Tag Archives: #Powell

It’s Still Transitory

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Said Jay, I’m not worried ‘bout wages
Creating inflation in stages
I’ll stick to my story
It’s still transitory
And will be for many more ages

So now it’s the Old Lady’s turn
To help explain if her concern
‘Bout rising inflation
Will be the causation
Of rate hikes and trader heartburn

Like a child having a temper tantrum, the Fed continues to hold its breath and stamp its feet and tell us, “[i]nflation is elevated, largely reflecting factors that are expected to be transitory. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to a sizable price increase in some sectors.” [my emphasis.]  In other words, it’s not the fault of their policies that inflation is elevated, it’s the darn pandemic and supply chain issues.  (This is remarkably similar to how the German Reichsbank president, Rudy Havenstein, behaved as that bank printed trillions of marks fanning the flames of the Weimar hyperinflation.  At every bank meeting the discussion centered on rising prices and not once did it occur to them that they were at fault by continuing to print money.)

Nonetheless, Chairman Powell must be extremely pleased this morning as he was able to announce the tapering of QE purchases, beginning this month, and equity and bond markets responded by rallying.  There was, however, another quieter announcement which may well have helped the cause, this one by the Treasury.  Given the rally in asset prices, collection of tax receipts by the government has grown dramatically and so the Treasury General Account (the government’s ‘checking’ account at the Fed) is now amply funded with over $210 billion available to spend.  This has allowed the Treasury to reduce their quarterly refunding amounts by…$15 billion, the exact amount by which the Fed is reducing its QE purchases.  Hmmmm.

So, to recap the Fed story, the tapering has begun, inflation is still transitory, although they continue to bastardize the meaning of that word, and they remain focused on the employment situation which, if things go well, could achieve maximum employment sometime next year.  Rate hikes will not be considered until they finish tapering QE to zero, and they will taper at the pace they deem correct based on conditions, so the $15 billion/month is subject to change.  One more thing; when asked at the press conference about inflation rising faster than anticipated, Powell responded, “We think we can be patient.  If a response is called for, we will not hesitate.”  Them’s pretty big words for a guy who can look at the economy’s behavior over the past twelve months and decide that inflation remains only a potential problem.

Enough about Jay, he’s not going to change, and in my view, he only has two meetings left anyway.  Consider this; President Biden needs to get the progressives onboard to have any chance of passing any part of the current spending bills and in order for them to compromise on that subject, they will want something in return.  They also hate Powell, as repeatedly vocalized by Senator Warren, so it is easy to foresee the President sacrificing Powell for the sake of his spending bill.  Especially given the results of the Virginia elections, which moved heavily against the Democrats, the administration will want to get this done before the mid-term elections next year.  I think Powell is toast.

On to the rest of the central bank world where this morning the BOE will announce their latest decision.  The market continues to be about 50/50 on a rate hike today, but have fully priced one in by December, so either today or next month.  Interestingly, the UK Gilt market is rallying this morning ahead of the announcement, with yields lower by 3.1 basis points.  What makes that so interesting is that the futures market is pricing in 100 basis points of rate hikes by the BOE within the next 12 months, which would take the base rate up to 1.0%.  Right now, 10-year Gilt yields are 1.03%.  If the futures market is right, then either Gilts are going to sell off sharply as the yield curve maintains its current shape or the market is beginning to price in much slower growth in the UK.  My money is on the latter as the UK has proven itself to be willing to fight inflation far more strenuously than the Fed in the past.  If slowing growth is a consequence, they will accept that more readily I believe.

Still on the central bank trail, it is worth highlighting that Poland’s central bank raised rates by 0.75% yesterday in a huge market surprise as they respond to quickly rising inflation.  Concerns are that CPI will reach 8.0% this year, so despite the rate hike, there is still much work to do as the current base rate there, after the hike, is 1.25%.  This morning the Norgesbank left rates on hold but essentially promised to raise them by 25bps next month to 0.50%. While they are the first G10 country to have raised interest rates, even at 0.50%, their deposit rate remains far, far below CPI of 4.1%.

So, to recap, central banks everywhere are finally starting to move in response to rapidly rising inflation.  While some countries are moving faster than others, the big picture is rates are set to go higher…for now.  However, when economic growth begins to slow more dramatically, and it is already started doing so, it remains to be seen how aggressive any central bank will be, especially the Fed.

Ok, let’s look at today’s markets.  As I said earlier, equities are rocking.  After yesterday’s US performance, where all 3 major indices reached new all-time highs, we saw strength in Asia (Nikkei +0.9%, Hang Seng +0.8%, Shanghai +0.8%) and Europe (DAX +0.5%, CAC +0.5%, FTSE 100 +0.2%).  US futures, on the other hand, are mixed with NASDAQ (+0.5%) firmer while the other two indices are little changed.

Bond prices have rallied everywhere in the world, which given the idea of tighter policy seems incongruent.  However, it has become abundantly clear that bond prices no longer reflect market expectations of inflation, but rather market expectations of QE.  At any rate, Treasuries (-3.5bps) are leading the way but Gilts (-3.1bps), Bunds (-1.7bps) and OATs (-1.8bps) are all seeing demand this morning.

After yesterday’s confusion, commodity prices are tending higher this morning with oil (+1.7%) leading the way, but gains, too, in NatGas (+0.75%), gold (+0.5%) and copper (+0.6%).  Agricultural products are mixed, as are the rest of the industrial metals, but generally, this space has seen strength today.

As to the dollar, it is king today, firmer vs. virtually every other currency in both the G10 and EMG blocs.  The euro (-0.6%) is the laggard in the G10 as the market is clearly voting the ECB will be even more dovish than the Fed going forward.  But the pound (-0.4%) is soft ahead of the BOE and surprisingly, NOK (-0.4%) is soft despite both rising oil prices and a relatively hawkish Norgesbank.  The best performer is the yen, which is essentially unchanged today.

In the EMG space, PLN (-1.0%) and HUF (-1.0%) are the laggards as both countries grapple with much faster inflation and lagging monetary policy.  But CZK (-0.7%) and TRY (-0.65%) are also under relative pressure as their monetary policies, too, are lagging the inflation situation.  Throughout Asia, most currencies slid as well, just not as much as we are seeing in EEMEA.

On the data front, Initial Claims (exp 275K) headlines this morning along with Continuing Claims (2150K), Nonfarm Productivity (-3.1%), Unit Labor Costs (7.0%) and the Trade Balance (-$80.2B).  It is hard to look at the productivity and ULC data and not be concerned about the future economic situation here.  Rapidly rising labor costs and shrinking productivity is not a pretty mix.  As to the Fed, mercifully there are no additional speakers today, so we need look only at data and market response.

Clearly market euphoria remains high at this time, and so further equity gains seem likely.  Alas, the underlying structure of things does not feel that stable to me.  I expect that we are getting much closer to a more substantial risk-off period which will result in a much stronger dollar (and yen), and likely weaker asset prices.  For hedgers, be careful.

Good luck and stay safe
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Feathered and Tarred

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The talk of the town is that Jay
Will outline the taper today
Inflation’s been mulish
And he has been foolish
-ly saying t’would soon go away

This outcome means Madame Lagarde
Remains as the final blowhard
Who claims that inflation
Is our ‘magination
Which might get her feathered and tarred

It’s Fed day today and the market discussion continues apace as to just what Chairman Powell and his FOMC acolytes are going to do this afternoon.  The overwhelming majority view amongst the economics set is the Fed will outline its plans to taper QE purchases starting immediately.  Expectations are for a reduction in purchases by $10 billion/month of Treasuries and $5 billion/month of Mortgage Backed Securities.  Many analysts also believe the statement will leave wiggle room for the FOMC to adjust the pace as necessary depending on the unfolding economic conditions.  Powell has been taking great pains in trying to separate the timing of reducing QE with the timing of raising interest rates, and I expect that will continue to be part of the discussion.  Of course, the market is currently pricing in two 25bp rate hikes in 2022, essentially saying the Fed will finish the taper next June and hike rates immediately.  This is clearly not Powell’s desired path, but the wisdom of crowds may just have it right.  We shall see.

