or so Super Mario pleaded
The virus is raging
And Mario’s waging
A war so its spread is impeded

Meanwhile Chairman Jay and his mates
Remain steadfast that in the States
Though forecasts are nice
They will not suffice
It’s hard growth they need to raise rates

And lastly, from China we learned
Inflation just might have returned
Though central banks scoff
Bond markets sold off
As clearly some folks are concerned

In the financial world these days, there is only one true constant, the Fed remains as dovish as possible.  Yesterday, Chairman Powell, speaking at an IMF sponsored event, explained that the Fed would continue to aggressively support the economy until it is once again “great”.  (And here I thought that description of America was verboten.)  He harped on the 9 million to 10 million jobs that are still missing from before the Covid-induced crisis and said any inflationary pressures this year would be temporary.  His colleague, SF Fed President Daly doubled down on those comments, once again explaining that the Fed will not react to mere forecasts of growth, they will wait until they see hard data describing that growth is real, before considering tightening policy.

Regarding inflation, Powell, when asked specifically on the subject, explained, “We would be monitoring inflation expectations very carefully.  If we see them moving persistently and materially above levels we’re comfortable with, then we’d react to that.”  Remember, the Fed constantly reminds us they have the tools to deal with rising inflation.  But talk is cheap.  It remains an open question as to whether they have the fortitude to address rising inflation in an economy that has not come close to reaching full employment, let alone maximum employment.  Recall Q4 2018, when a modest increase in interest rates and gradual reduction in the size of the balance sheet led to a sharp stock market sell-off and a reversal of Fed policies via the “Powell Pivot.”  And the economy then was clearly in better shape than now.

There is another inflation issue I find puzzling as well, and that is the Fed’s inexorable faith that the Core PCE number is the right way to measure inflation.  This is especially true since a number of Fed members, including Powell, have been vocal in their view that the U-3 Unemployment Rate, the one published the first Friday of each month, is a very imperfect indicator of the overall jobless situation despite its long history as a key indicator.  So, happily, they are willing to question the totality of the information available from a single data point.  And yet, while they pay some lip service to inflation expectations, they are absolutely beholden to a single inflation data point, and one that has very little in common with most people’s reality.  One would think that given their broad-mindedness regarding unemployment, that same attitude might extend to inflation.  Alas, my understanding is that their econometric models don’t work well with any other data point, and so rather than building models based on reality, they create their reality from the data that works.

While on the subject of inflation, Chinese data overnight showed that, while CPI rose only 0.4% Y/Y, PPI rose a much greater than expected 4.4%.  This matters because China remains the world’s major manufacturing center and if prices at the factory are rising there, the implication is that those higher prices are coming to a product near you soon. Another sign of pending inflation comes from an IHS Markit report explaining that the PMI price data is running at its highest level since 2008 and is showing no signs of slowing down.  Add to this the increases in shipping costs, and rising prices for every day items seem in store.  Thank goodness the Fed has tools!

A quick look at Europe shows a tale of two countries, with Italy heading into its fourth wave of lockdowns and PM Draghi putting together a €40 billion support package following on from a €30 billion package a few months ago.  The vaccine rollout remains slow and insufficient and the government has closed bars and restaurants (and that’s really a crime, given just how good the food is there!)  Germany, on the other hand, is leading the hawkish contingent of the ECB along with the Dutch, in pushing for tapering the PEPP activity as those economies have been far more resilient to the virus and are starting to see some price pressures.  Granted, this morning’s German IP data (-6.4% Y/Y) was much worse than expected, but forecasts remain quite positive there.  Unlike the Fed, the ECB seems to be turning a bit more hawkish, indicating the Frugal Four are gaining in power.  ECB PEPP purchases declined to just €10.2 billion last week, far below their average in Q1 and even more surprising given Madame Lagarde’s comments in the wake of the ECB meeting that they would be far more active in Q2.

Adding all the new information together brings us to a market situation this morning where Treasury bonds have sold off, yields are higher by 5 basis points in the US and about 4 basis points in the major European markets except Italy, where they are 8 basis points higher.  Equity markets are mixed in Europe (DAX +0.1%, CAC +0.25%, FTSE -0.1%) after broad weakness in Asia (Hang Seng -1.1%, Shanghai -0.9%) and US futures are little changed to slightly higher at this time.

