Tag Archives: #Powell

Clearly Reviving

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
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Kept at Bay

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

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

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

With that in mind, here are the latest expectations:

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

Source: Bloomberg

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
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Disinflation’s Deceased

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
Adf

No Need to be Austere

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

No line in the Sand

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Will Not Be Deterred

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There once was a really big boat
Designed, lots of cargo, to tote
But winds from the west
Made it come to rest
Widthwise in the Suez, not float

A mammoth cargo ship, the Ever Given has run aground in the Suez Canal while it was fully laden and heading northbound toward the Mediterranean Sea.  The problem is that, at over 400 meters in length, it is blocking the entire waterway in both directions.  The resulting traffic jam has affected more than 100 ships in both directions and could take several days to unclog.  As a point of interest, roughly 12% of global trade passes through the Suez each year, including 1 million barrels of oil per day and 8% of LNG shipments.  The market impact was seen immediately in oil prices which jumped more than 3%, although remain just below $60/bbl after the dramatic sell-off seen in crude during the past week.  Canal authorities are working feverishly to refloat the ship, but given its massive weight, 224,000 tons, they don’t have tugboats large enough to do the job on site.  While larger tugs are making their way to the grounding, things will be messy for a while.  Do not be surprised if oil prices continue to climb in the short run.

The ECB picked up the pace
Of purchases as they embrace
The call to do more
Or else, answer for
The failure in Europe’s workplace

Meanwhile, from the House what we heard
Was Powell will not be deterred
From keeping rates low
If prices do grow
While Janet, on taxes, deferred.

Looking beyond the ship’s bow to the rest of the world, the two key stories so far this week have been the data from the ECB about increased QE purchases, as well as the joint testimony at the House of Representatives by Powell and Yellen.  Regarding the ECB, they announced they had purchased €21 billion in bonds last week, up 50% from the previous weekly pace of €14 billion, and exactly what one would expect given Madame Lagarde’s promise of an increased pace of buying.  Unfortunately for the ECB, European sovereign bond yields rose between 10-15 basis points while they were increasing purchases, as they followed US Treasury yields higher.  The problem for the ECB is that if Treasury yields do continue to rally (and while unchanged this morning, they have fallen back by 13 basis points since Friday’s peak), it is entirely realistic that European bonds will see the same price action regardless of the ECB’s stepped up purchases.  Of course, that is the last thing the ECB wants to see in their efforts to stimulate both growth and inflation.  Essentially, what this tells us is that the ECB does not really have the ability to guide the market in a direction opposite the global macro factors.  Perhaps, whatever it takes is no longer enough!

As to the dynamic duo’s testimony, there was really nothing surprising to be learned.  Powell continues to explain that while things are looking better, the Fed’s focus is on the employment situation and they won’t stop supporting the economy until all the lost jobs are regained.  As to inflation, he pooh-poohed the idea that a short-term burst in prices will have any impact on either inflation expectations or actual longer-term inflation outcomes.  In other words, he has been completely consistent with the FOMC statement and press conference.  As to the diminutive one, she promised that more spending was coming, but that it would be necessary to raise taxes on some people as well as the corporate tax rate.  The working assumption seems to be that corporate taxes are due to head to 28%, from the current 21% level, in the next big piece of legislation.  After that, they both had to defend their positions from rank political comments by Congressfolk trying to burnish their own credentials.

And in truth, those are the stories that are top of the list today, showing just how dull things are in the markets.  However, with that in mind, following yesterday’s late day sell-off in US equities, Asian equities were pretty much lower across the board (Nikkei -2.0%, Hang Seng -2.0%, Shanghai -1.3%) and Europe is entirely in the red as well, albeit not nearly as severely (DAX -0.6%, CAC -0.3%, FTSE 100 -0.3%).  And all this equity price action is despite the fact that PMI data from Japan and Europe was far better than expected, with, for example German Mfg PMI posting a 66.6 reading and Eurozone Mfg posting at 62.4.  Services remains much weaker, but in all cases, the outcomes were better than forecast, although still just below the 50.0 level.  It seems that there is more to the current level of fear than the data.  As to the US, futures here are higher led by the NASDAQ (+0.7%) with the other two major indices up by a more modest 0.3%.

