Tag Archives: #Powell

Ready to Pop

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Investors are having some trouble
Determining if the stock bubble
Is ready to pop
Or if Jay will prop
It up, ere it all turns to rubble

So, volatile markets are here
Most likely the rest of this year
Then, add to this fact
A Russian attack
On Ukraine.  I’d forecast more fear

One has to be impressed with yesterday’s equity markets in the US, where the morning appeared to be Armageddon, while the afternoon evolved into euphoria.  Did anything actually change with respect to information during the day?  I would argue, no, there was nothing new of note.  The proximate cause of the stock market’s decline appeared to be fear over escalating tensions in the Ukraine.  Certainly, that has not changed.  Russia continues to mass troops on its border and is proceeding with live fire drills off the coast of Ireland.  The Pentagon issued an order for troops to be ready for rapid deployment, which Russia claimed was fanning the flames of this issue.  While the key protagonists continue to talk, as of yet, there has been no indication that a negotiated solution is imminent.  With that in mind, though, today’s market reactions indicate somewhat less concern over a kinetic war.  European equity markets are all nicely higher (DAX +0.6%, CAC +0.8%, FTSE 100 +0.75%) and NatGas in Europe (-2.4%) has retraced a bit of yesterday’s surge.  Granted, these reversals are only a fraction of yesterday’s movement, but at least markets are calmer this morning.

However, one day of calm is not nearly enough to claim that the worst is behind us.  And, of course, none of this even considers the FOMC meeting which begins this morning and from which we will learn the Fed’s latest views tomorrow afternoon.  The punditry is virtually unanimous in their view that the first Fed funds hike will come in March and there will be one each quarter thereafter.  In fact, if there are any outliers, they expect a faster pace of rate hikes with five or more this year as the Fed makes a more concerted effort to temper rising prices.

Now, we have not heard from a Fed speaker since January 13th, nearly two weeks ago, although at that time there was a growing consensus that tighter policy needed to come sooner and via both rate hikes and balance sheet reduction.  But let’s take a look at the data we have seen since then.  Retail Sales were awful, -1.9%; IP -0.1% and Capacity Utilization (76.5%) both disappointed as did the Michigan Sentiment indicator at 68.8, its lowest print since 2011.  While the housing market continues to perform well, Claims data was much higher than anticipated and the Chicago Fed Activity Index fell sharply to -0.15, where any negative reading is seen as a harbinger of future economic weakness.  Finally, the Atlanta Fed’s GDPNow indicator has fallen to 5.14%, down from nearly 10% in December.  The point is, the data story is not one of unadulterated growth, but rather of an economy that is struggling somewhat.  It is this issue that informs my decision that the Fed is likely to sound far more dovish than market expectations tomorrow,  The policy error that has been discussed by the punditry is the Fed tightening policy into an economic slowdown and exacerbating the situation.  I think they are keenly aware of this and will move far more slowly to tackle inflation, especially given their underlying view that inflation is going to return to its previous trend on its own once supply chains are rebuilt.

For now, barring live fire in Ukraine, it seems the market is quite likely to remain rangebound until we hear from Mr Powell tomorrow afternoon.  As such, it is reasonable to expect a bit less market volatility than we saw yesterday.  But, do not discount the fact that markets remain highly leveraged in all spaces and that the reduction of high leverage has been a key driver of every market correction in history.  Add that to the fact that a Fed that is tightening policy may push rates to a point where levered accounts are forced to respond, and you have the makings of increased market volatility going forward.  While greed remains a powerful emotion, nothing trumps fear as a driver of market activity.  Yesterday was just an inkling of how things may play out.  Keep that in mind as we go forward.

Touring the markets this morning, while Europe is bouncing from yesterday’s movement as mentioned above, Asia saw no respite with sharp declines across the board (Nikkei -1.7%, Hang Seng -1.7%, Shanghai -2.6%).  US futures, too, are under pressure at this hour with NASDAQ (-1.7%) leading the way, but the other main indices much lower as well.

Looking at bond markets, European sovereigns are all softer with yields backing up as risk is re-embraced (Bunds +2.1bps, OATs +1.4bps, Gilts +4.4bps) as are Treasury markets (+0.7bps), despite the weakness in equity futures.  Bond investors are having a hard time determining if they should respond to ongoing high inflation prints or risk reduction metrics.  In the end, I continue to believe the latter will be the driving force and yields will not rise very high despite rising inflation.  The Fed, and most central banks, are willing to live with rising prices if it means they can stabilize bond yields at relatively low levels.

In the commodity markets, oil (+0.1%), after falling sharply from its recent highs yesterday has rebounded slightly.  NatGas (-1.4%) in the US is also dipping although remains right around $4/mmBTU in the US and $30/mmBTU in Europe.  Gold (-0.25%) and Copper (-0.3%) continue to consolidate as prospects for weaker growth hamper gains of the latter while uncertainty over inflation continue to bedevil the former.

As to the dollar, it is stronger for a second day in a row today, with substantial gains against both G10 (NOK -0.7%, CHF -0.7%, SEK -0.6%) and EMG (PLN -0.75%, RON -0.5%, MXN -0.45%) currencies.  Clearly, the Ukraine situation remains a problem for those countries in proximity to the geography, while Mexico responds to slightly disappointing GDP growth data just released.  But in the end, the dollar remains the haven of choice during this crisis and is likely to remain well bid for now.  However, if, as I suspect, the Fed comes across as less hawkish tomorrow, look for the greenback to give up some of its recent gains.

This morning brings only second tier data; Case Shiller Home Prices (exp 18.0%) and Consumer Confidence (111.1).  So, odds are that the FX market will continue to take its cues from equities, and if the sell-off resumes in stocks, I would expect the dollar to remain firm.  For payables hedgers, consider taking advantage of this strong dollar as I foresee weakness in its future as the year progresses.

Good luck and stay safe
Adf

Confidence Wilts

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As central banks worldwide prepare
To raise rates investors don’t dare
Buy bonds, bunds or gilts
While confidence wilts
Defining Jay Powell’s nightmare

The upshot is negative rates
Are no longer apt for long dates
But we’re still a ways
From NIRP’s end of days
While Christine and friends have debates

Whatever else you thought mattered to markets (e.g. Russia/Ukraine, oil prices, omicron) you were wrong.  Right now, there is a single issue that has every pundit’s tongue wagging; the speed at which the Fed tightens policy.  Don’t get me wrong, oil’s impressive ongoing rally feeds into that discussion, but is clearly not the driver.  So too, omicron’s impact as it spreads rapidly, but seems clearly to be far less dangerous to the vast majority of people who contract the disease.  As to Russia and the widespread concerns that it will invade the Ukraine shortly, that would certainly have a short-term market impact, with risk appetite likely reduced, but it won’t have the staying power of the Fed tightening discussion.

So, coming full circle, let’s get back to the Fed.  The last official news we had was that tapering of asset purchases was due to end in March with the Fed funds rate beginning to rise sometime after that.  Based on the dot plot, expectations at the Eccles Building were for three 0.25% rate increases this year (Jun, Sep and Dec).  Finally, regarding the balance sheet, expectations were that process would begin at a modest level before the end of 2022 and its impact would be minimal, you remember, as exciting as watching paint dry.  However, while the cat’s away (Fed quiet period) the mice will play (punditry usurp the narrative).