Rather, it is the dollar that is today’s big winner, rallying against all its G10 counterparts with NOK (-0.6%) the laggard on still soft oil prices, but weakness seen in JPY (-0.3%) and AUD (-0.25%) with smaller declines elsewhere.  The yen’s weakness appears corrective in nature, as it had strengthened 1.7% in the past week. While Aussie is simply chopping about in its recent 0.7550/0.7675 trading range and slipping today.

In the EMG bloc, CZK (-0.65%) is the worst performer, followed by RUB (-0.5%) and KRW (-0.3%), although the bulk of the bloc is somewhat softer this morning.  Here, too, we appear to be seeing some trading reactions to the past week’s dollar weakness, although the bigger trend remains for dollar strength.

On the data front, PPI (exp 0.5%, 3.8% Y/Y) is the only release with the core expectations (0.2%, 2.7% Y/Y) also well above the Fed target.  Of course, the relationship between PPI and Core PCE is limited at best, however, it is certainly indicative of the fact that there are rising price pressures throughout many sectors of the economy.  It is not unreasonable to expect them to show up in PCE soon, as they will certainly begin to show up in CPI next week.

Only one Fed speaker is on the docket today, Dallas Fed President Kaplan, but it would be beyond shocking if he said anything that was different than what we have both read and heard this week; nothing will change until the hard data achieves their targets.

Despite new information this morning, or perhaps because of it, the market theme remains the same, Treasury yields are the key driver of markets, with the dollar following in step while equities will have an inverse relationship.  And, while Treasury yields are off their recent highs, they appear to have finished this short-term correction.  I have a feeling the dollar will be firmer today and continue with that into next week, at least.

Good luck, good weekend and stay safe
Adf

Clearly Reviving

The positive news keeps arriving
Explaining the ‘conomy’s thriving
Last Friday’s report
Was of such a sort
That showed growth is clearly reviving

The Nonfarm data on Friday was a generally spectacular report that was released into a near vacuum.  All of Europe was closed for the Good Friday holiday as were US equity markets.  The Treasury market was open for an abbreviated session and there were some futures markets open, but otherwise, it was extremely quiet.  And the thing is, this morning is little different, as Europe remains completely closed and in Asia, only Japan, South Korea and India had market activity.  Granted, US markets are fully open today, but as yet, we have not seen much activity.

A quick recap of the report showed Nonfarm Payrolls rose by 916K with revisions higher to the past two months of 156K.  The Unemployment Rate fell to 6.0%, its lowest post pandemic print and the Participation Rate continues to edge higher, now at 61.5%, although that remains a far cry from the 64% readings that had existed for the previous decade.  Arguably, this is one of the biggest concerns for the economy, the fact that the labor force may have permanently shrunk.  This is key because, remember, economic growth is simply the product of population growth and productivity gains.  In this case, population growth means the labor force population, so if that segment has shrunk, it bodes ill for the future of the economy.  But that is a longer-term issue.

Let’s try to put the employment situation into context regarding the Fed and its perceived reaction functions.  It was less than two months ago, February 23 to be exact, when Chairman Powell testified to Congress about the 10 million payroll jobs that had been lost and needed to be recovered before the Fed would consider they have achieved their maximum employment mandate.  At that time, expectations were this would not be accomplished before a minimum of two more years which was what helped inform the Fed’s broad belief that ZIRP would be appropriate through the end of 2023.  And this was the FOMC consensus view, with only a small minority of members expecting even a single rate hike before that time.

But since then, 1.6 million jobs have been created, a remarkable pace and arguably quite a bit faster than anticipated.  The bond market has seen this data, along with the other US economic information and determined that the recovery is moving along far faster than previously expected.  This is evident in the fact that the 10-year yield continues to climb.  Even in Friday’s abbreviated session, yields rose 5 basis points, and as NY is waking up, they have maintained those gains and appear to be edging higher still.  Similarly, the Fed Funds futures market is now pricing in its first full rate hike in December 2022, a full year before the Fed’s verbal guidance would have us believe.

The point here is the tension between the Fed and the markets is growing and the eventual outcome, meaning how the Fed responds, will impact every market significantly.  So, not only will the bond market have an opportunity to gyrate, but we will see increased volatility in stocks, commodities and the FX markets.  The Fed, however, has made it abundantly clear they are uninterested in inflation readings as they strongly believe not only will any inflation be ‘transitory’, but that if it should appear, they have the tools to thwart it quickly (they don’t). More importantly, they have a very specific view of what constitutes maximum employment.  And they have been explicit in their verbal guidance that they will give plenty of warning before they start to alter policy in any way.  The problem with this thesis is that economic surprises, by their very nature, tend to happen more quickly than expected.

