Protests Are Growing

In China the growth impulse waned
As policy makers have strained
To maintain control
While reaching the goal
Of growth that Xi has preordained

In other news protests are growing
By pundits that markets are showing
Too much in the way
Of rate hikes today
Since wags think inflation is slowing

Risk is getting battered this morning, but interestingly, so are many havens.  It seems that the combination of slowing growth and higher inflation is not all that positive for assets in general, at least not financial ones.  Who would have thunk it?

Our story starts in China where Q3 GDP was released at a slower than expected 4.9% down from 7.9% in Q2 and 18.3% in Q1.  If nothing else, the trend seems to be clear.  And, while Retail Sales there rose a more than expected 4.4%, IP (3.1%) and Fixed asset Investment (7.3%), the true drivers of the Chinese economy, both slumped sharply from last quarter and were well below estimates.  In other words, the Chinese economy is not growing as quickly as the punditry, and arguably, the market had expected.  This is made clear by the ongoing lackluster performance in Chinese equity markets which are also being accosted by President Xi’s ongoing transformation of the Chinese economy to one more of his liking.  (In this vein, the latest is the attack on the press such that all media must now be state-owned.  Clearly there is no 1st Amendment there.)  Of course, if the press is state-controlled, it is much easier for the government to prevent inconvenient stories about things like Evergrande from becoming widespread inside the country.  That being said, we know the Evergrande situation is under control because the PBOC told us so!

Ultimately, this matters to markets because China has been a significant growth engine for the global economy and if it is slowing more rapidly than expected, it doesn’t bode well for the rest of the world.  Apparently ongoing energy shortages in China continue to wreak havoc on manufacturing companies and hence supply chains around the world.  But don’t worry, factory gate inflation there is only running at 10.7%, so there seems little chance of inflationary pressures seeping into the rest of the world.  In the end, risk appetite is unlikely to increase substantially if the narrative turns to one of slower growth ahead, unable to support earnings expectations.

With this in mind, it is understandable why equity markets are under pressure this morning which has been true in almost every major market; Nikkei (-0.15%), Shanghai (-0.1%), DAX (-0.5%), CAC (-0.8%), FTSE 100 (-0.2%). US futures (-0.3%), with only the Hang Seng (+0.3%) bucking the trend.  Funnily enough, though, bond markets are also under universal pressure (Treasuries +4.4bps, Bunds +4.4bps, OATs +4.7bps, Gilts +6.7bps, Australia GBs +9.0bps, China +5.3bps, and the pièce de résistance, New Zealand +15.5bps) as it seems investors are beginning to fret more seriously over inflation and ensuing policy action by central bankers.

Yesterday, BOE Governor Andrew Bailey explained that the BOE will “have to act” to curb inflationary forces.  That is a pretty clear statement of intent and one based on the reality that inflation is well above their target and trending higher.  Interest rate markets quickly priced in rate hikes in the UK with the first expected next month and a second by February.  In fact, by next September, the market is now pricing in 4 rate hikes, expecting the base rate to be 1.00% vs. the current rate of 0.10%.  In New Zealand, meanwhile, CPI printed at 4.9% last night, well above the expected 4.2% and the market quickly adjusted its views on interest rates there as well, with a 0.375% increase now price for the late November meeting and expectations that in one year’s time, the OCR (overnight cash rate) will be up at 1.95% compared to today’s 0.50%.

Naturally, this price action doesn’t suit the central bank narrative and so there has been a concerted push back on the higher inflation story from many sectors.  My personal favorite is from the pundits who are focusing on the Fed staff economists with the claim that they are far more accurate than the Street and their current forecast of 2022 inflation of 1.7% should be the baseline.  But we have heard from others with vested interests in the low inflation narrative like Blackrock (who gets paid by the Fed to manage the purchases of assets) as well as a number of European central bankers (Villeroy and Vizco) who maintain that it is critical the ECB keep policy flexibility when PEPP ends.  This appears to be code for ignore the inflation and keep buying bonds.

The point of today’s story is that the carefully controlled narrative that has been fostered by the central banking community is under increasing pressure, if not falling apart completely.  Markets are pricing in rate hikes despite protests by central bankers, as they see rising inflation trends as becoming much more persistent than those central bankers would like you to believe.  At this point, no matter what inflation statistic you consider (CPI, PCE, trimmed-mean CPI, median CPI, sticky CPI) all are running well above the Fed’s 2.0% target and all are trending higher.  The same situation obtains in almost every major nation as the combination of 18 months of excessive money-printing and significant fiscal spending seems to have done the trick with respect to reviving both inflation and inflation expectations.  If I were the Fed, I’d be taking a victory lap as they have been fighting deflation for a decade.  Clearly, they have won!

So, if stocks and bonds are both falling, what is rising?  I’m sure you won’t be surprised that oil (+1.6%) is leading the way higher as demand continues to rise while supply doesn’t.  OPEC+ has refused to increase production any further and the US production situation remains under pressure from Biden administration policies.  While NatGas in the US is softer (-1.8%), in Europe, it is much firmer again (+16.2%) as Russia continues to restrict supply.  Precious metals remain unloved (Au -0.2%, Ag -0.2%) but industrial metals are firm (Cu +0.9%, Al +0.45%, Sn +1.2%) along with the agriculturals.

Finally, the dollar is definitely in demand rising against 9 of its G10 brethren (only NOK has managed to hold its own on the back of oil’s rally) but with the rest of the bunch falling between 0.1% and 0.5% on general dollar strength. After all, if neither NZD (-0.1%) nor GBP (-0.15%) can rally after interest rate markets have jumped like they have, what chance to other currencies have today?

EMG currencies are also under pressure this morning led by ZAR (-1.0%) and followed by MXN (-0.6%) with both falling despite rising oil and commodity prices.  Both seem to be suffering from a general malaise regarding EMG currencies as concerns grow that rising inflationary pressures are going to slow growth domestically, thus pressuring their central banks to maintain easier policy than necessary to fight rising inflation.  Stagflation is a b*tch.

Turning to the data front, this week sees much less of interest with housing being the focus:

Today IP 0.2%
Capacity Utilization 76.5%
Tuesday Housing Starts 1615K
Building Permits 16680K
Wednesday Fed Beige Book
Thursday Initial Claims 300K
Continuing Claims 2550K
Philly Fed 25.0
Leading Indicators 0.4%
Existing Home Sales 6.08M

Source: Bloomberg

On the Fed front, 10 more speakers are on the docket across a dozen different venues including Chairman Powell on Friday morning.  At this point, with inflation rising more rapidly than expected everywhere in the world and the market pricing in rate hikes far more aggressively than central banks deem appropriate, the case can be made that the central banks have lost control of the narrative.  I expect this week’s onslaught of commentary to try very hard to regain the upper hand.  However, as I have long maintained, at some point the Fed will speak and act and the market will not care.  We could well be approaching that point.  In that event, the only thing that seems certain is that volatility will rise.

As to the dollar today, I think we need to see some confirmation that this modest corrective decline is over, but for now, the medium-term trend remains for a higher dollar.  I see nothing to change that view yet.