As of this morning, the best I can figure is that current market expectations are something along the following lines: QE will still end in March but the first of at least four 0.25% rate hikes will occur at the March FOMC meeting as well.  In fact, at this point, the futures market is pricing in a 12.5% probability that the Fed will raise rates by 0.50% in March!  In addition, regarding the balance sheet, you may recall that in 2017, the last time the Fed tried to reduce the size of the balance sheet, they started at $10 billion/month and slowly expanded that to $50 billion/month right up until the stock market tanked and they reversed course.  This time, the punditry has interpreted Powell’s comments that the runoff will be happening more quickly than in 2017 as a starting point of between $40 billion and $50 billion per month and rising quickly to $100 billion/month as they strive to reach their target size, whatever that may be.

The arguments for this type of action are the economy is much stronger now than it was in 2017 and, more importantly, inflation is MUCH higher than it was in 2017, as well as the fact that the balance sheet is more than twice the size, so bigger steps are needed.  Now, don’t get me wrong, I am a strong proponent of the Fed disentangling itself as much as possible from the markets and economy, however, I can’t help but wonder if the Fed moves according to the evolving Street narrative, just how big an impact that will have on asset markets.  Consider that since the S&P 500 traded to its most recent high on January 4th, just 2 weeks ago, it has fallen 5.0%.  The NASDAQ 100 has fallen 10.5% from its pre-Thanksgiving high and 8.5% from its level on January 4th.  Ask yourself if you believe that Jay Powell will sit by and watch as a much deeper correction unfolds in equity markets.  I cannot help but feel that the narrative has run well ahead of reality, and that next week’s FOMC meeting is going to be significantly more dovish than currently considered.  We have seen quite substantial market movement in the past several weeks, and if there is one thing that we know for sure it is that central banks abhor sharp, quick movement in markets, whether higher (irrational exuberance anyone?) or lower (Powell pivot, “whatever it takes”.)

The argument for higher interest rates is clear with inflation around the world (ex Japan) soaring, but central bankers are unlikely, in my view, to tighten as rapidly as the market now seems to believe.  They simply cannot stand the pain and more importantly, fear the onset of a recession for which they will be blamed.  For now, though, this is the only story that matters, so we have another week of speculation until the FOMC reveals their latest moves.

Ok, so yesterday was a massive risk-off day, with equities getting clobbered while bonds sold off sharply on fears of central bank actions.  In fact, the only things that performed well were oil, which rose 2.7% (and another 1.5% this morning) and the dollar, which rallied against virtually all its G10 and EMG counterparts.  Overnight saw the Nikkei (-2.8%) follow in the footsteps of the US markets although the Hang Seng (+0.1%) and Shanghai (-0.3%) were far more sanguine.  Interestingly, European bourses are mostly green today (DAX +0.25%, CAC +0.55%, FTSE 100 +0.25%) despite further data showing inflation is showing no sign of abating either on the continent (German CPI 5.7%) or in the UK (CPI 5.4%, RPI 7.5%).  As to US futures, +0.2% describes them well at this hour.

Bond markets remain under severe pressure with yields higher everywhere except China and South Korea.  Treasuries (+1.4bps) continue their breakout and seem likely to trade to 2.0% sooner rather than later.  Bunds (+2.6bps and yielding +0.003%) have traded back to a positive yield for the first time since May 2019.  Of course, with inflation running at 5.7%, that seems small consolation.  OATs (+2.4bps) and the rest of the continental bonds are showing similar yield rises while Gilts (+5.2bps) are leading the way lower in price as investors respond to the higher than already high expectations for inflation this morning.  Remember, the BOE is tipped to raise the base rate as well next week, but the global impact will be far less than whatever the Fed does.

Oil prices continue to soar as the supply/demand situation continues to indicate insufficient supply for growing demand.  This morning, the IEA released an update showing they expect demand to grow by an additional 200K barrels/day in 2022 while OPEC+ members have been unable to meet their pumping quotas and are actually short by over 700K barrels/day.  I don’t believe it is a question of IF oil is going to trade back over $100/bbl, it is a question of HOW SOON.  Remember, with NatGas (-0.5% today) still incredibly expensive in Europe, utilities there are now substituting oil for gas as they try to generate electricity, adding more demand to the oil market.  And remember, none of this pricing includes the potential ramifications if Russia does invade the Ukraine and the pipelines that run through Ukraine get shut down.

Finally, the dollar is retracing some of yesterday’s substantial rally, falling against all its G10 brethren (NOK +0.45%, AUD +0.4%, CAD +0.3%) led by the commodity currencies, and falling against most of its EMG counterparts with RUB (+1.4%) and ZAR (+1.05%) leading the way.  The former is clearly benefitting from oil’s sharp rally, but also from rising interest rates there.  Meanwhile, a higher than expected CPI print in South Africa, (5.9%) has analysts calling for more rate hikes there this year and next with as much as 250bps expected now.

On the data front, yesterday saw a horrific Empire Manufacturing outcome (-0.7 vs. exp 25.0), clearly not a positive sign for the economic outlook.  This morning brings only Housing Starts (exp 1650K) and Building Permits (1703K), neither of which seem likely to move the needle.

With the Fed silent, the narrative continues to run amok (an interesting visual) but that is what is driving markets right now.  This is beginning to feel like an over reaction to the news we have seen, so I would be wary of expecting a continuation of yesterday’s risk-off sentiment.  While we will almost certainly see some more volatility before the FOMC announcements next week, it seems to me that we are likely to remain within recent trading ranges in the dollar rather than break out for now.

Good luck and stay safe
Adf

Policy, Tighter

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Apparently, seven percent
Defined for Chair Jay the extent
Of just how high prices
Can rise in this crisis
Ere hawkishness starts to foment

But is it too little too late?
As he’s not yet out of the gate
Toward, policy, tighter
Despite a speechwriter
That claims he won’t fail his mandate

There is no shame in being confused by the current market situation because, damn, it is really confusing!  On the one hand we see inflation not merely rising, but fairly streaking higher as yesterday’s 7.04% Y/Y CPI reading was the highest since June 1982.  With that as a backdrop, and harking back to our Economics 101 textbooks, arguably we would expect to see interest rates at much higher levels than we are currently experiencing.  After all, in its simplest form, real interest rates, which are what drive investment decisions, are simply the nominal interest rate less inflation. As of today, with effective Fed Funds at +0.08% and the 10-year Treasury at 1.75%, the calculated real interest rates are -6.96% in the front end and -5.29% in the 10-year, both of which are the lowest levels in the post WWII era.  The conclusion would be that investment should be climbing rapidly to take advantage.  Alas, most of the investment we have seen has been funneled into share repurchases rather than capacity expansion.

With this in mind, it makes sense that dollar priced assets are rising in value, so stocks and commodities would be expected to climb, as would the value of other currencies with respect to the dollar.  However, the confusion comes when looking at the bond market, where not only are real yields at historically depressed levels, but there is no indication that investors are selling bonds and seeking to exit the space.

Our economics textbook would have us believe that negative real yields of this magnitude are unsustainable with two possible pathways to adjustment.  The first pathway would be nominal yields climbing as investors would no longer be willing to hold paper with such a steep negative yield.  Back in the 1990’s, the term bond vigilantes was coined to describe how the bond market would not tolerate this type of activity and investors would sell bonds aggressively thus raising the cost of debt for the government.  So far, that has not been evident.  The second pathway is that the inflation would lead to significant demand destruction and ultimately a recession which would slow inflation and allow bondholders to get back to a positive real yield outcome.  Not only would that be hugely painful for the economy, it will take quite a while to complete.

The problem is, neither of those situations appear to be manifest.  The question of note is, is the bond market looking at the current situation and pricing in much slower growth ahead?  Certainly, the punditry is not looking for that type of outcome, but then, the punditry is often wrong.  Neither is the Fed looking for that type of outcome, at least not based on their latest economic projections which are looking for GDP growth of 3.6%-4.5% this year and 2.0%-2.5% next with nary a recession in sight in the long run.