This combination of facts has created the very real possibility of putting the Fed in a position where they need to choose between acting in a timely fashion or giving all that warning before acting.  If they choose door number one, they risk impugning their credibility and weakening their toolkit while door number two leaves them even further behind the curve than normal with negative economic consequences for us all.  If you wondered why many pundits have used the metaphor of the Fed painting itself into a corner, this is exactly what they are describing.

For now, though, there is precious little chance the Fed is going to change their stance or commentary until forced to do so, which means that we are going to continue to hear that they believe current policy is appropriate and they will give plenty of warning before any changes.  I hope they are right, but I fear they are not.

Markets take less time to discuss this morning as most of them are closed.  Of the major equity indices, only the Nikkei (+0.7%) was open last night as Commonwealth countries were closed for Easter Monday while China was closed for Tomb Sweeping Day (the Chinese version of Memorial Day).  US futures are pointing higher, which given Friday’s data should be no surprise.  So right now, we are looking at gains between 0.4% and 0.7%, with both the Dow and S&P sitting at all-time highs.

Bond markets were similarly closed pretty much everywhere, with the US market now edging higher by 0.4bps as traders sit down at their desks.  The current 10-year yield of 1.725% is at its highest level since January 2020, but remember, it remains far below the average seen during the past decade and even further below levels seen prior to that.  The point is yields are not constrained on the high side in any real way.

Oil prices (-1.7%) are under pressure this morning after OPEC+ indicated they would be increasing production somewhat thus taking pressure off of supplies.  However, given the speed of recovery in the US and China, the two largest consumers of oil, I expect that there is more upside here as well.

As to the dollar, it is a pretty dull session overall.  That is mostly because so many financial centers have been closed, so trading volumes and activity has been extremely light.  In the G10 space, there is a mix of gainers (GBP +0.25%, AUD +0.2%) and losers (SEK -0.25%, NOK -0.15%) but as can be seen by the limited movement, this is really just a bit of position adjustment.  In the EMG bloc, TRY (+0.6%) is the leading gainer after a slightly higher than expected inflation print and more hawkish words from the new central bank governor.  Otherwise, these currencies are also trading in a range with limited movement in either direction.  We will need to wait until tomorrow to see how other markets react to the US data.

Speaking of data, this week sees a mix of indicators as well as the FOMC Minutes.

Today ISM Services 59.0
Factory Orders -0.5%
Tuesday JOLTs Job Openings 6.9M
Wednesday Trade Balance -$70.5B
FOMC Minutes
Thursday Initial Claims 690K
Continuing Claims 3638K
Friday PPI 0.5% (3.8% Y/Y)
-ex food & energy 0.2% (2.7% Y/Y)

Source: Bloomberg

Away from this data, we hear from a handful of Fed speakers, including Chair Powell.  Powell, however, will be speaking at the virtual IMF/World Bank meetings being held this week.  In fact, that should remind us to all be aware of the tape, as we will be hearing from many global financial policymakers this week, and you never know what may come from that.

In the end, the bond market continues to be the key driver of markets, and the US Treasury market remains the driver of global bond markets.  I see no reason for US yields to back off given the consistent data story and the increased price pressures.  And that, my friends, means the dollar has further room to rise.

Good luck and stay safe
Adf

Kept at Bay

The key for investors today
Is payrolls and how they portray
The jobs situation
Thus, whether inflation
Will rocket, or be kept at bay

It’s Payrolls day, generally a session where there is a great deal of anticipation leading up to the release, often followed by a burst of activity and then a very slow afternoon.  However, given today also happens to be Good Friday, with all European markets closed in observation, as well as US equity markets, it is likely the burst activity, assuming one comes, will be compressed into an even shorter timeline than usual.  Of course, what makes this potentially unnerving is that market liquidity will be significantly impaired relative to most sessions, and any surprising outcome could result in a much larger move than would normally be the case.

It is not a bank holiday, which means the bond market will be trading, and that is, in truth, the market that continues to drive the action.  As evidenced by yesterday’s price action, the bond rally, with 10-year Treasury yields sliding 7 basis points, led to a declining dollar and new record highs in the stock market.  We also saw gold and other commodities rally as the combination of strong data (ISM at 64.7) and lower yields was a double-barreled benefit.

