Tag Archives: #Powell

Progress, Substantial

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To everyone who thought the Fed
Was ready to taper, Jay said
‘Til progress, substantial,
Is made, no financial
Adjustments are reckoned ahead

If, prior to yesterday, you were worried that the Fed was getting prepared to taper its asset purchases, stop worrying.  It doesn’t matter what Dallas Fed President Kaplan, or even SF Fed President Daly says about the timing of tapering.  The only ones who matter are Powell, Clarida, Williams and Brainerd, and as the Chairman made clear once again yesterday, they ain’t going to taper anytime soon.

In testimony to the House Financial Services Committee Chairman Jay sent a clear message; nothing is changing until the Fed (read the above-mentioned four) sees “substantial further progress” on their twin goals of maximum employment and an average inflation rate of 2.0%.  Obviously, they have moved a lot closer on the inflation front, with many pundits (present company included) saying that they have clearly exceeded their goal and need to address that issue.  But for as much vitriol as is reserved for our previous president, both the Fed and Congress are clearly all-in on the idea that the 3.5% Unemployment Rate achieved during his term just before the pandemic emerged, which was the lowest in 50 years, is actually the appropriate level of NAIRU.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment and is the economic acronym for the unemployment rate deemed to be the lowest possible without causing increased wage pressures leading to rising inflation.  For the longest time, this rate was thought to be somewhere in the 4.5%-5.5% area, but in the decade following the GFC, as policymakers pushed to run the economy as hot as possible, the lack of measured consumerinflation, despite record low unemployment, forced economists to rethink their models.  Arguably, it is this change in view that has led to the fascination with MMT and the willingness of the current Fed to continue QE despite the evident froth in the asset markets.  Of course, now those asset markets are not just paper ones like stocks and bonds, but also housing and commodities.

But that is the situation today, despite what appears to be very clear evidence that inflationary pressures are not just high, but longer lasting as well, the Fed has their story and they are sticking to it.  They made this clear to everyone last year with the new policy framework that specifically explains they will remain behind the curve on inflation because they will not adjust policy until they see real data, not surveys, that demonstrate growth is overheating.  Yet, given the Fed’s history, where they have often tightened policy in anticipation of higher inflation and thereby reduced growth, or even caused recessions, the market has learned to expect that type of response.  While I personally believe prudent policy would be to tighten at this time, I take Mr Powell at his word, they are not going to change anytime soon.  I assure you that of the dots in the last dot plot, Jay Powell’s was not one of the ones expecting interest rates to be 0.50% by the end of 2023.

One of the things that makes this so interesting is the difference of this policy with that of an increasing number of other central banks, where recognition of rising inflation is forcing them to rethink their commitment to ZIRP.  Earlier this week, the RBNZ abruptly ended QE and explained rates may rise before the summer is over.  Yesterday, the Bank of Canada reduced its QE purchases by another C$1 billion/week, furthering the progress they started in June, and Governor Macklem made clear that if inflation did persist, they would react appropriately.  Last night it was the Bank of Korea’s turn to explain that economic activity was picking up quickly and inflationary pressures alongside that which would make them consider raising the base rate at their next meeting.  Finally, all eyes are turning toward the BOE as this morning’s employment report showed that the recovery is still picking up pace and that wage growth, at a 7.3% Q/Q rise, is really starting to take off.  Market talk is now focused on whether the Old Lady will be the next to start to tighten.

In truth, the only three central banks that have made clear they are not ready to do so are the big 3, the Fed, ECB and BOJ.  The BOJ meets tonight with no changes to policy expected as they seem to be focused on what they can do to address climate change (my sense is they can have the same success on climate change as they have had on raising inflation, i.e. none).  Next week the ECB will unveil their new framework which seems likely to include the successor to the PEPP as well as their already telegraphed new symmetrical inflation target of 2.0%.  And then the Fed meets the following week, at which point they will work very hard to play down inflation in the statement but will not alter policy regardless.

As you consider the policy changes afoot, as well as the trajectory of inflation, and combine that with your finance 101 models that show inflation undermines the value of a currency in the FX markets, it would lead you to believe that the dollar has real downside opportunity vs. many currencies, just not the euro or the yen.  But markets are fickle, so don’t put all your eggs in that basket.

Turning to today’s activities, while Chinese equity markets performed well (Hang Seng +0.75%, Shanghai +1.0%) after Chinese GDP data was released at 7.9% for Q2, just a tick lower than forecast, and the rest of the data, Retail Sales and Fixed Asset Investment all beat expectations, the rest of the world has been much less exuberant.  For instance, the Nikkei (-1.15%) stumbled along with Australian and New Zealand indices, although the rest of SE Asia actually followed China higher.  Europe has been under pressure from the start this morning led by the DAX (-0.9
%) although the CAC (-0.75%) and FTSE 100 (-0.7%) are nothing to write home about.  US futures are also under pressure (Dow -0.5%, SPX -0.3%) although the NASDAQ continues to power ahead (+0.2%).

In this broadly risk-off session, it is no surprise that bond markets are rallying.  Treasuries, after seeing yields decline 7bps after Powell’s testimony, are down another 2bps this morning.  Similarly, we are seeing strength in Bunds (-1.4bps) and OATs (-1.1bps) although Gilts (+1.4bps) seem to be concerned about potential BOE policy changes.

On the commodity front, oil fell sharply after the Powell testimony and has continued its downward move, falling 1.8% this morning.  Gold, which had been higher earlier in the session is now down 0.15%, although copper (+0.6%) remains in positive territory.  At this point, risk has come under pressure across markets although there is no obvious catalyst.

It should not be surprising that as risk is jettisoned, the dollar is rebounding.  From what had been a mixed session earlier in the day, the dollar is now firmer against 9 of the G10 with NOK (-0.5%) the laggard although the entire commodity bloc is suffering.  The only gainer is the pound (+0.1%) which seems to be on the back of the idea the BOE may begin to tighten sooner than previously expected.

EMG currencies that are currently trading are all falling, led by ZAR (-0.7%), PLN (-0.5%) and HUF (-0.5%).  The rand is very obviously suffering alongside the commodity story, while HUF and PLN are under pressure as a story about both nations losing access to some EU funds because of their stance on issues of judicial and immigration policies is seen as a negative for their fiscal balances.  Overnight we did see strength in KRW (+0.6%) and TWD (+0.4%) with the former benefitting from the BOK’s comments on tightening policy while the latter saw substantial equity market inflows driving the currency higher.

Data today includes Initial (exp 350K) and Continuing (3.3M) Claims as well as Empire Mfg (18.0), Philly Fed (28.0), IP (0.6%) and Capacity Utilization (75.6%).  Yesterday’s PPI was also much higher than forecast, but that can be no surprise given the CPI data on Tuesday.  In addition, Chairman Powell testifies before the Senate Banking Panel today, with the same prepared testimony but a whole new set of questions.  (I did reach out to my Senator, Menendez, to ask why Chairman Powell thinks forcing prices higher is helping his constituents, but I’m guessing it won’t make the cut!)

And that’s the day.  Right now, with risk under pressure, the dollar has a firm tone.  But the background of numerous other central banks starting to tighten as they recognize rising inflation and the Fed ignoring it all does not bode well for the dollar in the medium term.

Good luck and stay safe
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QE’s Paradigm

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Said Daly, this “pop” was expected
But basically, we have projected
This only will last
A few months, then pass
Thus, higher rates we have rejected

Said Bullard, it may well be time
To alter QE’s paradigm
By end of this year
It ought to be clear
That tapering is not a crime

And finally, today Chairman Jay
Is like to have something to say
‘Bout why rising prices
Do not mean a crisis
Is brewing and soon on the way

The one thing about writing this note on a daily basis is that you really get to see the topic du jour.  In fact, arguably, that is the purpose of the note.  When Brexit happened in 2016, it was likely the topic of 75% of my output.  Covid dominated last year for at least 3 months, where virtually every discussion referenced its impact.  And now we are onto the next topic which just will not go away.  In fact, if anything it is growing in importance.  Of course, I mean inflation.