This brings us back to the $64 trillion question, why aren’t bonds selling off more aggressively?  And the answer is…nobody really knows.  It is possible that investors are still willing to believe that this inflationary spike is temporary, and we will soon see CPI readings falling and the Fed declaring victory, so bond ownership remains logical.  It is also possible that given the fact that the BBB bill was pulled and seems unlikely to pass into legislation, that Treasury issuance this year will decline such that the fact the Fed will no longer be purchasing new debt will not upset the supply/demand balance and upward pressure on yields will remain absent.  At least from a supply perspective.  The problem with this idea is that pesky inflation reading, which, not only remains at extremely high levels, but is unlikely to decline very much at all going forward.

Ultimately, something seems amiss in the bond market which is disconcerting as bond investors are typically the segment that pays closest attention to the reality on the ground.  While the hawkish cries from Fed members are increasing in number and tone (just yesterday both Harker and Daly said they expected raising rates in March made sense and 4 rate hikes this year would be appropriate), that implies Fed Funds will be 1.0% at the end of the year, still far below inflation and not nearly sufficient to slow those rising prices.

It seems to me there are three possible outcomes here; 1) bond investors get wise and sell long-dated Treasuries steepening the yield curve significantly; 2) the Fed gets far more aggressive, raising rates more than 100 basis points this year and pushes to invert the yield curve and drive a recession; or 3) as option 1) starts to play out, and both stocks and bonds start to decline sharply, the Fed decides that YCC is the proper course of action and caps Treasury yields while letting inflation run much hotter.  My greatest fear is that 3) is the answer at which they will arrive.

With all that cheeriness to consider, let’s look at how markets are behaving today.  Despite a modest equity rally in the US yesterday, risk has been less in demand since.  Asia (Nikkei -1.0%, Shanghai -1.2%, Hang Seng +0.1%) was generally lower and Europe (DAX 0.0%, CAC -0.5%, FTSE 100 -0.1%) is also uninspiring.  There has been virtually no data in either time zone, so this price action is likely based on growing concerns over the inflationary outlook.  US futures at this hour are basically unchanged.

As to the bond market, no major market has seen a move of even 0.5 basis points today with inflation concerns seeming to balance risk mitigation for now.

Commodity markets are mixed with oil (-0.1%) edging lower albeit still at its highest levels since 2014, while NatGas (-4.5%) has fallen as temperatures in the NorthEast have reverted back to seasonal norms.  Gold (-0.1%) has held most of its recent gains while copper (-0.7%) seems to have found a short-term ceiling after a nice rally over the past few sessions.

Finally, turning to the dollar, it is somewhat softer vs. most of its G10 brethren with NZD (+0.35%) leading the way, followed by CHF (+0.3%) and CAD (+0.2%) as demand for any other currency than the dollar begins to show up.  In EMG currencies, excluding TRY (-2.5%) which remains in its own policy driven world, the picture is more mixed.  RUB (-0.75%) has fallen in the wake of the news from Geneva that there was no progress between Russia, the US and NATO regarding the escalating situation in the Ukraine with the threat of economic sanctions growing.  BRL (-0.55%) is also under some pressure although this looks more like profit taking after a nearly 3% rally in the past two sessions.  On the plus side, THB (+0.5%) and PHP (+0.3%) are leading the way as they respond to the broadly weaker dollar sentiment.

Data today brings Initial (exp 200K) and Continuing (1733K) Claims as well as PPI (9.8%, 8.0% ex food & energy), but the latter would have to be much higher than expected to increase the pressure on the inflation narrative at this point. From the Fed we hear from Governor Brainerd as she testifies in her vice-chair nomination hearing, as well as from Barkin and Evans.  Given the commentary we have been getting, I expect that the idea of 4 rate hikes this year is really going to be cemented.

The dollar has really underperformed lately and quite frankly, it feels like it is getting overdone for now.  While I had always looked for the dollar to eventually decline this year, I did expect strength in Q1 at least.  However, given positioning seemed to be overloaded dollar longs, and with the Treasury market not participating in terms of driving yields higher, it is beginning to feel like a modest correction higher in the dollar is viable, but that the downtrend has begun.

Good luck and stay safe
Adf

Quite a Surprise

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This morning’s report on inflation
Is forecast as verification
The Fed is behind
The curve and must find
The will to cease accommodation

While last night from China we learned
The trend in inflation has turned
In quite a surprise
It fell from its highs
A positive for all concerned

Ahead of this morning’s CPI report (exp 7.0%, 5.4% ex food & energy) investors around the world have been feeling positively giddy about the current situation.  Sure, China’s growth forecasts have been cut due to omicron infection outbreaks and the Chinese response of further lockdowns, but that just means that combined with the first downtick in PPI there since February 2020 (10.3%, exp 11.3%, prev 12.9%), talk has turned to the PBOC cutting interest rates next week by between 5 and 10 basis points.  So, while many other nations are aggressively fighting inflation (Brazil, Mexico, Hungary) or at least beginning to tighten policy (UK, Sweden, Canada), the market addiction to ever increasing liquidity may now be satisfied by China.  While it is still too early to know if lower interest rates are coming from Beijing, what is clear is that the credit impulse in China (the amount of lending) seems to have bottomed and is starting to reverse higher.  That alone augers well for future global growth; so, buy Stonks!

Meanwhile, I think it is valuable to consider what we heard from Chairman Powell yesterday at his renomination hearings, as well as what the two erstwhile hawks, Esther George and Loretta Mester, had to say about things.  Mr Powell, when asked why the Fed was continuing to purchase assets with inflation well above target and unemployment near historic lows inadvertently let the cat out of the bag as to the most important thing for the Fed, that if they were to move at a more aggressive pace, it could upset markets and there could be declines in both the stock and bond markets.  Apparently, the unwritten portion of the Fed’s mandate, prevent markets from falling, remains the most important goal.  While Powell paid lip service to the idea that the Fed would seek to prevent the inflationary mindset from becoming “entrenched”, he certainly didn’t indicate any sense of urgency that the Fed’s glacial pace of change was a problem.

Perhaps more surprisingly, neither Mester nor George were particularly hawkish, with both explaining that the Dot Plot from December was a good guide and there was no reason to consider a rate hike as soon as March.  Regarding QT, neither was anxious to get that started either although both wanted to see it eventually occur.  Finally, this morning, former NY Fed President (and current Fed mouthpiece) Bill Dudley explained in a Bloomberg column that there was no hurry to reduce the size of the balance sheet and that when it begins, the impact would be “like watching paint dry.”  Now, where have we heard that before?  Oh yeah, I remember.  Then Fed Chair Yellen used those exact same words to describe the last attempt to shrink the balance sheet right up until Powell was forced to pivot after the equity market’s sharp decline in 2018.  Apparently, the dynamics of drying paint are more interesting than we have been led to believe.

For those seeking proof that investors welcomed yesterday’s comments, one need only look at market behavior in their wake.  US equity markets rallied after the testimony and never looked back all day.  Treasury bonds did very little, with the sharp trend higher in yields having hit a key resistance and unable to find the will to push through.  Finally, the dollar took it on the chin, declining vs virtually every major and emerging market currency yesterday with many of those moves continuing overnight.  Recapping: higher stocks, unchanged bonds and a weaker dollar are not a sign that the market expects much tighter policy from the Fed.