With that in mind, here are the latest expectations:

Nonfarm Payrolls 660K
Private Payrolls 643K
Manufacturing Payrolls 35K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

All that seems fine, but it is worth a look at the individual forecasts that make up that NFP number.  There is a wide dispersion of views ranging from a gain of just 350K to eight forecasts greater than 900K and three of those at a cool million each.

Let’s consider, for a moment, if the optimists are correct.  Harking back to Chairman Powell’s constant refrain regarding the recovery of the 10 million lost jobs, the expected timeline for that to happen remains sometime in late 2023.  But if this morning’s release is 1000K or more, that would seem to potentially shorten the timeline for those jobs to return.  And following that logic, it seems likely that the Fed may find themselves in a situation where ZIRP is no longer appropriate somewhat earlier in 2023 than currently expected as inflation rises, and unemployment falls back to their new goal of 3.5%-4.0%.  The implication here is that the bond market will anticipate this activity and we could see the 10-year yield break through to new highs quite quickly.  Based on broad market behavior as seen yesterday, a sharp decline in the bond market would likely result in the dollar rebounding sharply and equity futures, which are trading, retreating.  And all this on a day when there is much less liquidity than normal.

Of course, a weak number is likely to have just the opposite effect, with the bond bulls making the case that we have seen the high in yields, and dollar bears back in the saddle making the case the dollar’s run higher has ended.

And that’s really what we have in store for the day.  The two markets that were open overnight saw equities rally on the heels of the US equity rally, with the Nikkei (+1.6%) and Shanghai (+0.5%) both performing well.  Every European market is closed for the holiday and will be on Monday as well.  Meanwhile, US futures are all pointing modestly higher, roughly 0.25%, ahead of the payroll report.

As NY is walking in, we are seeing the first movement in Treasury yields and they have edged higher by 1.1bps at this point.  But as I highlight above, this is all about the data today.

In the commodity markets, only precious metals are trading but both gold and silver are essentially unchanged at this hour ahead of the data.  This follows yesterday’s strong performance with both rallying more than 1% in the session.

And finally, in the FX market, except for TRY (+0.7%) and KRW (+0.4%) there is no movement more than 0.2%, which is indicative of the fact that some positions are being adjusted but there is no news driving things.  In the case of TRY, the new central bank governor, in a speech today, made clear that he was not going to cut rates and that he was likely to raise them again in an effort to combat the rising inflation in the country.  This was well received by the market and has helped TRY recover much of its initial losses upon the sacking of the previous central bank chief.  As to KRW, they released CPI data last night, 1.5%, which was the highest print since January 2020, indicating that growth was persistent, and the BOK would be more vigilant going forward.  This also encouraged equity inflows resulting in the won’s modest appreciation.

So, now we wait for the payroll data.  Based on the releases that we have seen during the past couple of weeks, where the economy is clearly pushing ahead, I suspect this number will be somewhere above 800K, although 1000K is clearly not out of the question.  As such, my view is we will see the bonds sell off and the dollar retest its recent highs, if not break through them.

Good luck, good weekend and stay safe
Adf

Disinflation’s Deceased

The plan that the Prez just released
Has taxes and spending increased
As well as what’s planned
There’s pent up demand
As such, disinflation’s deceased

Risk remains in vogue this morning as the details of the $2.3 trillion spending plan released last evening by President Biden were more than enough to keep the risk train rolling.  While there was no mention of ‘shovel ready’ projects, and expectations are that it won’t be until sometime in the summer that any bill will make it to the president’s desk, it is full speed ahead for the investor community.  Certainly, there are no concerns over either financing the new bill nor with the prospect that adding more stimulus demand is likely to drive up prices even more rapidly than currently seen.  In other words, everything is great!

But is it really that great?  It is hard to live in the real world and not have noticed that the cost of living is rising, and seemingly faster than the data indicates.  By now, we have all heard about the shortage of microprocessors causing a reduction in auto production and even iPhones.  I’m pretty sure that less supply in these products will not lead to lower prices.  And if you still drive at all, you are aware of how much the price of gasoline has risen during the past year.  But lately we have heard from a number of companies on more mundane products and how prices are being raised there as well.  Kimberly-Clark, General Mills, J.M. Smucker and Hormel Foods have all announced price hikes in the past week or two, and they all make things we buy in the supermarket each week.  So, while the rising price of a once every 3-6 year purchase of an automobile is not likely to impact any individual regularly, when your toilet paper goes up in price, you notice.  The Fed must be thrilled.

