Tag Archives: #riskoff

Risk’s In Retreat

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In Germany, Covid’s widespread
And lockdowns seem likely ahead
But that hasn’t stopped
Inflation which popped
To levels the people there dread

The upshot is risk’s in retreat
As equities, traders, excrete
But bonds and the buck
Are showing their pluck
And havens now look mighty sweet

While Covid has obviously not disappeared, for a time it seemed much less important to investors and traders and so, had a lesser impact on price action.  But that was then.  During the past few weeks, Covid has once again become a much bigger problem despite the inoculation of large portions of the population in most developed countries.  Exhibit A is Austria, where they have imposed a full-scale vaccine mandate and have the police checking papers randomly to insure that anyone outside their home is vaccinated.  If you are found without papers, the penalty is prison.  However, Germany seems determined to catch up to Austria on this count, as the infection rate there climbs rapidly, and the healthcare system is getting overwhelmed.  There is talk that a nationwide lockdown is coming there as well, and soon.

Of course, what we learned during the first months of Covid’s spread was that when lockdowns are imposed, economic activity declines dramatically.  After all, in-person services all but end, and without government financial support, many people are unable to maintain their levels of consumption.  As such, the prospect of the largest economy in Europe going into a total lockdown is a pretty negative signal for future economic activity.  Alas for the authorities, the one thing that does not seem to be in retreat is inflation.  While Germany is contemplating a national lockdown, this morning it released its latest PPI data and in October, Producer Prices rose 3.8%, which takes their year-on-year rise to…18.4%!  This is the highest level since 1951 and obviously greatly concerning.  While some portion of these increased costs will be absorbed by companies, you can be sure that a substantial portion will be passed on to customers.  CPI is already at 4.6% and there is no indication that it is about to retreat.

And folks, this is Germany, the nation that is arguably the most phobic regarding inflation of any in the developed world.  Sure, Turkey and Argentina and Venezuela have bigger inflation problems right now.  So does Brazil, for that matter.  And many of these latter nations have long histories of inflation ruling the roost.  But ever since 1924, when the newly established Rentenbank helped break the Weimar hyperinflation, sound money and low inflation have been the hallmarks of German policy and politics.  So, the idea that any price index is printing in double digits, let alone nearly at 20% per annum, is extraordinary.  In fact, this is what makes yesterday’s comments from Isabel Schnabel, a German PhD economist and member of the ECB’s Executive Board, so remarkable.  For any German with sway over monetary policy to pooh-pooh the current inflation levels is unprecedented.  Even more remarkably, with Jens Weidmann leaving the role of Bundesbank President, Schnabel is on the short list to replace him.

This drama in Germany matters because if the Bundesbank, traditionally one of the most hawkish central banks, and the biggest counterweight to the ECB as a whole, is turning dovish, then the implications for the euro, as well as Eurozone assets, are huge.  If the Bundesbank will not be holding back Madame Lagarde’s push to do more, we can expect an expansion in QE from here and overall higher inflation going forward.  Both bonds and stocks will rally, as will the price of commodities in euros, while the euro itself will fall sharply.  In fact, this may be enough to offset any incipient dovishness from the Fed should Lael Brainerd wind up as Fed Chair.  It would certainly change medium and long-term views on the EURUSD exchange rate.  And you thought that the week before Thanksgiving would be quiet.

And so, it is a risk-off type day today.  While Asian equity markets managed more winners than losers (Nikkei +0.5%, Hang Seng -1.1%, Shanghai +1.1%), Europe is completely in the red (DAX -0.2%, CAC -0.3%, FTSE 100 -0.5%) and US futures are pointing down as well, with DJIA futures (-0.6%) leading the way.

Bond markets are behaving exactly as would be expected on a risk-off day, with Treasury yields falling 4.6bps while European Sovereigns (Bunds -5.5bps, OATs -5.4bps, Gilts -5.8bps) have rallied even further.  In fact, German 30-year bunds have fallen into negative territory again for the first time since August.

If you want to see risk being shed, look no further than oil (-3.1%) which is lower yet again and seems to have found a short-term top.  It seems the news of SPR releases as well as slowing growth prospects has been enough to halt the inexorable rally seen since April 2020.  Interestingly, a number of other commodities are performing quite well with NatGas (+1.1%), copper (+0.9%) and aluminum (+0.7%) all nicely higher.  Gold (+0.2%) continues to edge up as well, with more and more inflows given its haven status.  Somewhat surprisingly, Bitcoin (-4.7%, -10.5% in the past week) is not similarly benefitting, although the narrative of it being digital gold remains strong.  Perhaps it was simply massively overbought!

