You have to be mighty impressed The bond market’s not even stressed Although CPI Has reached a new high One wonders if yields are repressed Clearly, there is only one story of import these days, and that is whether or not inflation is transitory. Chairman Powell and his minions have spent the last several months harping on this idea, and although there was a time when several FOMC members seemed to get nervous and wanted to discuss tapering QE, it seems highly likely that next week’s FOMC meeting will focus on the fact that “substantial progress” has not yet been made toward the Fed’s goals of maximum employment and 2% average inflation. Well, at least on the goal of maximum employment. It seems pretty clear that they have made some progress on the inflation front. While the headline Y/Y print of 5.0% was clearly impressive, and the highest since August 2008, personally, I am more impressed with the core M/M print of 0.7% as that is not impacted by what happened during the pandemic. And the fact that this followed last month’s 0.9% print could indicate that inflation is becoming a bit less transitory. But the Fed has done a wonderful job of selling its story. One has to believe that Chairman Powell could not have wanted a better outcome than yesterday’s market price action with the S&P 500 making new highs while the bond market rallied sharply with the 10-year yield falling 6 basis points to 1.43%. For a moment, let us try to unpack this price action. On the one hand, it is easy to understand the equity rally as the decline in nominal yields alongside the rising recorded inflation has led to a dramatic fall in real yields. One view, which many utilize, is that real 10-year yields are simply the 10-year yield less the current headline CPI rate. Of course, right now, that comes to -3.57%, a level only seen a handful of times in the past, all of which occurred during significant inflationary periods in the 1970’s and early 1980’s. Negative real yields are a boon for stocks, but historically are awful for the dollar and yet the dollar actually rallied slightly yesterday. It seems to me that a more consistent outcome would require the dollar to decline sharply from here. After all, even using Bund yields, currently -0.284%, and Eurozone CPI (2.0%), one sees real yields in the Eurozone far higher (-2.284%) than here in the US. Something seems amiss. Something else to consider is bond positioning. There continues to be a great deal of discussion pointing to the bond market rally as a massive short squeeze. Last week’s CFTC data was hardly indicative of that type of movement, although we will learn more this afternoon. However, there is another place where both hedge funds and retail investors play, the ETF market, and when it comes to bond speculation, TLT is the product of choice. Interestingly, more than 37% of the shares outstanding have been shorted in this ETF, a pretty good indication that there were a lot of bets for a higher yield. But the word is that a significant portion of these shorts were closed out yesterday, on the order of $7 billion in short covering in total, which would certainly explain the sharp rally in the bond market. This begs the question, is the price action technical in nature rather than a reflection of the views that inflation is truly transitory? The problem with this question is we will not be able to answer it with any certainty for at least another three to four months. But for now, the Fed has the upper hand. In fact, there doesn’t seem to be any reason for them to adjust policy next week at all. Why taper if the current policy mix is working? Speaking of policy mixes that seem to be working, I would be remiss if I didn’t mention that the ECB meeting yesterday resulted in exactly…nothing. Policy was left unchanged, Madame Lagarde promised to continue to buy assets at a faster pace than the first quarter, and then she spent an hour in her press conference saying virtually nothing. It may have been her finest performance in the role. The bond market seems to have made up its mind that the Fed is correct although there remain many pundits who disagree. I expect that we will be continuing this discussion all summer long and with every high CPI print, you can look for the punditry to pump up the volume of their critiques of the Fed. However, we need only see one dip in the data for the Fed to claim victory and move on from the inflation discussion. Next month’s CPI report will truly be important as the base effects will have disappeared. Last year, the June M/M CPI was 0.5%. If inflation is truly with us, we need to see M/M in June 2021 to be at least that high, if not a repeat of the 0.6%-0.8% numbers we have been seeing lately. Between now and then we will see a number of price indicators including the Fed’s favorite core PCE. For the past several months, every price indicator has been high and surprising on the high side. The next months’ worth of data will be very important to both the Fed and the markets. Enjoy the ride. With two of the three key near-term catalysts now out of the way, all eyes will turn to next Wednesday’s FOMC meeting. But that leaves us 4 sessions to trade in the interim. Right now, with the fed narrative of transitory inflation dominating, it is easy to expect continued risk-on market performance. Interestingly, that was not actually the case in Asia as the Nikkei (0.0%) was flat and Shanghai (-0.5%) fell although the Hang Seng (+0.35%) managed to close higher on the day. Europe, however, got the memo and is green across the board (DAX +0.4%, CAC +0.7%, FTSE 100 +0.5%). US futures, too, are picking up buyers as they all trade 0.25% or so higher at this hour. Meanwhile, in the bond market, Treasury yields have backed up 1.3bps, which looks far more technical than fundamental. After all, they have fallen 18 bps in the past week, a rebound is no surprise. However, European sovereign markets were closed before the bond party really started yesterday afternoon and they are in catch up mode today. Bunds (-2.0bps) and OATS (-2.1bps) are performing well, but nothing like Gilts (-4.6bps), nor like the PIGS, all of which are seeing yield declines of at least 4bps. Commodity prices are generally higher led by oil (WTI +0.5%) with the industrial metals all performing well (Cu +1.9%, Fe +1.0%, Sn +0.6%) although despite the dramatic decline in yields, gold (-0.5%) continues to underperform. That feels like it is going to change soon. Finally, in FX markets, the dollar is king of the G10, rising against all of its counterparts here with NZD (-0.4%) and SEK (-0.4%) leading the way down. While the kiwi price action appears to be technical after having seen a decent rally lately, Sweden’s krona continues to suffer from its lower CPI print yesterday, once again delaying any idea that they may need to tighten policy in the near term. The rest of the bloc is softer, but the movement has been far less impressive. What makes that price action interesting is the fact that EMG currencies have actually had a much better performance with IDR (+0.4%), KRW (+0.4%) and TRY (+0.4%) all showing modest strength. In Turkey, FinMin comments regarding the divergence between CPI and PPI were taken somewhat hawkishly. In Seoul, a BOK governor mentioned the idea that one or two rate hikes should not be seen as tightening given the current record low level of interest rates (currently 0.50%). However, it seems the market would see 50bps of tightening as tightening. And lastly, the rupiah continues to benefit from foreign buying of bonds with inflows rising for a third consecutive week. Data this morning brings Michigan Sentiment (exp 84.4) and careful attention will be paid to the inflation expectation readings, with the 1yr expected at 4.7%. Remember, the Fed relies on those well-anchored inflation expectations, so if they are rising here, that might cause a little indigestion in Washington. At this stage, just as we are seeing the bond market rally ostensibly on short covering, my sense is the dollar is behaving in the same way. The data and rates would indicate the dollar should fall, but it continues to grind higher right now. In the end, “the fundamentals things apply, as time goes by”1, and right now, they all point to a weaker dollar. Good luck, good weekend and stay safe Adf 1. Apologies to Wilson Dooley
Tag Archives: #Powell
More Systemic
The winding down of the pandemic
Has fostered a massive polemic
Will rising costs fade
As Powell’s portrayed
Or are they a bit more systemic?
