Desperate Straits

In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded

Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits

There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today.  In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020.  This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020.  In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound.  If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.

But that is all backward-looking stuff.  Our concerns are what lies ahead.  In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along.  As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment.  Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns.  (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)

At the same time, the fiscal stimulus taps in Europe are only beginning to drip open.  While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level.  This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy.  Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion.  But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval.  This is the very definition of a day late and a dollar euro short.

Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity.  But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st.  Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be.  But we also know that the monetary story is critical to financial markets, so cannot ignore that.  On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar.  Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease.  This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.

The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form.  In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse.  Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.

Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today.  Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session.  Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there.  At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.

European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus.  Looking at smaller country indices shows lots of red as well.  Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.

Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly.  European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.

Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well.  The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies.  Stuff is in demand!

In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners.  We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%).  The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again.  The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.

On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5).  Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number.  That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.

In the end, though, it is still the Treasury market that continues to drive all others.  If yields resume their rise, look for a stronger dollar and pressure on equities and commodities.  If they were to head back down, so would the dollar while equities would find support.

Good luck, good weekend and stay safe
Adf

So Slyly

The stock market’s feeling some pains
As word is that capital gains
Will soon be taxed highly
As Biden, so slyly
Pays tribute to John Maynard Keynes

It can be no surprise that the Biden administration has begun to float trial balloons regarding higher tax rates as they were a key plank in Biden’s presidential campaign.  Given the remarkable amount of money that this administration seems to want to spend, there needs to be some additional revenue to help pay for things, although the gap between the spending plans and forecast revenue enhancements remains extremely wide.  For instance, while the mooted price tag for the American Jobs Plan, the latest proposal, is on the order of $2.3 trillion, the estimated revenues of the capital gains tax rise is somewhere in the $500 billion to $1 trillion zone.  That’s still a pretty big gap that needs to be filled.  Of course, we know that the Treasury will simply borrow the difference, and based on current form, the Fed will buy most of that.  Who knows, maybe MMT really does work, and everything will work out fine.

Investors, though, seeing the world through a slightly different prism than policymakers, may decide that while the extraordinary equity market rally has been lots of fun, it might be time to take some money off the table.  When the first headlines about a doubling of capital gains taxes hit the tape, US markets fell about 1.3% and finished lower on the day.  Now, we are still a long way from those tax laws being enacted, but do not be surprised if equity markets have more difficulty making new highs going forward.  After all, if the government is going to tax away your gains, the risk/reward equation will change for the worse.  (While on the subject of taxes, there was a rumor that the Treasury was talking about 70% marginal tax rates on Bitcoin and other cryptocurrency gains.  It should be no surprise they suffered as well.)

Attempting, us all, to assure
Lagarde said, t’would be “premature”
To taper our buying
Since we are still trying
To help the recovery endure

Yesterday’s other big story was the ECB meeting where, while policies were left unchanged as expected, there was a great deal of anticipation that Madame Lagarde might offer some hints as to the structural reforms due to be announced in June, or even give a bit more guidance on the current situation within the PEPP.  Alas, the information quotient from this meeting was pretty limited.  Lagarde insisted that increased buying in the PEPP, which was a key outcome from the March meeting, would remain in place, although the pace of purchases does not seem to have increased all that much.  Yet when asked directly about the probability of tapering those purchases, Lagarde was adamant that it was “simply premature” to discuss that subject.

What is becoming apparent at the ECB is that there is a growing divide between the hawks and doves regarding how policy should evolve.  The Frugal four are clearly seeing improved economic activity and the beginnings of rising prices while the more profligate southern countries continue to lag in both economic activity and rate of vaccinations.  It is becoming clear that a single monetary policy is no longer going to be efficient for both groups of countries simultaneously.  When Super Mario was ECB President, he simply ran roughshod over the hawks, but then he had the policy chops to do so on his own.  It remains to be seen if Madame Lagarde will have the same ability.  The upshot is that we could be looking at some more volatility in Eurozone markets if the hawks start speaking in concert and do not back Lagarde.  We shall see.