In that vein, I often wonder how the Fed considers its relationship with inflation.  Perhaps Powell rehearses discussions with an anthropomorphized version of inflation.  Maybe it would sound like this:

Inflation: Jay, I have to tell you, I’m feeling pretty strong lately.  I’ve been resting for the past 12 years and have a lot of energy available to jump pretty high.

Chairman Powell: That’s awfully nice, but let me warn you, ‘we have tools.’

Inflation: Tools?  What does that even mean?  Are you going to build a house?  (Nah, too expensive with prices rising 10% annually).  Repair the infrastructure?  (That will certainly drive up raw material prices even further.)

Chairman Powell:  Just what I said, we have tools.  My dear friend Paul Volcker, may he rest in peace, taught us how to deal with you 40 years ago.  We can stop you anytime we want.

Inflation:  Well, 40 years ago, was a different time and place.  The amount of outstanding debt was a fraction of where it is today.  Since you haven’t used those ‘tools’ in 40 years, I suspect they are rusty and ineffective now.  And even if you have them, I’m willing to bet you are either afraid to use them, or don’t know how.  I’m looking forward to our next conversation when I will be bigger, stronger and higher!

Chairman Powell:  Don’t mess with me, I told you, ‘we have tools!’

As Powell awakes shaking from this nightmare, he repeats to himself, we have tools, just like Christine has tools.  It will all be fine.

But seriously, it is very difficult to see the ongoing data releases, especially in the US, where GDP is clearly going to see a very big jump in Q2 and analysts are fighting to forecast the biggest GDP growth number in decades, and not wonder how prices are not going to rise even more rapidly.  In fact, we seem to be approaching a perfect storm, increased demand meets supply shortages.  The Fed is going to get their inflation, as will most central banks, and it is ultimately going to have a big impact on financial markets.  But not today.  Today, investors continue to see only the positives.

After yesterday’s Tech led rally in the US stock markets, Asia performed well (Nikkei +0.7%, Hang Seng +2.0%, Shanghai +0.7%) and Europe is largely green as well (DAX +0.3%, CAC +0.2%, FTSE 100 +0.4%).  As it is the first day of a new month and quarter, we saw PMI and Tankan data overnight, all of which continues to show positive vibes for the near future (although the Japanese data has been lagging that of the US and even Europe on these measures.)  US futures, meanwhile, are also looking good with the NASDAQ (+0.9%) once again leading things higher with lesser gains in the other two main indices.

Bond markets, interestingly, are also in fine fettle this morning, with yields declining in Treasuries (-2.1bps), bunds (-1.2bps), OATs (-1.2bps) and Gilts (-2.1bps).  But 10-year Treasury yields remain firmly above 1.7% and their spread to bunds and JGBs remain right at recent highs.  It appears to me as though bond traders are taking a rest ahead of tomorrow’s payroll report, which will be released on Good Friday, a day of limited liquidity.  If the economic bulls are right, and there is a print above 1 million jobs in NFP, I would expect that we will test 1.8% in the 10-year before the weekend arrives.  However, until then, it looks like the growing short position in bonds is getting adjusted.

Oil prices are firmer this morning with WTI up by 1.1%, alongside gains in gold (+0.25%) and the agricultural space.  Meanwhile, base metals are mixed with Cu (-0.65%) and Zn (-0.2%) softer while Al (+0.65%) and Ni (+0.8%) are firmer.

Lastly, the dollar is mixed today as well, with most of the G10 softer led by AUD (-0.4%) and CHF (-0.3%), although the euro has stopped its freefall, at least temporarily, and is currently 0.1% firmer on the session.  Aussie seems to be slipping on the view that the RBA’s first QE plan, A$100 billion, is complete but that there will be a second one announced next Tuesday.  The Swiss franc, on the other hand, seems to be developing some momentum on a technical view and is responding to market internals rather than fundamentals.

EMG currencies have had a much more mixed picture with both gainers and losers evident.  On the plus side, TRY (+0.8%) and ZAR (+0.5%) lead the way higher, while we are seeing RUB (-0.6%) and CNY (-0.3%) as the key laggards.  The rand seems to be benefitting from seasonal factors as technicians look at recent history when the ZAR has rallied consistently in April.  TRY is simply so volatile these days given the ongoing mess at the central bank, that it is difficult to ascribe any move less than 2% to a specific issue.  As to the negatives, RUB, despite oil’s gains, is suffering from news of a surprising new bond offering of RUB 1 trillion, while CNY seems to have been guided lower by the PBOC as the Chinese government has decided that a weaker currency is clearly going to be necessary to support their economy for now and the current US administration isn’t going to make a big deal about it.