In the bond market, Treasuries are seeing a bit of selling pressure as NY walks in, although the 10-year yield is only higher by 0.5bps.  Meanwhile, in Europe, there is a very modest bond rally (Bunds -1.3bps, OATs -1.4bps, Gilts -0.7bps) which is consistent with the modest risk off theme in equity markets there.  Price action in Asian bond markets, though, has been a bit more frantic with NZD bonds soaring (yields -15.7bps) as investors continue to respond to the government’s efforts to rein in housing prices, thus slowing inflation pressures.  This helped Aussie bonds as well, although yields there only fell 8 basis points.  The one truism is that bond market activity is far more interesting than equity market activity right now.

In the commodity markets, aside from oil’s rally on the supply disruption caused by the ship, price action has been far less significant.  Metals prices are very modestly higher (CU +0.35%, AL +2.1%, AU +0.2%) while the agricultural space is mixed, with a range of gainers and losers.

And finally, in the FX markets, the dollar is broadly stronger this morning, although not universally so.  In the G10, only NOK (+0.6%) and CAD (+0.1%) are firmer with the former clearly responding to higher oil prices, but also to a growing belief that the Norgesbank will be the first G10 bank to raise interest rates.  Meanwhile, the BOC, yesterday, explained that they were immediately stopping the expansion of their balance sheet, halting all programs, so also moving toward a tightening bias.  However, the rest of the bloc is softer, albeit by fairly modest amounts led by GBP (-0.3%) which posted lower than expected inflation readings.

Emerging market currencies are split in their behavior with ZAR (+0.9%), MXN (+0.7%) and RUB (+0.4%) all benefitting from the rising commodity price story while virtually every other currency in both APAC and the CE4 are softer on the decline in risk sentiment.  The one thing that is abundantly clear is that the EMG currencies are following the big risk meme.

Turning to this morning’s data releases, we see Durable Goods (exp 0.5%, 0.5% ex transport) and the preliminary PMI data (Mfg 59.5, Services 60.1).  Yesterday’s New Home Sales data disappointed at just 775K but was chalked up to a lack of supply.  It seems the supply of available housing is at generational lows these days, while prices rise sharply on the back of a doubling of lumber costs.  We also hear from Powell and Yellen again, this time at 10:00am in the Senate, but there is no reason to believe that anything different will be said.  In addition, four more Fed speakers will be heard, although the message continues to be consistent and clear, rates are not going to rise until 2023 earliest, no matter what happens.

For now, the dollar is benefitting from the market’s risk aversion, however, if Treasury yields fall further, I expect that the dollar will lose its luster and equities will find their footing.  On the other hand, if this is the temporary lull before the next lurch higher in yields, look for the dollar to continue to rally.

Good luck and stay safe
Adf

The Worry du Jour

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The Treasury Sec and Fed Chair
This morning are set to declare
While things are improving
They’re not near removing
The stimulus seen everywhere

Meanwhile, other Fedsters explained
Inflation may not be constrained
Though they’re all quite sure
The worry du jour
Will pass and cannot be sustained

While last week was actually Fed week, with the FOMC meeting and Powell press conference already six days past, it is starting to feel like this week is Fed week.  We have so many scheduled appearances by a wide range of Fed governors and regional presidents, as well as by Chairman Powell, that the Fed remains the primary theme in the markets.  Now, in fairness, the Fed has been a dominant part of any market discussion for the past decade plus (arguably since the GFC in 2008), but I cannot remember a week with this many Fed speeches lined up.

Of course, the question is, will we learn anything new from all these speeches?  And the answer, sadly, is probably not.  Chairman Powell and his acolytes have made it clear that they are not going to raise the benchmark Fed Funds rate until somewhere in the late 2023/early 2024 timeframe, and in any case, not until they see actual data, not forecasts, that unemployment has fallen and prices are rising.  With that as a given, the only question unanswered is about the back end of the Treasury curve, where 10-year yields have risen more than 70 basis points so far in 2021, although are lower by about 5bps this morning.  With the 2-year Treasury note stuck at about 0.15%, the steepening of the yield curve has been dramatic so far, but it must be remembered that historically, when the yield curve starts to steepen, it has gone much further than the moves so far, with a 2yr-10yr spread of 275 basis points quite common.  Compared to the current reading of 150 basis points, and assuming the 2-year won’t be moving, that implies the 10-year Treasury could well move to a yield of 2.90%!