By now you are all aware that June’s CPI reading was 5.4% on a headline basis and 4.5% ex food & energy with both readings substantially higher than forecasted by the punditry.  The monthly gains in both series was 0.9%.  Now my rudimentary math skills tell me that if I annualized 0.9%, I would wind up with an inflation rate of 11.4%.  I don’t know about you, but to me that number represents some real problems.  Of course, despite the reality on the ground, the FOMC cannot possibly admit that their policies are driving the economy into a ditch, so they continue to spin a tale of transitory price gains that are entirely due to short-term impacts on supply chains and gains relative to last year’s extremely depressed prices on the back of Covid inspired lockdowns.  And while, last year’s Covid-inspired lockdowns did have a major negative impact on prices, the idea that supply chain disruptions are short-term are more an article of faith, based on economic textbook theories, than a description of reality.

In addition, the other key leg of the Fed thinking is that inflation expectations remain ‘well-anchored.’  Alas, I fear that anchor may have come loose and is starting to drift with the current of inflation prints to a higher level.  This was made evident in the NY Fed’s survey of inflation expectations released on Monday showing that people expected inflation to be 4.8% in one year’s time.  The Fed also likes to point to inflation breakevens in the market (the difference between nominal Treasury yields and their TIPS counterparts) and how those have fallen.  It is true, they are lower than we saw at the peak in mid-May (2.56%), but in the past week, they have risen 15 basis points, to 2.37%, and appear to be headed yet higher.

And this is not merely a US phenomenon.  For instance, just this morning CPI in the UK printed at 2.5%, rising a more than expected 0.4% from last month, and we have seen this occur around the world, as both developed countries (e.g. Germany, Canada and Spain) and developing nations (e.g. Brazil, India and Mexico) have all been suffering from prices rising faster than expected.  Now, there are some nations that are addressing the issue with monetary policy by tightening (Brazil, Mexico and Hungary being the latest).  But there are others that continue to whistle pass this particular graveyard and remain adamant there is no problem (US, UK Europe).

Chairman Powell testifies to the House today (my apologies for mistakenly explaining it would be yesterday) and it has the opportunity to be quite interesting.  While there will not doubt be a certain amount of fawning by some members of the committee, at least a few members have a more conservative bent and may ask uncomfortable questions.  I keep waiting to hear someone ask, ‘Chairman Powell, can you please explain why you believe my constituents are better off when paying higher prices for the items they regularly purchase?  After all, isn’t that what Fed policy to raise inflation is all about?’  Alas, I don’t expect anyone to be so bold.

In the end, based on a lot of history, Powell will never directly answer a question on inflation other than to say that it is transitory and that the current monetary policy settings are appropriate.  If pressed further, he will explain the Fed “has the tools” necessary to combat inflation, but it is not yet time to use them.  While it is possible he has a Freudian slip and reveals his true thinking, he has become pretty polished in these affairs and the audience is generally not sharp enough to throw him off his game.

To sum it all up, inflation is screaming higher rising rapidly and the Fed remains sanguine and unlikely to adjust their policies in the near future.  While Daly and Bullard, two doves who spoke yesterday, indicated that tapering QE would likely be appropriate at some point, there was no evident hurry in their views.  Consumer prices are going higher from here, count on it.

There are some nations, however, that are willing to address inflation.  We already see several raising rates and last night, the RBNZ explained they would be ending QE by next week.  This was quite a surprise to the market and so we saw 10-year yields in New Zealand jump 7.3 basis points while NZD (+1.0%) has been the best performing currency in the world as expectations are now that the RBNZ will begin raising rates by the end of the summer.  But that the Fed had this type of common sense.

Ok, enough ranting on inflation.  Let’s see how this string of higher CPI prints has been impacting markets.  On the equity front, it has not been a happy period.  Yesterday saw US markets sell off, albeit only in the 0.3%-0.4% range. But Asia was far worse (Nikkei -0.4%, Hang Seng -0.6%, Shanghai -1.1%) and Europe is entirely in the red as well (DAX -0.2%, CAC -0.25%, FTSE 100 -0.6%) with the UK leading the way lower after that CPI print.  US futures, though, have had enough of the selling and are very modestly higher at this time.  Perhaps they think Powell will save the day.

Did I mention the 30-year bond auction was a disaster yesterday?  Apparently, with inflation running at 5.4%, locking in a yield of 1.975% for 30-years does not seem very attractive to investors.  Hence, the abrupt move to 2.05% after the auction announcement, with a long tail.  While yields are a touch lower this morning (10-year -2.0bps, 30-year -2.6bps) that has more to do with the jettisoning of equity risk than a desire to earn large negative real returns.  In Europe, it should be no surprise that Gilt yields are higher, +3.6bps, after the CPI print, but the continent is largely unchanged on the day.

Oil prices have backed off a bit, falling 0.8% this morning, but WTI remains just below $75/bbl and the trend is still firmly higher.  Gold is perking up a bit as declining real yields always helps the barbarous relic and is higher by 0.5% with silver +0.8%.  Base metals, however, are in a different place with Cu (-0.75%) and Al (-0.5%) leading the way lower.  Foodstuffs are generally higher, which of course explains the ongoing unrest in a growing list of developing countries.

As to the dollar, it is broadly weaker vs. its G10 counterparts, with kiwi far and away the leader while the rest of the bloc is firmer by between 0.1%-0.3%.  That feels much more like a dollar consolidation than any other stories beyond NZD and GBP’s inflation print.  In the EMG bloc, the picture is more mixed with PHP (-0.6%) the laggard as capital continues to flow out of the country amid foreign reserve levels sinking.  The rest of the APAC bloc was also soft, but much of that came yesterday in NY’s session with little adjustment from those levels.  On the plus side, MXN (+0.3%) is the leading gainer and the CE4 are all higher by about 0.2%, but this remains dollar consolidation after a run higher.

Somewhat anticlimactically we are going to see PPI this morning (exp 6.7%, 5.1% ex food & energy), but given the CPI has already been released, it will have to be really special to have an impact.  The Fed’s Beige Book is released at 2:00 but the highlight will be the Chairman at noon.  Frankly, until then, I don’t expect very much at all, but the market will be hanging on every word he speaks.

Broadly, the dollar remains well bid.  Yesterday saw the market anticipate the Fed being forced to tighten sooner than previously expected.  Powell has the opportunity to squelch that view or encourage it.  While I believe he will lean toward the former, that is the key market risk right now.  If I were a hedger, I would think about getting things done this morning, not this afternoon.

Good luck and stay safe
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Like Tides in the Sea

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Though Jay and the FOMC
Refuse to accept it can be
Most prices worldwide
Can be certified
As rising like tides in the sea

Back in 2011, wedged between the GFC and the European debt crisis, the world witnessed the Arab Spring.  This was a series of populist protests throughout the Middle East and North Africa that were triggered by a confluence of events including a desire for more freedom and democracy by a group of populations that had been oppressed by kleptocratic and authoritarian rulers.  But one of the key issues that was apparent in each of the nations involved was the fact that inflation, specifically food prices, were rising rapidly and the impoverished citizenry of many of these nations could no longer afford to feed themselves or their families.  Ultimately, while there was much angst at the time about changes in ruling regimes and much hope that the siren song of freedom would be heard in heretofore brutal dictatorships, very little changed except the name of the authoritarian and kleptocratic leader.