In addition to that part of the announcement, we are going to hear the Fed’s view on how inflation will evolve going forward, although at this point, I think even they have realized they cannot use the word transitory in their communications.  Talk about devaluing the meaning of a word!  What remains remarkable to me is the unwavering belief, at least the expressed unwavering belief, that while inflation may print high for a little while longer, it is due to settle back down to the 2% level going forward.  I continue to ask myself, why is that the central bank view?  And not just in the US, but in almost every developed nation.  For instance, just moments ago Madame Lagarde was quoted as saying, “Medium-term inflation outlook remains subdued,” and “conditions for rate hike unlikely to be met next year.”

To date, there has certainly been no indication that global supply chains are working more smoothly than they were during the summer, and every indication things will get worse before they get better.  The number of ships anchored off major ports continues to grow, the number of truck drivers continues to shrink and demand, courtesy of literally countless trillions of dollars of fiscal stimulus shows no sign of abating.  Add to that the current environmental zeitgeist, which demonizes fossil fuels and seeks to prevent any investment in their production thus reducing supply into accelerating demand and it is easy to make the case that prices are likely to rise going forward, not fall.

There is a saying in economics that, ‘the cure for high prices is high prices.’  The idea is that higher prices will encourage increased supply thus driving prices back down.  And historically, this has been true, especially in commodity markets.  However, the unspoken adjunct to that saying is that policies do not exist to prevent increased supply and that the incentive of higher revenues is sufficient to encourage that new supply to be created.  Alas, the world in which we find ourselves today is rife with policies that may have political support but are not economically sound.  The current US energy policy mix preventing oil drilling in ANWR and offshore, as well as the cancellation of the Keystone Pipeline served only to reduce the potential supply of oil with no replacement strategy.  If policy prevents new production, then no price is high enough to solve that problem, and therefore the ceiling on prices is much higher.

I focus on energy because it is a built-in component of everything that is produced and consumed, and while the Fed may ignore its price movement, manufacturers and service providers do not and will raise prices to cover those increased costs.  The upshot here is that instead of high prices encouraging new supply, it appears increasingly likely that prices will have to rise high enough to destroy new, and existing, demand before markets can once again return to a semblance of balance.  Given the fact that fiscal largesse has been extraordinary and household savings has exploded to unprecedented heights during the pandemic and remains well above pre-pandemic levels, it seems that demand is not going to diminish anytime soon.  I fear that rising prices is a new feature of our lives, across all segments, and something we must learn to address going forward.  While there is no reason to believe we are heading to a Weimar-style hyperinflation, do not be surprised if the “new normal” CPI is 3.5%-4.5% going forward.  At the current time, there is simply nothing to indicate this problem will be addressed by the Fed although we are likely to see smaller, open economy central banks raise interest rates far more aggressively.  As that process plays out, the dollar will almost certainly weaken, but we are still months away from that situation.

So, ahead of the FOMC statement and Powell presser this afternoon, here’s what’s been happening in markets.  Despite record high closes in the US markets yesterday, Asia (Nikkei -0.4%, Hang Seng -0.3%, Shanghai -0.2%) did not follow through at all.  Europe, too, sees no joy although only the FTSE 100 (-0.2%) has even moved on the day with other major markets essentially unchanged.  US futures are also little changed at this time with everyone waiting for Jay.

Bond markets, on the other hand are continuing their recent rally with Treasury yields lower by 1.4bps and Europe (Bunds -1.5bps, OATs -2.0bps, Gilts -0.3bps) all rallying as well.  Peripheral markets are doing even better as it seems the European view is turning toward the idea that the ECB will be outlining their new QE program in December with no capital key involved.

Commodity prices continue to give mixed signals with oil (WTI -2.4%) falling sharply, ostensibly on comments from President Biden admonishing OPEC+ to pump more oil.  Will that really get them to do so?  NatGas (-0.7%) is also a bit softer, but the metals complex is actually firmer with copper (+1.05%, aluminum +1.45%, and tin +1.8%) all showing strong gains.  This as opposed to precious metals which are essentially unchanged on the day.

As to the dollar, it is hard to describe today.  While versus the G10, it is generally weaker (CHF +0.4%, NZD +0.4%, SEK +0.3%) it has performed far better against EMG currencies (TRY -0.8%, RUB -0.7%, KRW -0.6%) although PLN (+0.4%) is having a good day.  Unpacking all this the Swiss story seems to be premised on the idea that the market is testing the SNB to see if they can force more intervention while the kiwi story is a response to stronger jobs data overnight.  Sweden seems to be benefitting from the emerging view of tighter policy from the Riksbank as they reduce QE.  On the EMG side, Turkey’s inflation rate continues to be breathtakingly high (CPI 19.89%, PPI 46.31%!) and yet there is no indication the central bank will respond by tightening policy as that is against the view of President Erdogan.  Oil’s decline is obviously driving the ruble lower, surprisingly not NOK, and KRW saw an increase in foreign equity sales and outflows thus weakening the won.

Ahead of the FOMC we see ADP Employment (exp 400K), ISM Services (62.0) and Factory Orders (0.1%), but while ADP will enter the conversation tomorrow, once we are past the Fed, I expect the morning session to be extremely quiet ahead of 2:00pm.  From there, all bets are off, although my take is the level of hawkishness on the FOMC is edging higher.  Perhaps there is some dollar strength to be seen post-Powell.

Good luck and stay safe
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A Beginning, a Middle and End

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“A beginning, a middle and end”
Is how Powell outlined the trend
Of current inflation
Which has caused frustration
For central banks who overspend

As Ralph Waldo Emerson so notably observed, “A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.”  I am reminded of this each time I read that (little statesman) Jay Powell or (the divine) Madame Lagarde explain that inflation is largely transitory.  Little-minded they certainly appear to be, no?  Every day the evidence grows that inflation is trending higher yet despite this information, they remain consistent in their belief (or at least in their comments) that all of this price appreciation will quickly pass.  Yesterday, at an ECB held virtual symposium, Powell expressed frustration that supply chain bottlenecks have not been resolved as quickly as the Fed’s models indicate they should be.  Or perhaps the frustration stems from the fact that they have been completely wrong about inflation and it is starting to have a serious impact on their idealized world.  Whatever the case, each time they try to gloss over the implications of inflation, they lose just a touch more credibility (to the extent they have any remaining) in the markets’ collective eyes.  While the Fed’s track record for forecasting has always been awful, the current situation appears to be one of either intransigence in the face of new evidence, or more likely, a recognition that a change in their narrative has the potential to lead to much worse outcomes.

Fortunately, they continue to explain that if inflation were to get out of hand, they have the tools to address the issue and they are not afraid to use them!  However, history indicates that is not the case.  Consider that those ‘tools’ consist of the ability to raise interest rates and tighten monetary policy.  We all recall that just 3 years ago, as the Fed was attempting to normalize its balance sheet, allowing purchased assets to mature without being replaced, as well as slowly move interest rates higher, the equity market tumbled 20% in Q4 2018.  This led to the Powell pivot, where he decided that a declining stock market was a negative for his personal balance sheet the economy and instead, the FOMC cut rates in January to mitigate the damage already done.  The situation today appears far more dangerous with market leverage and valuations at historic highs.  Tightening policy in this market condition is likely to result in at least a 20% revaluation of equities, something the Fed can clearly not countenance.  Hence, it is far easier to ignore inflation than to respond to it.  Meanwhile, Paul Volcker spins in his grave!

In the meantime, Eurozone inflation readings released thus far this morning have shown virtually every one at the highest levels since before the GFC, at the very least, if not the highest readings in three decades.  For instance, French CPI printed at 2.7%, its highest print since June 2008.  Italian CPI, at 3.0%, is merely its highest since 2012, but in fairness, prior to the euro’s creation, Italian CPI regularly ran at much higher levels resulting in a continuing depreciation of the lire. Shortly we will see German inflation, with some of its States already reporting levels above 4.2%, their highest prints since the mid 1990’s, which is also the current forecast for the nation as a whole.  The point is, there is absolutely no evidence that inflation is peaking, and while Powell and Lagarde twiddle their thumbs, things are going to get worse before they get better.