One of the key features driving equity market performance during the pandemic has been the promise of low rates forever, as any discounted cash flow analysis of a company’s future earnings was using a discount rate approaching 0.0%.  However, if 10-year yields rise that much (which implies 30-year yields will be somewhere in the 3.50%-4.0% area), it will be far more difficult to justify the current market valuations and we could well see some corrective price action in the stock market.  (That is a euphemism for stocks would tank!)  Now, if stocks were to correct lower, that would have an immediate impact on financing conditions, tightening them substantially, which in conjunction with rising back end yields would move the Fed away from its preferred stance of easy money.  Seemingly, it will be difficult for the Fed to allow that to occur and remain consistent with their stated objectives.

So, what might they do?  Well, this is the argument for yield curve control (YCC), that the Fed cannot simply allow the market to dictate financing terms during the recovery.  And it is the crux of the weaker dollar thesis.  But so far this week, as well as Chairman Powell, we have heard from governor Michelle Bowman and Richmond Fed president Tom Barkin, and not one of them has even hinted they are concerned with the rise in the back end.  As long as that remains the case, I expect that equity markets will have difficulty moving higher and I expect the dollar to benefit.  We have previously discussed the fact that the carrying costs of Treasury debt as a percentage of GDP is currently declining due to the dramatic decline in interest rates, and that Secretary Yellen has explicitly highlighted that issue as a reason to be unconcerned with additional borrowing.  Arguably, for as long as Yellen is okay with rising yields, the Fed will be okay as well.  But at some point, it certainly appears likely that a very steep yield curve will not fit well with the recovery thesis and the Fed will be forced to act.  However, until then, let us take them at their word and assume they are comfortable with the current situation.  We hear from nine more individual speakers this week across 18 different venues, including Powell and Yellen testifying to the House today and the Senate tomorrow, so by the end of the week, if there are even subtle shifts in view, we should have an idea.

As to today’s session, risk is under some pressure with equity markets having fallen throughout Asia (Nikkei -0.6%, Hang Seng -1.3%, Shanghai -0.9%) and all red in Europe as well (DAX -0.6%, CAC -0.7%, FTSE 100 -0.5%).  US futures are also pointing lower with declines on the order of 0.3% – 0.5% across the major indices.  It is also worth noting that prices have been softening over the past hour or two, which is different price action than we have seen lately, where early losses tend to be erased.

Bond markets are clearly demonstrating their haven status this morning with European sovereigns all seeing yield declines (Bunds -3.5bps, OATs -3.3bps, Gilts -4.1bps) which is right in line with the Treasury story, where 10-year yields have fallen 6.5bps now.

Commodity prices are also under pressure, with oil (-3.75%) back below $60/bbl and testing some key technical support levels.  Meanwhile, base metals are softer (copper 1.4%, Aluminum -1.7%) although the grains are mixed.  Finally, gold has bounced back from early declines and is up a scant 0.1% at this hour.

Turning to the dollar, it is stronger pretty much across the board, with JPY (+0.3%) the only G10 currency able to gain, and simply demonstrating its haven characteristics.  Otherwise, NZD (-1.7%) is the laggard, followed by AUD (-1.0%) and NOK (-0.8%).  While the NOK is obviously being undermined by oil’s decline, the NZD story revolves around an announcement that the government is going to try to rein in housing price increases, which have seen prices rise 23% in the past year, as they try to stop a housing bubble.  (Of course, they could simply raise rates to stop it, but that would obviously impact other things.)  However, the result was an immediate assessment of declining inward investment, hence the kiwi’s decline.  But away from the yen, the rest of the space is down at least 0.4%, so this is broad-based and significant.

Emerging market currencies are similarly under virtually universal pressure, with major losses seen in RUB (-1.4%), ZAR -1.1%) and MXN (-1.0%).  Obviously, these are all impacted by the decline in oil and commodity prices and will continue to be so going forward.  The CE4 are all much weaker as well, showing their high beta to the euro (-0.45%) and I would be remiss if I left out TRY (-0.9%) which was actually higher earlier in the session on what appears to have been a dead-cat bounce.  TRY has further to fall, especially if risk is being unwound.