Away from those stories, though, the market this morning is ostensibly focused on the better than expected PMI data that we have seen around the world.  Starting with Australia last night, and on to Japan and most of Europe and the UK, the big gainer was Services PMI, which is back above 50 everywhere except Japan, which printed at 48.3.  But Australia, the Eurozone and the UK are all back in expansionary territory as anticipation of the great reopening takes hold.  In this regard, the Japanese data makes sense as the nation is about to impose lockdowns again for the next two weeks in Tokyo, Kyoto and two other prefectures, closing bars and restaurants and banning public gatherings.

In addition to the PMI data, UK Retail Sales was quite strong, rising 4.9% M/M ex fuel, as were Japanese Department Store Sales (+21.8%).  With all of this positive data, it can be no surprise that the dollar is under pressure this morning, but it is a bit surprising that equity markets in Europe are under pressure (DAX -0.3%, CAC -0.2%, FTSE 100 -0.4%) and sovereign bond yields are softer (Bunds -1.3bps, OATs -1.2bps, Gilts -0.7bps).  While buy the rumor, sell the news is always a viable thought process, it strikes me that there were no rumors of this type of economic strength.

Finishing the market recap, commodities are firmer (WTI +0.5%, Au +0.1%, Cu +0.8%), which syncs well with the dollar’s weakness.  In the G10 space, the dollar is softer versus the entire spectrum of currencies, with EUR (+0.3%) and GBP (+0.3%) leading the way while JPY (+0.1%) is the laggard today.  In the EMG space, RUB (+0.6%) is the leading gainer after the Bank of Russia raised their base rate by 0.50% to 5.00% in a surprise as only 25bps was expected.  Away from that, the CE4 are all following the euro higher and then commodity currencies are also edging higher, but by much lesser amounts (ZAR +0.2%, MXN +0.2%).  There are a few decliners here, TRY (-0.2%), INR (-0.1%) but the size of the move is indicative of the lack of general interest.  Certainly, both those nations have been suffering more significantly with Covid lately, and it would not be a surprise to see both currencies continue to lag until that situation changes.

On the data front this morning, New Home Sales (exp 885K) is the major number, although preliminary PMI data (61.0 Mfg, 61.5 Services) is also due.  In the US, though, there is far more focus on ISM than PMI.  With the Fed coming up next week, there is no Fedspeak to be had, so as we head into the weekend, it is reasonable to expect a quiet session.  Equity futures are currently slightly in the green, roughly 0.15%, so perhaps the gut reaction to the tax news has passed and won’t have an impact.  But the one thing of which we can be certain appears to be that higher taxes are on the way.  That is a double whammy for equities as higher corporate tax rates will reduce earnings while higher cap gains taxes will encourage selling before those taxes come into effect.

In the end, though, nothing has changed the underlying market driver, the 10-year Treasury.  If yields there continue to slide, the dollar will remain weak across the board.  If they reverse, look for the dollar to rebound.  Next week, after the Fed, we see Core PCE data on Friday.  Currently, that is forecast to rise 1.8%.  a high side surprise there could well shake things up with regard to views on tapering with a corresponding impact on all markets.  But until the Fed on Wednesday, it seems we are in for some slow times.

Good luck, good weekend and stay safe
Adf

Prices Are Rising

While Jay and the Fed are persuaded
Inflation won’t soon be upgraded
The press keeps advising
That prices are rising
How long can rate hikes be evaded?

Chairman Powell gave yet another interview this weekend, this time to a national audience on 60 Minutes last night.  A cynic might believe that the Chairman is concerned the Fed’s message, inflation is still quite low and will not present any problems, is not getting across to the general public.  While those of us in the financial markets are well aware of everything he utters, his fame amongst the general populace is far less significant.  (After all, I’m pretty certain he doesn’t have either an Instagram or TikTok presence!)  The problem for the Fed if they are unable to get their message across is that people might start to believe their own eyes what they read in the papers and lately, that is not synching well with the Fed’s message.  The number of stories on inflation has been inflating along with a clearly growing interest by the general population, at least as evidenced by the number of Google searches on the subject.  The fear here is that all of this talk of rising prices might result in a change in inflation expectations by the general population, and according to the Fed’s models, that is when inflation starts to rise.