Finally, the dollar is clearly king this morning, rallying strongly vs all its G10 peers except the yen (+0.35%), with NOK (-1.1%) the biggest laggard on the back of oil’s decline, although the SEK (-0.9%) and EUR (-0.7%) are no slouches either.  The funny thing about the euro was it spent all day yesterday climbing slowly after touching new lows for the move.  However, this morning, it is below 1.13 and pressing those lows from Wednesday with no end in sight.

EMG currencies are also under pressure across the board with HUF (-1.6%) the worst performer as it has unwound the gains seen from yesterday’s surprising large rate hike, and is now suffering as Covid spreads rapidly and it may soon be a restricted zone for travel from Europe.  CZK (-1.1%) is next in line, as it too, is in the crosshairs of authorities to prevent travel there due to Covid.  In fact, the entire CE4 is the worst bloc, but we are also seeing further weakness in TRY (-0.6%) after yesterday’s rate cut, and RUB (-0.5%) with oil’s slide as the cause.

There is no data to be released today and only two Fed speakers, Waller and Clarida, with the latter losing his clout as he will soon be exiting the FOMC.  There continues to be a wide rift between the hawks and doves on the Fed, but as long as Powell, Brainerd and Williams remain dovish, and they have, the very modest steps toward tapering are all we are likely to see.  The problem is that while we are all acutely aware of inflation and the problems it brings, the FOMC is lost in its models and sees a very different reality.  Not only that, inflation diminishes the real value of the US’s outstanding debt and so serves an important purpose for the government.  While there continues to be lip service paid to inflation as a problem, policy actions show a willingness to tolerate higher inflation for a much longer time.  Alas, it will be topic number one with respect to markets for a long time to come.

For now, the dollar is performing well against all the major currencies, but there are many potential twists in our future.  As I have said before, payables hedgers should be picking levels to add to their hedges.

Good luck, good weekend and stay safe
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Shocked

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The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked

Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?

I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory.  Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles.  However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass.  In fact, back in the day, the Fed was still concerned about deflation.

Well Jay, how about now?  Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows.  And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years.  One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship.  The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.

And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond.  Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.

As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September.  While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement.  In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.

The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions.  While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act.  Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10.  Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.

So, how are markets digesting this news?  Not terribly well.  At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared.  However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit.  US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices.  Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.

Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps.  Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day.  But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out.  This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour.  But the rest of Europe is not so lucky, especially with the PIGS still under pressure.  I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.

Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs.  This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates.  NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October.  It seems that some of those fears have abated.  Gold, however, continues to rally, up another 0.4% today and about 4% in the past week.  Perhaps it has not entirely lost its inflationary magic.

And finally, the dollar continues to perform very well after a remarkable performance yesterday.  For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%.  ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse.  But don’t discount the euro having taken out every level of technical support around and falling 1%.  This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun.  In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements.  The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age.  The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.

With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly.  There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk.  In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term.  Later on?  Perhaps a very different story.

Good luck and stay safe
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Prices Rise in a Trice#CPI, #inflationexpectations

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There once was a world where the price
Of stuff stayed the same…paradise
But then central banks
Were born, and now thanks
To them prices rise in a trice

Now, worldwide the story’s the same
As these banks, inflation, can’t tame
They’re all terrified
That stocks might just slide
And they would come in for the blame

“I’d expect price increases to level off, and we’ll go back to inflation that’s closer to the 2% that we consider normal.  In the 70’s and 80’s inflation expectations became embedded in the American psyche.  That isn’t happening now.”  So said Treasury Secretary Yellen yesterday in an interview on NPR.  One has to wonder on what she bases these expectations.  Certainly not on any of the evidence as per the most recent data releases.

For instance, the NY Fed’s latest Inflation expectation survey was released yesterday with 1-year (5.7%) and 3-year (4.2%) both at the highest level in the series’ history since it began in 2013.  She cannot be looking at yesterday’s PPI data (8.6%, 6.8% core) as an indicator given both of these are at their highest level on a final demand basis since PPI started being measured in this manner in 2011.  However, a look a little deeper at the intermediate levels, earlier in the supply chain, show inflation running at levels between 11.8% and 27.8% Y/Y.  While all of these costs are not likely to flow into the price of finished goods, you can be sure that the pressure to raise prices throughout the chain for both goods and services remains great.  And of course, later this morning we will see the CPI data (exp 5.9% Y/Y, 4.3% ex food & energy) with both indicators forecast to show substantial increases from last month.  Secretary Yellen continues to try to sell the transitory story and twelve months of increasing prices later, it is wearing thin.

