Tag Archives: #riskoff

Anything But Preordained

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Could Be Dead

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Starting to Wane

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The rebound is starting to wane
In England, in France and in Spain
But prices keep rising
With German’s realizing
They’ve not yet transcended their pain

First, some housekeeping, I will be on my mandatory two-week leave starting Monday, so there will be no poetry after today until September 7.

Meanwhile, this morning’s market activity is bereft of interesting goings-on, with very few stories of note as the summer holiday season is clearly in full swing.  Perhaps the three most notable events were UK Retail Sales, German PPI and new Chinese legislation.  Frankly, none of them paint a very positive picture regarding either the economy or markets going forward.

Starting at the top, UK Retail Sales (-2.4% in July) fell short of expectations, with the Y/Y reading back down to +1.8% from a revised +6.8% and the universal description of the situation as the reopening rebound is over.  The spread of the delta variant continues to add pressure as closures are dotted throughout the country, and sentiment seems to be turning lower.  It ought be no surprise that the pound (-0.15%) has fallen further, taking its month-to-date losses to 2.5%.  Too, the FTSE 100 (-0.2%) is under pressure, although it does remain in a broader uptrend, unlike the pound.  However, the first indication here is that risk is being sold off, which seems a pretty good description of the day.

Next, we turn to Germany’s PPI reading (10.4% Y/Y, 1.9% M/M) which is actually the largest annual rise since January 1975, where prices were impacted by the oil crisis!  While we have all been constantly reassured that inflation is a fleeting event and there is absolutely no indication that the ECB will see this number and consider tightening policy in any way, shape or form, I suspect that the good people of Germany may see things a bit differently.  The chatter from Germany is a growing concern over rapidly rising prices with a real chance of political fallout coming.  Remember, Germany goes to the polls next month in an effort to replace Chancellor Merkel, who has been running the country for the past 16 years.  Currently no candidate looks particularly strong, so a weak coalition seems a very possible outcome.  It is not clear that a weakened Germany will be a positive for the euro, which while unchanged on the day has been trending steadily lower for the past two months and yesterday broke below, what I believe is, a key support level at 1.1704.  Look for further declines here.

And finally, the Chinese passed a stricter personal data protection law prohibiting private companies from collecting and keeping data on their customers without explicit permission, a practice that had heretofore been commonplace. This appears to be yet another attack on the tech sector in China as President Xi ensures that the Chinese tech behemoths are disempowered.  After all, similarly to the US, the value of the big platforms comes from these companies’ abilities to compile and monetize the meta-data they collect by using it for targeted advertising.  Of course, the law says nothing about the Chinese government collecting that data and maintaining it, as that is part and parcel of the new normal in China.  One cannot be surprised that Chinese equity markets continue to decline on the back of these ongoing attacks against formerly unsullied companies, with the Hang Seng (-1.85%) now lower by 21% from its peak in February, and showing no signs of stopping as international funds flow out of the country.  Shanghai (-1.1%) also fell sharply, but given this index has more SOE’s and less tech, its decline from its February peak is only 9%.  As to the renminbi, it softened a bit further and is pushing slowly back above 6.50 at this time, its weakest level since April.

Otherwise, nada.  Equity markets are in the red everywhere, with the Nikkei (-1.0%) also slipping and we are seeing losses throughout Europe (DAX -0.4%, CAC -0.3%, FTSE 100 -0.2%) as well.  US futures, too, are pointing lower, with all three indices looking at 0.4% declines.  Of course, yesterday, things looked awful at this hour and both the NASDAQ and S&P 500 managed to close higher on the day, albeit only slightly.

Bonds are definitely in the ascendancy with yields continuing to slide.  Treasury yields are lower by 1.5 bps, Bunds and OATs by 0.5bps and Gilts by 2.0bps.  The question to be asked here, though, is, does this represent confidence that inflation is truly transitory?, or is this a commentary on future economic activity?, or perhaps, is this simply the recognition that central banks have distorted these markets so much they no longer give useful signals?  Whatever the underlying driver, the reality of bonds’ haven appeal remains and given the signals from the equity market, falling bond yields are not a big surprise.