Data this morning brings Initial Claims (exp 675K), Continuing Claims (3.75M) and ISM Manufacturing (61.5) and Prices Paid (85.0).  FYI, that Prices Paid index is back at levels seen during the 50’s, 60’s and 70’s, all times when CPI inflation was far higher than 1.3%!

Frankly, with the payroll data tomorrow, I anticipate a generally quiet session, especially as much of Europe will be taking a long Easter holiday weekend starting quite soon.  The dollar’s trend remains firmly higher, but I don’t expect much movement today.

Good luck
Adf

No Need to be Austere

From every Fed speaker we hear
That prices might rise some this year
But they all confirm
It will be short-term
So, there’s no need to be austere

I feel like today’s note can be very short as there really has been nothing new of note to discuss.  Risk is on the rise as market participants continue to absorb the Federal Reserve message that monetary stimulus is going to continue, at least at the current pace, for at least the next two years.  That’s a lot of new money, nearly $3 trillion more to add to the Fed balance sheet, and if things hold true to form, at least 60% of it will wind up in the equity market.

This was confirmed by four Fed speakers yesterday, including Powell and Vice Chair Clarida, who made it quite clear that this was no time to start tapering, and that rising bond yields were a vote of confidence in the economy, not a precursor to rising inflation.  What about inflation you may ask?  While they fully expect some higher readings in the short run due to base effects, they will be transitory and present no problem.  And if inflation should ever climb to a more persistent level that makes them uncomfortable, they have the tools to address that too!  I know I feel a lot better now.

Europe?  The big news was the German IFO Expectations index printing at a much better than expected 100.4, despite the fact that Covid continues to run rampant through the country.  While they have managed to avoid the massive Easter lockdown that had been proposed earlier this week, the ongoing failure to vaccinate the population remains a damper on activity, or at least the perception of activity.  Otherwise, we learned that Italy is struggling to pay its bills, as they need to find €15 billion quickly in order to continue the present level of fiscal support, but have a much tougher time borrowing, and have not yet received the money from the Eurozone fiscal support package.  In the end, however long the Fed is going to be expanding its balance sheet, you can be sure the ECB will be doing it longer.

The UK?  Retail Sales were released showing the expected gains relative to last month (+2.
1% M/M. -3.7% Y/Y) and excitement is building that given the rapid pace of vaccinations there, the economy may be able to reopen more fully fairly soon.  Certainly, the pound has been a beneficiary of this versus the euro, with the EURGBP cross having declined more than 5% this year, meaning the pound has appreciated vs. the euro by that much.  Perhaps Brexit is not as big a deal as some thought.

Japan?  The latest $1 trillion budget is being passed, which simply adds to the three supplementary budgets from last year totaling nearly $750 billion, with most observers expecting more supplementary budgets this year.  But hey, the Japanese have perfected the art of borrowing unfathomable sums, having the central bank monetize them and maintaining near zero interest rates.  Perhaps it should be no surprise that USDJPY has been rising, because on a relative basis, the Japanese situation does seem worse than that here in the US.

Other than these stories, things are just not that exciting.  The Suez Canal remains closed and we are starting to see ships reroute around the Cape of Good Hope in Africa, which adds more than a week to transit times and considerable expense.  But I’m sure these price rises are transitory too, just ask the Fed.

So, let’s take a quick tour of markets.  Equities are all green right now and were so overnight.  The three main Asian indices, Nikkei, Hang Seng and Shanghai, all rose 1.6% last night after US markets turned around in the afternoon.  European bourses are looking good, with the DAX (+0.6%), CAC (+0.4%) and FTSE 100 (+0.7%) all solidly higher on the day.  As to US futures, both Dow and S&P futures are a touch higher, 0.2% or so, but NASDAQ futures are under a bit of pressure at this hour, -0.3%.