So, what does this mean for markets?  Well, we have already seen yield curves steepen in the US and throughout Europe as there is a strong belief that despite rising inflation, neither the Fed nor ECB is going to respond.  Yes, the Fed said they would think about tapering come November, but if anything, that is likely to simply steepen the curve further as the price-insensitive buyer of last resort reduces its purchases.  The real question is, at what point will the Fed decide that yields are too high and adjust policy to rein them in?  SMBC’s house forecast is for 1.80% by the end of the year, which is in line with much of the Street.  The conundrum, however, is that Street forecasts are for continued higher prices in equities as well, and it seems to me that the two scenarios are unlikely to be achieved simultaneously.  If rates do continue higher, while I think the short-term impact will be USD positive, I fear the equity market may not be quite as sanguine.

Overnight, markets continue to wrestle with the conflicting ideas of rising inflation and central bank sanguinity on its transitory nature.  While we have seen a sharp rise in yields over the past week, last night was a consolidating session with bond market movement quite limited.  Treasury yields have edged higher by 1.2bps, but at 1.53% remain a few ticks below the peak seen Monday.  We have seen similar, modest, price action on the continent (Bunds +0.5bps, OATs +0.4bps) although Gilts (+2.4bps) have responded to better-than-expected GDP results for Q2, which showed year on year growth of 23.6%.  Not surprisingly, this has helped the pound as well, which is firmer this morning by 0.1%.

Equity markets have also had mixed reviews with Asia (Nikkei -0.3%, Hang Seng -0.4%, Shanghai +0.9%) not giving consistent direction and Europe following suit (DAX -0.2%, CAC 0.0%, FTSE 100 +0.2%).  US futures are higher by about 0.5% at this hour as traders await this morning’s data releases.

While oil prices have slipped a bit this morning (WTI -0.8%) the same cannot be said for NatGas (+2.7%) as the energy situation remains fraught in Europe and the UK (and Asia).  The rest of the commodity space is generally under pressure as well with copper (-1.7%) and aluminum (-0.4%) both falling while the precious sector is essentially unchanged on the day.

The dollar, while mixed in the overnight session, saw significant strength yesterday which has seen the euro fall below 1.1600 for the first time since July 2020, and looking for all the world like it has further to run.  Unless yields in the US stop rising, my take is we could well see 1.12 before long.  But in the past two days we have seen some sharp declines; NOK (-1.5%), NZD (-1.3%) and EUR (-0.9%) have all suffered.  Even the yen (-0.45%) is declining here despite some evidence of risk mitigation.  In fact, it has weakened to its lowest point since the beginning of the Covid situation in February 2020, and here, too, looks as though it as room to run.  115 anyone?

EMG currencies have shown similar price behavior, falling sharply yesterday with a more mixed overnight session.  But the breadth of the decline is indicative of a dollar story, not any idiosyncratic issues in particular countries.  While those clearly exist, they are not driving the market right now.

This morning’s data calendar brings the weekly Initial (exp 330K) and Continuing (2790K) Claims data as well as the third look at Q2 GDP (6.6%).  Then at 9:45 we see Chicago PMI (65.0).  While the GDP data contains inflation information, it is not widely followed or used in models.  However, it is interesting to note that the Core PCE calculation there is at 6.1%, which happens to be the highest print since Q3 1983!  Perhaps this is why it is ignored.

We also hear from six Fed speakers in addition to Powell and Yellen sitting down in front of the House Financial Services Committee.  Of course, Powell has made clear his views on the transitory nature of inflation and I’m confident no question from a Congressman will get him to admit anything different.  Rather, I expect a staunch defense of the two disgraced Fed regional presidents who resigned after their insider trading was made known, and both he and Yellen to beseech Congress to raise the debt ceiling and not allow the government to shut down.  In other words, nothing new will occur.

The dollar has pretty clearly broken out of its recent range and I expect that this move has some legs.  I would be buying dollars on dips when the opportunity arises.  For payables hedgers, pick your spots and lock in comfortable rates.  The trend is now your friend.

Good luck and stay safe
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Raring to Spend

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Japan’s new PM
Fumio Kishida is
Raring to spend yen

The LDP elected Fumio Kishida as its new president, thereby assuring him of the job of Japan’s 65th Prime Minister.  Relacing Yoshihide Suga, Kishida-san has a tall task ahead of him in leading the nation back to a growth trajectory.  In addition, he must face the voters by November as well as rally his supporters in an upper house election next year.  Apparently, his plan is…spend more money!  He has promised to spend tens of trillions of yen (hundreds of billions of dollars equivalent) in order to help resuscitate the Japanese economy and bolster the middle class.

As refreshing as it is to have a new administration, it seems as though the policy playbook continues to consist of a single page…spend more yen.  Perhaps something will change in Japan, but it seems unlikely.  Rather, the nation will continue to struggle with the same macroeconomic issues that have plagued it for the past decades; excess debt driving slower growth amid an aging population.  The yen (+0.1%) has stabilized this morning but appears to be trending pretty sharply lower.  While support (USD resistance) is strong at 111.65-85, should we breech that level, a move toward 115.00 appears quite reasonable as well as likely.

As energy prices rise higher
Most governments seek a supplier
Of power that will
Completely fulfil
The orders that they all desire

In other news, it is becoming abundantly clear that the combination of energy policies that have been enacted recently are not having the desired outcome, assuming that outcome is to develop clean energy in abundance.  This is made evident by the dramatically rising prices of things like natural gas in Europe (+400% since 1Mar21) and the US (+130% YTD) and coal (+160% YTD).  Of course, the latter is rarely considered ‘clean’ but it is reliable.  And that is the crux of the matter.  Reliability of both wind and solar power has been called into question lately and reliance on baseload power sources like coal, which Europe, China, and India have in abundance, and NatGas, which they don’t, is driving policy decisions.

For instance, China is mulling energy price hikes for industry in an effort to reduce demand.  And if that doesn’t work, they will raise prices for residential users.  Go figure, a communist nation using price signals to adjust behavior!  At any rate, the immediate impact is likely to be downgraded growth prospects for China’s economy as rising energy prices will lead to rising export prices, lower exports, and lower growth.  We have already seen Chinese equity markets under pressure recently as the energy situation worsens.  Shanghai (-1.8%, -5.5% in past two weeks) is leading the way lower amid growing concern that Evergrande is not the biggest problem impacting China.  At some point, I expect the renminbi is going to suffer a bit more than its recent price action has shown.  Slowing growth and continued monetary expansion are going to add a great deal of pressure to the currency as it may be the only outlet available for the economy.  I fear it could be a “long cold lonely winter” in China this year.

Of course, it’s not just China where energy prices are rising, they are higher everywhere.  I’m sure you see it when you refill your gas tank, or when you pay your electric bill.  And this is a problem for economic growth as higher energy costs feed into product and service pricing directly, as well as reduce the amount of disposable income available for spending by the population.  Higher prices and slower growth (i.e. stagflation) are a very real risk, and by some measures have already arrived.

Beyond the direct discomfort we all will feel from its impacts, the policy questions are critical.  Consider, last time stagflation was upon us, then Fed Chairman Paul Volcker raised interest rates sharply in order to attack the inflation issue driving the US economy into a severe double-dip recession.  Oh yeah, the S&P 500 fell nearly 30% over the two-year period.  But ask yourself if, given the current zeitgeist as well as the current makeup of the Fed, there is any possibility that Chairman Powell (or his successor) will attack inflation in the same way.  It seems highly unlikely that would be the case.  Rather, it is a virtual certainty that the focus will be on the ‘stag’ part of the term and more money printing and spending will be recommended.  After all, given the increasing acceptance of the MMT mindset, that’s all that needs to be done.  Remember, policies matter, and if policies are designed to achieve short-term goals at the expense of longer-term needs, the ultimate outcome tends to be poor.  As in China, the currency is likely to be the relief valve for the economy which is what informs my view of longer-term USD weakness.  However, for now, the dollar is following 10-year Treasury yields, which seem to be trending higher, albeit not today when they have fallen 4.2 basis points.