Commodity prices remain under pressure generally, with oil (-0.8%) continuing its recent decline.  After a massive rally from last November through its peak in early July, crude has fallen 17% as of this morning.  In this case, while I understand the story regarding weakening economic growth, it seems to me the long term picture here remains quite positive as the Biden administration’s efforts to end oil production in the US, or at the very least starve it of future growth, means that supply is going to lag demand for years to come.  That implies higher prices are on the way.  As to the rest of the space, gold (+0.25%) continues to trade in its 1775-1805 range since mid-June with the exception of the two-day blip lower that was quickly erased.  Copper’s recent downtrend remains intact although it has bounce 0.3% this morning, and the rest of the industrial metals are either side of unchanged.

The dollar is broadly stronger this morning, with CAD (-0.7%) the weakest of the G10 currencies, clearly suffering from oil’s decline but also, seemingly, from self-inflicted wounds regarding its draconian Covid policies.  The Loonie has now fallen 4.25% this month with half of that coming in just the last two sessions.  But we are seeing continued weakness throughout the commodity bloc here with NOK (-0.45%) and AUD and NZD (both -0.3%) continuing their recent declines.  On the plus side, only CHF (+0.2%) has shown any strength of note.

Emerging market currencies are also under pressure this morning led by ZAR (-0.6%) and MXN (-0.4%) as softer commodity prices weigh heavily here.  We also continue to see weakness in some APAC currencies, with IDR (-0.35%) and KRW (-0.3%) suffering from concerns over the ongoing spread of the delta variant and the corresponding investor funds outflow from those nations.  On the flipside, PHP (+0.35%) was the only gainer of note in the region after the government loosened some Covid restrictions.

There is no economic data today and only one Fed speaker, Dallas Fed President Kaplan.  Of course, Kaplan has been the most vocal calling for tapering, so we already know his view, and after the Minutes from Wednesday, it seems he has persuaded many of his colleagues.  But once again I ask, if the economy is slowing, which I believe to be the case, will the Fed really start to remove accommodation?  I don’t believe that will be the case.  However, for now, the market is likely to bide its time until next week’s Jackson Hole speech by Powell.  Beware summer choppiness due to lack of liquidity and look for the current dollar uptrend to continue while I’m away.

Good luck, good weekend and stay safe
Adf

To Taper’s Ordained

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The Minutes on Wednesday explained
That QE would still be sustained
But ere this year ends
Some felt that the trends
Implied that, to taper’s, ordained

But ask yourself this, my good friends
What happens if tapering sends
The stock market down
Will they turn around
And restart QE as amends?

Remember all the times the Fed tried to tell the world that their current policy stance, notably the massive amount of QE purchases, were not the driving force in the equity market?  Stock market bulls played along with this as well, explaining that historically high valuation measures were all appropriate given the huge corporate profit margins, and had nothing to do with the Fed’s suppression of interest rates along the entire yield curve.  The bulls would point to 30-year interest rates below 2.00% and explain that when you discounted future cash flows at such low levels, it was only natural that stock valuations were high.  The fact that it was the Fed that was simultaneously buying up all the net Treasury issuance, and then some, thus driving rates artificially lower, as well as promising to do so for the foreseeable future was seen as a minor detail.

Perhaps that detail was not as minor as the bulls would have you believe!  Yesterday, the FOMC Minutes were released and the part that garnered all the attention was the discussion on the current asset purchase framework and how it might change in the future.

“Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met. At the same time, most participants remarked that this standard had been achieved with respect to the price- stability goal. (my emphasis) A few participants noted, however, that the transitory nature of this year’s rise in inflation, as well as the recent declines in longer-term yields and in market-based measures of inflation compensation, cast doubt on the degree of progress that had been made toward the price-stability goal since December.”