From our perspective in the markets, the importance of this lesson is the potential impact that sharply rising food prices can have on both financial markets and political outcomes.  This appears topical given the rioting that has begun in two very different countries, Cuba and South Africa.  In Cuba, the list of complaints could have been written in Tunisia in 2011, as the people there are growing tired of the conditions under which they are forced to live by Raul Castro and Miguel Diaz-Canel, the heirs to the Fidel Castro regime.  The economy is in tatters and food shortages are rampant with little hope of change as long as the government remains in place.  South Africa, meanwhile, has had a different catalyst, the imprisonment of former president Jacob Zuma, but the conditions on the ground, where inflation is rising sharply, and growth has been lagging are not dissimilar to what precedes this behavior anywhere.

While two countries don’t yet make a trend, it will be important to pay close attention to other EMG nations who are experiencing the same types of pressures.  Remember, just because the Fed, ECB and BOJ are not ready to raise rates as they studiously ignore rising inflation, the same has not been true in a number of emerging markets like Brazil, Hungary and Mexico, whose central banks are responding to the obvious rise in price pressures by raising their policy rates.  Inflation is insidious as it impacts all that we do and eventually weighs on how we approach our everyday tasks.  Yesterday, the NY Fed released its monthly survey of inflation expectations and it jumped to 4.8% in the one-year category, the highest level since the survey began.  While inflation is frequently described as a monetary phenomenon, it is also a psychological one.  When you expect prices to rise, you tend to err on the side of buying things sooner rather than waiting.  And that behavior drives prices as well.  As the evidence of more persistent price rises continues to increase, there will come a denouement between the Fed and reality.  It is at that point that we could see some cracks in the current narrative of “stonks to the moon!”  Remember, being hedged ahead of a significant policy change makes a great deal of sense, so don’t wait until it’s too late.

Meanwhile, the market story today is one of a modest continuation of recent trends with no substantial outliers.  It appears investors are waiting for more information from the ECB on their new policy framework next week, as well as this morning’s testimony by Chairman Powell at the House of Representatives.

After yesterday’s late day rally in the US, Asian equity markets were all in the green (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.3%) with the big data release Chinese trade numbers showing their exports climbed more than forecasts, clearly a positive sign for both China and global growth.  Europe has been a bit more mixed with extremely modest movement either side of unchanged and no story or data to discuss while US futures show the NASDAQ (+0.35%) continuing to power ahead although the other two main indices have done nothing.

Bond markets are rallying ever so slightly with Treasury yields lower by 0.8bps and similar declines throughout Europe (Bunds -0.7bps, OATs -1.5bps, Gilts -1.1bps).  As to commodity markets, they are mixed this morning with oil (+0.1%) marginally higher along with gold (+0.1%), while copper (-1.1%) is lagging.  The long-term trend for most commodities remains higher, although we continue to see short-term consolidation.

In the FX market, the most notable mover has been ZAR (-1.35%) which is continuing to suffer on the back of the rioting in the country and the likely negative impact it will have on the economy.  Other laggards in the EMG bloc are HUF (-0.5%), PLN (-0.5%) and MXN (-0.4%), as traders respond to differing issues in each nation.  Poland’s central bank has hinted that they will extend QE at a moment’s notice in the event the delta variant of Covid becomes a bigger problem, while Hungary seems to be suffering for its unwillingness to agree to a global corporate tax rate.  As to Mexico, the nominee for central bank governor, Arturo Herrera, explained he would not expect Banxico to begin a tightening cycle, despite the fact they have already raised rates once.  On the plus side, RUB (+0.4%) leads the way as traders anticipate future gains in the oil price.

In the G10 space, while the dollar is broadly firmer, the biggest movers have been GBP (-0.3%) and NOK (-0.3%), hardly the stuff of excitement.  Arguably, what we continue to see is short USD covering as positions remain overly short, albeit somewhat reduced from where things stood at the beginning of the quarter.

This morning, in addition to the Powell testimony, we see CPI (exp 4.9%, 4.0% ex food & energy), which ought to be quite interesting.  If the forecast is correct, it would be the first time that the Y/Y data fell since last November.  As well, if this is the case, Chair Powell will almost certainly point to the outcome in his comments today as a strong sign the Fed’s transitory inflation story playing out exactly as they anticipate.  Of course, a higher than expected print will require a bit more tap dancing on Powell’s part.

The FX market continues to consolidate with no large trend driving things currently.  Now that the relationship between the dollar and Treasuries has seemingly broken, traders are looking for new short-term drivers and waiting for clarification as to how the next trend will derive.  In other words, we are likely to continue to see somewhat choppy and directionless trading for the next several weeks unless we get something of real note.  So, paraphrasing Samuel Beckett, it appears we are ‘Waiting for Powell.”

Good luck and stay safe
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A Popular View

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It seems that a popular view

Explains that the Fed will pursue

A slowdown in buying

More bonds as they’re trying 

To bid, fondly, QE adieu






At least that’s what pundits all thought





The Powell press conference had wrought





They talked about talking





But are not yet walking





The path to where policy’s taut





It appears virtually unanimous that the punditry believes the FOMC is going to be tightening policy (i.e. tapering) in the ‘near future’.  Of course, the near future is just as imprecise as transitory, the Fed’s favorite word.  Neither of these words convey any specificity, which makes them very powerful in the narrative game, but perhaps not so powerful when directly addressed.  My take on transitory is as follows: initial expectations were it meant 2 or 3 quarters of price pressures which would then dissipate as supply chains were quickly reconnected.  However, it has since morphed into as much as 2 to 3 years given the reality that certain shortages, notably semiconductors, may take much longer to abate as the timeline to build out new capacity is typically 2 to 3 years.  I guess it all depends on your frame of reference as to what transitory means.  For instance, to a tortoise, 2 to 3 year is clearly but a blip in their lives, but to a fruit fly, it is beyond an eternity.  Sadly, the market’s attention span is much closer to that of a fruit fly’s than a tortoise’s so 2 to 3 years feels a lot more permanent than not.  This is especially so since there is no way to know if other, more persistent inflationary issues may arise in the interim.





As to the ‘near future’, that seems to mean somewhere between the middle of 2022 and the middle of 2024.  Here too, the timeline is extremely flexible to accommodate whatever story is trying to be sold told.  When puffing up the strength of the economic recovery, expectations tend toward the earliest estimates.  In fact, we continue to hear from several FOMC members that tapering will soon be appropriate.  However, if we look at who is making those comments (Bullard, Kaplan, Rosengren and Bostic), we find that only Raphael Bostic from Atlanta currently has a vote.  At the same time, those who are least interested in the idea of tapering include the leadership (Powell, Clarida and Williams) as well as the other governors (Bowman, Brainard, Quarles and Waller), and they have permanent votes.  In other words, my take on the FOMC meeting is it was far less hawkish than much of the punditry has described.  And there is one group, which really matters, that is apparently in agreement with me; the bond market!  Treasury prices after an initial sell-off (yield rally) have reversed that move and are essentially unchanged with a flatter yield curve.  It strikes me that if the Fed were to taper, yields would start to rise in the long end as the removal of that support would have a significant negative price impact.





So, if I were to piece together the narrative now it appears to be the following: inflation is still transitory if it remains well above target for the next 2 years and the bond market is convinced that is the case (ostensibly a survey showed that 70% of fixed income managers believe the transitory story).  Meanwhile, despite the transitory nature of inflation, the Fed is going to tighten its monetary policy sometime next year and potentially even raise the Fed Funds rate in 2023.  Personally, that seems somewhat contradictory to me, but apparently cognitive dissonance is a prerequisite to becoming an FOMC member these days.





At any rate, given the lack of actual policy changes by the Fed, all we have is the narrative.  This week we will have four more Fed speakers to continue to reiterate that narrative, that despite the transitory nature of inflation we are going to tighten policy in the future.  Of course, that begs the question, Why?  Why tighten policy if there is no inflation?  Cognitive dissonance indeed.