The inflation debate continues to be topic number one amongst market participants as the outcome is seen, rightly, as the key to future economic activity and correspondingly future market price action. This is true across all asset classes which is why everyone cares so much.
However, not every day brings us new and exciting news on the debate which leaves the markets to seek other catalysts for movement, sometimes really stretching to find a good narrative. Thus far, today falls under the heading of ‘looking for something to say.’
There has been limited new information released overnight which is likely why the fact that the Bank of Korea, though leaving their policy rate unchanged at 0.50%, has been a topic of conversation as they displayed a more hawkish sentiment, raising both GDP growth and inflation forecasts for 2021, and hinted that they would be looking to end their ultra-expansive monetary policy sooner than previously thought. Earlier expectations had been rates would not begin to rise until 2023, but now the market is pricing in two 25 basis point rate hikes in 2022. This is the fourth (BOC, BOE and RBNZ are the others) central bank of a major country that is discussing the beginning of the end of easy money. Granted, the combined GDP of these four nations, at a touch over $7 trillion, is less than one-third that of the US, but three of them are amongst the ten largest economies in the world and the fourth, New Zealand, has a history of leading the way in monetary policy on a global basis, at least since 1988 when they ‘invented’ the inflation targeting mantra that is prevalent today.
This sentiment of considering when to end easy money is making its way more clearly into the Fed’s talking points as well. Yesterday, Fed Vice-Chair Quarles remarked, “If my expectations about economic growth, employment and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.” He is at least the fourth Fed speaker this week to talk about talking about tapering asset purchases which tells us that the discussion is actively ongoing at the Marriner Eccles Building in Washington.
Perhaps what is even more interesting is the fact that the Treasury market is so nonplussed by the fact that the Fed is clearly considering the timing of a reduction in purchases at the same time we are printing the highest inflation numbers in years and the Federal government is sending out more stimulus checks and spending money like crazy. You may disagree with Chairman Powell’s policy actions, but you cannot deny the effectiveness of his recent communication policy. Based on price action in both bond and inflation markets, Powell’s story of transitory inflation has become the accepted truth. I sure hope he’s right, but my personal, anecdotal observations don’t agree with his thesis. Whether I’m looking at my cost of living or take a more monetarist view and look at the expansion of the monetary base, both point to a steady rise in prices with no end in sight. The market, however, cares little about the FX poet’s circumstances and a great deal about Chairman Powell’s pronouncements so until he is proven wrong, it has become clear the market has accepted the transitory story.
With this in mind, a survey of market activity shows pretty limited movement in every asset class. Equity markets had a mixed session in Asia (Nikkei -0.3%, Hang Seng -0.2%, Shanghai +0.4%) and are having a similiarly mixed session in Europe (DAX -0.3%, CAC +0.5%, FTSE 100 -0.1%). In other words, there is no theme of note on the risk side. Meanwhile, US futures are pointing slightly lower on the open, with the worst performer NASDAQ at -0.4% and the others with lesser declines. None of this points to a major risk theme.
Bond prices are generally a touch softer this morning with Treasury yields higher by 1.2 basis points while Bunds (+1.0bps), OATs (+0.5bps) and Gilts (+1.7bps) have all sold off slightly. However, in the bigger picture, all of these key bond markets are currently trading with yields right in the middle of their past three month’s activity. Again, it is hard to define a theme from today’s price action.
Commodity prices add to the mixed view with oil (WTI -0.8%) slightly softer as it consolidates after last month’s powerful rally. In the metals markets, precious metals are essentially unchanged this morning while industrial metals continue with the mixed theme as Cu (+0.5%) and Zn (+0.3%) are firmer while Al (-0.4%) and Sn (-0.3%) are softer. Ags have seen similar price action with Soybeans softer while both Wheat and Corn are firmer. One of the stories here has been the recent consolidation across most commodities which has been attributed to China’s efforts to prevent inflation and the expansion of bubbles in property and housing markets.
The dollar, however, is the one thing which has shown some consistency this morning, falling almost across the board. In fact, in G10, the dollar has fallen against all its counterparts with GBP (+0.4%) the firmest currency, but solid gains in NZD (+0.35%) and CAD (+0.3%) as well. The pound’s jump has been in the past few minutes responding to the BOE’s Gertjan Vlieghe’s comments that rate hikes are likely to begin in 2022, again, earlier than the market had been figuring.
EMG currencies are also gaining this morning led by the CE4 (HUF +0.65%, PLN +0.5%) as well as ZAR (+0.4%). APAC currencies performed well overnight with CNY (+0.25%) rising for the 12th session in the 15 so far this month. It has become abundantly clear that the PBOC is willing to allow CNY to continue to strengthen despite the potential impact on exports. This seems to be driven by their desire to cap inflation, especially in commodity prices, as well as the fact that the inflation narrative elsewhere in the world has shown that export clients have been able to absorb some level of price rises. To achieve both these aims, a modestly stronger renminbi is an excellent help.
On the data front, this morning brings Initial Claims (exp 425K), Continuing Claims (3.68M), the second look at Q1 GDP (6.5%) and Durable Goods (0.8%, 0.7% ex transport). However, while this is the biggest tranche of data so far this week, tomorrow’s core PCE release remains the most important number of the week in my view as excessive strength there seems to be the only thing that could give the Fed pause in their current views. Interestingly, we do not hear from another Fed speaker, at least in a scheduled appearance, until next Tuesday, so the data will be our best indication of what is happening.