Ok, so how are things looking this morning?  Well, in the equity market, the screen is entirely green. Last night, Asia followed the US lead  with gains across the board (Nikkei +1.9%, Hang Seng +2.8%, Shanghai +0.8%), and European bourses are also higher (DAX +0.35%, CAC +0.5%, FTSE 100 +0.7%) as data from the continent showed much better than expected Eurozone IP growth (2.3% vs 0.2% exp) as well as the first indication that inflation might be peaking in Germany with PPI there “only” printing at 16.1%, down from last month’s record 16.6%.  As to US futures, they are modestly higher ahead of the data, between 0.1%-0.2%.

In the bond market, while 10-year Treasury yields have edged higher by 0.7bps at this hour, they remain just below 1.75% and have shown no inclination, thus far, of breaking out much higher.  Arguably this implies that market participants are not yet full believers in the Fed tightening policy aggressively, and after yesterday’s performances, I think that is a good bet.  Meanwhile, European sovereign bonds are all rallying with yields falling nicely (Bunds -1.8bps, OATs -1.7bps, BTPs -1.3bps) as it remains clear that there is not going to be any tightening of note by the ECB this year.

On the commodity front, we continue to see strength in energy (WTI +0.5%, NatGas +5.2%) as well as industrial metals (Cu +2.9%, Zn +2.2%) although both gold -0.2%, and silver -0.2% are consolidating after strong moves higher yesterday.

Looking at FX markets, I would say the dollar is modestly weaker overall, albeit only in a few segments.  In the G10, NOK (+0.7%) and CAD (+0.2%) are the largest movers, by far, with both benefitting from oil’s continued rise.  The rest of the bloc, quite frankly, is tantamount to unchanged this morning.  In emerging markets, the picture is a bit more mixed with both gainers and losers about evenly split.  However, only 3 currencies have shown any real movement, BRL (-0.4%), KRW (+0.4%) and CLP (+0.3%).  The real seems to be consolidating some of its massive gains from yesterday, when it rallied 1.7% on the back of central bank comments implying that though inflation would fall back in 2022, it would require continued tight policy to achieve that outcome.  On the flip side, the won benefitted from a better than expected employment report showing more than 770K jobs added in the last year and indicating better economic growth going forward.  Finally, the Chilean peso seems to be benefitting from copper’s strong rally today.

Aside from this morning’s CPI report, we also see the Fed’s Beige Book at 2:00pm which has, in the past, been able to move markets if the narrative was strong enough.  Only one Fed speaker is on the docket, Kashkari, and even he, an uber-dove, is calling for 2 rate hikes this year as per his last comments.

The Fed tightening narrative is definitely having some difficulty these days which implies to me that the market has fully priced in its expectations and those expectations are that the Fed will not be able to tighten policy very much.  If the Fed is restrained, and tighter policy continues to get pushed further out in time, the dollar will suffer much sooner than I anticipated.  For those with opex and capex needs, perhaps moving up the timetable to execute makes some sense.

Good luck and stay safe
Adf

A New T#heme

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The news yesterday from the Fed
Was Vice-Chair Clarida has fled
While later today
Chair Jay seeks to sway
The Senate to keep him Fed head

But in the meantime, it would seem
The narrative has a new theme
It seems pretty clear
Four rate hikes this year
Have gone from the fringe to mainstream

As we walk in this morning, there seems to be a lot of movement with respect to market expectations regarding the Fed’s actions going forward and exactly how those actions are going to impact the various markets.  Today’s headline event is Chairman Powell’s renomination testimony in the Senate as everyone is waiting to see just how much effort Senator Elizabeth Warren puts into trying to derail the process.  It is widely known that the Senator does not care for Mr Powell going so far as to calling him “dangerous” in his recent semi-annual testimony to the Senate.  Yesterday, she also wrote a letter demanding to see all the personal trading records of all Fed officers which probably was part of the impetus for vice-Chair, Richard Clarida, to step down early from his post.  So, on the one hand, we will be treated(?) to the scene of some Senators trying to play gotcha with the Fed Chair today with the ever-present possibility that some comment is made with a real market impact.

On the other hand, the tightening train has not merely pulled away from the station but is starting to gather serious speed.  Earlier this morning, Atlanta Fed President Bostic commented that he sees 3 rate hikes this year and that the Fed “will act to ensure inflation doesn’t run away from us.”  Futures markets are now pricing in a more than 60% probability of a fourth rate hike in 2022 with an increasing number of Fed speakers explaining a rate hike in March would be appropriate.  We are also hearing the 4-hike scenario from an increasing number of pundits with Goldman Sachs economists publishing that view yesterday while JPMorgan Chairman Jamie Dimon explained that “four rate hikes of 0.25% each would not have an enormous effect on the economy.”  And that is likely correct, a Fed Funds rate of 1.0% doesn’t seem that onerous for businesses.  Of course, what impact would four interest rate hikes have on financial asset prices, especially if they were joined with a reduction in the size of the Fed’s balance sheet?  And it is this latter question that seems likely to be the key as we continue to hear from more and more Fed speakers that the idea of allowing the balance sheet to ‘run-off’ is appropriate.

For those of you with shorter memories, the last time the Fed tried to reduce the size of its balance sheet, from 2017-2018, they were also raising interest rates, albeit far more slowly.  Of course, CPI had peaked below 3.0% in that cycle, GDP was running at 2.4% and wages were growing at 2.5% while the balance sheet was less than half its current size.  The point is conditions were clearly very different.  However, not only did the equity market’s 20% decline inspire the Powell Pivot on Boxing Day 2018, but nine months later, the repo market blew up forcing the Fed to take dramatic action to ensure that sufficient liquidity was made available to the banking system.  I assure you, neither of those outcomes were part of the carefully described plans the Fed had made to ‘normalize’ monetary policy.

Will this time be different?  While starting conditions certainly are different, the one thing of which we can be sure is that the complexities of the international money markets remain opaque even to the central banks charged with their oversight.  While there is no way to anticipate exactly what will happen to derail the current plans, one can almost be certain that things will not work out the way they are currently planned.  Personally, I remain convinced that markets will have a very difficult time handling any reductions in the excess liquidity that has been the dominant feature of the post Covid-19 global financial markets, and that despite a lot of tough talk now, the Fed, at least, will be walking back that hawkishness before too long.

And perhaps, markets are beginning to agree with me.  After all, hawkish monetary policy is rarely the backdrop for a risk-on attitude.  Yet that is a pretty fair description of today’s price action.  Equities are rebounding along with commodities; bonds are benign, and the dollar is softening.

While yesterday saw US equity markets in the red most of the day, the NASDAQ staged a furious late day rally to close flat although market breadth was awful (1205 gainers vs. 2201 losers).  And while Asia was still under pressure (Nikkei -0.9%, Hang Seng 0.05, Shanghai -0.7%), Europe has taken heart from something as we are seeing solid gains across the board there (DAX +1.15%, CAC +1.35%, FTSE 100 +0.7%) despite a complete lack of news.  US futures, too, have turned green with all three main indices up about 0.3% at this hour.

The Treasury rout is on hold with yields essentially unchanged this morning and the 10-year right at the key level of 1.75%.  In Europe, Bunds (-0.9bps) and Gilts (-2.3bps) are both trading well while the rest of the sovereign market is virtually unchanged.  Again, there has been essentially no news of note.

Oil prices are rallying (WTI +1.4%) while NatGas (-0.9%) has consolidated some of yesterday’s gains despite the fact it is 14 degrees here in NJ this morning.  Gold (+0.3%) and silver (+0.6%) are both firmer, as are industrial metals (Cu +0.6%, Al +0.1%, Zn +2.4%) and the ags are strong as well.