The Fed is not the only central bank in this position as evidenced by comments this morning from Banca’d’Italia, and ECB Executive Board Member, Fabio Panetta’s comments, “We cannot be satisfied with inflation at 1.2% in 2022 and 1.4% in 2023.”  Here, too, the concern is over too low inflation although, in fairness, the inflationary impulse on the Continent is far less consistent than in the US.

One need not look too deep beneath the surface to find a viable explanation for this lack of concern over rising prices.  Clearly the ongoing need for central banks to continue to monetize purchase government debt issuance in order to support the government in power economy is the catalyst.  And there is no better rationale for a central bank to continue QE than a strong belief that inflation is too low along with a commitment to raise it.

That cynic might also question the timing of this 60 Minutes interview as it was aired just two days before the CPI data is to be released.  We are all aware that CPI prints for the next several months will be quite a bit higher than the Fed’s 2.0% target as the base effects from the initial impacts of the Covid-inspired lockdowns are now the comparison.  The month-on-month rate of CPI in March 2020 was -0.4% with it declining to -0.8% in April 2020.  Given the very real increases in price pressures we have observed in the past months, you can be sure that CPI tomorrow, currently expected at 0.5% M/M, 2.5% Y/Y will be quite high.  All told, Powell and the Fed will have to work overtime in order to ensure their message on inflation gets across, because if the general population starts to anticipate rising prices, even though the Fed ‘has tools’ to combat inflation, given the fragility of the economy, their ability to use those tools is highly suspect.  Inflation, once it gets rolling, has a history of being more persistent than desired, and as much as the Fed claimed to fear deflation, I’m pretty sure they are not looking forward to having to fight inflation either.  Especially as that would require actions that will slow the economy down, meaning they will be an easy political target for both sides of the aisle.

But CPI is tomorrow’s release, despite the fact that there are no less than ten stories on major media sites on the subject today.  In the meantime, markets are starting the week generally on their back foot, with risk definitely under some pressure today.  Equity markets in Asia, for instance, were all red (Nikkei -0.8%, Hang Seng -0.9%, Shanghai -1.1%) while European markets have been more mixed, but the mix is flat to down (DAX +0.1%, CAC 0.0%, FTSE 100 -0.4%).  US futures markets are also pointing slightly lower, with all three major indices off by about 0.15% as I type.

Bond market activity has been fairly quiet, with the 10-year Treasury yield unchanged on the day, although we are seeing very modest gains (yield declines) in most of Europe (Bunds -1.3bps, OATs -1.5bps).  Gilts are the lone exception here, with yields rising 1.0 basis point as the UK economy, despite a surprise spring snowstorm, welcomes the reopening of pubs for outdoor drinking/dining.  As the UK economy reopens, there is a great deal of focus on the £150 billion of savings that have accrued during the lockdown and how much of that will be quickly spent.  After all, that represents nearly 7% of GDP in the UK, and obviously, if spent would have a remarkable impact on growth there.

Commodity prices show oil rebounding from its recent lows (WTI +1.1%) as it pushes back to $60/bbl.  Metals prices, however, have been far more mixed with precious largely unchanged, and base metals showing both gains and losses (Cu -0.4%, Al +0.2%).

Finally, the dollar is edging lower this morning in general, but by no means universally.  G10 markets are led by GBP (+0.4%) on the economy reopening news and corresponding growth in confidence there, as well as JPY (+0.4%) which some will attribute to haven demand as equity markets suffered in Asia overnight, but I might attribute to Hideki Matsuyama’s fantastic win at the Masters yesterday.  On the downside, SEK (-0.25%) is the weakest of the bunch, which looks more like position trading than fundamentally driven activity.

EMG currencies are also mixed this morning, but most of the movement remains modest at best.  HUF (+0.6%) is the leading gainer followed by RUB (+0.3%) and PLN (+0.3%).  The HUF seems to be rallying on the news that the central bank will be buying the soon to be issued government green bonds as part of their QE exercise, helping to add demand there.  As to the other two, given the euro’s modest climb, it is no surprise to see EEMEA currencies rise.  On the downside, it is all APAC currencies that fell last night, led by INR (-0.4%) and KRW (-0.35%), which were victims of local equity market disposals by international investors.