In the meantime, as markets continue to try to figure out what exactly is happening, we wind up with paralysis by analysis and relatively limited movement.  For instance, equity markets in Asia were all essentially unchanged overnight, with not one of them moving even 0.1%.  Europe, on the other hand is having a tougher go this morning with red across the screen (DAX -0.1%, CAC -0.5% and FTSE 100 -0.5%) with a real outlier as Spain’s IBEX (-1.5%).  There has been no data released but there is growing concern that the Delta variant of Covid is going to cause another lockdown in Europe before they finished reopening the first time.  This is based on the fact that we have seen lockdowns reimposed in Australia, Japan, Singapore and Israel after all those nations seemed to be moving forward.  As to US futures, they are either side of unchanged at this hour awaiting some clarity on anything.





It can be no surprise that bond markets are rallying slightly with Treasuries (-1.7bps) leading the way but small yield declines in Europe as well (Bunds -0.8bps, OATs -1.1bps, Gilts -1.8bps).  With equity markets under pressure, this is a natural reaction.  And if you consider the reasoning, worries over another Covid wave, then slower growth would be expected.





Funnily enough, Covid is having a currency impact today as well.  In the G10, the new Health Minister, Sajid Javid, has said he wants to see the country return to normal “as soon and as quickly as possible.”  Despite the equity market concerns, the FX market saw that as bullish and the pound (+0.2%) is the leading gainer in the G10 this morning.  But as the morning has progressed and risk sentiment has become less positive, the dollar is starting to asset itself against most of the rest of the bloc with NZD (-0.35%) and NOK (-0.3%) the laggards.  Both of these are under pressure from declining commodity prices as oil (-0.1%) is sagging a bit.





In the EMG bloc, ZAR (-0.8%) is in the worst condition this morning as the Delta Covid variant has increased its spread and the government is behind the curve in treating the issue.  But we saw weakness overnight in THB (-0.6%), and this morning the CE4 are all under the gun as well.  And the story seems to be the same everywhere, tighter Covid restrictions are undermining currencies while positivity is helping them.





It is a big data week as it culminates in the payroll report on Friday:





TuesdayCase Shiller Home Prices14.85%
 Consumer Confidence119.0
WednesdayADP Employment550K
 Chicago PMI70.0
ThursdayInitial Claims389K
 Continuing Claims3335K
 ISM Manufacturing61.0
 ISM Prices Paid86.0
FridayNonfarm Payrolls700K
 Private Payrolls600K
 Manufacturing Payrolls25K
 Unemployment Rate5.7%
 Average Hourly Earnings0.3% (3.6% y/Y)
 Average Weekly Hours34.9
 Participation Rate61.7%
 Trade Balance-$71.3B
 Factory Orders1.5%





Source: Bloomberg





Obviously, all eyes will be on the payroll data as the Fed has made it clear that employment is their key focus for now.  There was an interesting story in the WSJ this morning highlighting how the states that have ended the Federal Unemployment Insurance bonus have seen an immediate pickup in employment with jobs suddenly being filled.  That bodes well for the future, but it also means we will have this issue for another quarter if all the states that maintain the bonuses continue to do so.





As mentioned above, several Fed speakers will be out selling the narrative that inflation is transitory, but tapering may be coming anyway.  (A cynic might think they are not being totally honest in what they are saying, but only a cynic.)





A quick top down look at the FX market leads me to believe that individual national stories are currently the real drivers.  So those nations that are raising interest rates to fight inflation (Mexico, Brazil, Hungary, Russia) are likely to see their currencies hold up.  Those nations that are having serious relapses in Covid infections (South Africa, much of Europe) are likely to see their currencies come under pressure.  Where the two meet (South Korea), it seems to depend on the day as to which way the currency goes.  With that in mind, though, I would bet the monetary policy story will have more permanence will be the ultimate driver.





Today, the dollar seems to be in fine fettle as risk is on the back foot given the increasing Covid concerns over the Delta variant.  But do not be surprised if tomorrow is different.





Good luck and stay safe





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			Nirvana Awaits
		


				

			Posted on  by 		

			


		

		

While Powell and friends fail to see





Inflation rise dangerously





Down south of the border





They fear its disorder





And burden on society










So, Mexico shocked and raised rates





While Fedspeak back here in the States





Continues the story





It’s all transitory





And claiming Nirvana awaits





Mexico became the latest emerging market nation to raise interest rates when they surprised the analyst’s community as well as markets by raising their base rate by 0.25% yesterday afternoon to 4.25%.  The FX market response was swift and certain with the peso gaining more than 1.0% in the first minutes after the announcement although that has since slightly abated.  “Although the shocks that have affected inflation are expected to be of a transitory nature, given their variety, magnitude and the extended time frame in which they have been affecting inflation, they may pose a risk to the price formation process,” the Banxico board explained in their accompanying statement.  In other words, although they are paying lip service to the transitory concept, when CPI rose to a higher than expected 6.02% yesterday, it was apparently a step too far.  Expectations for further rate hikes have already been built into the markets while views on the peso are improving as well.





The juxtaposition yesterday of Mexico with the UK, where the BOE left policy rates on hold at 0.10% and maintained the QE program intact despite raising its inflation forecast to 3.0% for next year, is quite interesting.  Historically, it was the emerging market central banks who would seek growth at any cost and allow inflation to run hot while trying to support the economy and the developed market central banks who managed a more disciplined monetary policy, working to prevent inflation from rising while allowing their economy’s to grow without explicit monetary policy support.  But it seems that another symptom of the Covid-19 pandemic is that it has reversed the ‘polarity’ of central bank thinking.  Mexico is the 4th major EMG nation (Russia, Brazil and Poland are the others) to have raised rates and are anticipated to continue doing so to combat rising prices.  Meanwhile, when the Bank of Canada reduced the amount of its QE purchases, it was not only the first G10 bank to actually remove some amount of monetary largess, it was seen as extraordinary.  





In the States, yesterday we heard from six more Fed speakers and it has become evident that there are two distinct views on the FOMC as to the proper course of action, although to a (wo)man, every speaker exclaimed that inflation was transitory.  Several regional Fed presidents (Bullard, Bostic and Kaplan) are clearly in the camp of tapering QE and potentially raising rates by the end of next year, but the Fed leadership (Powell, Clarida, Williams) are adamantly opposed to the idea of tightening policy anytime soon.  And the thing is, the hawks don’t even have a vote this year, although they do get to participate in the conversation.  The upshot is that it seems highly unlikely that the Fed is going to tighten policy anytime at all this year regardless of inflation readings going forward.  While ‘transitory’ has always been a fuzzy term, my take has always been a 2-3 quarter view, but yesterday we started to hear it could mean 2 years or more.  If that is the case, then prepare for a much worse ultimate outcome along with a much weaker dollar.





As markets and investors digest the latest central bank dogma, let us peruse the latest price action.  Yesterday’s equity market price action led to yet another set of new all-time highs in US indices and even Mexico’s Bolsa rose 0.75% after the rate hike!  Overnight saw a continuation of that view with the Nikkei (+0.65%), Hang Seng (+1.4%) and Shanghai (+1.15%) all rallying nicely.  Perhaps a bit more surprisingly this morning has seen a weaker performance in Europe (DAX -0.15%, CAC -0.1%, FTSE 100 +0.1%) despite slightly better than expected Confidence data out of Germany and Italy.  As vaccinations proceed apace on the continent, expectations for a renewed burst of growth are rising, yet today’s stock markets seem unimpressed.





At the same time, despite all the Fedspeak and concern over inflation, the 10-year Treasury yield has basically been unchanged all week and seems to have found a new home at 1.50%, right where it is now.  Since it had been a harbinger for markets up until the FOMC meeting last week, this is a bit surprising.  As to Europe, bonds there are actually under some pressure this morning (Bunds +1.7bps, OATs +2.9bps, Gilts +1.2bps) although given equity market performance, one is hard-pressed to call this a risk-on move.  Perhaps these markets are responding to the better tone of data, but they are not in sync with the equity space.