Finally, the dollar is under modest pressure with NOK (+0.4%) leading the G10 revival on the strength of oil’s rally, while CAD (+0.3%) follows closely behind.  JPY (-0.25%) is the only laggard here, again pointing to the risk characteristics in today’s price action.  EMG markets have seen similar price action with THB (+0.6%) the leading gainer followed by HUF (+0.4%) and KRW (+0.35%), all benefitting from the pause in the US yield rally and generally better risk appetite.

Today’s only data point has been released, NFIB Small Business Optimism (98.9, slightly better than 98.7 expected) and has had virtually no impact on the market.  This brings us back to the Fed as today’s most likely catalyst, as not only will we hear from Chair Powell starting at 10:00, but also from two of the most hawkish regional bank presidents, Mester and George between 9:00 and 9:30.

With risk in vogue for the session, I expect the dollar will have difficulty gaining any ground, but nothing has changed my short-term view that the Fed’s hawkishness is going to be the key driver of a stronger dollar…right up until they reverse course!

Good luck and stay safe
Adf

No Delay

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Investors have not yet digested
The truth of what Jay has suggested
There’ll be no delay
QT’s on the way
(Unless the Dow Jones is molested)

Given the change in tone from the Fed and a number of other central banks, where suddenly hawkishness is in vogue, the fact that risky assets (read stocks) have only given back a small proportion of their year-long gains is actually quite remarkable.  The implication is that equity investors are completely comfortable with the transition to positive real interest rates and that valuations at current nosebleed levels are appropriate.  The problem with this thesis is that one of the key arguments made by equity bulls during the past two years has been that negative real interest rates are a crucial support to the market, and as long as they remain in place, then stocks should only go higher.

But consider how high the Fed will have to raise interest rates to get back to real ZIRP, let alone positive real rates.  If CPI remains at its current level of 6.8% (the December data is to be released on Wednesday and is expected to print at 7.0%), that implies twenty-seven 0.25% rate hikes going forward!  That’s more than four years of rate rises assuming they act at every meeting.  Ask yourself how the equity market will perform during a four-year rate hiking cycle.  My take is there would be at least a few hiccups along the way, and some probably pretty large.  Consider, too, that looking at the Fed funds futures curve, the implied Fed funds rate in January 2026 is a shade under 2.0%.  In other words, despite the fact that we saw some pretty sharp movement across the interest rate markets last week, with 10-year yields rising 25 basis points and 2-year yields rising 13 basis points, those moves would just be the beginning if there was truly belief that the Fed was going to address inflation.

Rather, the evidence at this stage indicates that the market does not believe the Fed’s tough talk, at least not that they will do “whatever it takes” to address rising inflation.  Instead, market pricing indicates that the Fed will try to show they mean business but have no appetite to allow the equity market to decline any substantial amount.  If (when) stocks do start to fall, the current belief is the Fed will come to the rescue and halt any tightening in its tracks.  As I have written previously, Powell and his committee are caught in a trap of their own design, and will need to make a decision to either allow inflation to keep running hot to try to prevent an equity meltdown, or take a real stand on inflation and let the (blue) chips fall where they may.  The similarities between Jay Powell and Paul Volcker, the last Fed chair willing to take the latter stand, stop at the fact neither man had an economics PhD.  But Jay Powell is no Paul Volcker, and it seems incredibly unlikely that he will have the fortitude to continue the inflation fight in the face of sharply declining asset markets.

What does this mean for markets going forward?  As we remain in the early stages (after all, the Fed is still executing QE purchases, albeit fewer than they had been doing previously) tough talk and modest policy changes are likely to continue for now.  Equity markets are likely to continue their performance from the year’s first week and continue to slide, and I would expect that bond markets will remain under pressure as well.  And with the Fed leading the way vis-à-vis the ECB and BOJ, I expect the dollar should continue to perform fairly well against those currencies.

However, there will come a point when investors begin to grow wary of the short- and medium-term outlooks for risk assets amid a rising rate environment.  This will be highlighted by the fact that inflation will remain well above the interest rate levels, and in order to contain the psychology of inflation, the Fed will need to continue its tough talk.  Already, when looking at the S&P 500, despite being just 3% below its all-time highs, more that 50% of its components are trading below their 50-day moving averages (i.e. are in a down-trend) which tells you just how crucial the FAANG stocks are.  And none of those mega cap stocks will benefit from higher interest rates.  In the end, there is significant room for equity (and all risk asset) declines if the Fed toes the tightening line.

Looking at markets this morning shows that no new decisions have been taken as both equity and bond markets are little changed since Friday.  Perhaps investors are awaiting Wednesday’s CPI data to determine the likely path going forward.  Or perhaps they are awaiting the comments from both Powell and Brainerd, both of whom will be facing the Senate this week for confirmation hearings for their new terms.  However, we do continue to hear hawkish comments with Richmond Fed President Barkin explaining that a March rate hike would suit him, and ex-Fed member Bill Dudley explaining that there is MUCH more work to be done raising rates.

So, after Friday’s late sell-off in the US, equities in Asia rebounded a bit (Hang Seng +1.1%, Shanghai +0.4%, Nikkei closed) although European bourses are all modestly in the red (DAX -0.3%, CAC -0.4%, FTSE 100 -0.1%). US futures are also turning red with NASDAQ futures (-0.35%) leading the way down.

Meanwhile, bond markets are mixed this morning with Treasury yields edging higher by just 0.4bps as I type, albeit remaining at its highest levels since before the pandemic, while we are seeing modest yield declines in Europe (Bunds -1.0bps, OATS -1.5bps, Gilts -0.3bps).  The biggest mover though are Italian BTPs (-5.3bps) as they retrace some of their past two-week underperformance.

On the commodity front, oil (-0.2%) has edged back down a few cents although remains much closer to recent highs than lows, while NatGas (+4.4%) has jumped on the back of much colder weather forecasts in the US Northeast and Midwest areas.  Gold (+0.3%) continues to trade either side of $1800/oz, although copper (-0.2%) is under a bit of pressure this morning.

As to the dollar, it is mixed today with SEK (-0.4%), CHF (-0.35%) and EUR (-0.3%) all under pressure while JPY (+0.25%) is showing its haven bona fides.  This definitely feels like a risk move as there was virtually no data or commentary out overnight.  In the EMG space, RUB (+0.9%) is the leading gainer as traders continue to look for further tightening by the central bank despite the fact that real rates there are actually back to positive already.  INR (+0.35%) and IDR (+0.35%) also gained with the rupee benefitting from equity market inflows while the rupiah responded to word that the government would soon lift the coal export ban.  On the downside, the CE4 are in the worst shape, but those are merely following the euro’s decline.

There is a decent amount of data coming up this week as follows:

Tuesday NFIB Small Biz Optimism 98.5
Wednesday CPI 0.4% (7.0% Y/Y)
-ex food & energy 0.5% (5.4% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 200K
Continuing Claims 1760K
PPI 0.4% (9.8% Y/Y)
-ex food & energy 0.5% (8.0% Y/Y)
Friday Retail Sales -0.1%
-ex autos 0.2%
IP 0.2%
Capacity Utilization 77.0%
Michigan Sentiment 70.0

Source: Bloomberg

In addition to the data, we hear from seven Fed speakers and have the nomination hearings for Powell (Tuesday) and Brainerd (Thursday), so plenty of opportunity for more hawk-talk.

For now, I continue to like the dollar for as long as the Fed maintains the hawkish vibe.  However, I also expect that if risk assets start to really underperform, that talk will soften in a hurry.