Summing it all up, rising energy prices are starting to have deleterious effects on all parts of the global economy and the financial market implications are only going to grow.  In addition, the policy actions going forward are critical, and the chance of a policy error seem to grow daily.  The idea of short-term pain for long-term gain is obsolete in the year 2021.  Be prepared for more problems in the future.

Ok, a quick run around markets shows that after yesterday’s sharp US equity sell-off, Japan (Nikkei -2.1%) followed suit as did Shanghai although the Hang Seng managed to rally 0.7%.  Europe, on the other hand has decided that central banks will come to the rescue, as we are seeing a nice rebound from yesterday’s price action (DAX +1.1%, CAC +1.2%, FTSE 100 +1.0%).  US futures, too, are higher led by the NASDAQ (+1.0%) as declining yields are helping out.

But are yields really declining?  The fact that the bond market has bounced slightly after a dramatic 1-week decline is hardly a sign of a rebound.  Rather, it is normal trading activity.  While the trend remains for higher yields, today, all of Europe has seen yields slide on the order of 2 basis points alongside the Treasury yield declines.  This feels very much like a lull in the action, not a top/bottom in the market.

Commodity prices are behaving in a similar manner as oil (-0.8%) and NatGas (-1.2%) are leading the way lower, consolidating what has been an impressive rally.  Metals prices are mixed with gold (+0.6%) rebounding but base metals (Cu -0.4%, Al -0.2%, Sn -0.6%) all sliding.  Agricultural prices are mixed as the overall session seems to be one of position adjustments after a big move.

As to the dollar, it is mixed, albeit slightly firmer if anything.  In the G10, NOK (-0.35%) is falling alongside oil prices with NZD (-0.3%) the next worst performer on weakening commodity prices.  JPY (+0.1%) and CHF (+0.1%) are both modestly firmer, but here, too, things seem more position oriented than trend worthy.  EMG currencies are mixed with an equal number of gainers and losers, but the notable thing is that the biggest movers have only seen price adjustments of 0.3% or less.  In other words, there are precious few stories here to think about.

There is no data of note this morning, but we do hear from a lot of central bankers, notably Chairman Powell alongside Lagarde, Kuroda and Bailey (BOE) at an ECB forum.  We also hear from Harker, Daly and Bostic, but the narrative remains tapering is coming in November, and none of these three will be able to change that narrative.

In truth, I would have expected the dollar to soften today given the bond market, so the fact it remains reasonably well bid is a sign that there is further strength in this move.  The euro is pushing to critical technical support at 1.1650, a break of which is likely to see a much sharper decline.  Hedgers, keep that in mind.

Good luck and stay safe
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QE Galore

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With Kaplan and Rosengren out
The hawks have lost much of their clout
This opens the door
For QE galore
With tapering now more in doubt

As well, has Jay’s rep now been stained
So much that he won’t be retained
As Chair of the Fed
With Brainerd, instead
The one that progressives ordained?

All the action is in the bond market these days as investors and traders focus on the idea that the Fed is going to begin tapering its asset purchases in November.  Not surprisingly, demand for Treasuries has diminished on these prospects with the yield curve bear steepening as 10-year and 30-year yields climb more rapidly than the front end of the curve.  In fact, this morning, 10-year Treasury yields have risen a further 3.5 basis points, which makes 22bps since the FOMC meeting, and is now trading at 1.52%, its highest level since June.  Yields are rising elsewhere in the world as well, just not quite as rapidly as in the US.  For instance, Bunds (+3.2bps today, +13bps since Wednesday), OATs (+3.1bps today, 15bps since Wednesday) and Gilts (+4.8bps today, +20bps since Wednesday) are also under severe pressure.  While the BOE has absolutely discussed the idea of tapering, the same is not true with the ECB, which instead is discussing how it is going to replace PEPP when it expires in March 2022.

By the way, there is another victim to these rate rises, the NASDAQ, (futures -1.6%) where the tech sector lives and whose valuations have moved to extraordinary heights based on their long duration characteristics.

But let us consider how recent, sudden, changes in the makeup of the Fed may impact the current narrative.  It seems that two of the more hawkish Regional Fed presidents, Boston’s Rosengren and Dallas’ Kaplan, were actively trading their personal accounts at the same time they were privy to the inside discussions at the FOMC.  I can’t imagine more useful information short of knowledge of an acquisition, with respect to how to position my personal portfolio.  When this news broke last week, there was an initial uproar and then a slow boil rose such that both clearly felt pressured to step down.  (Of course, they had already sold out their positions ahead of the tapering discussion, so don’t worry, they kept their gains!)

There are a couple of things here which I have not yet seen widely discussed, but which must be considered when looking ahead.  First, the two of them were amongst the more hawkish FOMC members, with Kaplan the first to talk about tapering and Rosengren climbing on that bandwagon several months ago with vocal support.  So, will their replacements be quite as hawkish?  It would not surprise if Dallas goes for another hawk but given the progressivity of the bulk of New England, the new Boston Fed president seems far more likely to lean dovish in my view.  So, the tone of the FOMC seems likely to change.

Perhaps of more importance, though, is that this went on under Chairman Powell’s nose with no issues raised until it became public.  That is hardly a sign of strong leadership, and the very idea that two FOMC members were trading their personal accounts on the back of inside information is a huge black mark on his chairmanship.  You can be certain that when he sits down before the Senate Banking Panel today, Senator Warren is going to be tenacious in her attacks.  The point is, the idea that Powell will be reappointed may just have been squashed.  This means that Lael Brainerd, currently a Fed governor, may well get the (poison) chalice.  Governor Brainerd, just yesterday, explained that she was not nearly ready to taper, rather that the labor market was still “a bit short of the mark” of the “substantial further progress” threshold.  In fact, she is convinced that the economy will revert to its pre-pandemic characteristics soon after the delta variant dissipates.

If you consider the implications of this new information, we could well wind up with a more dovish FOMC generally with a much more dovish Fed chair.  Ask yourself if that scenario is likely to produce a consensus to taper asset purchases?  While Jay may get the process started, assuming economic activity holds up through November, they will never end QE with that type of FOMC bias.  In fact, it would not be surprising if the Biden administration nominated someone like Professor Stephanie Kelton, the queen of MMT, for one of the open governorships.

Summing up, recent surprising actions have now opened the door for a much more dovish Fed going forward.  This means that the fight against inflation, which even Powell has begun to admit could last a bit longer than initially anticipated, is of secondary, if not tertiary, importance.  For now, the dollar is following US rates higher as spreads widen in the dollar’s favor, but if the Fed gets reconstructed in a more dovish manner, which seems far more likely this morning than last week, I would expect the dollar to find a top sooner rather than later.

However, that is all prognostication of what may happen.  What is happening right now is that yields are rising on the taper talk and risk is being jettisoned as a result.  So, equity markets are generally under pressure.  Last night saw the Nikkei (-0.2%) slip a bit while the bulk of the rest of the region suffered more acutely (Australia -1.5%), although Shanghai (+0.5%) and the Hang Seng (+1.2%) were the positive outliers.  However, that seemed more like dip buying than fundamentally led activity.  Europe is really under the gun (DAX -1.15%, CAC -1.75%, FTSE 100 -0.5%) as yields, as discussed above, rise everywhere.

Commodity prices continue to show mixed behavior as oil (WTI +0.95%) and Nat Gas (+7.5%), rise sharply on supply concerns while metals (Au -0.9%, Cu -1.3%) all suffer on the back of concerns over economic growth and the dollar’s strength.