In commodity markets, prices are mixed this morning.  While oil (-0.25%) is softer, gold (+0.5%) and silver (+1.0%) are looking awfully good.  Base metals, too, are having a better session with Cu (+0.4%), Al (+1.5%) and Sn (+0.2%) all performing well.  Crop prices are also rising, between 0.25% and 0.5%.  Fear not for oil, however, as it remains firmly ensconced in its uptrend.





And lastly, in FX markets, the dollar is under modest pressure across most of the G10, with the bulk of the bloc firmer by between 0.1% and 0.2%, and only GBP (-0.2%) softer.  While we did see a slightly weaker than expected GfK Consumer Confidence number for the UK last night (-9 vs. expected -7) we also just saw CBI Retail Sales print at a much better than expected level.  In the end, it is hard to ascribe the pound’s movement, or any of the G10 really, to data.  It is far more likely positions being adjusted into the weekend.





In the emerging markets, the dollar is having a much tougher time with ZAR (+1.0%) and KRW (+0.6%) the leading gainers, but a number of currencies showing strength beyond ordinary market fluctuations.  While the rand’s move seems outsized, the strength in commodity prices is likely behind the trend in ZAR lately.  As to KRW, it seems that as well as the general risk on attitude, the market is pricing in the first policy tightening in Seoul and given the won’s recent mild weakness, traders were seen taking advantage to establish long positions.





We have some important data today led by Personal Income (exp -2.5%), Personal Spending (0.4%) and Core PCE (0.6% M/M, 3.4% Y/Y).  Then at 10:00 we see Michigan Confidence (86.5).  I want to believe the PCE data is important, but I fear that regardless of where it prints, it will be ignored as a product of base effects and so not a true reflection of the price situation.  Yesterday, Claims data was a bit worse than expected as was Durable Goods.  This is not to say things are collapsing, but it is growing more and more apparent, at least based on the data, that the peak in the economy has already been seen.  In fact, the Atlanta Fed GDPNow model has fallen back below 10.0% and appears to be trending lower.  The worst possible outcome for the economy would be slowing growth and rising inflation, and I fear that is where we may be heading given the current fiscal and monetary policy settings.  





That combination will be abysmal for the dollar but is unlikely to be clear before many more months have passed.  For now, I expect the dollar will revert to its risk profile, where risk-on days will see weakness and risk-off days see strength.  Today feels far more risk-on like and so a little further dollar weakness into the weekend seems a reasonable assumption.





Good luck, good weekend and stay safe





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			Real Savoir Faire
		


				

			Posted on  by 		

			


		

		

There once was an aging Fed Chair





With poise and some real savoir faire





He claimed the foundation





Of rising inflation





Were objects that, right now, were rare




















    





But soon when supply chains are mended





And joblessness falls as intended





Inflation will sink





To levels we think





Are fine, and the world will be splendid





Remember when the FOMC Statement and following press conference were seen as hawkish?  That was sooo last week!  There was talk of rate hikes in only TWO YEARS!  There was talk about talk about tapering the purchase of assets as monetary policy started to ‘normalize’.  (Not for nothing but given we have had the same monetary policy for effectively the past 13 years, ZIRP and QE might be considered normal now, not positive real rates and a stable balance sheet.)  Well, apparently the market reaction was not seen as appropriate by Chairman Jay and his cadre of central bankers, so we have heard a definitive retreat on those concepts in the ensuing six days.  





Just since Monday, we have heard from six different FOMC members and every one of them has essentially said, “just kidding!”  Yesterday, Chairman Powell testified to a House Subcommittee on Covid and was forced to explain, yet again, that policy changes were still a long way down the road and that inflation remains transitory.  It was not, however, just Powell delivering that message.  It was also Cleveland’s Loretta Mester, SF’s Mary Daly and NY’s John Williams amongst others.  Current policy settings are appropriate, inflation is transitory and there is still a long way to go before that elusive substantial further progress toward the Fed’s dual mandates will have been achieved.





History has shown that the Fed’s effective reaction function, at least since Alan Greenspan was Chair, is defined by an equity market decline of a certain amount.  This is especially true if the decline happens quickly whereupon they will jump in and ease policy.  It appears that the amount of market angst necessary to get the Fed to change their tune regarding infinite liquidity and monetary support continues to shrink.  It used to take a decline on the order of 15%-20% to get the Fed nervous.  This time, the S&P 500 fell less than 2% before virtually the entire committee was on the tape walking back their tough talk.  And yet, they would have you believe that when inflation is roaring higher for the rest of the year, they have the intestinal fortitude to fight it effectively by raising interest rates or reducing QE.  As actions speak louder than words, my money is on the Fed being completely unable to address rising inflation.  Be prepared.





This topic continues to be the primary narrative in markets around the world, with many other countries now grappling with the transitory inflation story as well.  Nothing else really matters, and rightly so.  If inflation is building a head of steam and will be rising around the world, central banks are going to be forced to respond.  Some will respond more forcefully and more quickly than others, and it is those currencies which are likely to outperform going forward.  Investors today are generally unfamiliar with investing in an inflationary environment.  The 1970’s were the last time we really saw inflation of substance and even I was still in college (and I am almost certainly much older than you) when that was the situation, with many, if not most, of the current investment community not yet even born.





A quick look at the chart of the Dollar Index (DXY) from that time shows that from the autumn of 1971, right after President Nixon closed the gold window and ended Breton Woods, through the end of 1979, right after Paul Volcker was named Fed Chair and had just started his inflation fight, the dollar declined about 28% (roughly 4% per annum).  Of course, once Volcker got going and US interest rates were raised dramatically to kill off inflation, the dollar rose more than 75% in the following four years.





The point is that while we may disparage the Fed’s actions as being wrong-headed, their policies matter immensely.  Jay Powell may wind up with his reputation in tatters akin to Arthur Burns and G. William Miller, the Fed Chairs who oversaw the sharp rises in inflation in the 1970’s preceding Mr Volcker.  It seems unlikely this outcome is his goal, however, his insistence on toeing the political line rather than hewing to sound money policies bodes ill for the future.





Anyway, while US equity markets have essentially retraced all their post FOMC losses, the rest of the world has seen a more mixed outcome.  In Asia last night, the Nikkei (0.0%) was essentially flat although there were gains in the Hang Seng (+1.8%) and Shanghai (+0.25%).  Europe, on the other hand, is under some pressure this morning with both the DAX (-0.5%) and CAC (-0.4%) feeling some pain based on softer than expected, though still strong, Flash PMI data.  The UK, however, is seeing a much better performance (FTSE 100 +0.35%) as not only was the PMI data stronger than expected, but there apparently is a breakthrough on the lingering Brexit issues of treating goods in Northern Ireland.  Meanwhile, US futures are essentially unchanged this morning, perhaps waiting for some more encouragement from today’s roster of Fed speakers.





Bond markets, after a very choppy few days, have calmed down greatly with Treasuries (+1.2bps) softening a bit while European sovereigns (Bunds -1.4bps, OATs -1.4bps) are seeing some demand.  UK Gilts are little changed as the market there awaits tomorrow’s BOE meeting, where some believe there is a chance for a more hawkish tilt.





Commodity prices are definitely firmer this morning led by oil (+0.7%) but also seeing strength in precious metals (Au +0.25%, Ag +0.7%), base metals (Cu +0.7%, Fe +1.4%, Sn +0.2%) and agricultural products (Soybeans +0.5%, Wheat +1.2%, Corn +0.4%).  Clearly the commodity markets see inflation in the future.





Finally, the dollar is mixed this morning but, in truth, the relatively small movements indicate a lack of interest.  Commodity currencies like NOK (+0.1%), AUD (+0.2%) and NZD (+0.2%) are the leading G10 gainers while JPY (-0.35%) continues to come under pressure, arguably suffering from the fact that Japan imports virtually all its commodities.