Good luck and stay safe
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On the Brink

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Most pundits worldwide seem to think
The Fed is now right on the brink
Of both raising rates
And having debates
On how soon the BS should shrink

And so, today’s Minutes are key
To see if the FOMC
Has made up its mind
That they’re now behind
The curve, and need hurry QT

I am old enough to remember the last time the Fed decided that they wanted to shrink their balance sheet and normalize policy, way back in 2018.  As I recall, when first mooted, then Fed Chair Janet Yellen (she of Treasury Secretary fame) described the process of the gradual reduction as ‘like watching paint dry.’  Who knew drying paint was so exciting!  Of course, she couldn’t bring herself to even start the process.  Ultimately, the combination of slowly raising the Fed Funds rate and simultaneously reducing the size of the balance sheet (which all occurred on Powell’s watch) led to a declining stock market throughout Q4 2018 with the largest Christmas Eve sell-off ever seen in stocks as the culmination of the events.  Two days later, Chairman Powell explained he was just kidding, and tighter monetary policy was a thing of the past.

But that was then.  It’s different this time!

Actually, it’s not.  In fact, what we have learned from observing markets for many years is that it is never different.  While the catalysts may change, market responses remain pretty much the same time and again.  So, here we are three years later with the Fed’s balance sheet having more than doubled in the intervening period, equity markets having made 70 record highs in the past twelve months and the 10-year bond yielding half what it was back then. Inflation is raging, as opposed to the situation back then, and GDP, while higher than back then, has clearly peaked and is reversing some of the pandemic-induced policy giddiness.  But human nature is still the same.  Greed and fear remain the constants and investor and trader responses to policy decisions are pretty cut and dried.  You can be confident that if longer date interest rates rise, whether in a steepening or flattening yield curve, the rationale for the mega cap stocks to maintain their value is going to diminish quickly.  And as they are the ‘generals’ of the equity market rally, when they start to fall, so will everything else, including the indices.  Ask yourself how long the Fed, whose members are virtually all multi-millionaires and hold large equity portfolios, are going to sit by and allow the stock market to correct just because some Austrian school monetary hawks believe in sound money.  Exactly.

However, we have not yet reached the point where the markets have started to decline substantially, as, of course, the Fed has not yet started to even raise interest rates, let alone shrink the balance sheet.  But that is the growing consensus view amongst the punditry, that today’s FOMC Minutes from the December meeting are going to reveal the level of interest to begin that part of policy normalization.  Many analysts continue to highlight the fact that inflation is becoming such a problem that the Fed will be forced to stay the course this time.  I wish it were so, but strongly believe that history has shown they will not.  Rather, they will change the inflation calculations and continue to explain that the alternative is worse.

Yesterday, Minneapolis Fed President Neel Kashkari, the most dovish of all FOMC members, explained that he believes the Fed Funds rate needs to rise 0.50% this year as, “…inflation has been higher and more persistent than I had expected.”   It is comments such as this that have the analyst community convinced the Fed is really going to tighten this time.  But we have heard these before as well.  This is not to say that the Minutes won’t hint at QT, they very well could do so.  However, when the rubber meets the road and risk assets are falling sharply in price, the Fed will exhibit its underlying Blepharospasm, and tighter policy will be a thing of the past (as will a stronger dollar!)

Now, leading up to the Minutes, let’s take a look at what happened last night.  In the wake of a bit of equity market schizophrenia in the US, we have seen a mixed picture.  Yesterday saw the NASDAQ fall sharply (there’s that concern over higher rates) while the Dow managed to rally.  Overnight saw the Nikkei (+0.1%) bide its time but the Hang Seng (-1.6%) and Shangahi (-1.0%) both suffer on a combination of the ongoing property sector problems as well as more lockdowns in country.  Europe, on the other hand, has managed to stay in the green (DAX +0.6%, CAC +0.5%, FTSE 100 +0.2%) after PMI Services data was released a little bit softer than forecast, but still seen as quite positive.  In a way, this was a ‘bad news is good’ idea as softening growth means the ECB doesn’t need to respond to Europe’s very high inflation readings so dramatically.  Alas, US futures are flat except for NASDAQ futures, which are lower by -0.4%.

In the bond market, while yesterday saw an early sell off in Treasuries, it was mostly unwound by the end of the day and this morning yields are little changed at 1.645%.  As to Europe, yesterday also saw Gilt yields rally sharply, 12.5 bps, but they have consolidated today, falling 1bp while the rest of the continent has seen much less movement.  Clearly, there is far less concern over ECB activity than either Fed or BOE.

As to the commodity space, oil (+0.3%) is edging higher and NatGas (+2.3%) is firming on the cold weather in the Northeast.  (Of course, compared to what happened in Kazakhastan, where the government was kicked out by the president because of high energy prices, this seems rather tame!)  Metals prices are mixed with gold (+0.2%) still hanging around $1800, while copper (-0.6%) is clearly less enamored of the current economic situation.

Finally, the dollar is under modest pressure this morning, with SEK (+0.5%) the leading G10 gainer after printing the strongest PMI data around, while JPY (+0.4%) has simply rebounded from its very sharp decline yesterday, although it remains in a very clear downtrend for now.  the rest of the G10 is modestly firmer vs. the dollar at this hour, but nothing to write home about.

In the EMG space, ZAR (+0.9%) is the leader, also seeming to benefit on the back of last week’s liquidity induced decline and seeing a rebound.  We are also seeing strength in PHP (+0.7%) and CZK (+0.6%) with the latter benefitting from expectations for further rate hikes while the former benefitted from a much lower than expected CPI print of just 3.6%.  Meanwhile, on the downside, IDR (-0.4%) was the worst performer as the infection rate rose sharply and KRW (-0.25%) fell after North Korea launched another ballistic missile and rejected further talks with the US.

On the data front, ADP Employment (exp 410K) leads this morning and then the Minutes are released at 2:00pm.  Aside from the Minutes, there are no speakers scheduled, so the dollar will need to take its cues from other markets.  Keep an eye on the 10-year as a continued rally in yields should see further dollar strength.

Good luck and stay safe
Adf

A Visit from Chair Jay

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With Apologies to Clement Clarke Moore

Tis the first day of trading in Aught Twenty-Two
And everyone’s asking just what will come true
Will Jay and his brethren, the taper, complete?
Or when stocks start falling, will they beat retreat?
Will Omicron’s spread lead to waves of despair?
Or will people choose to live life and not care?
And what of stock markets, will their recent rise
Have legs? Or will problems lead to their demise?
To these and more questions I’ll try to respond
With forecasts for currencies, stocks and the bond

To start, let’s consider, with brush strokes quite broad
How policymakers’ decisions are flawed
Consider inflation and how it is tracked
To most it is real but to Jay, just abstract
This led to the idea of average inflation
A policy blunder condemned to damnation
So, late to the party, the Fed shall arrive
Thus, CPI next year will still be ‘bove Five

While interest rates then ought most certainly rise
Jay can’t let that happen, and so we surmise
Despite all the talk of the taper to come
By Christmas this year they’ll have grown QE’s sum
And so, ten-year yields, when this year’s finally done
Will print on your screen at percentage of One

And what about stocks after last year’s huge gains
Are more in the future?  Or will we feel pains?
Alas, what I fear is though real rates will sink
So too, GDP, will not grow, though not shrink
Instead, when the history’s written next year
A stagnant economy will bring no cheer
Thus, stocks will deflate, though I don’t think crash land
But don’t be surprised if we fall ‘neath Four Grand

Let’s turn now to things you can see and can feel
Commodities, which unlike stocks, are quite real
For oil the first thing to note is the lack
Of funding, which has caused a drilling cutback
The thing is demand has not fallen in sync
Thus, causing the policymakers to blink
And rather than forcing the drillers to freeze
Instead, are now begging, drill more pretty please
But in the meantime, ere those new wells are sunk
One Hundred per barrel is near a slam-dunk