Good luck and stay safe
Adf

Hikes Are Impending

In London on Threadneedle Street
The Old Lady’s not been discrete
Some hikes are impending
With rates soon ascending
Before they shrink their balance sheet

The BOE has made it quite clear that they are itching to raise interest rates pretty soon in order to address rising inflation.  Today’s employment data, which saw the Unemployment Rate fall to 4.5% while employment grew by 235K on a 3M/3M basis, has helped to cement the idea that the economy is continuing to rebound sharply and price pressures are likely to continue to grow.  With CPI at 3.2%, already well above the 2.0% target, and tipped to rise much further by the end of the year given the rapid rise in energy and commodity prices, the BOE has come to believe they need to do something to prevent inflation from getting out of control.  Unlike the Fed, the BOE has also indicated they are quite comfortable raising interest rates before shrinking their balance sheet back to pre-pandemic levels.

The risk they face, which has become the talk of the market today, is that by raising rates so soon, especially before the Fed acts, they will simultaneously destroy the nascent growth impulse while failing to address the cause of the inflation.  And in truth, that could well happen.  Alas, that is a result of trying to address a stagflationary environment with the limited tools available to a central bank.  For the time being, the biggest decision a central bank has is to determine which affliction is a bigger problem, rising prices or slowing economic activity.  Since this seems to be the situation in almost every developed nation, we are going to witness a lot of variations on this theme going forward.

The interesting thing about the pound is that its behavior amid pending rate hikes, as well as the market narrative about the pound, seems to be quite negative.  For some reason, there has been a connection made between an early rate hike in the UK and a falling pound.  This is opposite what we have seen in most other countries, where those rate hikes have been supportive of the currency as would normally be expected.  But there is now talk that the UK is going to make a policy error by tightening ahead of the Fed.  This argument seems specious, however, as economic growth has rarely been a short-term driver of exchange rates, while interest rate changes are critical.  The idea that suddenly traders and investors are critiquing the long-term ramifications of the BOE is preposterous.  Instead, I would offer that any pound weakness, although an early decline after the data release has already been reversed, is far more likely due to the dollar’s continuing broad strength.  So, as I type, the pound is essentially unchanged on the day.

Of course, this begs the question, is the Fed going to start to tighten policy with their potential tapering decision next month.  My answer is leaning towards no.  The reasoning here is that we will have already seen the first estimate of Q3 GDP by the time the Fed meets, and the early indications are that GDP growth has really declined sharply with the Atlanta Fed’s GDPNow forecast declining to 1.306% after the payroll data on Friday.  Tightening policy into a clearly slowing economy seems highly improbable for this Fed regardless of the inflation situation.  It seems far more likely that a weak GDP print will result in the Fed walking back their tapering language by describing the slowing growth as an impediment from achieving that vaunted “substantial further progress” on their employment goals and thus tapering is not yet appropriate.  Remember, after nearly a decade of worrying about deflation, not inflation, concern over rising prices is not their normal response.  Despite talk of the tools they have available to fight inflation, there is no indication the Fed has the gumption to use them if the result would be a recession, or more frighteningly for them, a stock market decline.

Thus, the question that remains is, how will the market respond to a Fed that decides not to taper with inflation still rising?  Much of the current discussion regarding the Treasury market is around the idea that tapering is the driver of the steeper yield curve, although there is a strong case to be made it is simply consistently higher inflation readings doing the work.  For our purposes in the FX markets, it’s not clear the underlying driver matters that much.  The key is where do rates and yields go from here.  If they continue to rise, I expect the dollar has further room to rise as well.

Ok, with markets back to full strength today, a look around sees a pretty negative risk sentiment.  Equities in Asia (Nikkei -0.95%, Hang Seng -1.4%, Shanghai -1.25%) were all under pressure with the latter two dealing with yet another property company that is defaulting on a USD bond.  The China story appears to be getting a bit less comfortable as we watch what seems to be a slow motion implosion of the real estate bubble there.  As to Europe, its all red there as well (DAX -0.4%, CAC -0.5%, FTSE 100 -0.4%) as London is suffering despite the strong data and Germany seems to be feeling the weight of stagflation after PPI (+13.2% Y/Y in Sept) rose to its highest level since 1974 while the ZEW Surveys all fell even further than expected.  At this hour, US futures are either side of unchanged.

On this risk off day, bond markets are seeing a bit of a bid, but in truth, it is not that impressive, especially given how far they have fallen recently.  So, Treasury yields (-1.6bps) have edged just below 1.60% for now while European sovereigns (Bunds -0.6bps, OATs -0.8bps, Gilts -1.4bps) have also seen very modest demand.

Oil prices (+0.4%) continue to lead the way higher for most commodities, although today’s movement has been less consistent.  The trend, however, remains firmly upward in this space.  So, while NatGas (-1.6%) is lower on the session, we are seeing gains in gold (+0.5%) and aluminum (+0.7%) although copper (-0.25%) is consolidating today.  Many less visible commodity prices are rising though, things like lumber (+5.5%) and cotton (+2.3%) which are all part of the same trend.

Finally, the FX markets have seen a very slight amount of dollar weakness net, although there are quite a number of currencies that have fallen vs. the greenback as well.  In the G10, NOK (+0.7%) is the leader on oil price rises while AUD (+0.4%) and NZD (+0.4%) are following on the broader commodity price trend.  Interestingly, JPY (0.0%) is not seeing any bid despite a declining risk appetite.  This seems to be a situation where the spread between Treasuries and JGB’s has widened sufficiently to interest Japanese investors who are selling yen/buying dollars to buy bonds.  As long as Treasury yields continue to rise, look for USDJPY to follow.  After all, it has risen 1.7% in the past week alone.

In the emerging markets, THB (+1.3%) has been the big winner after the government eased restrictions for travelers entering the country thus opening the way for more tourism, a key part of the economy there.  ZAR (+0.85%) and MXN (+0.5%) are the next best performers on the strength of the commodity story.  On the downside, many APAC currencies (TWD (-0.35%, KRW -0.3%, INR -0.2%) saw declines on a combination of continued concerns over the potential implications of the Chinese real estate issue as well as rising commodity prices as all these nations are commodity importers.

Data-wise, NFIB Small Business Optimism was just released at a slightly weaker than expected 99.1, hardly a harbinger of strong future growth, while the JOLTS Jobs report (exp 10.954M) is due at 10:00 this morning.  There are three Fed speakers on the slate with vice-Chair Clarida at the World Bank/IMF meetings and Bostic and Barkin also due.  It will be interesting to see the evolution of the narrative as it becomes clearer that GDP growth is slowing rapidly.  But given that has not yet happened, I expect more taper talk for now.

There is no reason to think that the dollar’s recent strength has reached its peak.  If anything, my take is we are consolidating before the next leg higher so hedge accordingly.

Good luck and stay safe
Adf

Narrative Drift

Today it is more of the same
As energy traders proclaim
No price is too high
For NatGas, to buy
With policy blunders to blame

As such it is not too surprising
Inflation concerns keep on rising
Prepare for a shift
In narrative drift
Which right now CB’s are devising

Perhaps the most interesting feature of markets since the onset of the Covid-19 pandemic is the realization that prices for different things, be they equities, bonds, commodities, or currencies, can move so much faster and so much further than previously understood.  The simple truth is that markets as a price discovery mechanism are unparalleled in their brilliance.  Recall, for instance, back in April 2020, when crude oil traded at a negative price.  The implication was that crude oil holders were willing to pay someone to take it off their hands, something never before seen in a physical commodity market.  (Of course, in the interest rate markets, that had become old hat by then.)  Well, today European natural gas markets have gone the other way, rising 40% in both Amsterdam and London and taking prices to levels previously unseen.  Now, much to the chagrin of European policymakers, there is no upper limit on prices.  As winter approaches, with NatGas inventories currently just 74% of their long-term average, and with most of the EU reliant on Russia for its gas supplies, it is not hard to foresee that these prices will go higher still.