The US, though, is not the only place with this problem, it is a global issue.  Last night China released its inflation readings with PPI (13.5%) rising far more than expected and touching levels not seen since 1995.  CPI there rose to 1.5%, a tick higher than expected which indicates that either there is a serious lack of final demand in the country or they are simply manipulating the data to demonstrate that the government is in control.  (In fact, it is always remarkable to me when a Chinese data point is released that is not exactly as expected given the control the government exerts on every aspect of the process.)  Regardless, the fact is that price pressures continue to rise in China on the back of rising energy costs and shortages of available energy, and ultimately, given China’s status as the world’s largest exporter, those costs are going to feed into other nations’ import prices.

How about Europe?  Well, German CPI rose 4.5% Y/Y in October, the highest level since September 1993 in the wake of the German reunification which dramatically shook up the economy there.  Remember, too, the German’s have a severe phobia over inflation given the history of the Weimar Hyperinflation, so discontent with the ECB’s performance is growing apace in the country.

Essentially, it is abundantly clear that rising prices have become the norm, and that any idea that we are going to ease back to moderate inflation in the near-term are fantasy.  Naturally, with inflationary pressures abundant, one might expect that central banks would be out to address them by tightening policy.  And yet, while peripheral nations have already done so, the biggest countries remain extremely reluctant to tighten as concern over economic output and employment growth continue to dominate their thoughts.

Historically, central bank decision making always required balancing the two competing goals of pumping up supporting the economy while preventing prices from running away.  Between the GFC and the pandemic, though, there was no need to worry as measured inflation never reared its ugly head, so easy money supported growth with no inflationary consequences.  But post-pandemic fiscal largess has changed the equation and now central banks have to make a decision, with significant political blowback to either choice.  Yet the biggest risk is the lack of a decisiveness may well lead to the worst of all worlds, rising prices and slowing growth, i.e. stagflation.  I promise you a stagflationary environment will be devastating to financial assets all over.

Now, as we await the CPI data, let’s take a look around the markets to see how traders and investors are responding to all the latest news and data.

Equity markets are mostly following the US lead from yesterday with declines throughout most of Asia (Nikkei -0.6%, Hang Seng +0.7%, Shanghai -0.4%) and most of Europe (DAX -0.2%, CAC -0.3%, FTSE 100 +0.4%).  US futures are all pointing lower at this hour as well (DOW -0.3%, SPX -0.3%, NASDAQ -0.5%) so there is little in the way of joy at the current moment.  Risk is definitely under pressure.

What’s interesting is that bonds are not seen as a viable replacement despite declining stock prices as yields in Treasuries (+2.7bps) and throughout Europe (Bunds +0.8bps, OATs +2.1bps, Gilts +3.4bps) are higher.  So, stocks are lower and bonds are lower.  Did I mention that stagflation would be negative for financial assets?

On this very negative day, commodity prices, too, are under pressure with oil (-0.6%), NatGas (-1.8%), gold (-0.35%), copper (-0.3%) and tin (-1.1%) all suffering.  In fact, throughout the entire commodity complex, only aluminum (+2.0%) and corn (+0.5%) are showing gains.  At this point, oil remains in a strong uptrend, so any pullback is likely technical in nature.  NatGas continues to respond to the glorious weather in the northeast and Midwest with reduced near-term demand.  Even in Europe, Gazprom has finally started to let some more gas flow hence reducing price pressures there although it remains multiples of the US price.

Turning to the dollar, it is today’s clear winner, gaining against 9 of its G10 brethren, with CAD (flat) the only currency holding its own.  SEK (-0.6%) and NOK (-0.5%) lead the way lower with the latter tracking oil’s declines while the former is simply showing off its high beta characteristics with respect to dollar movement.  In the EMG bloc, TRY (-1.1%) is the laggard as traders anticipate another interest rate cut, despite high inflation, and there is concern over the fiscal situation given significant foreign debt payments are due next week.  ZAR (-0.9%) is slumping on the commodity story as well as concerns that the budget policy may sacrifice the currency on the altar of domestic needs.  But the weakness extends throughout the space with APAC currencies under pressure as well as LATAM currencies.  This is a dollar story today, with very little holding up to the perceived stability of the buck.