Speaking of the dollar, it is universally higher this morning against both G10 and EMG counterparts.  NZD (-0.8%) and GBP (-0.7%) are the downside leaders this morning, with kiwi feeling pressure from falling iron ore prices while the pound turned tail recently on position adjustments as traders await a dovish BOE speaker’s comments later in the session.  But, AUD (-0.6%) is also feeling the pressure from declining metals prices and in a more surprising outcome, NOK (-0.5%) is floundering despite rising oil prices and the fact that the Norgesbank was the First G10 central bank to actually raise rates!  As well, don’t forget JPY (-0.4%) which is now pushing to its highest levels of the year and not far from multi-year highs.  Remember, high energy prices are a distinct yen negative.

EMG currencies are being led lower by ZAR (-1.0%) on weaker metals prices and THB (-0.75%) which is continuing to feel pressure from its fiscal accounts.  But here too, the weakness is widespread (KRW -0.65%, MXN -0.6%, PLN -0.6%) as the dollar is simply in substantial demand on the back of the yield benefit.

On the data front, yesterday’s Durable Goods numbers were much stronger than expected, clearly helping the rate/dollar story.  This morning brings Case Shiller House Prices (exp 20.0%) as well as Consumer Confidence (115.0) and the Advanced Goods Trade Balance (-$87.3B).  But the feature event will be the 10:00am sit down by Powell and Yellen at the Senate.  We do hear from four other FOMC members, but none will garner the same attention.  It will be interesting to hear how he parries what are almost certain to be questions about the insider trading scandal as well as more persistent inflation.  Stay tuned!

The correlation of the dollar to the 10-year yield has risen sharply in the past several sessions and is now above 60%.  I see no reason for that to change, nor any reason for yields to stop climbing right now.  While I doubt we even get back to the March highs of 1.75%, that doesn’t mean we won’t see some more fireworks in the meantime.

Good luck and stay safe
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Far From Surreal

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The Fed explained that they all feel
A taper is far from surreal
The goal for inflation
Has reached satiation
While job growth ought soon seal the deal

Heading into the FOMC meeting, the consensus was growing around the idea that the Fed would begin tapering later this year, and the consensus feels gratified this morning.  Chairman Powell explained that, if things go as anticipated, tapering “could come as soon as the next meeting.”  That meeting is slated for November 2nd and 3rd, and so the market has now built this into their models and pricing.  In fact, they were pretty clear that the inflation part of the mandate has already been fulfilled, and they were just waiting on the jobs numbers.

An interesting aspect of the jobs situation, though, is how they have subtly adjusted their goals.  Back in December, when they first laid out their test of “substantial further progress”, the employment situation showed that some 10 million jobs had been lost due to Covid-19.  Since then, the economy has created 4.7 million jobs, less than half the losses.  Certainly, back then, the idea that recovering half the lost jobs would have been considered “substantial further progress” seems unlikely.  Expectations were rampant that once vaccinations were widely implemented at least 80% of those jobs would return.  Yet here we are with the Fed explaining that recovering only half of the lost jobs is now defined as substantial.  I don’t know about you, but that seems a pretty weak definition of substantial.

Now, given Powell’s hyper focus on maximum employment, one might ask why a 50% recovery of lost jobs is sufficient to move the needle on policy.  Of course, the only answer is that despite the Fed’s insistence that recent inflation readings are transitory and caused by supply chain bottlenecks and reopening of the economy, the reality is they have begun to realize that prices are rising a lot faster than they thought likely.  In addition, they must recognize that both housing price and rent inflation haven’t even been a significant part of the CPI/PCE readings to date and will only drive things higher.  in other words, they are clearly beginning to figure out that they are falling much further behind the curve than they had anticipated.

Turning to the other key release from the FOMC, the dot plot, it now appears that an internal consensus is growing that the first rate hike will occur in Q4 2022 with three more hikes in 2023 and an additional three or four in 2024.  The thing about this rate trajectory is that it still only takes Fed Funds to 2.00% after three more years.  That is not nearly enough to impact the inflationary impulse, which even they acknowledge will still be above their 2.0% target in 2024.  In essence, the dot plot is explaining that real interest rates in the US are going to be negative for a very long time.  Just how negative, though, remains the $64 trillion question.  Given inflation’s trajectory and the current school of thought regarding monetary policy (that lower rates leads to higher growth), I fear that the gap between Fed Funds and inflation is likely to be much larger than the 0.2% they anticipate in 2024.  While this will continue to support asset prices, and especially commodity prices, the impact on the dollar will depend on how other central banks respond to growing inflation in their respective economies.

Said China to its Evergrande
Defaulting on bonds is now banned
So, sell your assets
And pay dollar debts
Take seriously this command

CHINA TELLS EVERGRANDE TO AVOID NEAR-TERM DEFAULT ON BONDS

This headline flashed across the screens a short time ago and I could not resist a few words on the subject.  It speaks to the arrogance of the Xi administration that they believe commanding Evergrande not to default is sufficient to prevent Evergrande from defaulting.  One cannot help but recall the story of King Canute as he commanded the incoming tide to halt, except Canute was using that effort as an example of the limits of power, while Xi is clearly expecting Evergrande to obey him.  With Evergrande debt trading around 25₵ on the dollar, and the PBOC continuing in their efforts to wring leverage out of the system, it is a virtual guaranty that Evergrande is going under.  I wouldn’t want to be Hui Yan Ka, its Chairman, when he fails to follow a direct order.  Recall what happened to the Chairman of China Huarong when that company failed.

Ok, how are markets behaving in the wake of the FOMC meeting?  Pretty darn well!  Powell successfully explained that at some point they would begin slowing their infusion of liquidity without crashing markets.  No tantrum this time.  So, US equities rallied after the FOMC meeting with all three indices closing higher by about 1%.  Overnight in Asia we saw the Hang Seng (+1.2%) and Shanghai (+0.4%) both rally (Japan was closed for Autumnal Equinox Day), and we have seen strength throughout Europe this morning as well.  Gains on the continent (DAX and CAC +0.8%) are more impressive than in the UK (FTSE 100 +0.2%), although every market is higher on the day.  US futures are all currently about 0.5% higher, although that is a bit off the earlier session highs.  Overall, risk remains in vogue and we still have not had a 5% decline in the S&P in more than 200 trading days.

With risk in the fore, it is no surprise that bond yields are higher, but the reality is that they continue to trade in a pretty tight range.  Hence, Treasury yields are higher by 2.4bps this morning, but just back to 1.324%.  Essentially, we have been in a 1.20%-1.40%% trading range since July 4th and show no sign of that changing.  In Europe, yields have also edged higher, with Bunds (+1.6bps) showing the biggest move while both OATs (+0.9bps) and Gilts (+0.6bps) have moved less aggressively.

Commodity prices are mixed this morning with oil lower (-0.7%) along with copper (-0.25%) although the rest of the base metal complex (Al +0.6%, Sn +0.55%) are firmer along with gold (+0.3%).  Not surprisingly given the lack of consistency, agricultural prices are also mixed this morning.

The dollar, however, is clearly under pressure this morning with only JPY failing to gain, while the commodity bloc performs well (CAD +0.8%, NOK +0.6%, SEK +0.5%).  EMG currencies are also largely firmer led by ZAR (+0.9%) on the back of gold’s strength and PLN (+0.6%) which was simply reversing some of its recent weakness vs. the euro.  On the downside, the only notable decliner is TRY (-1.4%), which tumbled after the central bank cut its base rate by 100 basis points to 18% in a surprise move.  In fact, TRY has now reached a record low vs. the dollar and shows no signs of rebounding as long as President Erdogan continues to pressure the central bank to keep rates low amid spiraling inflation.  (This could be a harbinger of the US going forward if we aren’t careful!)

It is Flash PMI day and the European and UK data showed weaker than expected output readings though higher than expected price readings.  We shall see what happens in the US at 9:45. Prior to that we see Initial Claims (exp 320K) and Continuing Claims (2.6M) and we also see Leading Indicators at 10:00 (0.7%).  The BOE left policy on hold, as expected, but did raise their forecast for peak inflation this year above 4%.  However, they are also in the transitory camp, so clearly not overly concerned on the matter.