The barbarous relic we also must view
As many believe it contains value, true
Though there’s now a camp that claims it’s been replaced
By Bitcoin and Ether and feel gold’s a waste
But whether a hodler or gold bug are you
Their trends will diverge throughout Aught Twenty-Two
In gold’s case there will be strong growth in demand
And at year’s end it will have flown ‘bove Two Grand
But Bitcoin has shown with stonks it’s correlated
As they fall, so too, will Bitcoin be deflated
Come Christmas next do not be very surprised
If Bitcoin, to $30K, has been revised

And finally, let ‘s turn to foreign exchange
Where this year I think we shall see quite a range
At first while belief remains Jay is a hawk
More strength in the dollar is likely a lock
But as things progress and the ‘conomy slows
Then Jay will be forced to adjust the Fed’s prose
From hawkish to dovish is what we will get
And H2 next year will, the dollar, beset

The euro, at first, will, new lows, likely test
But when it comes clear that QT’s not progressed
As well as the fact that Lagarde’s ECB
Has quietly lessened their rampant QE
Investors will find that when euros are sought
At year’s end, One-Thirty is where they’ll be bought

A similar story in England abounds
Where tightening money will strengthen their pounds
The Old Lady, sited on Threadneedle Street
Will not, on inflation, decide to retreat
Instead, rates will rise there four times through this year
And Sterling, One-Sixty, on screens will appear

From here let’s head east to the nation whose Wall
Was built in an effort, the Huns, to forestall
In modern times, though, their economy’s grown
With output that spans T-shirts to the iPhone
With exports remaining the key to success
A weaker renminbi will help reduce stress
The thing is the goal of the President, Xi
Is not really growth but a strong currency
The upshot is when this year comes to an end
Five-Ninety renminbi we’ll all comprehend

A bit further east lies a nation of isles
Which taught us that Zen leads to healthy lifestyles
This nation, despite lacking metals or oil
Grew rich on the sheer dint of well-designed toil
Its yen has developed a clear reputation
For safety since the GFC dislocation
So, this year when growth disappoints round the earth
One Hundred and Five yen the buck will be worth

Our eastward excursion is not yet complete
As Canada’s Loonie moves to the front seat
Up north they have already started the shift
From policy ease to a much tighter drift
Responding to prices that have been on fire
And trying to stop them from going still higher
Thus, don’t be surprised when the CAD follows rates
And reaches One-Ten come the year’s final dates

And lastly let’s make a right turn and head toward
The nation where all that tequila is poured
Already, Banxico is fighting the fight
To hold back inflation with all of its might
The problem for them is inflation’s a bear
And so hard to halt when it’s rampant elsewhere
So, this year despite all the central bank’s drive
To Twenty-Two look for the peso to dive.

Now let’s turn to something of greater import
How much I appreciate all your support
As we begin yet one more year in this game
There’s one thing I must very clearly exclaim
May Twenty-Two be a year of, tidings, glad
With happiness, health and no cause to be sad

Have a very happy and healthy Twenty Twenty-Two!

Til ‘flation Responds

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Apparently, Powell has learned
Why everyone’s been so concerned
With prices exploding
The sense of foreboding
‘Bout ‘flation seemed very well earned

So, Jay and his friends at the Fed
Said by March, that they would stop dead
The buying of bonds
Til ‘flation responds
(Or til stocks fall deep in the red)

By now you are all aware that the FOMC will be reducing QE twice as rapidly as their earlier pace, meaning that by March 2022, QE should have ended.  Chairman Powell was clear that inflation has not only been more persistent than they had reason to believe last year but has also moved much higher than they thought possible, and so they are now forced to respond.  Interestingly, when asked during the press conference why they will take even as long as they are to taper policy rather than simply stop buying more assets now if that is the appropriate policy, Powell let slip what I, and many others, have been saying all along; by reducing QE gradually, it will have a lesser impact on markets.  In other words, the Fed is more concerned with Wall Street (i.e. the stock market) than it is with Main Street.  Arguably, despite a more hawkish dot plot than had been anticipated, with the median expectation of 3 rate hikes in 2022 and 3 more in 2023, the stock market rallied sharply in the wake of the press conference.  If one is seeking an explanation, I would offer that Chairman Powell has just confirmed that the Fed put remains alive and well and is likely struck far closer to the market than had previously been imagined, maybe just 10% away.

One other thing of note was that Powell referred to the speed with which this economic cycle has been unfolding, much more rapidly than the post-GFC cycle, and also hinted that the Fed would consider reducing the size of its balance sheet as well going forward.  Recall, however, what happened last time, when the Fed was both raising the Fed funds rate and allowing the balance sheet to run off by $50 billion/month back in 2018; stocks fell 20% in Q4 and the Powell Pivot was born.  FWIW my sense is that the Fed will not be able to raise rates as much as the dot plot forecasts.  Rather, the terminal rate will be, at most, 2.00% (last time it was 2.50%), and that any shrinkage of the balance sheet will be minimal.  The last decade of monetary policy has permanently changed the role of central banks and defined their behavior in a new manner.  While not described as such by those “independent” central banks, debt monetization (buying government bonds) is now a critical role required to keep most economies functioning as debt/GDP ratios continue to climb.  In other words, MMT is the reality and it will require a much more dramatic, and long-lasting, negative shock for that to change.

One last thing on this; the bond market has heard what Powell said and immediately rallied.  The charitable explanation is that bond investors are now comforted by the Fed’s recognition that inflation is a problem and will be addressed.  Powell’s explanation about foreign demand seems unlikely, at least according to the statistics showing foreign net sales of bonds.  Of more concern would be the explanation that bond investors are concerned about a policy mistake here, where the Fed is tightening too late and will drive the economy into a recession, as they always have done when they tighten policy.

With Jay and the Fed finally past
The market will get to contrast
The Fed’s hawkish sounds
With Europe’s shutdowns
And watch Christine hold rates steadfast

But beyond the Fed, this has been central bank policy week with so many other central bank decisions today.  Last night the Philippines left policy on hold at 1.50%, as did Indonesia at 3.50%, both as expected.  Then, this morning the Swiss National Bank (-0.75%) left rates on hold and explained the franc remains “highly valued”.  Hungary raised their Deposit rate by 0.30% as expected and Norges Bank raised by 0.25%, also as expected, while promising another 0.25% in March.  Taiwan left rates unchanged at 1.125%, as expected and Turkey continue their unique inflation fighting policy by cutting the one-week repo rate by 1.00%, down to 14.00% although did indicate they may be done cutting for now.  As to the Turkish lira, if you were wondering, it has fallen another 3.8% as I type and is now well through 15.00 to the dollar.  YTD, TRY has fallen more than 51% vs. the dollar and quite frankly, given the more hawkish turn at the Fed, seems like it has further to go!

Which of course, brings us to the final two meetings today, the ECB and the BOE.  Madame Lagarde and most of her minions have been very clear that they are not about to change policy, meaning they will continue both the PEPP and APP and are right now simply considering how they are going to manage policy once the PEPP expires in March.  That is another way of saying they are trying to figure out how to continue to buy as many bonds as they are now, while losing one of their programs.  I’m not worried about them finding a way to continue QE ad infinitum, but the form that takes is the question at hand.  While European inflation pressures have certainly lagged those in the US, they are still well above their 2.0% target, and currently show no signs of abating.  If anything, the fact that electricity prices on the continent continue to skyrocket, I would expect overall prices to only go higher.  But Madame Lagarde is all-in on MMT and will drag the few monetary hawks in the Eurozone down with her.  Do not be surprised if the ECB sounds dovish today and the euro suffers accordingly.