Data wise, there is important information beyond tomorrow’s CPI as follows:

Today Monthly Budget Statement -$658B
Tuesday CPI 0.5% (2.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Wednesday Fed Beige Book
Thursday Initial Claims 700K
Continuing Claims 3700K
Retail Sales 5.5%
-ex autos 4.8%
Empire Manufacturing 18.8
Philly Fed 40.0
IP 2.5%
Capacity Utilization 75.6%
Business Inventories 0.5%
Friday Housing Starts 1600K
Building Permits 1750K
Michigan Sentiment 89.0

Source: Bloomberg

So, there is much to learn this week, especially on Thursday, although if the CPI data is large enough, it is likely to dominate conversation for a while.  The FOMC is back on tour this week with ten more speakers, including Chairman Powell on Wednesday, across at least 15 different venues.  I expect there will be a great deal of effort downplaying any thoughts that inflation is making a permanent comeback and that current policy is perfect for right now.

In the end, though, the dollar remains beholden to the Treasury bond, as do most markets, and so all eyes will continue to be on its movement going forward.  Strong data that pushes it to its recent high yield at 1.75% or beyond will result in the dollar rallying.  On the other hand, if the data goes the other way, look for the dollar to retreat a bit further.

Good luck and stay safe
Adf

The Grand Mal

A very large family fund
Was clearly surprised and quite stunned
When bankers said, Pay
The money today
You owe, or you soon will be shunned

Turns out, though, no money was there
So bankers then went on a tear
They sold massive blocks
Of certain large stocks
And warned levered funds to beware

Meanwhile in the Suez Canal
The ship that had caused the grand mal
In trade supply chains
Is floating again
Though not near its final locale

There is a blend of good and bad news in markets today, at least with respect to broad ideas regarding risk.  On the plus side, the Ever Given is no longer completely wedged into the sand in the Suez Canal, with the stern of the ship back in the water.  While that is clearly a positive, the bow of the ship remains lodged in the bank and is the target of the salvage teams working to extract it.  Once that is accomplished, which may still take several more days, it will then need to undergo a series of tests to insure that no significant damage was done to the hull and that it won’t run into problems further along its journey.  In the meantime, more than 450 ships are waiting to pass through the canal in both directions, so it will take a few weeks, at least, for supply chains to get back to their prior working timelines.  But at least this is a step forward.

On the less positive side, stories about a remarkable liquidation of equity positions are filtering out of the market regarding a family office called Archegos, which was run by a former Tiger Investment fund manager and managed a huge long/short portfolio of equities on a highly levered basis.  (n.b. a long/short fund is a strategy where the manager typically selects specific companies in a sector, or sometimes sectors against each other, to bet on the relative performance of one vs. the other). It turns out that a number of these positions moved against the fund and margin calls were made for billions of dollars that could not be met.  The result was a massive liquidation of some individual stock positions, apparently in excess of $30 billion, with remarkable impacts on those names.

While only the funds brokers will mourn its passing, as it was a massive fee payer, it does highlight the potential disruption that can occur when leverage goes awry.  And of course, leverage going awry simply means that stock prices decline.  One of the things that central bank largesse has fomented that does not get a great deal of press, is the extraordinary growth in the amount of margin purchases that are outstanding.  According to FINRA data, since the nadir in the 2009 GFC, margin debt has grown 375% while the S&P 500 has risen just under 200% (both of these are in real terms).  While Archegos is only the first to break, do not be surprised if/when other funds run into similar problems because their particular set of investments didn’t pan out.  The takeaway here is that there is a great deal of risk embedded into the system, and much of it is hidden from view.  Risk management (aka hedging) remains a critical part of portfolio management, and that is true for corporate treasuries as well as for fund managers.