In the bond market, 10-year Treasury yields are higher by 4.1bps in the wake of yesterday’s really mediocre 7-year auction.  While it wasn’t as bad as the last one of this maturity, it continues to call into question just how able the Treasury will be to sell sufficient bonds to fund all their wish list.  Even at $80 billion per month of purchases, the Fed is falling behind the curve here and may well need to pick up the pace if yields start to climb more.  I know that is not their current story, but oversupply is certainly at least part of the reason that Treasuries have been so weak.  And today, despite ECB support, European sovereign bonds are all lower with yields higher by 4.5bps or more virtually across the board.  Either the ECB has taken today off, or there are bigger worries afoot.  One little known fact is that alongside the ECB, European commercial banks had been huge buyers of their own country’s debt for all of last year.  However, that pace has slowed, so perhaps today’s movement is showing a lack of natural buyers here as well.

Commodity prices are pretty much firmer across the board with the exception of precious metals, which continue to suffer on the back of higher US yields.  But oil (+2.3%) is back at $60/bbl and base metals and agricultural prices are all firmer this morning.

Finally, the dollar is broadly weaker at this hour, with the commodity bloc of the G10 leading that group (NZD +0.5%), NOK (+0.4%), (AUD +0.4%), although the pound (+0.3%) is also doing well after the Retail Sales numbers.  Meanwhile, the havens are under pressure (JPY -0.5%), CHF (-0.15%), as there is no need for a haven when the central bank has your back!

EMG currencies are a bit less interesting, although the APAC bloc was almost uniformly higher by small amounts.  That was simply on the back of the risk-on attitude that was manifest overnight.  The one exception here is TRY (-1.1%) which continues to suffer over the change of central bank leadership and concerns that inflation will run rampant in Turkey.  Two other noteworthy things here were in LATAM, where Banxico left rates on hold at 4.0%  yesterday afternoon and reaffirmed they were entirely focused on data, and that S&P downgrade Chile’s credit rating to A from A+ on the back of the changes in government structure and concerns about the medium term fiscal position.

On the data front we see Personal Income (exp -7.2%), Personal Spending (-0.8%), Core PCE (1.5%) and then at 10:00 Michigan Sentiment (83.6).  To me, the only number that matters is the PCE print, but this is a February number, so not expected to be impacted by the significant base effects from last year’s events.  Of course, given the constant chorus of any rising inflation will be transitory, we will need to see a lot of high prints before the market gets nervous…or will we?  After all, the bond market seems to be getting nervous already.

At any rate, while the dollar is under pressure this morning, my take is that if US yields continue to climb, we are likely to see it retrace its steps.  At this point, I would argue the dollar’s trend is higher and will be until we see much higher inflation readings later this spring and summer.

Good luck, good weekend and stay safe
Adf

No line in the Sand

The story from Janet and Jay
Continues to point to a day
In two years, nay three
That both can foresee
A rate hike could be on the way

Until then, while growth should expand
No policy changes are planned
If prices should rise
Though, we’ll recognize
There’s simply no line in the sand

With a dearth of new news overnight, the market appears to be consolidating at current levels awaiting the next big thing.  With that in mind, market participants continue to parse the words of the numerous central bank and financial officials who have been speaking lately.  Atop this list sits the second day of testimony by Fed Chair Powell and Treasury Secretary Yellen, who yesterday were in front of the Senate Banking Committee.  While several senators tried to get a clearer picture of potential future activities from both Powell and Yellen, they have become quite practiced at not saying anything of note in these settings.

Perhaps the most interesting thing to be learned was, when Yellen was being questioned about her change of heart on the growth of the Federal debt load (in 2017 she publicly worried over a debt/GDP ratio of 75% vs. today’s level of 127%), she repeated her new belief that the Federal government has room to borrow trillions of more dollars to fund their wish list.  “My views on the amount of fiscal space that the United States [has], I would say, have changed somewhat since 2017.  Interest payments on that debt relative to GDP have not gone up at all, and so I think that’s a more meaningful metric of the burden of the debt on society and on the federal finances.” She explained.  It is remarkable what a change of venue will do to one’s opinions.  Now that she is Treasury Secretary, and wants to spend more money, it appears much easier for her to justify the new borrowing required.

At the same time, Chair Powell explained that the rise in bond yields was of no concern and that it represented a vote of confidence in the growth of the economy.  We heard this, too, from Atlanta Fed President Bostic yesterday, and this is clearly the new mantra.  So, while 10-year yields have backed off their recent highs by a few basis points, be prepared for further movement higher as positive data gets released.  The bond market has a history of testing the Fed in times like this, and remember, history also shows that when the 2yr-10-yr spread starts to steepen, it doesn’t stop until it reaches 250-275 basis points, which is more than one full percent higher than its current level.  I expect to see that test sometime this summer, as inflation rises.  Beware the impact on risk assets in that scenario.