Looking at the dollar’s recent price action, we have seen weakness but it has run into pretty strong support. The link between Treasury yields and the dollar remains strong, and I expect that to be the case until at least the Fed’s June meeting. In truth, the dollar’s weakness today feels a bit overdone so I anticipate no further declines and potentially, a little rebound.
Good luck and stay safe
Adf
Not Really There
There once was a Fed Reserve Chair
Whose minions explained with fanfare
Though prices were climbing
With all the pump priming
Inflation was not really there
Investors responded with glee
And bought everything they did see
So, risk was a hit
While yields fell a bit
As money remains largely free
Brainerd, Bostic and Bullard, though sounding like a law firm, are actually three FOMC members who spoke yesterday. In what has been a remarkably consistent performance by virtually every single member of the committee (Robert Kaplan excepted), they all said exactly the same thing: prices will rise due to bottlenecks and shortages in the near-term, but that this was a short-term impact of the pandemic response, and that soon those issues would abate and prices would quickly stabilize again. They pointed to ‘well-anchored’ inflation expectations and reminded one and all that they have the tools necessary to combat inflation in the event their version of events does not come to pass. You have to give Chairman Powell credit for convincing 16 ostensibly independent thinkers that his mantra is the only reality.
The market response was one of rainbows and unicorns, with rallies across all assets as risk was snapped up everywhere. After all, it has been nearly two weeks since the CPI print was released at substantially higher levels than anticipated raising fears amongst investors that the Fed was losing control. But two weeks of soothing words and relatively benign data has been sufficient to exorcise those inflation demons. In the meantime, the Fed continues to purchase assets and expand its balance sheet as though the economy is teetering on the brink of destruction while they await the “substantial progress” toward their goals to be met.
One consequence of the Fed’s QE program has been that high-quality collateral for short term loans, a critical part of the financial plumbing of the US (and global) economy has been in short supply. For the past two months, Treasury bill issues have been clearing at 0.00%, meaning the government’s cost of financing has been nil. This is due to a combination of factors including the Treasury running down the balances in the Treasury General Account at the Fed (the government’s checking account) and the ongoing Fed QE purchases of $80 billion per month. This has resulted in the Treasury needing to issue less T-bills while simultaneously injecting more funds into the economy. Banks, meanwhile, wind up with lots of bank reserves on their balance sheets and no place to put them given the relative dearth of lending. The upshot is that the Fed’s Reverse Repurchase Program (RRP) is seeing unprecedented demand with yields actually starting to dip below zero. This is straining other securities markets as well given the bulk of activity in markets, especially derivatives activity, is done on a margin, not cash, basis. While so far, there have not been any major problems, as the stress in this corner of the market increases, history shows that a weak link will break with broader negative market consequences. For now, however, the Fed is able to brush off any concerns.
The result of the constant commentary from Fed speakers, with three more on the schedule for today, as well as the fading of the memories of the high CPI print has been a wholesale reengagement of the risk-on meme. Growth continues to rebound, while zero interest rates continue to force investors out the risk curve to find a return. What could possibly go wrong?
Today, the answer is, nothing. Risk is back with a vengeance as evidenced by a strong equity session in Asia (Shanghai +2.4%, Hang Seng +1.75%, Nikkei +0.7%) and a solid one in Europe as well (DAX +0.8%, CAC +0.15%, FTSE 100 0.0%). The Chinese (and Hong Kong) rally seems to be a product of the PBOC focusing their attentions on the commodity market, not equities, as the source of imbalances and a potential target of interventionist policies thus allowing speculators there to run free. German equities are the beneficiary of better than expected ZEW data, with both the current conditions (95.7) and Expectations (102.9) indices leading the way. While yesterday’s US equity rally faded a bit late in the day, futures this morning are all pointing higher by about 0.3%.
Arguably, the FOMC trio had a bigger impact on the bond market, where 10-year Treasury yields are now back below 1.60%, down 1 basis point this morning and at their lowest level in more than two weeks. It is certainly hard to believe that the bond market is remotely concerned about inflation at this time. Remember, though, Friday we see the core PCE print, which is the number the Fed truly cares about, and while it is forecast to print above the 2.0% target, (0.6% M/M, 2.9% Y/Y) we also know that the Fed strongly believes this is transitory and is no reason to panic. Markets, however, if that print is even stronger, may not agree with that sentiment.
Commodity prices are having a less positive day as the ongoing concerns about Chinese actions to prevent price rises continues to weigh on sentiment. Oil has slipped just a bit (-0.3%) but we are seeing declines in Cu (-0.4%), Al (-1.1%) and Fe (-3.1%), all directly in the crosshairs of the Chinese government. Agricultural product prices are mixed today while precious metals remain little changed.
Finally, the dollar is mostly lower this morning with broad weakness seen in the EMG bloc, but less consistency in G10. While SEK (+0.5%) leads the way higher, the rest of the bloc has been more mixed. NOK (-0.2%) is clearly suffering from oil’s decline, while JPY (-0.2%) seems to be giving ground as havens are unloved. EUR (+0.25%) has been helped by that German ZEW data as well as the beginnings of a perception that the Fed is going to be more aggressively dovish than the ECB for a long time to come. In that event, the euro will certainly rise further, although it has a key resistance level at 1.2350 to overcome.
ZAR (+0.7%) leads the emerging market parade higher as concerns over inflation there abate, and South Africa continues to have amongst the highest real yields in the world. KRW (+0.4%) is next in line as consumer sentiment in South Korea rose to its highest level in 3 years. The other noteworthy move has been CNY (+0.2%) not so much for the size of the move as much as for the fact that it has breached the 6.40 level and the government has indicated they are going to be taking additional steps to open the FX market in China to help local companies hedge their own FX risks. The only laggard of note is TRY (-0.3%) which is suffering as President Erdogan has replaced yet another member of the central bank’s board, inviting concerns inflation will run higher with no response.
Data today shows Case Shiller Home Prices (exp +12.5%) as well as New Home Sales (950K) and Consumer Confidence (119.0), none of which are likely to change either Fed views or market opinions. As mentioned above, three Fed speakers will regale us with their sermon on transitory inflation, and I expect that the dollar will remain under pressure for the time being. In fact, until we see core PCE on Friday, it is hard to make a case that the dollar will turn around and only then if the number is higher than expected.