Now, on to the day’s price action.  Equity markets are mixed, though starting to look a bit better as early losses in Europe have turned around.  Asia saw modest gains (Nikkei +0.7%, Hang Seng 0.0%, Shanghai +0.5%) and now Europe is picking up, with the three main indices (DAX, CAC, FTSE 100) all higher by 0.5%.  However, in the US, there still appears to be some fallout from the Archegos mess, with futures all pointing lower by about 0.4%.

In the bond market, Treasury yields have slipped 2.5 basis points this morning as there is clearly some haven appeal, although European sovereigns, with those equity markets performing well, have seen yields edge higher, but by less than 1 basis point.  Clearly, the bond market is not a point of interest today given the activity in stocks.

Oil prices (+1.1%), which had briefly fallen on the initial reports of the refloating of the Ever Given, have since rebounded as it has become clear that ships will not be moving through the canal anytime soon.  Metals prices are mixed, with precious metals still under pressure, while base metals have shown more resilience as gains in Al and Sn offset losses in Cu and Zn.  (I’ll bet you didn’t think you would need to remember your periodic table to read about finance!)

As to the dollar, it is generally higher this morning, with gains across most currencies in both the G10 and EMG blocs.  In the developed world, SEK (-0.5%) is the laggard as concerns over the next wave of the Covid virus spread, which is becoming a theme on the Continent as well.  The euro (-0.2%) continues to slide slowly as the 3rd wave (4th wave?) of Covid makes its way through Germany and other nations, and further discussions of more restrictive lockdowns continue.  On the plus side, GBP (+0.35%) is the leading gainer as the UK takes yet another step toward reopening the economy, by relaxing a few more restrictions.

In the Emerging markets, MXN (-0.8%) and TRY (-0.75%) are the laggards with the former under pressure due to some legislative proposals that will tighten the government’s grip on PEMEX, while the lira is suffering as the market starts to build expectations for a rate cut under the new central bank governor.  But the CE4 are all weaker, showing their high beta relationship to the euro, and a number of APAC currencies, including CNY (-0.3%) are weaker as well.

On the data front, there is a great deal of info this week, culminating in the payroll report on Friday.

Tuesday Case Shiller Home Prices 11.35%
Consumer Confidence 96.8
Wednesday ADP Employment 550K
Chicago PMI 60.0
Thursday Initial Claims 680K
Continuing Claims 3775K
ISM Manufacturing 61.4
ISM Prices Paid 82.0
Friday Nonfarm Payrolls 643K
Private Payrolls 635K
Manufacturing Payrolls 37K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

So, plenty to learn and clearly, the latest stage of reopening of the economy has economists looking for a substantial amount of jobs growth.  Of course, even if this forecast is accurate, Chairman Powell is still going to be looking for the other 9 million jobs that have disappeared before he considers tightening policy.  It remains to be seen if the market will continue to tighten for him.  After a deluge of Fed speakers last week, each and every one explaining they would not be changing policy for a long time and that there was no concern over potential rising inflation, this week sees only a handful of Fed speakers, with NY’s John Williams arguably the most influential.  But I don’t expect any change of message, which has clearly been drilled into the entire committee.

While broad equity indices have not suffered greatly, I cannot help but believe that the Archegos situation will give some people pause in their ongoing accumulation of risk.  While not looking for a crash, I expect that we will see choppy markets amid reduced liquidity and would not be surprised to see a bit more risk reduction.  In that environment, the dollar should remain broadly bid.

Good luck and stay safe
Adf

Will Not Be Deterred

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

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

His New Paradigm

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

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
Adf

Our Fear and Our Dread

Said Madame Lagarde, don’t misread
The fact that our PEPP has lost speed
The quarter to come
A good rule of thumb
Is twice as much is guaranteed
 
This morning, though, markets have said
That’s just not enough to imbed
The idea your actions
Of frequent transactions
Will offset our fears and our dread
 
As we walk in this morning, there is a distinct change in tone in the markets from yesterday.  It seems that the initial impressions of yesterday’s two big events, the ECB meeting and the 30-year auction, were fleeting, and fear, once again, has taken over.
 