The first issue (a consequence of policy decisions) is that deciding to allow a geopolitical adversary to control your energy supply is looking to be a worse and worse decision every day.  Gazprom’s own data shows that they have reduced the flow of gas to Europe via Belarus and Poland by 70% and via Ukraine by 20% in the past week.  It cannot be surprising that prices in Europe continue to rise.  And the knock-on effects are growing.  You may recall two weeks ago when a fertilizer company in the UK shuttered two plants because the NatGas feedstock became so expensive it no longer made economic sense to produce fertilizer.  One consequence of that was there was a huge reduction in a byproduct of fertilizer production, pure CO2, which is used for refrigeration and has impaired the ability of food processors to ship food to supermarkets and stores.  Empty shelves are a result.  Just today, a major ammonia producer shuttered its plants as the feedstock is too expensive for profitable production as well.  The point is that NatGas is used as more than a heating fuel, it is a critical input for many industrial processes.  Shuttering these processes will have an immediate negative impact on economic activity as well as push prices higher.  If you are wondering why there are concerns over stagflation returning, look no further.

The bigger problem is that there is no reason to believe these prices will sell off anytime soon.  Arguably, we are witnessing the purest expression of supply and demand working itself out.  As a consequence of these earlier decisions, the EU will now be forced to respond by spending more money and reducing tax income in order to support their citizens and businesses who find themselves in more difficult financial straits due to the sharp rise in the price of NatGas.

Now, a trading truth is that nothing goes up (or down) in a straight line, so there will certainly be some type of pullback in prices in the short run.  However, the underlying supply-demand dynamic certainly appears to point to a supply shortage and consistently higher prices for a critical power source in Europe.  Slower economic growth and higher prices are very likely to follow, a combination that the ECB has never before had to address.  It is not clear that they will be very effective at doing so, quite frankly, so beware the euro as further weakness seems to be the base case.

The other main story of note
Concerns a new debt ceiling vote
Majority wailing
The other side’s failing
May yet, a default, soon promote

Alas, we cannot avoid a quick mention of the debt ceiling issue as the clock is certainly winding down toward a point where a technical default has become possible.  Political bickering continues and shows no sign of stopping as neither side wants to take responsibility for allowing more spending, but neither do they want to be responsible for a default.  (Perhaps that sums up politicians perfectly, they don’t want to take responsibility for anything!)  This is more than a technical issue though as financial markets are failing to see the humor in the situation and starting to respond.  Hence, today has seen a broad sell-off in virtually every asset, with equities down worldwide, bonds down worldwide and most commodities lower (NatGas excepted).  In fact, the only thing that has risen is the dollar, versus every one of its main counterparts.

The rundown in equities shows Asia (Nikkei -1.05%, Hang Seng -0.6%, Shanghai closed) failing to take heart from yesterday’s US price action.  European investors are very unhappy about the NatGas situation with the DAX (-2.2%), CAC (-2.15%) and FTSE 100 (-1.8%) all sharply lower.  It certainly hasn’t helped that German Factory Orders fell a much worse than expected -7.7% in August either.  US futures are currently lower by about 1.25% as risk is clearly not today’s flavor.

Funnily enough, bond markets are also under pressure today, with Treasuries (+1.6bps), Bunds (+1.6bps), OATs (+2.2bps) and Gilts (+3.0bps) all seeing heavy selling.  It seems that inflation concerns are a more important determinant than risk concerns as the evidence of rising prices being persistent continues to grow.

In the commodity space, pretty much everything, except NatGas (+0.6% to $6.33/mmBTU) is lower as well, although this appears to be consolidation rather than the beginning of a new trend.  So, oil (-0.6%), gold (-0.5%), copper (-1.0%) and aluminum (-0.85%) are all under pressure.  Given the dollar’s strength, this should not be that surprising, although overall, I continue to expect a rising dollar and rising commodity prices.

As to the dollar, it is king today, rising 1.1% vs NZD, despite a 0.25% interest rate increase by the RBNZ last night, 1.0% vs. NOK and 0.85% vs SEK with the latter seeing a negative monthly GDP outcome in a huge surprise, thus marking down growth expectations significantly for the year.  But the rest of the G10 is much softer save JPY, which is essentially unchanged on the day.  Meanwhile, the euro has fallen a further 0.5% and is now approaching modest support at 1.1500.  Look for further declines there.

As to emerging market currencies, all that were open last night or today are lower with MXN (-1.2%) leading the way on a combination of lower oil and higher inflation, but HUF (-0.9%), ZAR (-0.8%) and CZK (-0.8%) all suffering on either weaker commodity prices are concerns over insufficient monetary tightening in an inflationary economy.  Even INR (-0.7%) is feeling the heat from rising inflationary pressures.  It is universal.

On the data front, only ADP Employment (exp 430K) is due this morning and there are no Fed speakers scheduled.  Right now, it feels like the dollar is primed to continue to move higher regardless of the data, or anything else.  Fear is growing among investors and they are searching for the safest vehicles they can find.  The steepening of the yield curve indicates the demand is in the 2yr, not the 10yr space, which makes sense, as in an inflationary environment, you want to hold the shortest duration possible.  Beware the FAANG stocks as they are very long duration equivalents.  Instead, it feels like the dollar is a good place to hang out.

Good luck and stay safe
Adf

At All Costs#

Ahead of the winter’s white frosts
The Chinese told firms, “at all costs”
Get oil and gas
And coal, so en masse
Our energy never exhausts

In Europe, as prices keep rising
For Nat Gas, most firms are revising
The prices they charge
Which has, by and large
Helped CPI keep on surprising

Ostensibly, the reason that the Fed, and any central bank, looks at prices on an -ex food & energy basis is because they realize that they have very little control over the prices of either one.  The only tool they have to control them is extremely blunt, that of interest rates.  After all, if they raise interest rates high enough to cause a recession, demand for food & energy is likely to decline, certainly that of energy, and so prices should fall.  Of course, precious few central bankers are willing to cause a recession as they know that their own job would be on the line.

And yet, central banks cannot ignore the impact of food & energy prices on the economy.  This is especially so for energy as it is used to make or provide everything else, so rising energy prices eventually feed into rising prices for non-energy products like computers and washing machines and haircuts.  As has become abundantly clear over the past months, energy prices continue to rise sharply and alongside them, we are seeing sharp rises in consumer prices as well.

Protestations by Lagarde and Powell that inflation is transitory do not detract from the fact that energy prices are exploding higher and that those charged with securing energy for their country or company are willing to continue to pay over the odds to do so.  Yesterday, an edict from the Chinese government to all its major companies exhorted them to get energy supplies for the winter “at all costs.”  This morning, they followed up by telling their coal mining companies to produce at maximum levels and ignore quotas.  Clearly, there is concern in Beijing that with winter coming, there will not be enough energy to heat homes and run factories, an unmitigated disaster.  But this price insensitive buying simply drives the price higher.  (see Federal Reserve impact on bonds via QE for an example.)