On the data front, New Home Sales (exp 870K) are the main release, although we also see the Richmond Fed Manufacturing Index (16), a less widely followed version of Philly or Empire State.  But really, I expect the day’s highlight will be the Powell/Yellen testimony, and arguably, the Q&A that comes after their opening statements.  While most Congressmen and women consistently demonstrate their economic ignorance in these settings, there are a few who might ask interesting questions.  But for now, there is no change on the horizon, so there is no cap on yields. While they are falling today, they have plenty of room to rise, and with them, so too the dollar.

Good luck and stay safe
Adf

Flames of Concern

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In Turkey, the president canned
The central bank chief, and has fanned
The flames of concern
As traders now spurn
The lira in lieu of the rand

The top FX story this morning clearly revolves around the abrupt firing of the Turkish central bank’s governor, Naci Agbal, after he had the audacity to raise rates a surprising 2.0% last week in his effort to combat rising inflation.  The market had applauded the rate move and TRY had risen sharply, more than 4%, in the aftermath.  Unfortunately for him, Turkish president Erdogan is strongly of the opinion that rising inflation is caused by higher interest rates and is adamantly against the idea of raising rates.  (It appears that Erdogan is an MMTer at heart).  Arguably this is because it costs his government more to borrow for his spending plans, but whatever the rationale, this is at least the second central bank governor he has fired after a rate hike.  It cannot be a surprise that the lira has fallen dramatically in markets this morning and is down more than 10% as I type.  I highlight this to remind readers that abrupt and very large movements remain quite feasible in the FX markets.

Meanwhile, it’s the Treasury bond
About which most markets respond
Two camps have emerged
Where one side has urged
A cap, while the other side’s yawned

But really, the story that matters the most in markets right now continues to be the future price action in US Treasury markets.  The battle lines have been drawn with the inflationistas convinced that the combination of massive money printing by the Fed (M2 +25.8% Y/Y as of January 31) combined with the recently passed $1.9 trillion Covid bill is going to lead to significant price rises and much higher yields in the bond market.  In this camp, many expect the Fed to be forced to cap yields, either tacitly, by extending the maturity of QE purchases, or explicitly by telling us so, thus driving real yields lower and the dollar down as well.

In the other camp are the deflationists, a shrinking group, who nevertheless believe that the underlying drivers of declining inflation over the past 40 years; namely globalization, technology and demographics, remain firmly in place and will reassert themselves in the medium term.  This camp will also point to the fact that the ratio of interest payments to GDP, a key metric determining the affordability of government debt loads, continues to decline in the US and so a short-term rise in Treasury yields is no cause for concern.   Arguably, Treasury Secretary Yellen lives in this camp as she has consistently expressed her belief that the risks to the economy now are not doing enough to support growth and has been completely unconcerned with the rapid growth of Treasury debt to fund the serial government programs that have been enacted.  In this telling, the current price action in bonds is temporary and will soon be corrected as it becomes clear inflation is not a significant problem.

Ultimately, what this means is that the rest of us are beholden to the outcome of this situation and need to remain vigilant for clues as to how the situation will evolve.  Perhaps this week we will get some clues, if not from the data, then from the twenty-two different Fed speeches that are on the calendar.  Almost every FOMC member will be regaling us with their views following last week’s FOMC meeting.  In fact, the first, Richmond Fed president Barkin, has already spoken overnight and dismissed concerns over rising yields as an issue, rather explaining they were a vote of confidence in the economy and no problem at all.  We shall see!

Ok, on to markets, where the overriding theme is… there is no theme.   Equity markets were mixed overnight (Nikkei -2.1%, Hang Seng -0.4%, Shanghai +1.1%) and European bourses are showing a similar spread (DAX +0.25%, CAC -0.25%, FTSE 100 0.0%). US futures?  Same thing here with NASDAQ up 0.8% while DOW futures are slightly softer, -0.1% and SPUs are +0.1%.