Good luck and stay safe
Adf
Retrogression
To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression
“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity. Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.
No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything. So, is this really as hawkish as the commentariat would have us believe? Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report. Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy. Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time. Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).
The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis. That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”
Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do. The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion. In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco. Of that group, Chicago’s Evans and SF’s Daly are uber-dovish. Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all. This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months. Do not get overexcited about the Fed tapering.
Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive. Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released. Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session. In other words, it was hardly a rout based on the Minutes. The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit. Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.
As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%. But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps. This is hardly the sign of a market preparing for a Fed change of heart. European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps). Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.
Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%). However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions. The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day. Agricultural products, though, maintain their bids with small gains across the board.
Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April. This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.
Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes. Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%). Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night. However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.
Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%). All of these are benefitting from the broad based, but mild, dollar weakness. The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.
Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0). Then at 10:00 we see Leading Indicators (1.3%). On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.
Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment. Look for the dollar to drift lower on the day.
Good luck and stay safe
Adf
The Seeds of Inflation
Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory
But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone
Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation. It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip. The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives. But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed. (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)
For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%. While both those results were exactly as forecast, the trend for both remains sharply higher. The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation? After all, it is not as though the data comes with a disclaimer. Ultimately, a decision is going to have to be made that rising prices are becoming a problem. Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.
For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession. The June data will be the first test as that monthly CPI print last year was a robust 0.5%. Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities. But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand. In fact, it is this uncertainty that is the primary rationale for corporate hedging. There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results. FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.
This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing. Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%. Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector. In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday. The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency. Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.
Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds. So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged. Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets. Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.
Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%). The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs. Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.
It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher. Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today. Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength. There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.
As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.
| Today | ISM Manufacturing | 65.0 |
| ISM Prices Paid | 86.1 | |
| Construction Spending | 1.7% | |
| Tuesday | Trade Balance | -$74.3B |
| Factory Orders | 1.3% | |
| -ex transport | 1.8% | |
| Wednesday | ADP Employment | 875K |
| ISM Services | 64.1 | |
| Thursday | Initial Claims | 540K |
| Continuing Claims | 3.62M | |
| Nonfarm Productivity | 4..2% | |
| Unit Labor Costs | -1.0% | |
| Friday | Nonfarm Payrolls | 978K |
| Private Payrolls | 900K | |
| Manufacturing Payrolls | 60K | |
| Unemployment Rate | 5.7% | |
| Average Hourly Earnings | 0.0% (-0.4% Y/Y) | |
| Average Weekly Hours | 34.9 | |
| Participation Rate | 61.6% | |
| Consumer Credit | $20.0B |
Source: Bloomberg
As well, we hear from five Fed speakers, including Chairman Powell this afternoon. Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.
Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future. Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact. Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar. We shall see. As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast. While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.
Good luck and stay safe
Adf
Filled With Froth
Said Jay, markets seem filled with froth
But let me tell you, we are loth
To even discuss
The tapering fuss.
To ZIRP and QE we are troth
Now, ask yourself what markets heard
Jay cooed like his favorite white bird
So, dollars were sold
Investors bought gold
With equity bulls undeterred
The Chairman was very clear yesterday afternoon in his press conference, the Fed is not anywhere near thinking about changing their current policy mix. While paying lip service to the idea that if inflation turns out not to be ‘transitory’ they have the tools to address it, the overwhelming belief in the Mariner Eccles Building appears to be that by autumn, inflation will be a thing of the past and the Fed will still have their foot on the proverbial accelerator.
This does raise the question that, if economic growth is rebounding so smartly, why does the Fed need to buy $120 billion of assets each month and maintain their policy rate at 0.00%? While I am just an FX guy, it seems to me that the current policy stance is more appropriate for an apocalyptic economic crisis, something like we suffered last year or in 2008-9, rather than for an economy that is growing at 7.0% or more. But that’s just me. Clearly, Chairman Powell and his committee are concerned that the economy cannot continue to grow on its own, else they wouldn’t be doing what they are doing.
When it comes to the tapering of asset purchases, Powell was also explicit that it is not nearly time to consider the idea. Yes, we had one good NFP number, but we need a string of them to convince the Fed that we are past the worst of things. Remember, the opening two lines of the Fed statement continue to be about Covid. “The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals. The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world.” Until such time as that statement changes, we don’t need to hear the press conference to know that nothing is going to change.
With this in mind, let us consider the potential impact on markets. Starting with Treasuries, it seems reasonable to assume that yields are reflective of investors collective view on inflation going forward. The Fed has been purchasing $120 billion / month since last June and is not about to change. At this stage, it would appear the market has factored those purchases into the current yield. This means, future movements are far more likely to be indicative of the evolving view on inflation. Yesterday, after the press conference, 10-year yields slipped by 4bps, but this morning, they have recouped those losses and we currently sit at 1.65%. With commodity prices clearly still on a massive roll (WTI +1.4%, Cu +0.8%), while the Fed is convinced that any inflation will be transitory, it is not obvious that the rest of the market agrees. Powell said the Fed would need to see a string of strong data. Well, next week the early expectations for NFP are 888K, which would be two very strong months in a row. Is that a string? Certainly, it’s a line. But I doubt it will move the needle at the Fed. Maximum employment is still a long way off, and there will be no changes until then. As inflation readings climb, and they will, Treasury yields will continue to climb as well. There is nothing magical about 1.75%, the level reached at the end of March, and I expect that by the end of Q2, we will be looking at 10-year yields close to, or above 2.0%.
If Treasury yields are at 2.0%, what happens to equity markets? In this case, it is not as clear cut as one might think. First off, this Fed clearly has a different reaction function to data than previous iterations as they have been explicit that pre-emptive tightening to prevent potential future inflation is not going to happen. This implies that any rise in yields is not reflective of expected Fed policy changes, but rather as a response to rising inflationary pressures. History has shown that when inflation rises but stays below 3.0%, equity markets can remain buoyant, but once that threshold has been breached, it is a different story. Remember, especially in the tech sector, but in truth quite generally, the reason low rates boost the stock market is because any discount cash flow model, when discounting at ultra-low rates means current values should be higher. This is why rising yields become a problem for equity prices. In fact, it is reasonable to analogize being long growth stocks to being long bond duration, so when bond prices fall and yields rise accordingly the same thing happens to those stocks. If this relationship holds going forward, and inflationary concerns do continue to percolate in the market, it would appear equity prices could be in for a bumpy ride.