And higher these prices continue to go.  Nat Gas, which is the preferred form of fossil fuel, continues to rise dramatically in both Europe and Asia.  In both geographies, it has risen to nearly $35.00/mmBTU, almost 6x as expensive as US Nat Gas.  On an energy equivalent basis, that comes out to $190/bbl of oil.  And you wonder why the Chinese want to dig as much coal as possible.  The problem they are already having, which is adding to their overall economic concerns, is that they have run into an energy shortage and have been restricting power availability to the industrial sector in order to ensure that households have enough.  Of course, starving industry is going to have a pretty negative impact on the economy, hence the call for obtaining energy at all costs.  But that has its own problems, as driving prices higher will divert spending to energy from both investment and consumption.  In other words, as is often the case, there is no good answer to this problem.

If you are wondering how this impacts foreign exchange, let me explain.  First, energy is priced in dollars almost everywhere in the world, at least at a wholesale level.  So, buying energy requires having dollars to spend to do so.  I would contend one reason we have seen the dollar maintain its strength recently, and break out of a medium-term range, is because countries are panicking over their winter energy needs and need dollars to secure supplies.  Second, as energy prices rise, so too does inflation.  And while Mr Powell continues to refuse to accept that is the case, the market is not so stubborn on the issue.  We have seen the yield curve steepen sharply over the past several weeks, something which is historically a dollar positive, and with expectations for the taper firmly implanted into the market’s collective conscience, the strong view is interest rates in the US are going higher.  This, too, is very dollar supportive.  While I remain unconvinced that the Fed will ultimately be willing to tighten policy in any significant manner, that remains the current market narrative.  We shall see how things evolve, but for now, the dollar has legs alongside interest rates and energy prices.

Ok, to today’s price action.  The notable thing is the reduction in risk appetite that has been evident for the past several sessions.  For instance, yesterday we finally achieved a 5% correction in the S&P 500 for the first time in more than 200 sessions.  While prices remain extremely overvalued on traditional measures, it is not yet clear if the ‘buy the dip’ mentality will prevail as we enter a new fiscal quarter.  We shall see.

Overnight, Asia was mostly lower (Nikkei -2.3%, Hang Seng -0.4%) but Shanghai (+0.9%) managed to rally.  Of course, remember, Shanghai has been massively underperforming for quite a while.  Other than China, though, the rest of Asia was all red.  Europe, too, is bright red this morning (DAX -0.8%, CAC -0.8%, FTSE 100 -1.0%) as the broad risk-off sentiment combines with modestly weaker than expected PMI data and higher than expected Eurozone CPI data.  As to the latter, the 3.4% headline print is the highest since Sept 2008, right at the beginning of the GFC.  Yesterday, German CPI printed at 4.1%, which is the highest level since the wake of the reunification in 1993.  For a culture that still recalls the Weimar hyperinflation, things must be pretty uncomfortable there.  It is a good thing this inflation is transitory!

Not surprisingly, with risk being jettisoned, bonds are in demand this morning and although Treasuries are unchanged in this session, they did rally all day yesterday with yields declining nearly 5bps.  As to Europe, Bunds (-3.2bps) and OATs (-3.2bps) are firmly higher with the rest of the continent while Gilts (-1.5bps) are not seeing quite as much love despite an underperforming stock market.  I think one reason is that UK PMI data was actually better than expected and higher than last month, an outlier versus the continent.

Commodity prices are mixed this morning as despite my opening monologue, oil (WTI -0.9%) and Nat Gas (-0.7%) are both under pressure.  Of course, both have been rallying sharply for months, so nothing goes up in a straight line.  Precious metals are little changed on the day, but industrial metals are strong (Cu +1.6%, Al +0.5%, Sn +1.2%).  Ags, on the other hand, are mixed with no pattern whatsoever.

As to the dollar, it is under modest pressure this morning in what appears to be a consolidation at the end of the week.  The one noteworthy mover in the G10 is NOK (+0.75%) which is rallying despite oil’s decline as the market reacted to a surprisingly large decline in the Unemployment rate there to 2.4%.  But otherwise, GBP (+0.3%) is the next best performer and the rest of the bloc is +/-0.2%, with CAD (-0.2%) the laggard on weak oil prices.

EMG currencies have many more gainers than losers this morning with only RUB (-0.6%) on oil weakness, and KRW (-0.35%) on a smaller than expected trade surplus, declining of note, while THB (+0.6%), PLN (+0.6%) and HUF (+0.4%) all have shown some strength.  In Bangkok, the central bank vowed to monitor the baht, which has been falling steadily over the past 9 months to its weakest point in more than 4 years.  PLN saw higher than expected CPI data (5.8%) which has the market looking for higher rates from the central bank, while HUF was the beneficiary of central bank comments that the monetary tightening campaign was “far from the end.”

There is a veritable trove of data to be released this morning starting with Personal Income (exp 0.2%), Personal Spending (0.7%) and the Core PCE (3.5%) at 8:30.  Then at 10:00 we see ISM Manufacturing (59.5) and Prices Paid (78.5) as well as Michigan Sentiment (71.0).  If the PCE number prints on plan, the Fed will be crowing about how it, too, is falling and has peaked.  However, that is crow they will ultimately have to eat, as the peak is not nearly in.

The underlying picture for the dollar remains quite positive on both a technical and fundamental basis, but it appears today is a consolidation day.  Perhaps, a good time to buy dollars still needed to hedge.

Good luck, good weekend and stay safe
Adf

QE Galore

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Flames of Concern

The story is still Evergrande
Whose actions last night have now fanned
The flames of concern
‘Til bondholders learn
If coupons will be paid as planned

Though pundits have spilled lots of ink
Explaining there’s really no link
Twixt Evergrande’s woes
And fears of new lows
The truth is they’re linked I would think

It must be very frustrating to be a government financial official these days as despite all their efforts to lead investors to a desired outcome, regardless of minor details like reality, investors and traders continue to respond to things like cash flows and liquidity, or lack thereof.  Hence, this morning we find ourselves in a situation where China Evergrande officially failed to pay an $83.2 million coupon yesterday and now has a 30-day grace period before they can be forced into default on the bond.  The concern arises because China Evergrande has more than $300 billion in bonds outstanding and another $300 billion in other liabilities and it is pretty clear they are not going to be able to even service that debt, let alone repay it.

At the same time, the number of articles written about how this is an isolated situation and how the PBOC will step in to prevent a disorderly outcome and protect the individuals who are on the hook continue to grow by leaps and bounds.  The true victims here are the many thousands of Chinese people who contracted with Evergrande to build their home, some of whom prepaid for the entire project while others merely put down significant (>50%) deposits, and who now stand to lose all their money.  Arguably, the question is whether or not the Chinese government is going to bail them out, even if they allow Evergrande to go to the wall.  Sanguinity in this situation seems optimistic.  Remember, the PBOC has been working very hard to delever the Chinese property market, and there is no quicker way to accomplish that than by allowing the market to reprice the outstanding debt of an insolvent entity.  As well, part of President Xi’s calculus will be what type of pain will be felt elsewhere in the world.  After all, if adversaries, like the US, suffer because of this, I doubt Xi would lose any sleep.