Bond markets, however, are rallying somewhat after last week’s gyrations with the 10-year Treasury yield down 4.6bps and back below 1.70%.  The yield declines in Europe are far more muted (Bunds -1.5bps, OATs -1.0bps, Gilts -1.5bps) although we did see JGB’s (-2.9bps) rally last night.  If pressed, I would say that investors, given the lack of theme are taking advantage of the recent rise in yields to earn a bit more.

In the commodity space, earlier price action saw much deeper declines, but as New York is walking in, oil (-0.2%) is just marginally lower; gold (-0.4%) has retraced some early losses and the base metals are mixed at this time with copper (+0.6%) higher while aluminum (-0.2%) is lagging.

Finally, looking at the dollar, aside from TRY’s collapse, the rest of the EMG space is far less dramatic with MXN (-0.75%) the laggard on a combination of weaker oil and the ongoing border crisis being seen as a negative for the economy there.  On the positive side, the gains are de minimis (PLN +0.3%, KRW +0.25%, PLN +0.2%) with CE4 currencies tracking the euros modest gains and Korea benefitting from comments about a faster than previously expected recovery.

G10 currencies, which had been mixed earlier, have started to gain a bit, led by CHF (+0.3%) and SEK (+0.3%) although the rest of the bunch have seen much smaller movement overall.  The interesting CHF story was that the SNB executed $118 billion of FX intervention last year, which may come under further scrutiny by the US Treasury given the fact that Switzerland was named a currency manipulator last year.  In the end, though, given the remarkably small size of the Swiss economy, it is hard to believe that there has been any real impact on the US economy by their actions.  The SNB meets this week and will almost certainly defend their activities as a requirement to prevent further strength in the currency which could drive a significant deflationary spiral, at least so they believe.

On the data front, there is a good deal coming up as follows:

Today Existing Home Sales 6.49M
Tuesday Current Account Balance -$188.3B
New Home Sales 873K
Wednesday Durable Goods 0.7%
-ex transport 0.6%
PMI Manufacturing (prelim) 59.5
Thursday Initial Claims 730K
Continuing Claims 4.0M
GDP Q4 4.1%
Friday Personal Income -7.2%
Personal Spending -0.8%
Core PCE Deflator 1.5%
Michigan Sentiment 83.6

Source: Bloomberg

In truth, the Friday data seems the most important, as the Personal Spending and PCE are keys being watched most closely.  We all know that the housing market is hot, and that PMI is likely to be strong as the economy reopens.  But what will happen with the Fed’s key measure of inflation?

And then, amidst all the Fed speak, we have Chair Powell in two joint appearances with Treasury Secretary Yellen, first before the House tomorrow and then the Senate on Wednesday, but given the sheer breadth of commentary we are going to hear, it will be important to see if a theme regarding the bond market’s recent declines with ensuing yield increases becomes a key topic.  Certainly, market participants are highly focused on the subject.

So, adding it all up, we have a decent amount of data and a lot of Fed speakers coming our way.  As I strongly believe the dollar’s direction will be driven by the bond market for the near-term, at least, listen carefully to those comments.  Powell actually starts the commentary this morning at 9:00.  The more unconcerned the Fed speakers are with rising yields, the more likely, in my estimation, the dollar is to rise.

Good luck and stay safe
Adf

His New Paradigm

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No longer will we
Buy stocks every month.  Instead
We will surprise you

Last night, the final major central bank meeting of the week was held, and in it the BOJ announced the results of its policy review.  The two most notable features of this review were the scrapping of the annual ¥6 trillion target of equity ETF purchases, although they did explain that if they felt it necessary and conditions warranted, they could purchase up to ¥12 trillion, and a formalized range of the targeted yield in 10-year JGB’s at 0.25% either side of 0.00%.  As an addendum, they also indicated that any equity purchases going forward would be linked to the TOPIX Index, which tracks the entire first section of the Japanese stock market, rather than the Nikkei 225, which is far more concentrated.  Remember, one of the concerns registered by investors has been that the BOJ is not only the largest holder of JGB’s, but also the largest holder of Japanese equities in the country/world.  Regarding the JGB market, the market’s working assumption has been the acceptable trading range was +/- 0.20%, so this is a bit wider despite Kuroda-san’s insistence that nothing had changed.