As to the BOE, that is much tougher to discern as inflation pressures there are far more prevalent and members of the MPC have been more vocal with respect to discussing how they need to respond by beginning to raise the base rate.  But with the UK flipping out over the omicron variant and set to cancel Christmas impose more lockdowns, it is not clear the BOE will feel comfortable starting their tightening cycle into slower economic activity.  Ahead of the meeting, the futures market is pricing in just a 25% probability of a 0.15% rate hike.  My money is on nothing happening, but we shall see shortly.

Oh yeah, tonight we hear from the BOJ, but that is so anticlimactic it is remarkable.  There will be no policy shifts there and the yen will remain hostage to everything else that is ongoing.  Quite frankly, given the yen has been sliding lately, I expect Kuroda-san must be quite happy with the way things are.

And that’s really the story today.  Powell managed to pull off a hawkish turn and get markets to embrace risk, truly an impressive feat.  However, over time, I expect that equity markets will decide that tighter monetary policy, especially if central bank balance sheets begin to shrink, is not really a benefit and will start to buckle.  But right now, all screens are green and FOMO is the dominant driver.

In the near term, I think the dollar has further to run higher, but over time, especially when equity markets reverse course, I expect the dollar will fall victim to the impossible trilemma, where the Fed can only prop up stocks and bonds simultaneously, while the dollar’s decline will be the outlet valve required for the economy.  But that is many months away.  For now, buy dollars and buy stocks, I guess.

Good luck and stay safe
Adf

Not Quite Right

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The data from China last night
Could, President Xi, give a fright
While IP was fine
Consumption’s decline
Show’s everything there’s not quite right

Now, turning our focus back home
The question that’s facing Jerome
Is should he increase
The speed that they cease
QE?  Or just leave it alone?

Clearly, the big news today is the FOMC meeting with the statement to be released at 2:00 and Chair Powell to face the press 30 minutes later.  As has been discussed ad nauseum since Powell’s Congressional testimony two weeks ago, expectations are for the Fed to reduce QE purchases more quickly than the previously outlined $15 billion/month with many looking for that pace to double.  If that does occur, QE will have concluded by the end of March.  This timing is important because the Fed has consistently maintained that they would not raise the Fed funds rate while QE was ongoing.  Hence, doubling the pace of reduction opens the door for the first interest rate hike as soon as April.

And let’s face it, the Fed has fallen a long way behind the curve with the latest evidence yesterday’s PPI data (9.6%, 7.7% core) printing much higher than expected and at its highest level since the series was renamed the PPI from its previous Wholesale Price Index in 2010.  Prior to that, it was in the 1970’s that last saw prices rising at this rate.  So, ahead of the meeting results, investors are trying to analyze just how quickly US monetary policy will be changing.  Recall, yesterday I made a case for a slower reduction than currently assumed, but as of now, nobody really knows.

What we do know, however, is that the economic situation in China is not playing out in the manner President Xi would like.  Last night China released its monthly growth data which showed Retail Sales (3.9% Y/Y) Fixed Asset Investment (5.2% Y/Y) and Property Investment (6.0% Y/Y) all rising more slowly than forecast and more slowly than last month. Only IP (3.8% Y/Y) managed to grow.  As well, Measured Unemployment rose to 5.0%, higher than expected and clearly not the goal.  For the past several years China has been ostensibly attempting to evolve its economy from the current mercantilist state, where production for export drives growth, to a more domestically focused consumer-led economy like the West.  Alas, they have been unable to make the progress they would have liked and now have to deal with not only Covid, but the ongoing meltdown in the property sector which will only serve to hold the consumer back further.  Interestingly, the PBOC did not adjust the Medium-term Lending Rate as some pundits had expected, keeping it at 2.95%, and so, it should not be that surprising that the renminbi has maintained its strength, although has appeared to stop rising.  A 2.95% coupon in today’s world remains quite attractive, at least for now, and continues to draw international investment.

Aside from these stories, the other headline of note was UK inflation printing at 5.1%, its highest level since 2011 and clearly well above the BOE’s 2.0% target.  Remember, the BOE (and ECB) meet tomorrow and there remains a great deal of uncertainty surrounding their actions given the imminent lockdown in the UK as the omicron variant spreads rapidly.  Can the BOE really tighten into a situation where growth will clearly be impaired?  It is this uncertainty that has pushed the timing of the first interest rate hike by the BOE back to February, at least according to futures markets.  But as you can see, the BOE is in the same position as the Fed, inflation is roaring but there are other concerns that prevent it from acting to stem the problem.  In sum, the betting right now is the Fed doubles the pace of taper and the BOE holds off on raising rates until February, but either, or both, of those remain far less than certain.  Expect some more market volatility across all asset classes today and tomorrow.

With all that in mind, here’s a quick look at markets overnight.  Equities in Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.4%) mostly followed the US declines of yesterday, although Japan did manage to eke out a small gain and stop its recent trend lower.  Europe, on the other hand, is having a better go of it with the DAX (+0.3%) and CAC (+0.6%) both performing well as inflation data there was largely in line with expectations, albeit far higher than targets, and there is little concern the ECB is going to do anything tomorrow to rock the boat.  In the UK, however, that higher inflation print is weighing on equities with the FTSE 100 (-0.2%) underperforming the rest of Europe.  Ahead of the open, and the FOMC, US futures are little changed in general, although NASDAQ futures continue to slide, down (-0.25%) as I type.

The rally in European stocks has encouraged a risk-on attitude and so bond markets are selling off a bit with yields edging higher.  Well, edging except in the UK, where Gilts (+3.7bps) are clearly showing their concern over the inflation print.  But in the US (Treasuries +0.3bps), Germany (Bunds +1.2bps) and France (OATs +0.9bps) things are far less dramatic.  Given the imminent rate decisions, I expect that there is a chance for more movement later and most traders are simply biding their time for now.

The commodity picture is a little gloomier this morning with oil (-1.2%) leading the way lower and weakness in metals (Cu -1.5%, Ag -0.5%, Al -1.4%) widespread.  Gold is little changed on the day and only NatGas (+2.1%) is showing any life.  These markets are looking for a sign to help define the next big trend and so are also awaiting the FOMC outcome today.

Finally, the dollar continues to consolidate its recent gains but has been range trading for the past month.  The trend remains higher, but we will need confirmation from the FOMC today to really help it break out I believe.  In the G10, the biggest gainer has been AUD (+0.4%), but that appears to be positional, as Aussie has been sliding for the past week and seems to be taking a breather.  Otherwise, in this bloc there are an equal number of gainers and laggards with none moving more than 0.2%, so essentially trendless.

In the emerging markets, TRY (-2.1%) continues its decline toward oblivion with no end in sight.  Elsewhere, ZAR (-0.6%) has suffered on continue high inflation and the SARB’s unwillingness to fight it more aggressively.  INR (-0.5%) suffered on the back of a record high trade deficit and concerns that if the Fed does tighten, funding their C/A gap will get that much more expensive.  Beyond those, though, there has been far less movement and far less interest overall.

We do have some important data this morning led by Empire Mfg (exp 25.0) and Retail Sales (0.8%, 0.9% ex autos) at 8:30 and then Business Inventories (1.1%) at 10:00 before the FOMC at 2:00.  The inventory data bears watching as an indication of whether companies are beginning to stockpile more and more product given the supply chain issues that remain front and center across most industries.

And that’s really what we have at this point in time.  A truly hawkish Fed should help support the dollar further, while anything else is likely to see the dollar back up as hawkish is the default setting right now.

Good luck and stay safe
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