But in the end, markets this morning are demonstrating that they are beginning to get concerned over this situation.  While it may not be a Lehman moment, given that when Lehman was allowed to fail it was truly a surprise to the markets, the breadth of this problem is quite significant and the spillover into the entire Chinese property market, which represents ~25% of the Chinese economy, is enormous.  If you recall my discussion regarding “fingers of instability” from last week (Wednesday 9/15), this is exactly the type of thing I was describing.  There is no way, ex ante, to know what might trigger a more significant market adjustment (read decline), but the interconnectedness of Chinese property developers, Chinese banks, Chinese shadow financiers and the rest of the world’s financial system is far too complex to parse.  However, it is reasonable to estimate that there will be multiple knock-on effects from this default, and that the PBOC, no matter how well intentioned, may not be able to maintain control of an orderly market.  Risk should be off, and it is this morning.

It ought not be surprising that Chinese shares were lower last night with the Hang Seng (-1.3%) leading the way but Shanghai (-0.8%) not that far behind.  Interestingly, the only real winner overnight was the Nikkei (+2.1%) which seemed to be making up for their holiday yesterday.  European shares are having a rough go of it as well, with the DAX (-0.8%), CAC (-1.0%) and FTSE 100 (-0.3%) all under the gun.  There seem to be several concerns in these markets with the primary issue the fact that these economies, especially Germany’s, are hugely dependent on Chinese economic growth for their own success, so signs that China will be slowing down due to the Evergrande mess are weighing on these markets.  In addition, the German IFO surveys were all released this morning at weaker than expected levels and continue to slide from their peaks in June.  Slowing growth is quickly becoming a market meme.  After yesterday’s rally in the US, futures this morning are all leaning lower as well, on the order of -0.3% or so.

The bond market this morning, though, is a bit of a head-scratcher.  While Treasuries are doing what they are supposed to, rallying with yields down 2.6bps, the European sovereign market is all selling off despite the fall in equity prices.  So, yields are higher in Germany (Bunds +1.4bps) and France (OATs +2.2bps), with Italy (BTPs +5.0bps) really seeing some aggressive selling.  Gilts are essentially unchanged on the day.  But this is a bit unusual, that a clear risk off session would see alleged haven assets sell off as well.

Commodity markets are having a mixed day with oil unchanged at this hour while gold (+0.75%) is rebounding somewhat from yesterday’s sharp decline.  Copper (+0.1%) has edged higher, but aluminum (-1.4%) is soft this morning.  Agricultural prices are all lower by between 0.25% and 0.5%.  In other words, it is hard to detect much signal here.

As to the dollar, it is broadly stronger with only CHF +0.1%) able to rally this morning.  While the euro is little changed, we are seeing weakness in the Antipodean currencies (AUD, NZD -0.4%) and commodity currencies (CAC -0.2%, NOK -0.15%).  Granted, the moves have not been large, but they have been consistent.

In the EMG bloc, the dollar has put on a more impressive show with ZAR (-1.3%) and TRY (-0.9%) leading the way, although we have seen other currencies (PHP -0.6%, MXN -0.4%) also slide during the session.  The rand story seems to be a hangover from yesterday’s SARB meeting, where they left rates on hold despite rising inflation there.  TRY, too, is still responding to the surprise interest rate cut by the central bank yesterday.  In Manila, concern seems to be growing that the Philippines external balances are worsening too rapidly and will present trouble going forward.  (I’m not sure you remember what it means to run a current account deficit and have markets discipline your actions as it no longer occurs in the US, but it is still the reality for every emerging market economy.)

On the data front, we see only New Home Sales (exp 715K), a number unlikely to have an impact on markets.  However, we hear from six different Fed speakers today, including Chairman Powell, so I expect that there will be a real effort at fine-tuning their message.  Three of the speakers are amongst the most hawkish (Mester, George and Bostic), but of this group, only Bostic is a voter.  You can expect more definitive tapering talk from these three, but in the end, Powell’s words still carry the most weight.

The dollar remains in a trading range and we are going to need some exogenous catalyst to change that.  An Evergrande collapse could have that type of impact, but I believe it will take a lot more contagion for that to be the case.  So, using the euro as a proxy, 1.17-1.19 is still the right idea in my view.

Good luck, good weekend and stay safe
Adf

Would That, Fear, Provoke?

Remember when everyone said
That Jay and his friends at the Fed
Would taper their buying
While still pacifying
Investors, lest screens all turn red?

Well, what if before the Fed spoke
That Evergrande quickly went broke?
Would traders still bet
The buying of debt
Will end? Or would that, fear, provoke?

Fear is in the air this morning as concerns over the status of China Evergrande’s ability to repay its mountain of debt seriously escalate.  Remember, Evergrande is the Chinese property developer with more than $300 billion in debt outstanding, and that has said they will not be repaying an $84 million loan due today, with the prospect for interest payments due this Thursday also gravely in doubt.  One cannot be surprised that the Hang Seng (-3.3%) reacted so negatively this morning, after all, that is the Evergrande’s main listing exchange.  Other property developers listed there came under substantial pressure as well, with one (Sinic Holdings Group) seeing its price fall 87% before trading was suspended.

Of equal interest to the fact that equity markets are trembling on the Evergrande story is the plethora of press that continues to explain that even if Evergrande goes bust, any fallout will be limited.  Columnists and pundits point to the damage that occurred when the Fed allowed Lehman Brothers to go bust and explain that will never be allowed again.  And while I’m certain they are correct, financial officials have exactly zero interest in allowing that type of situation to repeat, it remains far from clear they can prevent it.  That is, of course, unless the Chinese government is going to step in and pay the debts, something that seems highly unlikely.  As I continue to read and hear how this situation is nothing like Lehman, having had a front row seat to that disaster, I cannot help but see a great many parallels, including many assurances that the underlying cause of that contagion, subprime mortgage loans, was a small portion of the market and any fallout would be controlled.  We all know how well that worked out.

Remember, too, that Chinese President Xi Jinping has been aggressively attacking different sectors of the Chinese economy, specifically those sectors where great wealth (and power) was amassed and has implemented numerous changes to the previous rules.  This is the key reason the Shanghai stock market has underperformed the S&P 500 by 25% over the past year.  One of Xi’s problems is that property development has been a critical part of the growth of China’s economy and a source of significant income to all the provinces and cities.  Proceeds from the sales of property have funded infrastructure as well as helped moderate taxes.  If Evergrande goes under, the impact on the entire Chinese economy seems likely to be significant.  And all this is happening while the growth in China’s credit impulse has been declining rapidly, portending slower growth there anyway.

History has shown that situations of this nature are rarely effectively contained and there is usually fallout across numerous different areas.  Consider that global equity market indices have been hovering just below all-time high levels with stretched valuations on any measure on the basis of TINA and FOMO.  But between the two key emotions evident in investing, fear and greed, I assure you, fear is by far the more powerful.  While anything can still happen, fear is starting to spread more widely today than last week as evidenced by the sea of red across all equity markets today.

If you think that the Fed is going to taper their asset purchases into a period of market weakness, you are gravely mistaken.  The combination of slowing growth and market fear will induce a call for more support, not less, and history has shown that ever since October 1987 and Alan Greenspan’s response to Black Monday, the Fed will respond with more money.  The question this time is, will it be enough to stop the fall?  Interesting times lie ahead.