So, it seems they are in sync on the fact that the employment situation has room to run, and they don’t want to act too early because of that.  But what I find more interesting is that they can use the term ‘price stability’ when discussing inflation running in the 4.0%-5.0% range.  As well, it is apparent that many of the committee members are drinking their own Kool-Aid on the transitory story.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year because they saw the Committee’s “substantial further progress” criterion as satisfied with respect to the price-stability goal and as close to being satisfied with respect to the maximum employment goal. Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year because they saw prevailing conditions in the labor market as not being close to meeting the Committee’s “substantial further progress” standard or because of uncertainty about the degree of progress toward the price-stability goal.” (my emphasis)

But this was the money line, the clear talk that most of the committee expected tapering to begin before the end of the year.  While we have not yet heard any of the three key leaders (Powell, Williams and Brainerd) say they were ready to taper, it seems that most of the rest of the committee is on board.  Jackson Hole suddenly became much more interesting, because if Powell discusses tapering as likely to occur soon, it will be a done deal.  But if he doesn’t explain that tapering is coming soon, it is possible that we see four dissents, at the next meeting.  And how about this for a thought, what if those three are the only votes to stand pat, and the other six voting members want to start the taper?  That would truly be unprecedented and, I think, have major negative market ramifications.  I don’t expect that to occur, but after everything that has occurred over the past 18 months, I wouldn’t rule out anything anymore.

At any rate, the tapering talk remains topic number one in every market, and one cannot be surprised that the market’s reaction has been a clear risk-off response.  Equity markets around the world are lower, substantially so in Europe; bond markets are rallying as risk is jettisoned; commodity prices are falling, and the dollar is king!

So, let’s take a tour and see where things are.  Starting in Asia, we saw equities decline throughout the region with the Nikkei (-1.1%), Hang Seng (-2.1%) and Shanghai (-0.6%) all under pressure.  But the real pressure was felt in Korea (KOSPI -1.9%) and Taiwan (TAIEX -2.7%).  In fact, the only markets in the region to hold their own were in New Zealand.  Turning to Europe, it is a uniform decline with the DAX (-1.6%), CAC (-2.5%), and FTSE 100 (-2.0%) all falling sharply, with the lesser known indices also completely in the red.  I guess the prospect of less Fed largesse is not seen as a positive after all.  Meanwhile, ahead of this morning’s opening, US equity futures are all sharply lower, on the order of 0.75%.

Turning to the bond market, the prospect of less Fed buying is having an interesting outcome, bonds are rallying.  Of course, this is because Treasuries remain the ultimate financial safe-haven trade and as investors flee risky assets, bonds are the natural response.  So, 10-year Treasury yields have fallen 3.5bps, and we are seeing yields decline in the European market as well, at least those countries that are deemed solvent.  So, Bunds (-1.4bps), OATs (-1.1bps) and Gilts (-3.4bps) are all seeing demand.  Yields for the PIGS, however, are unchanged to higher on the day.

Commodity prices are uniformly lower, except for gold, which is essentially unchanged on the day.  Oil (-3.7%) leads the way down, but we are seeing weakness in base metals (Cu -3.3%) as well as the Agricultural space (Wheat -1.5%, Soybeans -1.2%).

Finally, the dollar is on top of the world this morning, as investors are buying dollars to buy bonds, or so it seems.  In classic risk-off fashion, only the yen (+0.1%) has managed to hold its own vs. the dollar as the rest of the G10 bloc is weaker led by NOK (-0.95%) and AUD (-0.95%).  NZD (-0.7%) and CAD (-0.7%) are also suffering greatly given the commodity weakness story.  But do not ignore the euro (-0.15%) which while it hasn’t moved very far, has managed to finally trade below the key 1.1704 support level, and is set, in my view, to head much lower.

In the EMG space, ZAR (-1.3%) is the leading decliner, falling alongside the commodity complex.  KRW (-0.7%) has given back all of yesterday’s gains as equity outflows continue to dominate the market there, but we are seeing weakness across the board with most currencies falling between 0.3%-0.6% purely on the dollar’s overall strength.