A quick recap shows that ECB President Lagarde, in responding to the growing questions about the reduced pace of ECB PEPP purchases, promised to significantly increase them during the next quarter.  While she refused to quantify ‘significantly’, the analyst community is moving toward the idea that means at least doubling the weekly purchase amounts to ~€25 billion.  At the same time, we heard from several ECB members this morning that this action did not presage increasing the size of the PEPP, which still has approximately €1 trillion in firepower remaining.  Lagarde emphasized the flexible nature of the program and explained that varying the speed of purchases is exactly why that flexibility was created.  However, despite today’s comments, Lagarde also assured us that, if necessary, the ECB could recalibrate the program, which is lawyer/central bank speak for increase the size.
 
The market liked what it heard, and the result was a bond rally on both sides of the Atlantic.  Several hours later, the results of the Treasury’s 30-year auction were released and, while not fantastic, were also not as disastrous as the 7-year auction from two weeks ago.  In the end, bond yields basically ended the day flat, equities rallied, and the dollar was under pressure all day.  Risk had regained its allure and the bulls were back in command.
 
Aahh, the good old days.  This morning, it is almost as though Madame Lagarde never said a word, or perhaps said too many.  Bond markets are selling off sharply, with 10-year Treasury yields higher by 7 basis points and above 1.60%, while European sovereigns are weaker across the board, led by UK gilts (+5.4bps), but with most continental bonds showing yield gains of 2.0-3.0 basis points.  So, what happened to all the goodwill from yesterday?
 
Perhaps that goodwill has fled from fears of rising inflation after President Biden (sort of) laid out his plan for vaccinating the entire nation by May and reopening the economy by summer.  Many analysts have pointed to the massive increase in savings and combined that with the newest stimulus checks to come (as soon as this weekend according to Treasury Secretary Yellen) and forecast a huge spending surge, significant economic growth and rising inflation. After all, the Atlanta Fed’s GDPNow forecast is at 8.35%, which while slightly lower than a few weeks ago, is still an extremely rapid pace for the US economy.  This pundit, however, questions whether or not that spending surge will materialize.  Historically, after a deeply shocking financial event like we have just experienced, behaviors tend to change, with the most common being a tendency to maintain a higher savings ratio.  As such, expectations for a massive consumer boom may be a bit optimistic.
 
Or, perhaps the goodwill has disappeared after further crackdowns by Chinese authorities on its most successful companies, with TenCent now under the gun, receiving fines and being reined in following their efforts to crush Ant Financial.  The Hang Seng certainly felt it, falling 2.2% overnight, although Shanghai (+0.5%) and the Nikkei (+1.7%) were still euphoric from yesterday’s US equity rally.  Rapidly rising Brazilian inflation (5.2% vs. 3.0% target) could be the cause, as concerns now increase that the central bank, when it meets next week, will be raising rates 0.50% to battle that, despite the economic weakness and ongoing Covid related stresses.
 
There is, however, one other potential cause of the bond market’s poor performance, which I believe is leading to the general risk-off attitude; but it is a sort of inside baseball issue.  The Supplementary Leverage Ratio (SLR) is part of bank regulation that was designed to insure banks would remain stable during hard times and not need to be bailed out, a la 2008.  However, during the initial stresses of the Covid crisis, the Fed suspended the need for banks to count Treasury securities and bank reserves as part of that ratio, thus allowing banks to hold more of those assets on their books while remaining within the regulations.  But this exemption is due to expire on March 31, which means banks either need a LOT more equity capital, or they need to shrink their balance sheet by selling off those excess Treasuries.  And, of course, selling Treasuries is much easier and exactly what we have seen in the past two weeks.  If the Fed does not give further guidance on this issue, and lets it expire, bonds probably have further to fall.  Ironically, that doesn’t seem to fit with what the Fed really wants to happen, as the higher yields would result in tighter financial conditions, especially if equity markets sold off in sync.  So, my guess is the Fed blinks and rolls the exemption over for at least 6 months, but until we know, look for bouts of selling in bonds and all the ensuing market reactions that come with that.
 
Just like today’s, where European markets are lower (DAX -0.6%, CAC -0.1%, FTSE 100 -0.1%) although in the latter two cases not by much and US futures are also lower, especially the tech laden NASDAQ (-1.4%) although also SPX (-0.4%). 
 