Most of Asia was on holiday last night, with only Hong Kong and Australia (ASX 200 -2.1%) open.  But Europe is open for business and the picture is not pretty.  The FTSE 100 (-1.55%) is the best performing market today with the continent (DAX -2.15%, CAC -2.1%) emblematic of every market currently open.  US futures, meanwhile, are the relative winners with losses ‘only’ ranging from the NASDAQ (-1.1%) to the Dow (-1.6%).  Now, don’t you feel better?

It can be no surprise that bonds are in demand this morning as risk is undeniably ‘off’ across all markets.  Treasury yields have fallen 3.6bps amid a flattening yield curve, while European sovereigns have all seen price gains as well with yields there slipping between 2.6bps (OATs) and 3.2 bps (Bunds).  In every case, we are seeing yield curves flatten, which tends to imply an increasing expectation of weaker economic activity.

Commodity prices are broadly under pressure as well this morning, with oil (-2.0%) leading the way but weakness across industrial metals (Cu -2.0%, Al -0.65%, Sn -1.2%) and agriculturals (corn -1.6%, wheat -0.9%, soybeans -1.0%) as well.  Gold (+0.2%) on the other hand, seems to have retained some of its haven status.

Speaking of havens, the dollar, yen and Swiss franc remain the currencies of choice in a crisis, so it should be no surprise they are today’s leaders.  Versus the dollar, the yen (+0.4%) and franc (+0.2%) are the only gainers on the day.  Elsewhere in the G10, AUD (-0.55%), SEK (-0.5%), CAD (-0.5%) and NOK (-0.4%) are the worst performers.  Obviously, oil’s decline is weighing on the krone and Loonie, but AUD is feeling it from the rest of the commodity complex, notably iron ore (Australia’s largest export by value) which has fallen to $105/ton, less than half its price on July 15th!

In the emerging markets, RUB (-0.8%) is feeling the heat from oil, while ZAR (-0.55%) has metals fatigue.  But every EMG currency that was open last night or is trading right now is down versus the dollar, with no prospects of a rebound unless risk attitude changes.  And that seems unlikely today.

On the data front, aside from the Fed on Wednesday, it is a housing related week.

Tuesday Housing Starts 1550K
Building Permits 1600K
Wednesday Existing Home Sales 5.88M
FOMC Rate Decision 0.00%-0.25%
Thursday Initial Claims 320K
Continuing Claims 2630K
Flash PMI Manufacturing 60.8
Friday New Home Sales 710K

Source: Bloomberg

As well as the Fed, on Thursday the Bank of England meets and while there is no expectation of a policy move then, there is increasing talk of tighter policy there as well.  Again, if fear continues to dominate markets, central banks are highly unlikely to tighten, and, in fact, far more likely to add yet more liquidity to the system.  Once the Fed meeting has passed, the FOMC members will get back out on the circuit to insure we understand what they are trying to do.  so, we will hear from five of them on Friday, and then a bunch more activity next week.

Today’s watchword is fear.  Markets are afraid and risk is being tossed overboard.  Absent a comment or event that can offset the China Evergrande led story, I see no reason for the dollar to do anything but rally.

Good luck and stay safe
Adf

Dissatisfaction

The Chinese would have us believe
Their growth targets, they will achieve
Alas, recent data
When looked at pro rata
Shows trust in their words is naïve

Meanwhile, in the UK, inflation
Is rising across that great nation
The market’s reaction
Is dissatisfaction
Thus, Gilts have seen depreciation

Just how fast is China’s GDP growing?  That is the question to be answered after last night’s data dump was distinctly worse than expected.  The big outlier was Retail Sales, which grew only 2.5% Y/Y in August, down from 8.5% in July and far below the expected 7.0% forecast.  But it was not just the Chinese consumer who slowed down their activity, IP rose only 5.3% Y/Y, again well below the July print of 6.4% and far below the forecast of 5.8%.  Even property investment was weaker than forecast, rising 10.9%, down from 12.7% in July and below the 11.3% forecast.  So, what gives?

Well, there seem to be several issues ongoing there, some of which may be temporary, like lockdowns due to the spreading delta variant of Covid, while others are likely to be with us for a longer time, notably the fallout from the bankruptcy of China Evergrande on the property market there.  The Chinese government is walking a very fine line of trying to support the economy without overstimulating those areas that tend toward speculation, notably real estate.  This is, however, extraordinarily difficult to achieve, even for a government that controls almost every lever of power domestically.  The problem is that the Chinese economy remains hugely reliant on exports (i.e. growth elsewhere in the world) in order to prosper.  So, as growth globally seems to be abating, the impact on China is profound and very likely will continue to detract from its GDP results.

Adding to the Chinese government’s difficulties is that the largest property company there, Evergrande, is bankrupt and will need to begin liquidating at least a portion of its property portfolio.  Remember, it has more than $300 billion in USD debt and the government has already said that interest and principal payments due next week will not be made.  A key concern is the prospect of contagion for other property companies in China, as well as for dollar bonds issued by other Chinese and non-US entities.  History has shown that contagion from a significant bankruptcy has the ability to spread far and wide, especially given the globalized nature of financial markets.  While we will certainly hear from Chinese officials that everything is under control, recall that the Fed assured us that the subprime crisis was under control, right before they let Lehman Brothers go under and explode the GFC on the world.  The point is, there is a very real risk that investors become wary of certain asset classes and risk overall which could easily lead to a more severe asset price correction.  This is not a prediction, merely an observation of the fact that the probability of something occurring has clearly risen.

Speaking of things rising, the other key story of the morning is inflation in the UK, which printed at 3.2%, its highest level since March 2012, and continues to trend higher.  This cannot be surprising given that inflation is rising rapidly everywhere in the world, but the difference is the BOE may have a greater ability to respond than some of its central bank counterparts, notably the Fed.  For instance, the UK debt/GDP ratio, while having risen recently to 98.8%, remains well below that of the rest of the G7, notably the Fed as the US number has risen to around 130%.  As such, markets have begun to price in actual base rate hikes by the BOE, looking for the base rate to rise to 0.50% (from 0.10% today) by the end of next year with the first hike expected in May.  While that may not seem like much overall (it is not really), it is far more than anticipated here in the US.  And remember, our CPI is running above 5.0% vs. 3.2% in the UK.

The upshot of the key stories overnight is that taking risk is becoming harder to justify for investors all over the world.  While there has certainly not yet been a defining break from the current ‘buy the dip’ mentality, fingers of instability* seem to be developing throughout financial markets globally.  The implication is that the probability of a severe correction seems to be growing, although the timing and catalyst remain completely opaque.

So, how has the most recent news impacted markets?  Based on this morning’s price action, there is clearly at least some concern growing.  For example, equity markets in Asia were all in the red (Nikkei -0.5%, Hang Seng -1.8%, Shanghai -0.2%) as the fallout of slowing Chinese growth and the China Evergrande story continue to weigh on sentiment there.  In Europe, the continent is under some pressure (DAX -0.1%, CAC -0.5%) although the UK (FTSE 100 +0.1%) seems to be shaking off the higher than expected CPI readings.  As to US futures, as I type, they are currently marginally higher, about 0.2% each, but this follows on yesterday’s afternoon sell-off resulting in lower closes.  Nothing about this performance screams risk-on, although it is not entirely bad news.

The bond market seems a bit more cautious as Treasury yields have fallen further and are down 1.3bps this morning after a 4bp decline yesterday.  This is hardly the sign of speculative fever.  In Europe at this hour, yields are essentially unchanged except in Italy, where BTP yields have risen 1.6bps as concerns grow over the amount of leeway the Italian government has to continue supporting its economy.