Clearly, that is not yet the case (after all, inflation hasn’t yet reared its ugly head), as evidenced by the overnight price action in the wake of Powell’s comments. Asia was strong (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +0.5%) and most of Europe is as well (CAC +0.55%, FTSE 100 +0.7%) although the German DAX (-0.25%) is a bit of a laggard this morning as concerns over Q1 GDP rise due to the third Covid wave. US futures, though, are all-in with Jay, rising between 0.5% (Dow) and 1.0% (NASDAQ). That makes sense given the assurances that there will be no tapering forever the foreseeable future.
As to the dollar, there are two different narratives at odds here. On the one hand, the fundamentalists continue to point to a weaker dollar in the future as rising inflation tends to devalue a currency, and when combined with the massive fiscal deficit policy, a dollar decline becomes the only outlet available for pressure on the economy. On the other hand, rising yields tend to support the dollar, so as Treasury yields continue to rise, if they stay ahead of the inflation statistics, there is reason to believe that the dollar has further to gain from here. Of course, if inflation outstrips the rise in nominal yields such that real yields decline, we could easily have a situation with higher nominal Treasury yields and a much weaker dollar. For now, the inflation data is lagging the Treasury market, but I suspect that by the end of May, that will not be the case, meaning the long-awaited dollar decline has a much better chance to get started then.
In the meantime, the dollar has softened ever so slightly this morning. Versus G10 currencies, only JPY (-0.25%) has declined as the rebound in Treasury yields this morning seems to be garnering interest in the Japanese investment community. But, while the dollar is softer vs. everything else, nothing has even moved 0.2%, which implies there is no news beyond the Fed. In the EMG space, the dollar is also largely softer, led by HUF (+0.5%), THB (+0.45%) and INR (+0.45%). HUF continues to benefit from the relatively hawkish stance of the central bank, while the baht rallied despite a reduction in the 2021 GDP estimate to 2.3% as Covid infections increase in the nation. Meanwhile, INR appears to be the beneficiary of the Fed’s stance as clearly, the ongoing domestic disaster regarding its response to the latest wave of Covid infections cannot be seen as a positive.
On the data front, we start with Initial Claims (exp 540K) and Continuing Claims (3.59M) but also see the first look at Q1 GDP (6.6%), with a range of estimates from 4.5% to 10.0%! With the Fed meeting behind us, we should start to hear from FOMC members again, but today only has Governor Quarles discussing financial regulation, a much drier subject than inflation. Tomorrow, however, we will see the latest Core PCE data, and that has the chance to move things around.
As of now, the dollar remains on its back foot given the Fed’s clear message that tapering is a long way off and easy money is here for now. However, if Treasury yields start to rise further, especially if they get back toward the 1.75% level, I expect the dollar will rebound. On the other hand, if Treasuries remain quiet, the dollar probably has further to fall.
Good luck and stay safe
Adf
Lower Forever’s Outdated
A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away
The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated
Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm. Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.
What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today. Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities. So, what’s all the hubbub?
Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward. In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus. As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data. Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year. And they well could do so.
However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it. And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%. No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial. In fact, I doubt two months will qualify. If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases. I think the market is way ahead of itself on this issue.
Consider, as well, this puzzle. The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money. As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields. Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt. One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds. So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases? Personally, I cannot do so, it is one or the other.
Which brings us to what can we expect today? Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement. As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.
Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets. If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure. However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price. We shall see starting at 2:00 today.
As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals. Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions. Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.
Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday. In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps). There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates. By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.
On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level. While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.
The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%). The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth. Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.
EMG currencies are a bit more mixed, with a spread of gainers and losers this morning. On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty. A negative ruling could have a major impact on Poland’s banking sector and by extension the economy. Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news. On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.
Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact. Equity futures are biding their time as are most market participants as we all await Mr Powell. Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.
Good luck and stay safe
Adf
Ephemeral
Inflation remains
Ephemeral in Japan
Will Suga as well?
Leadership in Japan remains a fraught situation as highlighted this week. First, three by-elections were held over the weekend and the governing LDP lost all three convincingly. PM Yoshihide Suga is looking more and more like the prototypical Japanese PM, a one-year caretaker of the seat. Previous PM, Shinzo Abe, was the exception in Japanese politics, getting elected and reelected several times and overseeing the country for more than 8 years. But, since 2000, Suga-san is the 9th PM (counting Abe as 1 despite the fact he held office at two different times). In fact, if you remove Abe-san from the equation, the average tenor of a Japanese PM is roughly 1 year. Running a large country is a very difficult job, and in the first year, most leaders are barely beginning to understand all the issues, let alone trying to address whichever they deem important. In Japan, not unlike Italy, the rapid turnover has left the nation in a less favorable position than ought to have been the case.
Of course, long tenure is no guarantee of success in a leadership role, just ask BOJ Governor Haruhiko Kuroda. He was appointed to the role in February 2013 and has been a strong proponent of ultra-easy monetary policy as a means to stoke inflation in Japan. The stated target is 2.0%, and for the past 8 years, the BOJ has not even come close except for the period from March 2013-March 2014 when a large hike in the Goods and Services Tax raised prices on everyday items and saw measured inflation peak at 3.7% in August. Alas for Kuroda-san, once the base effects of the tax hike disappeared, the underlying lack of inflationary impulse reasserted itself and in the wake of the Covid-19 pandemic lockdowns, CPI currently sits at -0.2%.
Last night, the BOJ met and left policy on hold, as expected, but released its latest economic and inflation forecasts, including the first look at their views for 2023. Despite rapidly rising commodity prices as well as a slightly upgraded GDP growth forecast, the BOJ projects that even by 2023, CPI will only rise to 1.0%. Thus, a decade of monetary policy largesse in Japan will have singularly failed to achieve the only target of concern, CPI at 2.0%.