As well as the CPI data, given tomorrow’s holiday, we see Initial (exp 260K) and Continuing (2050K) Claims at 8:30.  There are actually no further Fed speakers today with Bullard yesterday remarking that two rate hikes were likely in 2022.  We shall see.

With the inflation narrative so strong, this morning’s data will be key to determining the short-term direction of markets.  A higher than expected print is likely to see further declines in both stocks and bonds with the dollar benefitting.  A weaker outcome seems likely to unleash yet another bout of risk acquisition with the opposite effects.

Good luck and stay safe
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Extinct

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Down Under the RBA blinked
Regarding their policy linked
To Yield Curve Control
Which seemed, on the whole
To crumble and now is extinct

The question’s now how will the Fed
Address what’s become more widespread?
As prices keep rising
The market’s surmising
That rate hikes will soon go ahead

Here’s the thing, how is it that the Fed, and virtually every central bank in the developed world, have all been so incredibly wrong regarding inflation’s persistence while virtually every private economist (and markets) have been spot on regarding this issue?  Are the economists at the Fed and the other central banks really bad at their jobs?  Are the models they use that flawed?  Or, perhaps, have the central banks been knowingly trying to mislead both markets and citizens as they recognize they have no good options left regarding policy?

It is a sad situation that my fervent desire is they are simply incompetent.  Alas, I fear that central bank policy has evolved from trying to prevent excessive economic outcomes to trying to drive them.  After all, how else could one describe the goal of maximum employment other than as an extreme?  At any rate, as the saying goes, these chickens are finally coming home to roost.  The latest central bank to concede that their previous forecasts were misguided and their policy settings inappropriate was the RBA which last night ended its 20-month efforts at yield curve control while explaining,

“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.”

And that is how a central bank cries ‘uncle!’

Recall, the RBA targeted the April 2024 AGB to keep it at a yield of, first 0.25%, and then after more lockdowns and concerns over the impact on the economy, they lowered that level to 0.10%.  Initially, it had success in that effort as after the announcement, the yield declined from 0.55% to 0.285% in the first days and hovered either side of 0.25% until they adjusted things lower.  In fact, just this past September, the yield was right near 0.0%.  But then, reality intervened and inflation data around the world started demonstrating its persistence.  On October 25, the yield was 0.125%, still behaving as the RBA desired.  By October 29, the end of last week, the yield had skyrocketed to 0.775%!  In truth, last night’s RBA decision was made by the market, not by the RBA.  This is key to remember, however much control you may believe central banks have, the market is still bigger and will force the central bank’s hand when necessary.

Which of course, brings us to the FOMC meeting that starts this morning and whose results will be announced tomorrow afternoon at 2:00pm.  Has the market done enough to force the Fed’s hand into adjusting (read tightening) policy even faster than they have expressed?  Will the Fed find themselves forced to raise rates immediately upon completing the taper or will they be able to wait an extended length of time before acting?  The latter has been their claim all along.  Thus far, bond traders and investors have driven yields in the front end higher by 25bps in the 2-year and 35bps in the 3-year over the past 6 weeks.  Clearly, the belief is the Fed will be raising rates much sooner than had previously been considered.

The problem for the Fed is that the economic data is not showing the robust growth that they so fervently desire in order to raise interest rates.  While inflation is burning, growth seems to be slowing.  Raising rates into that environment could easily lead to even slower growth while having only a minimal impact on prices, the worst of all worlds for the Fed.  If this is the outcome, it also seems likely that risk assets may suffer, especially given their extremely extended valuations.  One must be very careful in managing portfolio risk into this situation as things could easily get out of hand quickly.  As the RBA demonstrated last night, their control over interest rates was illusory and the Fed’s may well be the same.

With those cheery thoughts in our heads, a look at markets this morning shows that risk is generally being shed, which cannot be that surprising.  In Asia, equity markets were all in the red (Nikkei -0.4%, Hang Seng -0.2%, Shanghai -1.1%) as the euphoria over the LDP election in Japan was short-lived and the market took fright at the closure of 18 schools in China over the increased spread of Covid.  In Europe, equity markets are mixed with the DAX (+0.5%) and CAC (+0.4%) both firmer on confirmation of solid PMI Manufacturing data, but the FTSE 100 (-0.5%) is suffering a bit as investors grow concerned the BOE will actually raise the base rate tomorrow.