Commodity markets show oil prices continuing to rise (WTI +1.35%) after inventory numbers continue to show drawdowns and Gulf of Mexico production remains reduced due to the recent hurricane Nicholas.  While gold prices are little changed on the day, both copper (+0.6%) and aluminum (+1.6%) are firmer on supply questions.  Certainly nothing has changed my view that the price of “stuff” is going to continue higher in step with the ongoing central bank additions of liquidity to markets and economies.

Finally, the dollar is under pressure this morning, which given the risk-off sentiment, is a bit unusual.  But against its G10 brethren, the greenback is lower across the board with NOK (+0.85%) the clear leader on the strength of oil’s rally, although we are seeing haven assets CHF (+0.4%) and JPY (+0.4%) as the next best performers.  The rest of the bloc has seen much lesser gains, but dollar weakness is clear.

The same situation obtains in the EMG markets, where the dollar is weaker against all its counterparts, although the mix of gainers is somewhat unusual.  ZAR (+0.5%) is the top performer on the back of strengthening commodity prices and it is no surprise to see RUB (+0.4%) doing well either.  But both HUF (+0.45%) and CZK (+0.4%) are near the top of the list as both have seen higher than forecast inflation readings recently and both central banks are tipped to raise rates in the next two weeks.  As such, traders are trying to get ahead of the curve there.  The rest of the bloc is also firmer, but the movement has been much less pronounced with no particular stories to note.

On the data front this morning, Empire Manufacturing (exp 17.9), IP (0.5%) and Capacity Utilization (76.4%) are on the docket, none of which are likely to change many opinions.  The Fed remains in their quiet period until the FOMC meeting next week, so we will continue to need to take our FX cues from other markets.  Right now, it appears that 10-year yields are leading the way, so if they continue to slide, look for the dollar to follow suit.

Good luck and stay safe
Adf

*see “Ubiquity” by Mark Buchanan, a book I cannot recommend highly enough

Anything But Preordained

Some pundits think Madame Lagarde
Is ready, the PEPP, to retard
But others believe
She’ll never achieve
Her goals sans her bank’s credit card

Meanwhile data last night explained
That factory prices had gained
The idea inflation
Is due for cessation
Is anything but preordained

Two noteworthy stories this morning are the ECB meeting, where shortly we will learn if the much-mooted reduction in PEPP purchases is, in fact, on the way and Chinese inflation data.  Similar to the Fed, despite a more lackluster economic performance across the Eurozone as a whole, the hawkish contingent of the ECB (Germany, Austria, Finland and the Netherlands) have been extremely vocal in their calls for tapering PEPP bond purchases.  While the Germans have been the most vocal, and are also seeing the highest inflation readings, this entire bloc has a history of fiscal prudence and the ongoing ECB asset purchase programs, which essentially fund fiscal policy in the PIGS, remains a significant concern.  However, the majority of nations in the Eurozone appear quite comfortable with the ongoing purchase programs.  At times like this, one cannot think along the lines of the economic logic of tapering; instead one must consider the political logic.  Remember, Lagarde is a politician, not a true central banker steeped in policy and economics.  To the extent that enough of her constituents believe the current purchase rate of €80 billion to €85 billion per month is appropriate, that is the rate she will maintain.

Markets are generally, I believe, looking for a modest reduction in PEPP purchases, so if the ECB does not adjust purchases lower, I would expect European sovereign bonds (currently slightly firmer with yields lower by about 1 basis point) to rally and the euro (+0.15% this morning) to decline.  European bourses, currently all lower by between 0.25% and 0.75%, are also likely to perform well on the news.

On a different note, China reported its inflation data last night and while CPI there remains muted (0.8% Y/Y), PPI (9.5% Y/Y) is absolutely soaring.  This is the highest reading since August 2008, right before the GFC began, and is the product of rising commodity prices as well as increases in shipping costs and shortages of labor.  The reason this matters so much to the rest of the world is that China continues to be the source of a significant portion of “stuff” consumed by most nations.  Whether that is tee-shirts or iPhones, rising prices at the Chinese factory gate imply further price pressures elsewhere in the world, notably here in the US.  Several studies have shown a strong relationship between Chinese PPI and US CPI, and the logic behind the relationship seems impeccable.  Perhaps a key question is whether or not Chinese PPI increases are also transitory, as that would offer some hope for the Fed.  Alas, history has shown that the moderation of Chinese PPI is measured in years, not months.

Before we turn to today’s markets, I believe it is worthwhile to mention the latest Fedspeak.  Yesterday we heard from NY Fed president John Williams who stayed on message, explaining that substantial further progress had been made on the Fed’s inflation goal, but not yet on the employment goal.  He followed that up by telling us that if things go according to his forecasts, tapering could well begin before the end of the year.  The theme of tapering before the end of 2021, assuming the economy grows according to plan, has been reiterated by numerous Fed speakers at this point, with both Kaplan and Bostic adding to Williams’ comments yesterday.  But what happens if growth does not achieve those lofty goals?  After all, the Atlanta Fed’s own GDPNow data is now forecasting 1.943% growth in Q3.  That seems quite a bit lower than FOMC forecasts.  And yesterday’s JOLTS data showed nearly 11 million job openings are extant, as the supply of willing workers continues to shrink.  A cynic might believe that the current Fedspeak regarding the potential for tapering shortly, assuming data adheres to forecasts, is just a ruse as there is limited expectation, within the Fed, that the data will perform.  This will allow the Fed to maintain their easy money with a strong rationale while sounding more responsible.  But that would be too cynical by half. Do remember, however, Fed forecasts are notoriously inaccurate.

OK, markets overnight are continuing down a very modest risk-off path.  Equities in Asia were generally lower (Nikkei -0.6%, Hang Seng -2.3%) with Shanghai (+0.5%) a major exception.  Ongoing crackdowns on on-line gaming continue to undermine the value of some of China’s biggest (HK listed) companies, while the debt problems at China Evergrande continue to explode.  (China Evergrande is the second largest real estate company in China with a massive debt load of >$350 billion and has been dramatically impacted by China’s attempts to deflate its real estate bubble.  It has been downgraded multiple times and its stock price has now fallen well below its IPO price.  There are grave concerns about its ability to remain an ongoing company, but given the size of its debt load, a failure would have a major impact on the Chinese banking sector as well as, potentially, markets worldwide.  Think Lehman Brothers.)  Alongside the previously mentioned weakness in Europe, US futures are all currently lower by about 0.25%.

Treasury prices are continuing their modest rally, with yields falling another 1.2bps as risk appetite generally wanes.  Given the FOMC meeting is still two weeks away, investors remain comfortable that Treasuries are still a better buy than other securities.  Interestingly, the debt ceiling question does not seem to have reached the market’s collective consciousness yet, although it does offer the opportunity for some serious concern.  However, history shows that despite all the huffing and puffing, Congress will never allow a default, so this is probably the correct behavior.

Commodity prices are rebounding with oil (+0.8%), gold (+0.45%) and copper (+1.3%) leading the way.  The rest of the industrial space is generally firmer although foodstuffs are all softer this morning in anticipation of upcoming crop reports (“sell Mortimer!”)