Personally, I think the people of Japan should be thankful that the BOJ remains unsuccessful in this effort as the value of their savings remains intact despite ZIRP having been in place since, essentially, 1999. While they may not be earning much interest, at least their purchasing power remains available. But the current central bank zeitgeist is that 2.0% inflation is the holy grail and that designing monetary policy to achieve that end is the essence of the job. The remarkable thing about this mindset is that every nation has a completely different underlying situation with respect to its demographics, debt load, fiscal accounts and growth capabilities, which argues that perhaps the one size fits all approach of 2.0% CPI may not be universally appropriate.
In the end, though, 2.0% is the only number that matters to a central banker, and for now, virtually everyone worldwide is trying to design their policy to achieve it. As I have repeatedly discussed previously, here at home I expect that soon enough, Chairman Powell and friends will find themselves having to dampen inflation to achieve their goal, but for now, pretty much every G10 central bank remains all-in on their attempts to push price increases higher. That means that ZIRP, NIRP and QE will not be ending anytime soon. Do not believe the tapering talk here in the US, the Fed is extremely unlikely to consider it until late next year, I believe, at the earliest.
Delving into Japanese monetary policy seemed appropriate as central banks are this week’s story line and we await the FOMC outcome tomorrow afternoon. In addition to the BOJ, early this morning Sweden’s Riksbank also met and left policy unchanged with their base rate at 0.0% and maintained its QE program of purchasing a total of SEK 700 billion to help keep liquidity flowing into the market. But there, too, the inflation target of 2.0% is not expected to be achieved until 2024 now, a year later than previous views, and there is no expectation that interest rates will be raised until then.
What have these latest policy statements done for markets? Not very much. Overall, risk appetite is modestly under pressure this morning as Japan’s Nikkei (-0.5%) was the worst performer in Asia with both the Hang Seng and Shanghai indices essentially unchanged on the day. I would not ascribe the Nikkei’s weakness to the BOJ, but rather to the general tone of malaise in today’s markets. European equity markets have also been underwhelming with red numbers across the board (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%) albeit not excessively so. Here, too, apathy seems the best explanation, although one can’t help but be impressed with the fact that yet another bank, this time UBS, reported significant losses ($774M) due to their relationship with Archegos. As to US futures, their current miniscule gains of 0.1% really don’t offer much information.
Bond prices are also under very modest pressure with 10-year Treasury yields higher by 1.1bps and most of Europe’s sovereign market seeing yield rises of between 0.5bps and 1.0bps. In other words, activity remains light as investors and traders await the word of god Powell tomorrow.
Commodity prices, on the other hand, are not waiting for anything as they continue to march higher across the board. Oil (+0.8%) is leading the energy space higher, while copper (+1.1%) is leading the base metals space higher. Gold and silver have also edged slightly higher, although they continue to lag the pace of the overall commodity rally.
The dollar, which had been uniformly higher earlier this morning is now a bit more mixed, although regardless of the direction of the move, the magnitude has been fairly small. In the G10 space, the leading decliner is AUD (-0.2%) which is happening despite the commodity rally, although it is well off its lows for the session. That said, it is difficult to get too excited about any currency movement of such modest magnitude. Away from Aussie, JPY (-0.2%) is also a touch softer and the rest of the G10 is +/- 0.1% changed from yesterday’s closing levels, tantamount to unchanged.
EMG currencies have seen a bit more movement, but only TRY (+0.75%) is showing a substantial change from yesterday. it seems that there is a growing belief that the tension between the US and Turkey regarding the Armenian genocide announcement by the Biden administration seems to be ebbing as Turkish President Erdogan refrained from escalating things. This has encouraged traders to believe that the impact will be small and return their focus to the highest real yields around. But away from the lira, gainers remain modest (KRW +0.25%, TWD +0.2%) with both of these currencies benefitting from equity inflows. On the downside, ZAR (-0.35%) is the laggard as despite commodity price strength, focus seems to be shifting to the broader economic problems in the nation, especially with regard to a lack of power generation capacity.
Data this morning brings Case Shiller Home Prices (exp 11.8%) and Consumer Confidence (113.0), neither of which is likely to have a big impact although the Case Shiller number certainly calls into question the concept of low inflation. With the FOMC tomorrow, there are no Fed speakers today, so I anticipate a relatively dull session. Treasury yields continue to be the underlying driver for the dollar in my view, so keep your eyes there.
Good luck and stay safe
Adf
QE Will Wane
Some pundits have come to believe
That sometime before New Year’s Eve
The Fed will explain
That QE will wane
Though others are sure they’re naïve
So, let’s listen to what the Fed
Has very consistently said
Without hard statistics,
Not simple heuristics,
The idea of tapering’s dead
As a new week begins, all eyes are turning to the central bank conclaves scheduled for the latest clues in monetary policy activity. Recall last week, the Bank of Canada surprised almost everyone by explaining they would reduce the amount of QE by 25% (C$1 billion/week) as they see stronger growth and incipient inflationary pressures beyond the widely discussed base effects that are coming soon to a screen near you. This has clearly inspired the punditry, as evidenced by a recent survey of economists carried out by Bloomberg, showing more than 60% of those surveyed expect the Fed to begin to taper QE before the end of this year. When the same questions were asked in March, less than 50% of those surveyed expected a tapering this year. Obviously, we have seen a run of very strong survey data, as well as a very strong payroll report at the beginning of this month. In addition, the vaccine rate has increased substantially, with the combination of these things leading to significantly upgraded economic forecasts for the US this year.
And yet, everything we have heard from Chairman Powell and the rest of the FOMC has been incredibly consistent; they are not even thinking about thinking about tapering monetary policy and will not do so until substantial further progress toward their goals of maximum employment and average inflation of 2.0% are achieved. In addition, Powell has promised to communicate very clearly, well in advance, that changes are in the offing. While we have had two strong employment reports in a row, the combined job gains remain a fraction of the 10 million that Powell has repeatedly explained need to be regained. Arguably, we will need to see NFP numbers north of 750K for the next 6-9 months before the Fed is even close to their target and will consider taking their foot off the proverbial accelerator.