Speaking of interest rates, given the risk-off tendencies seen today, it should be no surprise that bond yields are lower.  While Treasury yields are unchanged as traders await the FOMC, in Europe, yields are tumbling.  Bunds (-3.5bps) and OATs (-5.6bps) may be the largest markets but Italian BTPs (-10.7bps) are the biggest mover as investors seem to believe that the ECB will remain as dovish as possible after last week’s ECB confab.  Only Gilts (-0.4bps) are not joining the party, but then the BOE seems set to crash it with a rate hike, so there is no surprise there.

Once again, commodity prices are mixed this morning, with strong gains in the agricultural space (wheat >$8.00/bushel for the first time since 2008) and NatGas also firmer (+3.0%), but oil (-0.35%). Gold (-0.1%), copper (-0.5%) and the rest of the base metals softer.  In other words, there is no theme here.

Finally, the dollar is having a pretty good day, at least in the G10 as risk-off is the attitude.  AUD (-0.85%) is the worst performing currency as positions get unwound after the RBA’s actions last night.  This has dragged kiwi (-0.7%) down with it.  But NOK (-0.6%) on lower oil prices and CAD (-0.3%) on the same are also under pressure.  In fact, only JPY (+0.35%) has managed to rally as a traditional haven asset.  In emerging markets, the outlier was THB (+0.6%) which has rallied on a sharp decline in Covid cases leading to equity inflows, while the other currency gainers have all seen only marginal strength.  On the downside, RUB (-0.5%) is feeling the oil heat while ZAR (-0.2%) and MXN (-0.2%) both suffer from the metals’ markets malaise.

There is absolutely no data today, nor Fed speakers as all eyes now turn toward ADP Employment tomorrow morning and the FOMC statement and following press conference tomorrow afternoon.  At this point, my sense remains that the market perception is the Fed will be the most hawkish of all central banks in the transition from QE infinity to the end of QE.  That should generally help support the dollar for now.  however, over time, the evolution of inflation and policy remains less clear, and if, as I suspect, the Fed decides that higher inflation is better than weakening growth, the dollar could well come under much greater pressure.  I just don’t think that is on the cards for at least another six months.

Good luck and stay safe
Adf

A Touch of Despair

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The Beige Book detected the fact
That bottom lines all have been whacked
As wages explode
While growth, somewhat, slowed
Inflation, it seems, ain’t abstract

Meanwhile we heard from a vice-Chair
Whose words had a touch of despair
It seems he now thinks
There just might be links
Twixt QE and price everywhere

Chairman Powell’s comments due tomorrow are taking on much greater importance than just a few days ago as the Fed narrative is seemingly in the middle of a change.  While many have been willing to dismiss the fact that the regional Fed presidents have been more hawkish lately, leading the charge for the beginning of tapering, the Fed governors had been far more sanguine on the subject, at least until very recently.  Tuesday, we heard from Governor Waller about his concerns that inflation could be more persistent, especially if one looked at the headline measures as he dismissed the other measures as efforts at manipulation.  Yesterday it was vice-Chair Quarles’ turn to put the market on notice that inflation’s persistence has begun to become troublesome and while he still felt price pressures would abate next year, his level of confidence in that forecast was clearly declining.  Both of them hinted at the possible need for rate hikes sooner than previously expected.

Yesterday, too, the release of the Fed’s Beige Book presented a clear picture of two issues: wages were rising rapidly, and growth was slowing.  The problem stems from the fact that despite wage increases of 20% or more, companies are still having a problem staffing up to desired levels and that has led to reduced output.  It has also led to business after business explaining that they would be raising prices to offset increased costs for not just wages, but raw materials and shipping.  In your Economics 101 textbook (likely Samuelson’s) this was the very definition of a wage-price spiral.

It is this recent hawkish turn by several Fed governors that brings even greater attention to Chairman Powell’s comments tomorrow.  The market is already assuming that tapering will begin next month, but the question remains, will the Fed be able to continue along that line if economic activity continues to slide?  I raise this issue because after Tuesday’s weaker than expected housing data, the Atlanta Fed’s GDPNow indicator has fallen to 0.533% for Q3.  And that’s an annual rate, down from Q2’s 6.8% GDP growth.  It appears the Fed may have a difficult decision to make in the near future; fight rapidly rising inflation or fight rapidly slowing growth. As I’ve written before, stagflation is a b*tch.