In the EMG space, the picture is also mixed with HUF (+0.7%) the leading gainer after the central bank raised its benchmark rate to 0.9% yesterday a 0.3% increase that was expected.  But the idea that they are joining the several other EMG central banks in tightening mode (Brazil, Russia, Ukraine) has investors buying up the forint.  Away from that, ZAR (+0.4%) is clearly benefitting from higher commodity prices as are RUB (+0.2%) and MXN (+0.1%) although the latter two are quite modest.  On the downside, KRW (-0.5%) saw the sharpest declines as a combination of equity outflows as well as a sharp rise in Covid infections was seen quite negatively.  But in truth, most APAC currencies were under some pressure overnight, albeit not to the extent seen in Seoul.





Today’s data brings the Flash PMI (exp 61.5 Mfg, 70.0 Services) as well as New Home Sales (865K).  But more importantly, we have three more Fed speakers set to reiterate the message that policy is not going to change for a while yet, so no need for investors to panic in any market.  The dollar responded logically to the idea that the Fed was going to tighten policy, but now that they have gone out of their way to walk that idea back, I expect the dollar is more likely to drift lower for now.  Perhaps when it becomes clearer that the Fed is actually going to move, we could see some strength again.  But that is likely still a few weeks or months away.  Trade the range for now.





Good luck and stay safe





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			Do Not Be Afraid
		


				

			Posted on  by 		

			


		

		

Said Jay, “you must listen to me”





And not to the numbers you see





Do not be afraid





Inflation will fade





So, keep up the stock buying spree!





Last week’s FOMC meeting seems to have been an inflection point in the recent market narrative which has resulted in a great many conflicting thoughts about the future.  The dichotomy of the meeting was the virtual absence of discussion on current high inflation readings juxtaposed with the Dot Plot forecasts on interest rates rising in 2023.  Arguably, the Dot Plot reflects the participants’ growing concern that inflation is rising, and that the FOMC will need to address that situation.  One could argue that this dichotomy has been the underlying cause for the increased volatility evident in markets, with sharp gains and losses seen across bonds, equities and currencies.





This afternoon, Chairman Powell will once again regale us with his views as he testifies before the House Select Subcommittee on the Coronavirus Crisis.  His prepared testimony was released yesterday afternoon with some key comments.  “Inflation has increased notably in recent months.  As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”  That pretty much sums up the Fed view and confirms that there is very little concern about inflation over time.  





Yesterday we also heard from three other Fed speakers, NY’s Williams, Dallas’ Kaplan and St Louis’ Bullard, with slightly different messages.  Williams, a permanent voter, remains adamant that it is too soon to consider adjusting policy, although he is willing to discuss the idea of tapering.  Meanwhile, both Kaplan and Bullard, both non-voters, are far more interested in getting the tapering talk off the ground as both see the economy picking up pace and have evidenced concern about overheating areas in the economy.  One can surmise from these comments that both of them are amongst the ‘dots’ above 1.0% for 2023.  In fact, Bullard admitted that he was a 0.6% ‘dot’ for 2022 in comments last week.  





Looking ahead, we have a long list of Fed speakers this week, with Mester, a hawkish non-voter, and Daly, a dovish voter, also set to comment today.  It almost appears as though voting members have been given a set of marching (speaking?) orders to which they are to adhere that express no concern over prices and the need to continue with current policy for the foreseeable future, while non-voting members have no such restrictions.  This is a very different dynamic than what we have become used to seeing, where everybody on the committee was saying the same thing.  Perhaps this is Powell’s solution to being able to maintain the policy he wants while having the Fed overall avoid criticism for groupthink.  But groupthink remains the base case, trust me.





During this period of policy adjustments, or at least narrative adjustments, investors have found themselves without their previous strong signals that all asset prices will rise and that havens serve little purpose.  Instead, we have seen a much choppier market in both stock and bond prices as previously long-held convictions have come into question. The most notable change has been in the shape of the yield curve, which has flattened dramatically.  For instance, the 2yr-10-yr spread, which had reached a high above 160 basis points in early April has seen a decline from 137 to below 110 and a rebound back to 122 in the past three sessions.  Other than March 2020, during the initial Covid confusion, there has not been movement of that nature since President Trump was elected in 2016.  And that was a one-day phenomenon.  At this point, the volatility we are experiencing is likely to continue until a new narrative takes hold.  As to today’s session, so far, we are seeing a modest bond rally with yields softer in Treasuries (-1.7bps after a 5bp rally yesterday) and European sovereigns (Bunds -0.4bps, OATs -1.4bps, Gilts -0.5bps) all slightly firmer on the day.  





Meanwhile, equity markets are also somewhat confused.  Last night, for instance, the Nikkei (+3.1%) rebounded sharply after the BOJ explained they had restarted their ETF buying program on Monday, so all was right with the world.  The Hang Seng (-0.6%) didn’t get that message but Shanghai (+0.8%) did despite rising short-term interest rates in China.  Those climbing rates appear to be a function of quarter end demand for bank funding that is not being supplied by the PBOC.  My sense is once July comes those rates will drift back down.  Europe, has had a more mixed equity session after a nice rally yesterday, with both the DAX and CAC flat on the day and the FTSE 100 (+0.3%) rising a bit, but weakness in the peripheral markets of Spain and Italy, with both of those lower by about 0.5%.  US futures are virtually unchanged at this hour as market participants seem to be awaiting Mr Powell.





Commodity markets are following suit, with some gainers (Au +0.2%, Ag +0.2%, Al +0.1%), some losers (WTI -0.7%, Soybeans -0.7% and Fe -3.2%) and many with little overall movement.  In a market that has lost its direction with respect to both growth and inflation expectations, or at least one which is re-evaluating those expectations, it should be no surprise there is a hodgepodge of price movements.





The dollar, however, is broadly firmer on the day, with GBP (-0.35%) the weakest performer in the G10 as traders await Thursday’s BOE meeting and their latest discussion on the inflation situation in the UK.  This will be BOE Chief Economist Andy Haldane’s last meeting, and he is expected to make some hawkish noises, but thus far, the rest of the committee has not been aligned with him.  Right now, the market is not looking for him to receive any support, hence the pound’s ongoing weakness, but if we do hear some hawkishness from another member or two, do not be surprised if the pound jumps back up.  As to the rest of the G10, losses range from 0.1%-0.25% and are all a reflection of the dollar’s strength, rather than any idiosyncratic stories here.  





Emerging market currencies are also broadly softer this morning, with a mix of laggards across all three blocs.  HUF (-0.5%), ZAR (-0.5%, THB (-0.45%) and MXN (-0.35%) reflect that this is a dollar and Fed story, not an EMG one.  The one exception to this rule is TRY (+1.0%) as hopes for an early lifting of Covid restrictions and a modest rise in Consumer Confidence there has underpinned the lira.





On the data front, we see Existing Home Sales (exp 5.72M) this morning at 10:00, but that seems unlikely to excite the market.  Rather, I expect limited movement until Chairman Powell speaks this afternoon.  





For now, volatility is likely to be the norm as the market adjusts to whatever the new narrative eventually becomes.  The inflation debate continues to rage and when Core PCE is released later this week, there will be more commentary.  However, it will require high inflation readings into the autumn to change the Fed’s stance, in my view, and until then, the idea that the Fed is considering tighter policy is likely to support the dollar for now.  However, that doesn’t mean further strength necessarily, just not any real weakness.





Good luck and stay safe





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			No Exit
		


				

			Posted on  by 		

			


		

		
So, Powell and friends started talking


‘bout talking, and markets were rocking


Though they won’t stop buying


More bonds, they are trying


To exit QE, which is shocking


The question is how long they last


Ere haunted by all of their past


As Sartre made clear


No Exit is near


Be careful, the trouble is vast


Technically, I am out of the office today and tomorrow, but felt that I needed to quickly opine on yesterday’s FOMC meeting.