As to the dollar, it is on its heels this morning, down versus all its G10 counterparts led by NOK (+0.35%) and GBP (+0.3%).  Clearly the former is benefitting from oil’s rise while the pound seems to be benefitting from BOE comments indicating a greater concern with inflation and the fact the Old Lady may need to address that sooner than previously anticipated.  In the EMG bloc, there are far more winners than losers, but the gains have been muted.  For instance, PHP (+0.4%) has been the biggest winner, followed by ZAR (+0.3%) and RUB (+0.25%).  While the latter two are clear beneficiaries of firmer oil and commodity prices, PHP seems to have gained on the back of a potential reversal of Covid lockdown policy by the government, with less restrictions coming.  On the downside, only KRW (-0.25%) was really under pressure as the Asian risk-off environment continues to see local equity market sales and outflows by international investors.

On the data front, this morning brings only Initial (exp 335K) and Continuing (2.73M) Claims.  However, we do hear from four more Fed speakers, with only Chicago’s Evans having yet to say tapering could be a 2021 event.  In truth, at this point, given how consistent the message has been, I feel like data is more likely to drive markets than comments.  Given today’s calendar is so light, I expect we will see another day of modest movement.  The one caveat is if the ECB surprises in some manner, with a greater risk of a more dovish stance than the market assumes.

Good luck and stay safe
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Could Be Dead

The tapering talk at the Fed
Continues as they look ahead
Though growth’s clearly slowing
Inflation is growing
So, QE, next year, could be dead

In Europe, though, it’s not the same
As price rises largely are tame
But plenty of squawks
From ECB hawks
Have feathered the doves with great shame

Central bank meetings continue to be key highlights on the calendar and this week is no different.  Thus far we have already heard from the RBA, who left policy unchanged, as despite inflation running at 3.8% Q/Q, are unwilling to tighten policy amid a massive nationwide lockdown.  After all, how can they justify tighter policy as growth continues to sag?

This morning the BOC meets, and the universal view is that the Overnight Lending rate will be left unchanged at 0.25%.  However, you may recall that the BOC has actually begun to taper its QE purchases, reducing the weekly amount of purchases to C$2 billion from its peak setting of C$4 billion.  Most of the punditry believe that there will be no change in the rate of QE at this meeting as the bank will want to evaluate the impact of the delta variant on the Canadian economy more fully, but most also believe that the next step lower will occur in October.  In either event, though, it seems the currency markets remain far more focused on the US half of the equation than on what the other central bank is doing.  After all, since the BOC began to taper policy in April, the Loonie has weakened by more than 1%, although it did show initial strength in the wake of the surprise announcement.

Turning to tomorrow’s ECB meeting, there has also been a clear delineation between the hawks and doves as to the proper steps going forward.  Given the macroeconomic situation in Europe, where growth is slowing from relatively modest levels and inflation remains far below levels seen in either the US or Canada (or Australia or the UK), it would seem that the doves should retain the upper hand in the discussion.

But one of the key, inherent, flaws in the Eurozone is that different countries tend to have very different economies as well as very different fiscal policies, and so the individual economic outcomes vary greatly.  Thus, while Spain remains mired with excessively high unemployment and lackluster growth prospects, as does Italy, Germany has seen rising prices in a much more sustained fashion, with CPI there running a full percentage point above the Eurozone as a whole.  Given that German DNA is vehemently anti-inflation (a result of the suffering of the Weimar Hyperinflation of the 1920’s), this situation has resulted in Bundesbank President Jens Weidmann and some of his closest colleagues (Austria’s Holtzmann and the Netherlands’ Knot) vociferously calling for a reduction in the rate of purchases in the PEPP.  However, most of the rest of the committee sees no need to slow things down.  The question tomorrow is whether or not Madame Lagarde will be able to tether the hawks.  While there is market talk that tapering will occur, my money is on no change in the pace of purchases.  The direct impact of this should be further modest weakness in the euro and a rebound in European sovereign bond market prices.

As to the Fed, they meet in two weeks’ time and after Powell’s Jackson Hole performance, I think there are vanishingly few players who believe they are going to even announce the tapering schedule then.  However, that does not mean that the segment of the FOMC who are adamantly pro-taper will be quiet, and so expect to hear a steady stream of tapering talk until the quiet period begins on Saturday.  In fact, just last night St Louis President Bullard was interviewed by the FT and reiterated his vocal stance that tapering needs to begin right away.  As well, we will hear from Dallas’ Kaplan later today with his message guaranteed to be the same.  Of more interest will be NY’s Williams, who speaks this afternoon at 1:10pm, and who has yet to voice his tapering opinion.  If he does say tapering is necessary, that would be an important signal, so we must pay close attention.

With all that in mind, markets overnight have started to take a somewhat dimmer view of risk, especially in Europe.  In fact, looking around, only the Nikkei (+0.9%) has been able to see any positivity as the rest of Asia (Hang Seng -0.1%, Shanghai -0.1%) edged lower while Europe (DAX -0.7%, CAC -0.4%, FTSE 100 -0.5%) are seeing much greater selling.  That said, the situation on the Continent was worse earlier in the session with losses everywhere greater than 1.0%.  US futures, meanwhile, are essentially unchanged on the morning, although leaning slightly lower.

In the bond market, buyers have returned with Treasury yields falling 2.4bps, reversing half of yesterday’s climb.  But Europe, too, is seeing demand for havens with Bunds (-1.2bps), OATs (-1.5bps) and Gilts (-1.0bps) all decently bid this morning.  Certainly, if the ECB does reduce its PEPP purchases you can expect yields across the board in Europe to rise.  And, in fact, that is why I don’t expect that to occur!

In a bit of a conundrum, commodity prices are generally higher, alongside the dollar.  Looking at WTI (+1.4%), it seems that energy is on the rise everywhere.  (Pay attention to Uranium, which has rallied 32% in the past month and is structurally bullish as current demand is significantly greater than the run rate of production.)  But weirdly, other than copper (-0.8%) every other key commodity is higher this morning with Au (+0.3%), Al (+0.5%) and Soybeans (+0.7%) leading the way.

This is strange because the dollar is broadly, albeit generally modestly, higher this morning.  In the G10, EUR, CAD and DKK are all softer by 0.2% while only NZD (+0.1%) has managed any gains on the back of the strength in commodity prices.  In the emerging markets, the situation is far more pronounced with TRY (-1.0%) leading the way lower after the central bank indicated rate cuts were coming, although we also saw weakness overnight in KRW (-0.75%), THB (-0.5%) and TWD (-0.4%).  All of these Asian currencies suffered on a pure risk-off viewpoint as equity markets in these nations fell as well.  But it’s not just APAC currencies as we are seeing weakness in EMEA with HUF (-0.5%) and PLN (-0.3%) also under pressure.

On the data front, today brings the JOLTS Job Openings report (exp 10.049M) which continues to indicate the labor market is quite tight despite the payroll data last week.  And after that we get the Fed’s Beige Book at 2:00.  To my mind, Williams’ speech at 1:10pm is the most important story of the day, so we will need to pay close attention when he starts speaking.

Overall, it appears that the dollar bulls have regained the upper hand and are slowly pushing the greenback higher versus most counterparts.  If Williams does agree tapering is needed, I expect the dollar to take another leg higher.  But if he is clear that there is no rush, especially with the delta variant impact, look for the dollar to cede some of its recent gains and equity markets to regain a little spring in their step.

Good luck and stay safe
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