There are no Fed speakers today although we hear from six of them tomorrow as they continue to try to finetune their message.  The dollar pushed up to its recent highs in the immediate aftermath of the FOMC meeting, but as risk was embraced, it fell back off.  If the market is convinced that the Fed really will taper, and if they actually do, I expect it to support the dollar, at least in the near term.  However, my sense is that slowing economic data will halt any initial progress they make which could well see the dollar decline as long positions are unwound.  For today, though, a modest drift higher from current levels seems reasonable.

Good luck and stay safe
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Avoiding a Crash

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The Chinese have taken a stand
Regarding the firm, Evergrande
They’ve added more cash
Avoiding a crash
And now feel they’ve got things in hand

So, now all eyes turn to the Fed
And tapering timing, instead
The question at hand
Is can they withstand
Slow growth while still moving ahead?

Fear was palpable on Monday as China Evergrande missed an interest payment and concerns grew that a major disruption in Chinese debt markets, with the ability to spread elsewhere, was around the corner.  Yesterday, however, investors collectively decided that the world was not, in fact, going to end, and dip buyers got to work supporting equity markets.  The buyers’ faith has been rewarded as last night, the PBOC added net CNY70 billion to the markets to help tide over financing issues.  In addition, an oddly worded statement was released that Evergrande had addressed the interest payment due tomorrow via private negotiations with bondholders.  (Critically, that doesn’t mean they paid, just that the bondholders aren’t going to sue for repayment, hence avoiding a bankruptcy filing.)  As is always the case in a situation of this nature, nothing has actually changed at Evergrande so they are still bankrupt with a massive amount of debt that they will never repay in full, but no government, whether communist or democratic, ever wants to actually deal with the problem and liquidate.  This is the enduring lesson of Lehman Brothers.

Which means…it’s Fed day!  As we all know, this afternoon at 2:00 the FOMC will release the statement with their latest views and 30 minutes later, Chairman Powell will face the press.  At this time, the topic of most interest to everyone is the timing of the Fed’s reduction in asset purchases, aka tapering.  When we last left this story (prior to the Fed’s quiet period a week and a half ago, pretty much every Fed regional president (Kashkari excluded) and a few minor governors had indicated that tapering was appropriate soon.  On the other hand, the power center, Powell, Brainerd and Williams, had said no such thing, but had admitted that the conversation had begun.

You may recall that at the August FOMC meeting, the Fed indicated that the goal of “substantial further progress” had not yet been met with regard to the maximum employment mandate, although they begrudgingly admitted that the inflation side of the coin had been achieved.  (As an aside, while there has never been an answer to the question of how long an averaging period the Fed would consider with respect to their revamped average inflation target, simple arithmetic shows that if one averages the core PCE data from May 2020 through July 2021, the result is 2.0%.  If the forecast for the August core number, to be released on October 1, is correct at 3.6%, that means that one can head back to March 2020 and still show an average of 2.0%.  And remember, core PCE is not about to collapse back down to 2.0% or lower anytime soon, so this exercise will continue to expand the averaging period.)

Current expectations are that the initial tapering will start in either November or December of this year, and certainly by January 2022.  Clearly, based on the inflation mandate, we are already behind schedule, but the problem the Fed has is that the recent growth data has been far less impressive.  The August NFP data was quite disappointing at 235K, a 500K miss to estimates.  Not only that, while the July data was strong, the June data was also a major miss, which begs the question, was July the aberration or August?  Ask yourself this, will Chairman Powell, who is up for reappointment shortly, tighten policy into an economy where employment growth is slowing?  There is every possibility that tapering is put on hold for a few more months in order to be sure that monetary stimulus withdrawal is not premature.  The fact that a decision like that will only stoke the inflationary fires further will be addressed by an even more strident statement that inflation is transitory, dammit!  My point is, it is not a slam dunk that they announce tapering today.

For a perfect example as to why this is the case, look no further than the ECB, where today we heard another ECB member, the Estonian central bank chief, explain that when the PEPP runs out in March, it would be appropriate to expand the older APP program to pick up the slack.  In other words, they will technically keep their word and let the PEPP expire, but they will not stop QE.  The Fed, ECB and BOJ have all realized that their respective economies are addicted to QE and that withdrawal symptoms will be remarkably painful, so none of them are inclined to go through that process.  Can-kicking remains these central banks’ strongest talent.

OK, to markets ahead of the Fed.  Asia was mixed as the Nikkei (-0.7%) remains under pressure, clearly unimpressed by the BOJ’s ongoing efforts which were reiterated last night after their meeting.  However, Chinese equities (Hang Seng +0.5%, Shanghai +0.4%), not surprisingly, fared better after the liquidity injection.  In Europe, it is all green as further hints that the ECB will let the PEPP lapse in name only has investors confident that monetary support is a permanent situation.  So, the DAX (+0.55%), CAC (+1.1%) and FTSE 100 (+1.2%) are all poppin’.  US futures have also gotten the message and are firmer by about 0.5% this morning.

Bond markets are ever so slightly softer with yields edging up a bit.  Treasuries have been the worst performer although yields are only higher by 1.4bps.  In Europe, Bunds are unchanged while OATs and Gilts have risen 0.5bps each.

Commodity prices, on the other hand, have performed quite well this morning with oil (WTI +1.5%) leading energy higher and base metals (Cu +2.4%, Al +1.6%, Sn +3.6%) all much firmer although gold (0.0%) is not taking part in the fun.  Ags are also firmer this morning as the commodity space is finding buyers everywhere.

The dollar is somewhat softer this morning with NOK (+0.5%) leading the G10 and the rest of the commodity bloc also strong (CAD +0.3%, AUD +0.25%, NZXD +0.25%).  The one true laggard is JPY (-0.3%) which is suffering from the lack of a need for a haven along with general malaise after the BOJ.  In the EMG space, HUF (-0.75%) is the outlier, falling after the central bank raised rates a less than expected 15 basis points after three consecutive 30 basis point hikes, and hinted that despite inflation’s rise, less hikes would be coming in the future.  Away from that, though, there is a mix of gainers and loser with the commodity bloc strong (CLP +0.45%, ZAR +0.4%, RUB +0.4%) while commodity importers are suffering (INR -0.35%, PHP -0.25%, PLN -0.2%).

Ahead of the Fed we see Existing Home Sales (exp 5.89M), but really, look for a quiet market until 2:00 and the FOMC statement.  My view is they will be less hawkish than the market seems to expect, and I think that will be a negative for the dollar, but at this point, all we can do is wait.

Good luck and stay safe
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Severely Distraught

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At Jackson Hole, Powell explained
Inflation goals have been attained
But joblessness still
Is high, so they will
Go slow ere their bond buying’s waned

The market heard slow and they thought
The stock market had to be bought
So, prices keep rising
And it’s not surprising
The hawks are severely distraught

In my absence, clearly the biggest story has been Chairman Powell’s Jackson Hole speech, where he promised at some point that the Fed would begin to taper their bond purchases, but that it was still a bit too early to do so.  He admitted that inflation had achieved their target but was still quite concerned over the employment portion of the Fed’s mandate, hence the ongoing delay in the tapering.  And perhaps he was prescient as after Jackson Hole the NFP number was a massively disappointing miss, just 235K vs 733K median forecast.  And to be clear, that number was well below the lowest forecast of 70 estimates.  The point is, the evolution of the economy is clearly not adhering to the views expressed by many, if not most, FOMC members.  We have begun to see significant reductions in GDP growth forecasts for the second half of the year, with major investment banks all cutting their forecasts and the Atlanta Fed’s GDPNow number falling to a remarkably precise 3.661% for Q3.

With this as a backdrop, it can be no surprise that the dollar has fallen dramatically during the past two weeks.  For instance, in the G10, NOK (+4.2%) and NZD (+4.2%) both led the way higher as commodity prices rebounded, oil especially, and the US interest rates fell.  In fact, the only currency to underperform the dollar since my last note has been the Japanese yen (-0.15%), which is essentially unchanged.  The story is the same in the EMG space with virtually every currency rising led by ZAR (+6.9%) and BRL (+4.1%).  In fact, only Argentina’s peso (-0.65%) managed to decline over the previous two weeks.  The point is, the belief in a stronger dollar, based on the idea of the Fed tapering QE and then eventually raising interest rates, has come a cropper.  The question is, where do we go from here?