Adding to the economic problems is the continued slowing of growth in China where ongoing power shortages combined with a resurgence of Covid related shutdowns and the implosion of China Evergrande have resulted in the slowest, non-Covid, growth in decades.  At the same time, the PBOC continues to drain liquidity from the economy in an effort to reduce leverage which has the effect of further slowing activity there.  Given China has been the global growth engine for at least the past decade, a slowdown there means we are going to see slower activity everywhere else.  Alas, for the central banking community, it is not clear that will help price pressures abate, not as long as energy and raw material prices continue to rise.

Summing it all up shows that growth worldwide is falling from Q2’s peak while price pressures are flowing from commodities to shipping and now wages.  All this is occurring with interest rates broadly at their lowest levels in history. (I know some countries have raised rates a bit, but the reality is there is far less room to ease policy than tighten overall.)  Given this backdrop, it remains amazing to me that equity markets worldwide have been able to continue to perform well.  And yet, they continue to do so broadly, albeit not last night.  However, I believe that interest rate markets are beginning to recognize that the future may not be so rosy as we are seeing yields continue to climb and inflation breakevens rise to levels not seen in nearly a decade.  Remember, there is no perpetual motion machine and no free lunch.  Central banks have spent the entire post GFC period continually supporting markets while allowing significant imbalances to develop across all segments of the economy and, ironically, markets.  I have often said the Fed’s biggest problem will arrive when they announce a policy change and the market ignores the announcement.  I fear that time is growing much nearer.

With those cheery thoughts to support us, let’s take a look at the overnight session.  It seems that risk is having a bit of a struggle today with most of Asia (Nikkei -1.9%, Hang Seng -0.5%, Shanghai +0.2%) under pressure and Europe (DAX -0.1%, CAC -0.4%, FTSE 100 -0.6%), too, having difficulty this morning.  US futures are also pointing lower, -0.3% or so across the major ones, which implies pressure at the opening at the very least.  China continues to be a drag on the global markets as other Chinese real estate companies are starting to fall and the word is Evergrande’s sales have fallen 97%.  I guess buying from a bankrupt company is not that attractive a proposition.

In a bit of a surprise, European sovereign bond yields are rising this morning (Bunds +1.6bps, OATs +1.2bps, Gilts +3.7bps) as ordinarily one would expect a rush into safe havens when risk is on the run.  However, as the EU begins another summit, it is likely to simply highlight the ongoing problems across the continent, notably in energy, and that seems to be sapping confidence from investors.  Treasury yields are very marginally softer on the day, so far, but with more and more Fed members talking up inflation worries, I expect they are likely to continue to rise for a while yet.

Commodity markets are under pressure today as well with oil (WTI -0.8%) and NatGas (-1.7%) leading the way, but weakness, too, in copper (-2.9%), aluminum (-0.3%) and all the main agriculturals (soy -0.7%, wheat -0.7%, corn -0.5%).  By contrast, gold’s unchanged price is looking good!

As to the dollar, it is broadly, though not universally, stronger this morning.  In the G10, AUD (-0.3%) and NZD (-0.3%) lead the way down with the rest of the commodity bloc also suffering a bit.  On the plus side, JPY (+0.25%) is the only gainer, which given equity price action seems pretty standard.  In the emerging markets, TRY (-2.4%) is the outlier after the central bank cut interest rates by 2.0%, double the expected outcome, to 16.0%, despite inflation running at 19.6% in September.  You may recall that President Erdogan fired several central bankers last week as they were clearly not willing to do his bidding.  There is nothing promising about the lira these days.  Aside from that, the rest of the space is softer led by ZAR (-0.7%) on weaker commodity prices, and PLN (-0.4%) as investors’ concerns grow that the EU is going to try to punish Poland for its recent court ruling that said EU law does not reign supreme in Poland.  Other movers have been less significant but are spread across all three geographies.

On the data front, this morning brings the weekly Initial (exp 297K) and Continuing (2548K) Claims numbers as well as Philly Fed (25.0), Leading Indicators (+0.4%) and Existing Home Sales (6.09M).  Of this group, I expect the Philly number will give the most information, but in truth, I believe traders and investors are more interested in hearing from Chris Waller again as well as NY Fed president Williams this morning to try to get any more information about the evolving Fed story.

Broadly speaking, I believe the US interest rate story continues to underpin the dollar and I see nothing to change that view.  The dollar has been trending higher since summer and while the last week has seen marginal dollar softness, I believe it is merely a good time to take advantage and buy dollars for receivables hedgers.

Good luck and stay safe
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Protests Are Growing

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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
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Hikes Are Impending

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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
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Narrative Drift

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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
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At All Costs#

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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
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QE Galore

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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
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