While the FOMC statement was virtually identical to the April statement, not really even mentioning the fact that inflation is running much hotter than they had obviously expected, the big news was the dot plot, where the median expectation changed to 0.50% of rate rises by the end of 2023.  Previously, that rate was still expected to be 0.00%, so clearly at least some FOMC members have figured out that inflation is rising.  Substantial further progress on their goal of maximum employment has not yet been made and remains “a way’s off.”


But the market focused on the dot plot as it is the first indication that tighter policy may be coming.  In fact, in the press conference, Powell explicitly said that this was the meeting where they began to talk about talking about policy changes, so perhaps that tired phraseology will be discarded.


The bond market reacted in quite an interesting manner, as every maturity up to the 10-year saw yields rise, but the 30-year was unchanged on the day.  The fact that the 30-year ignored all the fireworks implies that market opinions on growth and inflation have not really changed, just the timing of the eventual movement by the Fed has been altered.  Stock prices sold off a bit, but not very hard, far less than 1.0%, but boy did precious metals get whacked, with gold down nearly 3% on the day and a further 1% this morning.


And finally, the dollar was the star of the markets, rallying against everyone of its major counterparts, with the biggest laggards the commodity focused currencies like NOK (-2.7%), SEK (-2.5%), MXN (-2.5%) and ZAR (-2.3%).  But it was a universal rout.  Markets had been getting shorter and shorter dollars as the narrative had been the rest of the world was catching up to the US and trusting that the Fed was no nearer raising rates now than in April.  I’m guessing some of those opinions have changed.


However, my strong suspicion is that nothing really has changed and that the Fed is still a very long way from actually tapering, let alone raising rates.  Ultimately, the biggest risk they face, at least the biggest risk they perceive, is that if they start to tighten and equity prices decline sharply, they will not be able to sit back and let that happen.  They have well and truly painted themselves into a corner with No Exit.  Thus far, the movement has been insignificant.  But if it begins to build, just like the Powell Pivot on Boxing Day in 2018, the Fed will be back to promising unlimited liquidity forever.  And the dollar, at that point will suffer greatly.


For those who are dollar sellers, take advantage of this movement.  It may last a week or two but will not go on indefinitely.  At least sell some!


Good luck, good weekend and stay safe


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			Getting Upset
		


				

			Posted on  by 		

			


		

		
The Chinese are getting upset


Commodity prices, as yet


Continue to rise


As shrinking supplies


Now pose, to their model, a threat


So, naturally, what did they do?


They ordered state firms to eschew


Stockpiling provisions


As now all decisions


Will come from Beijing ‘pon review


With the FOMC meeting on virtually everyone’s mind this morning, market activity overall has been muted.  However, the one place in the world that doesn’t revolve around the Fed is China, and news from there last night is quite interesting.  You may recall my quick story about the Department of Price two weeks’ ago and how that ‘august’ institution warned commodity hoarders and speculators to stop what they were doing.  Well, apparently, not enough people listened to those warnings as last night two more Orwellian entities in China joined the conversation regarding commodity prices.  The State-owned Assets Supervision and Administration Commission (SASAC) ordered companies under its purview, the SOE’s, to “control risks and limit their exposure to overseas commodities markets”.  This was clearly the stick to accompany the carrot dangled by the National Food and Strategic Reserves Administration, which has indicated it will soon release state stockpiles of copper, aluminum and zinc amongst other metals.


It is obvious that China has figured out that rising commodity prices may soon start to pass through from the factory to the consumer and drive CPI higher on the mainland.  President Xi is clearly concerned that rising prices could lead to some political unrest given that the bargain he has made with his citizens is to enhance their lives economically so he can control all the levers of power.  Thus, if inflation starts to rise more seriously, the population may call his leadership into question.


The problem for China, however, is that while in the past, they had been the marginal buyer of virtually all commodities as they grew their economic capacity dramatically, that situation no longer holds.  Yes, they still have an impact, but in this post-Covid environment where the rest of the world is rebounding very quickly, demand for commodities outside of China is growing rapidly.  But perhaps more importantly, because the previous decade saw commodity prices lag financial prices, investment in the sector was greatly reduced.  This has led to reduced supplies of many critical things and now that demand is resurgent, not surprisingly the prices of copper, steel and other commodities have been rising rapidly even if China isn’t buying as much as they used to.


Adding to this dynamic is the great conundrum of ESG.  On the one hand, ESG’s goals are to reduce environmental impact of economic activity which has largely played out as trying to substitute electricity for fossil fuels as a power source.  On the other hand, in order to electrify economies, the amount of metals like steel and copper required to achieve the stated goals is dramatically higher than the current model.  So, reducing investment in commodity producers results in much higher prices for the very commodities needed to achieve ESG goals in the long run.  While this is not the only argument to rebut the Fed’s transitory inflation story, it is an important part of the inflationists’ views.  China’s actions will only have a very temporary impact on the prices of the commodities in question, but the long-term demand is here to stay.  Until investment in extraction of commodities increases sufficiently to bring more capacity online, odds are that commodity prices will continue to rise, whether Xi Jinping likes it or not.  And if input prices continue to rise, at some point soon, so will prices of end products.  We have been witnessing the beginnings of that trend, but I fear it has much further to go.


Interestingly, despite all the sturm und drang in Beijing about metals prices, after a sharp decline yesterday, this morning they are edging higher (Cu +0.2%, Al +0.1%, Fe +0.5%, Steel +2.8%) although not nearly reversing yesterday’s moves.  If you ever wanted proof that China no longer calls the shots in commodities, here is exhibit A.


Today Chairman Jay will expound


On growth and its stunning rebound


But do not expect


That he will project


Some changes will shortly gain ground


The other story today, really the biggest for our session, is the FOMC meeting.  Broadly speaking, expectations are that the Fed will not make any policy changes of note, although there will clearly be some tweaking to the statement.  They cannot ignore the 5.0% CPI reading, I think, and they will certainly focus on the idea that the employment situation isn’t improving as rapidly as they would like.  And ultimately, for now, it is the latter issue that will continue to inform policy choices.  So tapering is not going to be on the menu, and when Powell is asked in the press conference, as he surely will be, I expect a response along the lines of, substantial further progress needs to be made before they will change things.


If I were to assess the risks, it feels like there is more risk of a hawkish outcome than a dovish one as the inflation story will not go away.  But that implies to me that the market is according a hawkish twist some real probability, so the big surprise to markets would be if they were excessively dovish.  However, I think Powell will do everything he can to be as nondescript as possible, stay on message and there will be very little movement.


A brief recap of markets overnight shows that Asian equities suffered, led by Shanghai (-1.1%).  Not only are they dealing with rising commodity prices, but the data released (Retail Sales, IP and Fixed Asset Investment) all disappointed vs. expectations.  China’s negativity bled into the Nikkei (-0.5%) and Hang Seng (-0.7%) as well.  Europe, on the other hand, has gone nowhere ahead of the Fed, with virtually every equity index within 0.1% of yesterday’s closes.  It should be no surprise that US futures markets are also essentially unchanged ahead of the Fed.


As to the bond market, we are beginning to see a touch of strength with yields declining ever so slightly.  Treasuries are lower by 0.5bps, while Bunds (-1.1bps), OATs (-0.9bps) and Gilts (-0.7bps) are also performing reasonably well ahead of this afternoon’s announcements.  It remains remarkable to me that with inflation rising universally, bond yields continue to ignore the situation.  One has to give credit to the central banks for selling their transitory story.


In the FX markets, the picture is mixed with gainers and losers evenly split in the G10.  AUD and NZD (+0.3% each) lead the way higher, although there does not appear to be a clear catalyst implying this is a positioning issue.  GBP (+0.25%) has gained on the back of slightly higher than expected CPI readings (2.1% vs. 1.9% expected), as traders look for more concrete tightening of policy there.  On the downside, both NOK and SEK have fallen by 0.35%, despite oil’s modest gains and a lack of other news.  Again, this feels more technical than fundamental.