But other than that, and of course the fact that the Ever Given remains wedged side-to-side in the Suez Canal, there is very little happening in markets today. (Apparently, the economic cost to the global economy of this incident is $400 million per HOUR!  And consider what it is doing to the concept of just-in-time delivery for supply chains.  We have not yet felt the full impact of this event.)

A quick tour of markets shows that Asian equity markets were mixed, with the Nikkei (+1.1%), by far the best performer, while the Hang Seng (0.0%) and Shanghai (-0.1%) essentially tread water.  European markets are mostly red, but the movement has been minimal.  The DAX (-0.2%), CAC (-0.2%) and FTSE 100 (-0.3%) are perfectly representative of pretty much the entire European equity space.  Meanwhile, US futures are edging higher (NASDAQ +0.4%, SPX +0.25%, DOW +0.2%) after yesterday’s late day sell-off.  Anecdotally, one of the things I have noticed lately is that the US equity markets tend to close nearer their trading lows than highs, which is a far cry from their behavior up through January, where late day price action almost always pushed prices higher.  The other thing that is changing is that the huge retail push into single stock options has been fading lately.  Perhaps it’s not as easy to make money in the stock market as it was claimed several weeks ago.

As to the bond market, we continue to see modest strength in the European sovereign market, where the ECB’s impact is clear to all.  This morning, in contrast to Treasury yields edging slightly higher (+0.5bps), we are looking at yield declines of between 1.3bps (OATs) and 2.5bps (Gilts) with Bunds in between.  There is no question that the ECB’s purchase numbers this week will be close to last week’s rather than near their longer-term average.  As an aside, we heard from BOE chief economist Haldane this morning and he explained that the UK economy could be set for a “rip roaring” move higher in Q2 given the amount of savings available to spend as long as the vaccine roll-out continues apace.

On the commodity front, despite the ongoing disruption in the Suez, oil prices have slipped back by 1.3%, although continue to hold above the psychologically important $60/bbl level.  As to metals prices, they have drifted down as well, along with most agricultural products.  Again, the movements here are not substantial and are indicative of modest position adjustments rather than a new trend of any sort.

Lastly, turning to the dollar, it too has had a mixed session, with both gains and losses across the spectrum.  In the G10, AUD (+0.4%) is the leader, followed by the GBP (+0.3%) and then lesser gains amongst most of the rest.  Meanwhile, JPY (-0.35%) has been the laggard in the group.  Aussie was the beneficiary of short covering as well as exporter interest taking advantage of its recent declines, while the pound seems to have been responding to the Haldane comments of potential strong growth.  As to the yen, while there are some concerns the BOJ may cut back on its JGB purchases, it appears the yen was a victim of some importer selling ahead of the Fiscal year end next week.

EMG currencies are also mixed, with gainers led by RUB (+1.0%), ZAR (+0.7%) and MXN (+0.45%) while the laggards have a distinctly Asian flavor (THB -0.35%, MYR -0.35%, TWD -0.3%).  The ruble appears to be benefitting from a trading bounce after a 3-day losing streak, while the rand is gaining ahead of a central bank meeting today, although expectations are for no policy change given the still low inflation readings in the country.  On the downside, the Bank of Thailand left policy on hold, as expected, but forecast a narrowing of the current account surplus, thus weakening the baht.  Meanwhile, both the ringgit and the Taiwan dollar are suffering from concerns over continued USD strength in combination with some technical moves.  Overall, the bloc remains beholden to the dollar, so should the buck start to gain vs. the G10, look for these currencies to suffer more acutely.

As it is Thursday, we start the day with Initial Claims (exp 730K) and Continuing Claims (4.0M), but also see a Q4 GDP revision (4.1%, unchanged) along with some of the ancillary GDP readings that tend to be ignored.  In addition, we hear from five more Fed speakers, but it is hard to believe that any of them is going to have something truly new to tell us.  We already know they are not going to raise rates until 2023 at the earliest and that they are comfortable with higher inflation and higher bond yields.  What else is there?

With all this in mind, I keep coming back to the Treasury market as the single key driver of markets overall.  If yields resume their rising trend, look for the dollar to rally and equities to fade.  If yields edge back lower, there is room for modest dollar weakness.

Good luck and stay safe
Adf