Of course, there is one thing that could force earlier action by the Fed, inflation rising more quickly than anticipated. As of now, the Fed remains unconcerned over price rises and have made it clear that while the data for the next several months will be rising quickly, it is a transitory impact from the now famous base effects caused by the Covid induced swoon this time last year. Even then, given the new framework of average inflation targeting, rather than a hard numeric target, a few more months of above 2.0% core PCE will hardly dissuade them from their views as they have nearly a decade of lower than 2.0% core PCE to offset.
But what if inflation is more than a transitory event? While the plural of anecdote is not data, it certainly must mean something when every week we hear from another major consumer brand that prices will be rising later this year. Personal care products, food and beverages have all been tipped for higher prices this year. The same is true with autos and many manufactured goods as the consistent rise in input prices (read commodities) is forcing the hands of manufacturers. While it is true that, by definition, core PCE removes food & energy prices, to my knowledge, neither toothpaste nor Teslas are core purchases.
The medium-term risk appears to be that inflation runs, not only hotter than the Fed expects, but hot enough that they begin to become uncomfortable with its impact. While the natural response would be to simply raise rates, given Jay’s effective promise not to raise rates until 2023, as well as the fact that the Treasury can ill afford higher interest rates (nor for that matter can the rest of the economy given the amount of leverage that is outstanding), the Fed may well find themselves in quite a bind later this year. One cannot look at the price of copper (+1.9% today, 25.6% YTD), aluminum (+1.2%, 21.1%) or iron ore (+0.4%, 16.0%) without considering that those critical inputs, neither food nor energy, are going to drive price pressures higher. And, by the way, food and energy prices have been rocketing as well (Corn +38% YTD, Wheat +13.1%, Soybeans +18.2%, WTI +26.1%). Chairman of the Fed may not be that attractive a position by the time Powell’s term ends in February.
Turning to the markets, if I had to characterize them in a theme, it would be idle. Equity markets are generally flat to lower with the odd exception in Asia (Nikkei +0.4%, Hang Seng -0.4%, Shanghai -1.0%) and Europe (DAX -0.2%, CAC 0.0%, FTSE 100 0.0%). US futures are also noncommittal this morning, with the NASDAQ (-0.3%) the only one having really moved.
In the bond market, the rally we had seen over the past three weeks has stalled and is starting to cede some ground. For instance, Treasuries (+3.7bps) are leading the way higher but we are seeing higher yields throughout Europe (Bunds +2.3bps, OATs +2.5bps, Gilts +3.0bps) and even saw gains overnight in Australia (+1.8bps) and Japan (+0.5bps). Historically, that would have seemed to be a risk-on phenomenon, but given the lack of equity strength, this feels a lot more like an inflationary call.
While the metals space is strong today, oil is actually softer (-1.7%) as concerns over the rampant spread of Covid in India and other emerging markets undermines the vaccine news in the West.
As to the dollar, it is generally, but not universally, weaker this morning. In the G10, AUD (+0.6%), NZD (+0.3%) and CAD (+0.3%) are the leaders, with all benefitting from the metals rally, which has been sufficient to offset weaker oil prices for the Loonie. On the downside, NOK (-0.1%) is clearly feeling a bit of pressure from oil, although 0.1% hardly makes a statement. EMG currencies are showing the same type of price action with TRY (+1.2%) the leading gainer as it rebounds from near-record lows amid hopes the tension with the US will be temporary. Away from the lira, TWD (+0.5%) rallied on concerns that the Taiwanese government would be pressured by the US with respect to its currency and competition concerns. We saw similar, but lesser pressure on KRW (+0.4%). Meanwhile, the modest declines seen in HUF (-0.2%) and MXN (-0.1%) define the other side of the spectrum.
Clearly, the FOMC meeting is the highlight of the week, but there is other important data as well, including the BOJ tonight.
| Today | Durable Goods | 2.5% |
| -ex transport | 1.6% | |
| Tuesday | Case Shiller Home Prices | 11.8% |
| Consumer Confidence | 112.0 | |
| Wednesday | FOMC Decision | 0.00% – 0.25% |
| IOER | 0.12% | |
| Thursday | Initial Claims | 550K |
| Continuing Claims | 3.59M | |
| GDP Q1 | 6.9% | |
| Personal Consumption | 10.3% | |
| Friday | Personal Income | 20.0% |
| Personal Spending | 4.2% | |
| Core PCE | 1.8% | |
| Chicago PMI | 64.2 | |
| Michigan Sentiment | 87.5 |
Source: Bloomberg
The end of the week is where all the action will be, assuming Chairman Powell doesn’t shake things up Wednesday afternoon. Core PCE is forecast to print at its highest level since February 2020, but if you recall the CPI data, it was a tick higher than forecast as well. Of course, for now, it doesn’t matter. This is all transitory.
Nothing has changed my opinion with respect to the relationship between the dollar and the 10-year Treasury yield. While it is not actually tick for tick, if yields do back up, I would look for the dollar to find its footing in the near term. I know the dollar bears are back in force, but we need to see a break above the 1.2350 level in the euro to really turn the tide in my view. Otherwise, we are simply at the bottom of the dollar’s range.
Good luck and stay safe
Adf
Powell Won’t Waver
The story last quarter was prices
Would rise, leading up to a crisis
So, bond markets dropped
The dollar, she popped
And gold bugs all made sacrifices
But now a new narrative line
Explains that inflation’s benign
So, bonds are in favor
As Powell won’t waver
While dollars resume their decline
All year long the market story has been driven by the yield on the 10-year Treasury bond. Ever since the run-off elections in Georgia in the beginning of January, market anticipation has been for significant growth in the US on the heels of increased vaccination rates and increased fiscal stimulus. In Q1, Treasury yields rose dramatically, touching as high as 1.77% at their top toward the end of March. Meanwhile, the dollar, which had been slated to decline all year, rallied versus every emerging market currency and all but CAD, GBP and NOK in the G10.
But, as of the first of this month, the world appears to be a different place, as Treasury bonds have rallied driving yields lower and supporting equity and commodity markets. At the same time, the dollar has come under broad-based pressure and reversed a large portion of its Q1 gains.