EMG currencies are also little changed overall, with a touch of weakness seen in the APAC bloc overnight, but only on the order of -0.1%, while RUB (+0.3%) and MXN (+0.25%) are the leaders, clearly helped by oil’s ongoing gains, but also seeming to benefit from some political stories.


Data this morning bring Housing Starts (exp 1630K) and Building Permits (1730K), but they will not be noticed with the Fed story coming later this afternoon.  Yesterday’s data was mixed at best with Retail Sales disappointing for May but seeing large positive revisions in April to offset, while PPI once again printed at much higher than expected levels (6.6%).  But let’s face it, today is Fed day and we are unlikely to see much movement until at least 2:00 when the statement is released if not until 2:30 when Chairman Powell starts to speak.  At this time, any hawkishness is very likely to support the dollar with the opposite true as well, a dovish tilt will lead to a dollar decline.


Good luck and stay safe


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			No Yang, Only Yin
		


				

			Posted on  by 		

			


		

		
According to every newspaper


The Fed’s getting ready to taper


With late Twenty-two


The popular view


Of when, QE, they will escape(r)


But what if, before they begin


To taper, to Powell’s chagrin


The bond market tanks


As traders and banks


Believe there’s no yang, only yin


The Fed begins its two-day meeting this morning and the outcome remains the primary topic of conversation within every financial market.  The growing consensus is that there will be some discussion in the meeting of when the Fed should begin to reduce their QE purchases as well as what form that should take.  Given the extraordinary heat in the housing market, there have been numerous calls for the Fed to stop buying mortgage-backed securities first as that market hardly needs any more support.  In the end, however, the details of how they choose to adjust policy matters less than the fact that they are choosing to do so at all.


As pointed out yesterday, the bond market’s rally thus far in Q2 appears to be far more related to the lack of new Treasury supply than increasing demand and declining concerns over future inflation.  If that view is correct, then discussing the timing of tapering QE will seem quite premature.  It is true Treasury Secretary Yellen said that higher interest rates would be a good thing, but it seems highly likely she was not thinking of 10-year yields at 3.0% or more, rather somewhere just south of 2.0%.  In other words, a modest increase from current levels.  History, however, shows that markets rarely correct in a modest manner, rather they tend to move to extremes before retracing to a new equilibrium.  Thus, even if 2.0% is a new equilibrium (and I don’t believe that will be the case) do not be surprised to see yields significantly higher first.


In this view, the impact on markets worldwide is likely to be significant.  It seems unlikely that equity markets anywhere will respond positively to higher interest rates at all, let alone sharply higher rates.  As well, bond markets will, by definition, have been falling rapidly with much higher yields, not just in the US but elsewhere as well.  As to the dollar, it would seem that it will also be a big beneficiary of higher US yields, arguably with USDJPY the most impacted.  A quick look at recent correlations between different currencies and US 10-year yields shows the yen is the only major currency that has a significant correlation to yields (0.46).  But I would not discount the idea that the dollar will rally versus pretty much the rest of the G10 as well as the EMG bloc in a situation where dollar yields are rising sharply.  Consider that in this situation, we will likely be looking at a classic risk-off scenario when the dollar tends to perform best.


Of course, there are many in the camp who believe that the central banking community will remain in control of markets and that inflation is transitory thus allowing them to adjust policy at their preferred pace.  It is this scenario that Ms Yellen clearly is expecting, or at least describing in her desire for higher yields.


And this is the crux of the market’s future decisions; will central banks be able to slowly reduce monetary accommodation as economies around the world slowly return to pre-pandemic levels of activity, or will the dramatic increase in government debt issuance force central banks to maintain their QE programs in order to prevent the economic chaos that could result from sharply higher interest rates?  While my money is on the latter, it remains too soon to determine which broad outcome will occur.  It is also not clear to me that tomorrow’s FOMC announcement is going to be that big a deal in the long run, as it seems doubtful there will be any actual policy changes, even if they begin to discuss how they might do so in the future.  Remember, talk is cheap, even central bank forward guidance!


Markets remain in a holding pattern ahead of tomorrow’s FOMC statement and Powell’s press conference, although there have been some idiosyncratic moves overnight.  For instance, while Japanese equity markets continue to rally (Nikkei +1.0%) on the back of optimism regarding the Olympics and the idea that Covid inspired lockdowns will be ending soon, the same was not true in China where the Hang Seng (-0.7%) and Shanghai (-0.9%) markets both suffered after the PBOC failed to inject any additional liquidity into the money markets there.  With quarter-end approaching, demand for funds by financial institutions is rising and the fact that the PBOC continues to be somewhat parsimonious has been a key support for the renminbi, but not really helped the equity markets there.  Remember, China is quite concerned over what had been a growing housing bubble, and this is designed to help restrict the growth of that situation.


European equity markets are somewhat mixed this morning as the major indices have performed well (DAX +0.5%, CAC +0.4%, FTSE 100 +0.3%) but both Italy (-0.2%) and Spain (-0.5%) are lagging on the day.  The data of note has been CPI which showed that Germany (+2.5%) continues to feel the most inflationary pressure, while both France (+1.8%) and Italy (+1.2%) remain unable to find much inflationary impulse at all.  This is certainly a far cry from the situation here in the US and speaks to the idea that the ECB is not likely to begin tapering anytime soon.  In fact, it would not be surprising if they wind up either extending PEPP or expanding the original QE known as APP.  US futures, meanwhile, are little changed at this hour after yesterday’s mixed session.


Global bond markets are on hold this morning with none of the major nations seeing movement of even 1 basis point, despite yesterday’s Treasury sell-off raising 10-year yields by nearly 6 bps.  That movement has been described as technical in nature given the complete lack of new information seen.


On the commodity front, oil (WTI +0.8%) continues to power higher driving the entire energy complex in that direction but the rest of the space has seen quite a different outcome.  Precious metals (Au -0.2%, Ag -0.8%) continue their recent weak performance while industrial metals (Cu -3.5%, Al -1.3%, Sn -2.1%) have been absolutely crushed.  Agricultural products are mostly softer on the weather story, although soybeans is bucking that trend with a modest gain on the day.


As to the FX market, the dollar is mixed in both G10 and EMG blocs.  In the G10, AUD (-0.2%) has suffered on the back of dovish RBA Minutes released last night as they indicated it was premature to discuss tapering.  CAD (-0.3%) appears to be suffering on the back of the base metals decline and the pound (-0.25%) is on its back foot after slightly disappointing employment data.  Interestingly, NOK is unchanged on the day despite oil’s rally and CHF’s 0.1% gain, which leads the pack appears to be technical in nature.


In the EMG bloc, TRY (-1.3%) is suffering after the US-Turkey meeting at the G7 meetings was less fruitful than hoped with no breakthroughs achieved.  HUF (-0.7%) is declining after conflicting statements from a central bank member regarding a short-term liquidity facility has traders uncertain if policy accommodation is going to be ended soon or not.  Remember, uncertainty breeds contempt in markets.  Away from those two, however, the rest of the block saw very small movements with no significant stories.


On the data front, we get two important pieces this morning; Retail sales (exp -0.7%, +0.4% ex autos) and PPI (6.2%, 4.8% ex food & energy).  In addition, at 8:30 we see Empire Manufacturing (22.7) and then later we see IP (0.7%) and Capacity Utilization (75.1%).  Retail Sales is likely to dominate the discussion unless PPI is really high, above 7.0%.  But in the end, markets continue to wait for tomorrow’s FOMC, so large movement still seems unlikely today.  That said, if we do see Treasury yields creeping higher, I expect the dollar to perform pretty well.


Good luck and stay safe


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