In what cannot be a terribly surprising outcome, the Nikkei 225 fell on the news, -1.4%, although the TOPIX actually edged higher by 0.2%.  I guess when the biggest, and least price sensitive, buyer shifts from one index to another, this outcome is to be expected.  As to the JGB market, pretty much nothing happened with yields rising a scant 0.5bps and well within the new formal range at +0.10%.  Finally, the yen is essentially unchanged on the day as well, although the dollar’s broad-based strength of the past several weeks has really helped the BOJ here as the yen has declined more than 5% year-to-date, something the BOJ had been singularly unable to engineer on its own.

The bond market wasted no time
In forcing a major yield climb
Responding to Jay
And all he did say
Defining his new paradigm

While Treasury yields have backed off a touch this morning, the damage has clearly been done by Chairman Powell.  His Wednesday press conference, where he doubled down on just how dovish he was going to remain regardless of the bond market’s performance, has set the stage for what will ultimately be his biggest test.  After all, as a policy response, it is not a great leap to dramatically cut interest rates in the face of a pandemic driven economic collapse. However, once a policymaker insists that they are unconcerned with inflation and they are going to allow the economy to “run hot” for a while, it is a MUCH harder problem to determine when too much movement has occurred and to rein in potential excesses that can prevent the ultimate goals from being reached.

It is this set of conditions in which we currently find ourselves and which will be the lead story for months to come.  If history is any guide, the bond market will continue to sell off, ostensibly on the back of stronger economic data, but in reality, as an ongoing test of Powell and the new Fed stance.  Jay was extremely clear on Wednesday that he was unconcerned with the movement in the bond market, describing financial conditions as very accommodative.  Starting next month, the inflation data is going to be rising much more rapidly as the comparison from 2020 will show much stronger price pressures on a Y/Y basis.  This is THE battle for the next six months, with all other markets destined to react to the outcome.

The two possible outcomes shape up as follows: the Fed will be forced to respond to rising yields as the pressure on the Treasury grows and financing costs increase too rapidly thus resulting in expanded QE, Operation Twist, or YCC; or Powell stays true to his word and allows 10-year yields to rise much higher (think 2.8%-3.0%) with a corresponding steepening in the yield curve which drives the equity bus over a cliff and forces a Fed response to a cratering stock market under the guise of tightening financial conditions that need to be addressed.  Through our FX lens, the first will result in the dollar topping out much sooner than the second, as it will cap real yields and ultimately send them farther into negative territory.  But in either case, it appears that the dollar has room to run for the time being.  It will be an epic battle and my money is on the market forcing the Fed to blink before they would like.

Now to today’s markets.  After yesterday’s tech led US sell-off, we already saw that Japanese stocks were under pressure, but there was weakness across the board in Asia (Hang Seng -1.4%, Shanghai -1.7%) and we are entirely red in Europe as well (DAX -0.4%, CAC -0.4%, FTSE 100 -0.6%).  US futures, on the other hand, are pointing higher at this hour, up between 0.2%-0.5%.  We shall see if that holds up.

Bonds have reversed some of yesterday’s declines (higher yields) with Treasuries 1 basis point lower and European sovereigns seeing larger yield declines (Bunds -3bps, OATs -3bps, Gilts -4.5bps).  However, if the Treasury market resumes its decline, I would expect European yields to track higher as well, albeit at a slower pace.

Oil prices got smoked yesterday, falling more than 10% at one point before closing down 7.5% on the day.  That puts this morning’s modest 0.6% rise into context.  It appears that the oil market had gotten a bit ahead of itself.  As to the rest of the commodity bloc, metals are generally lower this morning although most ags are firmer.

Finally, the dollar is beginning to edge higher as New York walks in, with SEK (-0.3%) and NOK (-0.25%) leading the way down, although the entire G10 bloc in negative territory.  As neither nation had new news, these moves appear to be simple follow-ons to the resuming dollar trend of modest strength.  The EMG space is a bit different, with several currencies faring well this morning, notably TRY (+1.15%) on continued buying after the surprising rate hike, and MXN (+0.65%) as traders start to bet on Banxico raising rates more aggressively, following in the footsteps of Brazil.  On the downside, KRW (-0.6%) essentially gave up yesterday’s gains on the broad risk-off sentiment in Asia, which also dragged TWD (-0.5%) lower.  After that, the bulk of the movement in this space has been modest, at best, in either direction.