Currently, the narrative appears to be along the following lines: US GDP growth in 2021 is going to be spectacular, well above 6.0% and its strongest since 1984. Inflation, meanwhile, will print at higher levels for Q2 purely as a result of base effects, but will then resume its long-term downtrend and the Fed will be required to continue to support the economy aggressively in order to meet their goals. By the way, the Fed’s newly articulated goal is for maximum employment, not full employment, and they have promised to become completely reactive, waiting for hard data to confirm positive results in employment and wages, before considering any efforts to rein in rising prices.
Equity markets still love the story as the implication is that interest rates will not be rising at all this year, nor next year for that matter, at least in the front end of the curve. Treasury markets, which appeared to get a little panicked in Q1 have reverted to form and seem to be pricing one of two things; either less impressive economic growth, or anticipation that the Fed will expand QE or YCC as Powell and friends seek to prevent any significant rise in yields. Meanwhile, the dollar is falling again, gold is rising and commodity prices (the one true constant) remain firm.
Have we reached economic nirvana? Some skepticism might be in order given the myriad issues that can undermine this narrative. The primary issue is, of course, another wave of Covid spreading throughout the US and the world. As the virus mutates, it is not clear that the current vaccines are going to be effective preventatives to new strains. While the vaccination progress in the US and UK has been excellent, with 40% and 50% of their respective populations receiving at least the first dose, the same cannot be said elsewhere in the world. In fact, the newsworthy item of the day is that India reported 315,800 new cases just yesterday! Alongside Brazil and Turkey, these three nations, with a combined population of nearly 1.7 billion find themselves in the midst of another serious wave of infection. Remember that a huge part of the reopening and growth narrative is the ending of the pandemic. It is still too early to make that claim, and so, perhaps a bit early to count the 2021 GDP growth figures as a given.
However, there is a second issue of note that cannot be ignored, and that is the inflation story. While it is clear that the Fed has convinced themselves inflation is not a concern, that the elevated readings that are almost certain to come over the next three months will be ‘transitory’, there is a case to be made that rising inflation may have a more lasting impact.
Consider that oil prices have risen dramatically from their levels this time last year and continue to trend higher. Now, while the Fed looks at core prices, ex food & energy, the reality is that rising energy prices feed into everyday items beyond the cost of filling your gas tank. Given that virtually everything produced and consumed requires energy to create, eventually higher energy prices feed into the cost of all those products. It can be even more direct for services such as shipping, where energy price surcharges are common. But just because something is labeled a surcharge doesn’t mean it hasn’t raised the price of the item consumed. The point is, rising energy prices and rising commodity prices in general, are leading to higher input costs which will eventually lead to higher prices. We continue to see the evidence in data like PPI and the price indices in the PMI and ISM data.
And these are just the two largest known issues. Less probable, but potentially highly significant, we could see increased tension in US-China relations, with a stepped-up trade war, or even a confrontation over the situation in Taiwan. Neither can one rule out more mischief from Russia, or Middle Eastern strife that could easily impact the supply of oil and hence its price. The point is, it seems early to declare that the worst is behind us and price securities and risk as though that is the case.
Market activity today is relatively muted as investors and traders await the latest word(s) from Madame Lagarde and the ECB. Expectations are there will be no changes to policy, but the real hope is that she will give clearer guidance on their plans going forward. You may recall at the last meeting they expressed some dismay that bond yields had risen as much as they had and promised to increase PEPP purchases. Since then, while they have increased those purchases, the amount of increase has been less than impressive and yields in Europe, while not rising further, have not returned to previous lower levels. At the same time, as US yields have fallen back more than 20bps from their recent highs, the euro (+0.2%) has resumed its climb and is back above 1.20 for the first time since early March. One thing we know is that the ECB can ill afford a stronger euro, so some type of response may be forthcoming.
Speaking of central banks, yesterday’s big surprise came from north of the border as the Bank of Canada, while leaving policy on hold, changed their tune on the timing for the end of QE. They brought forward their tapering timeline and the market brought forward the rate hike timeline in response. It seems that the employment situation in Canada has returned far closer to pre-Covid levels than in the US, with more than 90% of the jobs lost having been regained. While CAD has given up 0.1% this morning, this is after a nearly 1.0% rise yesterday in the wake of the BOC announcement.
A quick look at equity markets around the world shows that Asia had a pretty good session (Nikkei +2.4%, Hang Seng +0.5%, Shanghai -0.25%) while Europe is all green and has been steadily climbing all day (DAX +0.45%, CAC +0.6%, FTSE 100 +0.1%). US futures, however, are ever so slightly softer, down about 0.15% across the board, although this was after solid rallies yesterday afternoon. Meanwhile, bond markets are under the barest of pressures with yields edging higher in the US (+0.5bps) and Europe (Bunds +0.4bps, OATs +0.8bps, Gilts -0.4bps), really showing a market waiting for the next piece of data.
Energy prices are under modest pressure this morning (WTI -0.5%), as are precious metals (Au -0.3%, Ag -0.6%) and industrials (Cu 0.0%, Zn -0.2%, Al -0.2%).
It can be little surprise that the dollar is mixed this morning, given the lack of a coherent market theme, although there are some modest surprises. NOK (+0.25%) for example is stronger in the face of weaker oil prices. Meanwhile NZD (-0.3%) is the weak link in the G10, on the back of market internals and stop-loss selling. EMG currencies have a few more substantial movers with RUB (+1.25%) the leading gainer by far after President Putin’s state of the nation address focused entirely on domestic issues rather than feared saber rattling. This encouraged bond buying and strength in the ruble. On the other end of the spectrum is TRY (-0.8%) which has seen further investor outflow after reports that the US administration is prepared to raise the issue of the Armenian genocide and put further pressure to isolate President Erdogan. However, away from those two movers, the rest of the bloc is +/- 0.2% or less.
Aside from the ECB meeting, the US data slate brings Initial Claims (exp 610K), Continuing Claims (3.6M), Leading Indicators (1.0%) and Existing Home Sales (6.11M). Clearly the Claims data is the most important of the bunch with a strong number possibly helping to halt the Treasury rally and potentially support the dollar. We are in the Fed quiet period, so no speakers there.
The rest of the day will take its tone from Madame Lagarde, but if she is less than forceful, I would expect the current trend (modestly lower yields, modestly higher equities and modestly weaker dollar) to continue.
Good luck and stay safe
Adf
fxpoetry 