Commodity prices are also under a bit of pressure with oil (-0.25%) slipping a bit as well as precious (gold -1.0%) and base (copper -1.25%) metals.  In fact, today is also seeing weakness throughout the agricultural sector, with declines of the 0.75%-1.75% range across the board.
 
And what of the dollar, you ask?  Stronger across the board, with yesterday’s leading gainers showing the way lower today.  NZD (-0.75%), SEK (-0.7%) and CHF (-0.7%) are in the worst shape, but in truth, the entire G10 is under pretty significant pressure with only CAD (-0.15%) showing any signs of holding up as Canadian government bond yields rise right along with US yields. 
 
Emerging market currencies are also under significant pressure this morning, led by TRY (-1.5%) but seeing MXN (-1.3%) and ZAR (-1.0%) also suffering greatly.  In fact, all of LATAM and the CE4 are under significant pressure today but then all of them had seen substantial strength yesterday.  In fact, the two-day movement in many of these currencies is virtually nil.  Their futures will depend on a combination of the ongoing evolution of US interest rates and their unique  domestic situation.  If rising inflation is ignored in order to support these economies, look for much further weakness in that nation’s currency.  In other words, there is every chance that the dollar gains strength broadly against this bloc in the next several months.
 
On the data front, today brings PPI (exp 2.7%, 2.6% core) and Michigan Sentiment (78.5).  Certainly, that PPI data looks like inflation is in the pipeline, but the relationship between PPI and CPI is not nearly as strong as you might think, with just a 0.079% correlation over the past 5 years, although it does have a stronger relationship to core PCE (0.228%).  But if history is any guide, the market will not be flustered by any print at all. 
 
So, today is shaping up as risk-off with both bonds and stocks selling and no commentary from the Fed coming.  Just like yesterday’s risk appetite fed stronger currencies, it appears the opposite is true today.  I don’t expect to see substantial further gains, but a modest continuation of the dollar rally does feel like it is in the cards.
 
Good luck, good weekend and stay safe
Adf
 

Covid’s Predations

There once was a time when reflation
Was cause for widespread celebration
Because it implied
That growth nationwide
Recovered from Covid’s predation

But lately concerns have been rising
That markets are destabilizing
As data that’s good
Does more than it should
To raise yields, thus need tranquilizing

There is an ongoing battle in markets these days, between the G10 central banks, led by the Fed, and the bond market and its investors and traders.  What we know with certainty is that the central banks are keen to maintain their easy money policies for a much longer period of time as they await clear economic recovery and a higher, but steady, inflation level.  In the past week we have heard from a number of different central bank speakers, notably Jay Powell and Christine Lagarde, that current policy settings are appropriate, and that while the sharp move higher in 10-year yields has “caught their eye” there is no indication they will respond.

But the other thing of which we are pretty certain is that markets love to test central banks when they think they have an edge.  And while the equity market mantra for the past decade has been, ‘don’t fight the Fed’, that is not really a bond market sentiment.  Rather, bond investors and traders will frequently make their collective views known via significant selling pressure driving interest rates up to a point where the central bank blinks.  And it certainly feels like that is an apt description of the current market price action.

The problem for the central banks is that they currently find themselves fighting this battle with one hand tied behind their back, and it is their own fault.  Remember, one of the key ‘tools’ that central banks use is forward guidance and verbal intervention to sway market opinion.  But the current timing is such that both the ECB and Fed have meetings upcoming and are in their self-imposed quiet periods, where central bank members are not supposed to make public comments that could impact markets.  And this means that they are unable to make comments implying imminent action if markets continue to misbehave.  Of course, the Fed could simply start buying longer dated debt in the market without announcing that is what they are doing, but while that may have been an acceptable methodology thirty years ago, the Fed’s MO these days is that they feel they must explain everything they do, so seems highly unlikely.