There is no US data to be released today, and no Fed speakers either.  Rather, the big story in the market is the triple witching in equities (expiration of options, futures and futures options), which oftentimes has a significant market impact.  And meanwhile, all eyes will remain on the Treasury market, as it is currently the single most important signal available.

Good luck, good weekend and stay safe
Adf

Tempting the Fates

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What everyone now can assume
Is Jay and his friends in the room
Will never raise rates
Thus, tempting the fates
In search of a ne’er ending boom

Well, that’s that!  To anyone who thought that the Fed was concerned over rising back-end yields and a steeper yield curve, Chairman Powell made it abundantly clear that it is not even on their radar.  No longer will the Fed be concerned with mere forecasts of economic strength or pending inflation.  As in the Battle of Bunker Hill, they will not “…fire until they see the whites of [inflation’s] eyes”.   “Until we give a signal, you can assume we are not there yet,” Powell explained when asked about the timing of tapering asset purchases and tightening policy.  It would seem that is a pretty clear statement of intent on the Fed’s part, to maintain the current policy for years to come.

To recap, the Fed raised their forecasts for GDP growth to 6.5% in 2021, 3.3% in 2022 and 2.2% in 2023, while increasing their inflation forecasts (core PCE) to 2.2%, 2.0% and 2.1% respectively for the same years.  Finally, their view on unemployment adjusted to 4.5% this year with declines to 3.9% and 3.5% in ’22 and ’23.  All in all, they have quite a rosy view of the future, above trend growth, full employment and no inflation.  I sure hope they are correct, but I fear that the world may not turn out as they currently see it through their rose-tinted glasses.  The market’s biggest concern continues to be inflation, which, after decades of secular decline, appears to be at an inflection point for the future.  This can be seen in the bond market’s reaction to yesterday’s activities.

Prior to the FOMC statement, (which, by the way, was virtually verbatim with the January statement, except for one sentence describing the economic situation), risk was under pressure as equity markets were slipping, 10-year Treasury yields were rallying to new highs for the move and the dollar was firming up.  But the statement release halted those movements, and once the press conference got underway, Powell’s dovishness was evident.  This encouraged all three markets to reverse early moves and stocks closed higher, bonds flat and the dollar softer.  It seems, there was a great deal of positive sentiment at that time.

However, over the ensuing 16 hours, there has been a slight shift in sentiment as evidenced by the fact that the 10-year Treasury is now down 2/3’s of a point with the yield higher by 8 basis points, rising to 1.72%.  This is the highest yield seen since January 2020, pre-pandemic, but certainly shows no sign of stopping here.  In fact, 30-year Treasuries now yield 2.5%, their highest level since July 2019, and here, too, there is no evidence that the move is slowing down.  If anything, both of these bonds appear to be picking up speed in their race to higher levels.  Meanwhile, TIP yields are climbing as well, but not quite as quickly taking the 10-year breakeven to 2.31%.  In other words, that is the market forecast for inflation.  FYI, this is the highest level in this measure since May 2013.  As mentioned above, it appears there is a secular change in inflation on the way.

Perhaps what makes this most remarkable is the dramatic difference in the Fed’s stance and that of some other major central banks.  On the one hand, Madame Lagarde informed us last week that the ECB would be speeding up their PEPP purchases to counter the effect of rising yields.  Again, this morning she explained, “what we are responding to is a yield increase that could get ahead of the expected economic recovery.”   On the other hand, the Norges Bank, while leaving rates on hold at 0.00% this morning predicted it would start raising rates in the “latter half” of this year, far sooner than previous expectations.  Meanwhile, in the emerging markets, we have an even more aggressive story, with the Banco Central do Brazil raising the overnight SELIC rate by a more than expected 0.75% last night, as despite Covid continuing to ravage the country and the economy stuttering, inflation is starting to move higher at a faster pace.