With Jay in the mirror, rearview
It’s Christine’s time, now, to come through
On Thursday we’ll hear
If she’s set to steer
The ECB toward Waterloo

As the market walks in after the Labor Day holiday in the US, we are seeing the beginnings of a correction of the past two week’s price action, at least in the FX markets.  Surveying the overnight data shows a minor dichotomy in Germany, where IP (+1.0%) rose a bit more than expected although the ZEW Surveys were both softer than expected.  Meanwhile, Eurozone GDP grew at a slightly better than previously reported 2.2% quarterly rate in Q2, although that does not include the most recent wave of delta variant imposed lockdowns.  In other words, we are no longer observing either uniform strength or weakness in the data, with different parts of each national economy being impacted very differently by Covid-19.  One other thing to note here is the decline in support for the ruling CDU party in Germany where elections will be held in less than two weeks.  It seems that despite 16 years of relative prosperity there, under the leadership of Chancellor Angela Merkel, the populace is looking for a change.  This matters to the FX markets as a change in German economic policy priorities is going to have a major impact on the Eurozone, and by extension the euro.  Of course, at this point, it is too early to tell just what that impact may be.

Of more immediate interest to the market will be Thursday’s ECB meeting, where, while policy settings will not be altered, all eyes and ears will be on Madame Lagarde to understand if the ECB, too, is now beginning to consider a tapering of its QE purchases.  Last week, CPI data from the Eurozone printed at 3.0%, its highest level since September 2008, and well above the ECB’s 2.0% target (albeit not quite as far above as in the US).  This has some of the punditry starting to expect that the ECB, too, is ready to begin to taper QE.  However, the Eurozone growth impulse remains significantly slower than that in the US, and with the area unemployment rate still running at an uncomfortably high 7.6%, (much higher in the PIGS), it remains difficult to see why they would be so keen to begin removing accommodation.  Given the ECB storyline, similar to the Fed, is that inflation is transitory, there is no reason to believe the ECB is getting set to move soon.  Rather, I expect that although the PEPP may well end next March on schedule, it will simply be replaced with either an extension or expansion of the original APP, and likely both.  The reality is that the bulk of the Eurozone would see a collapse in growth without the ongoing support of the ECB.

Turning away from that happy news, a quick survey of markets shows that equities in Asia have continued their recent strong performance (Nikkei +0.9%, Hang Seng +0.7%, Shanghai +1.5%), all of which have rallied sharply in the past two weeks.  Europe, however, has not embraced today’s data, or is nervous about potential ECB action, as markets there are a bit softer (DAX -0.3%, CAC -0.1%, FTSE 100 -0.4%).  US futures markets are essentially unchanged at this hour, continuing their recent very slow grind higher.

Of more interest today is the bond market, where Treasury yields have rallied 4.1 basis points and we are seeing higher yields throughout Europe as well (Bunds +3.9bps, OATs +4.3bps, Gilts +3.2bps).  During my break, yields have managed to rally 10bps (including today) which really tells you that the market is still completely in thrall to the transitory story.  Either that, or the Fed continues to absorb any excess paper around.  However, higher yields seem to be helping the dollar more than other currencies despite similar size movements.

While the movement has not been significant, especially compared to the dollar weakness seen during the past two weeks, we are seeing strength in the dollar vs G10 currencies (AUD -0.5%, CAD -0.4%); EMG currencies (ZAR -0.6%, TRY -0.6%); and commodities (WTI -0.6%, Au -0.7%, Cu -1.1%).  Looking at today’s price action, it appears that US rate movement has been the dominant driver.

On the data front, it is a remarkably quiet week with just a handful of numbers:

Wednesday JOLTs Job Openings 10.0M
Fed’s Beige Book
Thursday Initial Claims 335K
Continuing Claims 2744K
PPI 0.6% (8.2% Y/Y)
-ex food & energy 0.5% (6.6% Y/Y)

Source: Bloomberg

We also hear from six Fed speakers, with NY President Williams the most important voice.  But thus far, the Fed’s messaging has been quite effective as they continue to assuage fixed income investors with the transitory tale and thus interest rates remain near their longer-term lows.  While at some point I expect this narrative to lose its hold on the investment community, it does not appear to be an imminent threat.

While I was out, the market flipped its views from concern over tapering leading to higher interest rates, to when tapering comes, it will be “like watching paint dry”*.  FX investors and traders determined there was no cause for a much stronger dollar, and so the buck gave back previous gains and now sits back in the middle of its trading range.  As such, we need to search for the next potential catalyst to change big picture views.  While my money is on the collapse of the transitory narrative, and ensuing dollar weakness, you can be certain the Fed will fight hard to keep that story going.  In other words, I expect that the trading range will remain intact for the foreseeable future.  Trade accordingly.

Good luck and stay safe
Adf

*June 15, 2017 comments from then Fed Chair Janet Yellen regarding the normalization of Fed policy and the balance sheet, where she described the process as similar to watching paint dry.  It turns out, that policy process was a bit more exciting, especially in Q4 2018 when equity markets fell 20% and Chair Powell was forced to abandon that policy.

Beyond His Control

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Next week look for Jay to extol
His record, when in Jackson Hole,
He offers the view
Equality’s skew
Is mostly beyond his control

Now keep that in mind when you hear
That China has also made clear
Division of wealth
Is better for health
Thus, taxes will soon be severe

In a market with muted price action across all asset classes overnight, two stories this morning seem to encapsulate the current zeitgeist.  First is the fact that, in what can only be described as extraordinarily ironic, when Chairman Powell regales us next week regarding the evils of inequality and all the things the Fed is heroically doing to right those wrongs, he will be doing so from the seat of the richest county in the United States.  That’s right, Teton County has the nation’s highest per capita income from wealth.  Apparently, irony is second only to hypocrisy when considering political commentary.  And make no mistake, the Fed is completely political.

The other story of note, and one that follows directly from the recent Chinese attacks on their own successful tech companies, is that China has now made clear that wealth in the country needs to be more evenly divided.  Given the fact that China is ostensibly a communist country, or at the very least clearly run by a communist party, it also seems a bit ironic that there is so much concern over wealth inequality.  One would have thought the Gini coefficient would have been far lower there.  But I guess, equality is the new freedom, a valuable political slogan if not an actual goal.  The reason this matters, however, is that it implies the recent Chinese efforts to rein in certain highly successful companies, and especially their high profile bosses, has no end in sight.  From an investment point of view, it appears the Chinese equity markets are going to have any gains severely impeded.  Look, too, for new taxes on estates and wealth there, all of which will have a decided impact on international investing.

Remarkably, beyond those stories, it is difficult to come up with anything that is truly meaningful regarding markets today.  The RBNZ did wind up leaving interest rates on hold, backing away from the expected 0.25% increase, as the fact that the nation has reverted to a complete and total lockdown due to the single case of Covid that was detected last week, has given them pause on their views of future growth.  NZD (-0.4%) is the worst G10 currency performer today on the back of that policy activity (or lack thereof), but given the tiny size of the nation, it has not had any other significant impact.

Inflation data was released in both Europe (2.2%, 0.7% core) as expected and the UK (CPI 2.0%, 1.9% core) with both of those readings 0.2% lower than forecast.  So, while inflation is seemingly running quite hot in the US, it appears to have potentially plateaued across the pond.  While we can be certain that the ECB is not going to change its current policy stance anytime soon, there has been a great deal more discussion regarding the BOE.  Hawkish vibes were emanating from Threadneedle Street recently, but if inflation is not going to rise further, then those views may soon be called into question.  However, there is a case to be made that this is a temporary lull in the CPI data and that looking ahead, readings will push up toward 4.0%, at least, as previously announced price increases start to be felt throughout the economy.  Thus far, the FX impact from this data has been essentially nil, but equity markets in Europe and the UK are all under modest pressure this morning (DAX -0.1%, CAC -0.35%, FTSE 100 -0.35%).