Thus we have a situation where bond investors see news stories like the passage by the Senate of the $1.9 trillion stimulus bill, the increased rate of vaccinations throughout the US population and the rapidly declining pace of infection and have jumped to the conclusion that the recovery in the US is going to be both sooner and more robust than earlier forecasts.  This, in turn, has them believing that inflation is going to pick up and that the Fed will be forced to raise rates to cool the economy.  At the same time, Powell (and Lagarde) could not have been more explicit in their comments that current policy is appropriate, and they have no intention of adjusting it until they achieve their goals.  And, by the way, those goalposts have moved quite a bit since the last tightening cycle, such that headline gains in economic data is not nearly good enough, instead they are focused on subsectors of that data like minority employment and wage growth, historically the last part of the economy to benefit from a recovery.

Add it all up and you have a situation where the bond market is observing much faster growth and raising rates accordingly while the Fed is looking at the pockets of the economy where things move more slowly and trying to boost them.  The Fed’s problem is higher rates are not helping their cause, nor are they helping to maintain easy financial conditions.  And their other current problem is they can’t even talk about it for another 9 days.  Markets can wreak a great deal of havoc in a period that long as evidenced by this morning’s rising 10-year yields and declining stock futures during the first day of that quiet period.

Which is a perfect segue into today’s session, where risk is largely under pressure.  Last night saw weakness throughout Asian equity indices with the Nikkei (-0.4%), Hang Seng (-1.9%) and Shanghai (-2.3%) all lower although there were pockets of strength in the commodity producing countries.  Europe, on the other hand, is broadly higher this morning led by Italy’s FTSE MIB (+2.0%) but seeing strength elsewhere (DAX +1.3%, CAC +0.9%) on news that the European vaccination program is scheduled to pick up the pace.  US futures, though, are continuing to feel the pressure from higher US yields, especially in the tech space as the NASDAQ (-1.5%) leads the decline with the S&P (-0.5%) and DOW (-0.1%) not nearly as badly impacted.

But Treasury yields continue to rise with the 10-year higher by another 2.5 basis point this morning and pressing 1.60% again, a level it touched Friday after the much better than expected payroll report.  However, in Europe, bonds are mixed with Bunds (+0.7bps) a bit softer while OATs and Gilts have both seen yields edge lower by 0.5bps.

Commodity prices continue to perform well in response to the improving data and increasing vaccination rates with oil (+0.3%) modestly higher and maintaining the highest levels seen in more than 2 years.  In the metals markets, base metals are mixed while precious metals continue to suffer from rising US yields.  And finally, agricultural products continue their steady rise higher.

Lastly, the dollar continues to benefit from higher yields as it is higher vs. literally every one of its counterparts in both the G10 and EMG.  There is no need to discuss specific stories here as this is a universal dollar strength situation, where investors are beginning to unwind emerging market positions as well as their short dollar views.  While those positions remain elevated in comparison to historical levels, they have been reduced by about 40% from the peak shorts seen last
August.

On the data front, arguably the most important data point this week is Wednesday’s CPI, but there is a bit more than that coming out.

Tuesday NFIB Small Biz Optimism 96.5
Wednesday CPI 0.4% (1.7% Y/Y)
-ex food & energy 0.2% (1.4% Y/Y)
Thursday ECB meeting -0.5% (unchanged)
Initial Claims 725K
Continuing Claims 4.2M
JOLTs Job Openings 6650K
Friday PPI 0.4% (2.7% Y/Y)
-ex food & energy 0.2% (2.6% Y/Y)
Michigan Sentiment 78.0

Source: Bloomberg

I think it could be instructive to see that PPI data as well, which could be a harbinger of CPI in the coming months.  Now I know that Jay has explained this will be transient, and he may well be right, but history shows the bond market will need to see proof inflation is transient before calming down.

Obviously, there are no Fed speakers scheduled and we don’t hear from the ECB until Thursday, so market participants have free reign to do what they see is correct.  Currently, rising rates has called into question the validity of the tech stock boom and seen a rotation into value stocks.  Meanwhile, rising rates has also seen general pressure on stock indices and the dollar continues to benefit from that scenario.  As I have written many times, historically a steeper US yield curve meant a strong dollar, and as the curve continues to bear steepen, it is hard to call a top for the greenback.

Good luck and stay safe
Adf