The point here is that after almost a full year of synchronous monetary policy around the world, things are starting to change at different rates in different places.  The one thing almost certain to follow from this change in policies is that market volatility, across all asset classes, is likely to increase.  And since most markets either get measured in dollars, or versus dollars, and the inherent volatility in the US bond market is increasing, we may soon be testing central bank limits of control, especially the Fed’s.  After all, if the 2yr-10-yr spread widened to 2.75%, a level it has reached numerous times in the past, will the Fed remain sanguine on the subject?  Will the stock market implode?  Will the dollar race higher?  These are the questions that are likely to be on our lips going forward.  The fun is just beginning as the Fed embarks on its new policy roadway.

With all that in mind, what is this morning’s session doing?  Based on the different central bank activities, things are performing as one would expect.  The initial warm glow following the FOMC meeting followed into Asia with gains in most major markets there (Nikkei +1.0%, Hang Seng +1.3%, Shanghai +0.5%) although Australia’s ASX 200 fell 0.7% during the session.  Meanwhile, Lagarde’s comments, reiterating that the ECB would be buying more bonds has encouraged equity investors in Europe with gains across the board led by the DAX (+1.2%), although the rest of the set are far less impressive (CAC +0.25%, FTSE 100 +0.1%).  However, US futures tell a different story, as the rising long bond yields are continuing to have a severe impact on the NASDAQ with futures there -1.0% and dragging SPX (-0.3%) down with it although DOW futures have actually edged higher by 0.2%.  This is the ongoing rotation story, out of growth/big tech and into value and cyclical stocks.

In the bond market, the damage is severe with Treasuries leading the way followed by Gilts (+5.5bps) as the market awaits the BOE meeting results, and then much smaller rises in yields on the continent (Bunds +2.6bps, OATs +1.9bps, Italian BTPs +1.7bps) as traders recognize that the ECB is going to prevent a dramatic decline there.

Perhaps the most surprising outcome this morning is in the commodity bloc, where virtually all commodity prices are lower, albeit not by too much.  Oil (-0.3%), gold (-0.5%) and copper (-0.3%) are uniformly under pressure.  This could be a response to the Fed’s benign inflation forecasts, but I think it is more likely a response to the dollar’s strength.

Speaking of the dollar, it is mostly stronger this morning, recouping the bulk of yesterday afternoon’s losses.  In the G10, only AUD (+0.25%) is higher of note after the employment report released overnight showed far more strength than expected (Unemployment Rate fell to 5.8%).  But otherwise, the rest of the bloc is under pressure, once again led by SEK (-0.45%) and CHF (-0.35%), with both currencies seeing outflows on the back of higher USD yields.  In the EMG bloc, TRY (+2.0%) has just jumped higher after the central bank there surprised the market and raised rates by 2.0% rather than the 1.0% expected.  So, like Brazil, despite economic concerns, inflation is rearing its ugly head. However, beyond that, last night saw strength in KRW (+0.6%) after the BOK indicated they will not allow excessive market volatility (read declines) in the wake of the FOMC meeting.  And that was really the extent of the positives.  On the downside, PLN (-0.9%) is the laggard, as the market is concerned over additional Covid closures slowing any comeback and encouraging easier monetary policy further into the future than previously thought.  The rest of the CE4 are in similar, if not as dire straits this morning as the euro’s softness is undermining the whole group.  As to LATAM, the peso is starting the day unchanged and the rest of the continent has not yet opened.

On the data front, today brings Initial Claims (exp 700K), Continuing Claims (4.034M), Philly Fed (23.3) and Leading Indicators (0.3%).  In addition, we hear from the BOE, with no policy change expected, and then Chairman Powell speaks around noon at the BIS conference.  My guess is that there will be a great deal of interest in what he has to say and if he tries to walk back the idea that the Fed is comfortable with the yield curve steepening as quickly as it is. One thing to recognize is that markets can move much faster than anticipated when given a green light.  With the 10-year yield currently at 1.737%, a move to 2.0% by the end of the month is quite realistic.  And my sense is that might raise a few eyebrows at the Mariner Eccles building.

As to the dollar, follow the yields.  If they continue to rise, so will the dollar.  If they stop, I expect the dollar will as well.

Good luck and stay safe
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