As to markets elsewhere, Asia saw some rebounding from its recent travails, with the Nikkei (+0.6%), Hang Seng (+0.5%) and Shanghai (+1.1%) all having their first positive day in five sessions.  We also saw a reversal in some currency activity there as KRW (+0.7%) was the best performer after comments from the central bank describing the recent weakness as an overshoot and that the Finance Ministry is monitoring things closely.

A look at bonds shows that Treasury yields have backed up 1.2bps this morning after having fallen by about 10bps in the prior three sessions.  European sovereigns, though, continue to find support as the ECB continues to hoover up virtually all the paper issued.  As such, Bunds, OATs and Gilts have all seen yields slip about 1 basis point.

Finally, the dollar can only be described as mixed this morning, with movement in the G10, aside from kiwi’s decline, pretty minimal, <0.2%, although with an equal number slightly lower and higher.  EMG currencies show the same pattern, with most movement quite limited and only one notable laggard (TRY -0.7%) which also seems to be a trading response to its recent strong rally (+3.3% in the past 5 sessions).  In other words, there is very little to discuss at all today.

On the data front, after yesterday’s disappointing Retail Sales number (-1.1%, exp -0.3%), this morning brings Housing Starts (exp 1600K) and Building Permits (1610K) and then this afternoon, we get the potentially most interesting news, the FOMC Minutes.

On the Fedspeak front, thus far, the only three FOMC members who have not advocated for tapering are Powell, Williams and Brainerd, as even Kashkari, yesterday, said he could see the case for tapering by early next year.  But Powell gave no indication he is ready to go down that road, so barring an insurrection at the Fed, one has to believe any tighter policy is still some ways away.  Today, we hear from Bullard, but he has already made his tapering bona fides known.

And that is really all there is today.  It truly has all the hallmarks of a summer doldrums day, with limited price action and limited news, unless something shocking comes from the Minutes.  My money is on nothing, and a range trading day ahead of us.

Good luck and stay safe
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The Chorus has Grown

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T’was only a few months ago
When Kaplan from Dallas said, whoa
The time has arrived
Where growth has revived
And bond buying needs to go slow

Since then, though, the chorus has grown
As seven more members have shown
That they all agree
It’s time for QE
To end and leave markets alone

We continue to hear from more FOMC members that it is time to taper the Fed’s purchases of both Treasuries and mortgage-backed securities.  Last Wednesday, of course, the big news was that Vice-Chairman Richard Clarida came out so hawkishly in his comments, not only calling for tapering bond purchases but also raising rates sooner than the median forecast had anticipated.  Yesterday, three Fed speakers were all on the same page, with Boston’s Eric Rosengren the newest name added to the tapering crew (Bostic and Barkin were already known taperers.)  That takes the count to at least eight (Clarida, Bostic, Barkin, Rosengren, Bullard, Daly, Waller and Kaplan) with the two most hawkish FOMC members, Loretta Mester and Esther George, on the docket for today and tomorrow respectively.  It is not unreasonable, based on their respective histories, to expect both of them to call for tapering as well.  That would make ten of the seventeen members as confirmed supporters of the process.

The question is, will that be enough?  The Fed’s power core for the last several years has been concentrated in four members, Powell, Clarida, Williams and Brainerd.  Of this group, only Clarida has publicly proclaimed it has come time to taper.  And potentially, his importance is diminishing as his term ends within months and he is seen as highly unlikely to be reappointed.  Rather, the talk of the town is that Chairman Powell is also losing fans in the Senate with respect to his reappointment, and that Governor Lael Brainerd is the new leading candidate to become Fed Chair.  As it happens, neither of those two have come out for tapering soon, and in fact, last week, Ms Brainerd was adamant in her belief it was far too early to do so.  The point is, the Fed has never been a democratic institution although it is an extremely political one.  Having a majority of members agree on a view only matters if it is a majority of the right members.  By my count, that is not yet the case.  Perhaps come Jackson Hole in two plus weeks, we will hear the Chairman agree, but tapering is not yet a done deal.

Traders, however, see the world very differently than pundits, and certainly very differently than the Fed itself.  And what has become very clear in the past several days is that traders are increasingly placing bets that tapering is coming…and coming soon.  The combination of all those Fed speakers talking about tapering, the very strong NFP data as well as yesterday’s JOLTs blowout (>10 million jobs are open), and the constant stream of stories about rising wages (just this morning a BBG story on JPM raising salaries to compete to hold onto staff is simply the latest) have been sufficient to logically conclude that it is time for the Fed to begin removing accommodation.  Hence, Treasury yields have backed up nearly 20 basis points from the lows seen last Wednesday morning, the dollar has risen against all its counterparts and the price of oil has fallen by more than 4%.

Looking ahead, the question becomes, is this likely to continue?  Or have we reached a peak?  It is not unreasonable to assume that both George and Mester will call for tapering this week.  It is also not unreasonable to assume that the CPI data tomorrow is going to point to a still rising price environment, whether it ticks slightly higher or lower than last month’s 5.4% headline print.  Any number in that vicinity remains far above the Fed’s average target of 2.0%.  The point is that there is nothing obvious on the horizon that should cause the tapering hawks to back off, at least not until the end of the month.  As such, hedgers need to be prepared for a continuation of the recent price action.

Meanwhile, a look at today’s markets shows that these recent trends remain intact.  While Asian equity markets continue to follow their own drummer (Nikkei +0.25%, Hang Seng +1.25%, Shanghai +1.0%), European bourses continue to struggle (DAX +0.2%, CAC +0.1%, FTSE 100 -0.1%) as do US futures with all three major indices either side of unchanged.  Asia seems to be benefitting from the view that the PBOC is preparing to ease policy further as China responds to the increased lockdowns due to the delta variant of Covid that has been spreading quite rapidly there, in addition to the fact that the Chinese authorities have not named a new target in its seemingly random crackdown of successful companies.

Bond markets, while edging higher today, have been generally losing ground.  So, while Treasury yields are lower by 0.5bps this morning, they are at 1.32%, well off the lows seen last week.  European sovereigns are generally a touch firmer as well, with yields down by between 0.5bps and 1 bp but they, too, have seen yields climb back a bit lately.

Commodity prices, which have been under severe pressure, are rebounding slightly this morning, although this has the appearance of a trading bounce more than a sea change in view.  Commodity prices are likely to be amongst the hardest hit if the Fed really does start to tighten policy.  But this morning, oil (+2.0%) has rebounded nicely although gold (0.0%) has been unable to bounce from yesterday’s massive sell-off.  Copper (+0.65%) is leading base metals modestly higher and ags have bumped up a bit as well.

As to the dollar, right now it is arguably slightly stronger overall, but only just as there are a mix of gainers and losers vs. the greenback.  In the G10 space, the euro (-0.1%) is continuing toward its test of key support at 1.1704, albeit quite slowly.  The entire space, though, is +/- 0.2% or less, which is indicative of position adjustments rather than news driven activity.

EMG currencies are also mixed with KRW (-0.5%) the weakest of the bunch on the back of concerns over the impact of the delta variant as well as equity market outflows by international investors.  PLN (-0.4%) is the next weakest as central bank comments seemed to delay the timing of a mooted rate hike.  On the flip side, TRY (+0.6%) is the leader as Unemployment data there was released at a much lower than expected 10.6%.

Data today showed that Small Business Optimism has suffered lately with the NFIB Index falling to 99.7.  At 8:30 we see Nonfarm Productivity (exp 3.2%) and Unit Labor Costs (+1.0%), although it is unlikely either will have a big market impact.  Arguably, market participants are all waiting for tomorrow’s CPI data for the next big piece of news.

At this point, the dollar’s modest uptrend remains in place and I see no reason to believe that will change.  At least not until we hear differently from Powell or the data turns much worse.

Good luck and stay safe
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