On the data front, this morning brings the weekly Initial Claims (exp 364K) and Continuing Claims (2.8M) as well as Philly Fed (23.1) and Leading Indicators (+0.7%).  There’s no scheduled Fedspeak, but what else can they say after yesterday’s Minutes anyway?  If you recall, Monday’s Empire Mfg was quite weak, so I would not be surprised to see Philly follow suit.  In fact, I think the biggest problem the Fed is going to have is that the data is rolling over and looking like a slowing economy, despite high inflation.  If they keep seeing economic weakness, are they really going to taper into a weakening economy?  They may start, but I doubt they get two months in before they stop, especially if equities continue to revalue (fall).  As to the dollar, for now, I like its prospects and suspect that we are going to trade to levels not seen since June of last year.

Good luck and stay safe
Adf

They’re Still Exposed

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Though merely a few angstroms wide
The pressure that Covid’s applied
To all politicians
Has led to conditions
That many find unjustified

For instance, New Zealand has closed
Its borders, and rights they’ve bulldozed
To help in prevention
Of viral retention
Unfortunately, they’re still exposed

While the major headlines around the world continue to focus on the ongoing events in Afghanistan, at this point, they have had limited, if any, impact on markets in general.  And let’s face it, if for some reason there was a negative market impact traced to the Afgahi government collapse, it is pretty clear that the global central bank response would simply be to print more money thus supporting markets more completely.  But so far, that has not been the case (I just hope you weren’t long Afghani, interestingly the name of their currency as well, as it has fallen about 4.5% in the past 72 hours.)

This means we must turn our attention elsewhere for market moving information.  Asia continues to be the region with the most interesting issues, although Oceania is making a run for the money there in the following way; PM Ardern of New Zealand has imposed a level 4 lockdown for the next three days because a single case of the delta variant of Covid-19 has been found in the entire country!  This has resulted in a significant reevaluation of the RBNZ’s next move.  Prior to this devastating outbreak, the punditry had largely concluded that the RBNZ would be the first developed country to raise rates at their meeting tonight.  But now, second thoughts have crept in and a number of economists have changed their view and are calling for no change.  You would have thought that Covid was the most powerful force in the universe based on the (over)reaction of policymakers.  A single case!  At any rate, this change in view has resulted in NZD (-1.4%) falling sharply along with the local equity market, while NZ government bonds rallied almost a full point with yields declining by 9.7bps to 1.70%.  A single case! 

Meanwhile, in Australia, the government is proposing rounding up 24,000 unvaccinated children in a stadium to insure they are vaccinated as half that nation remains under lockdown.  The economic data Down Under has clearly rolled over with Consumer confidence the latest number to fall, while the RBA minutes, released last night, indicated that they were “prepared to act” in the event a further outbreak had a significant impact on the economy.  Not surprisingly, the market understood that to be a more dovish stance than the comments immediately following their meeting two weeks ago when they promised to start taper asset purchases next month.  AUD (-0.7%) is correspondingly under pressure as well today.

As to Asia, the big news continues to come from China where the government continues its relentless attack on its tech behemoths as President Xi has become more focused on removing any sources of power that do not emanate from his office.  Chinese equity markets sold off once again (Shanghai -2.0%, Hang Seng -1.7%) as investors read about the newest competition rules that were to come into force there and would break down the walls between financial networks run by Alibaba and Tencent.  It appears that capitalism with Chinese characteristics actually means, government-controlled businesses…full stop.

And so, before Europe even walked in, risk was under severe pressure and continues that way as I type.  Markets remain amazingly resilient with respect to business failures, but when it comes to potential policy failures, investors have less confidence that everything will work out well.  Remember, too, that it has been many months since we have even seen a 5% drawdown in the S&P 500, so do not be surprised if this is the catalyst for some further risk mitigation.

Thus far, today is definitely in the risk-off column with not just the Chinese markets declining, but the Nikkei (-0.4%) also sliding, albeit not nearly as drastically.  European markets are generally weak (Dax -0.24%, CAC -0.55%, FTSE MIB -1.0%, IBEX -0.95%) although the UK (FTSE 100 +0.1%) is holding its own after much better than expected employment data was released earlier.  It seems the combination of a highly vaccinated population and massive fiscal and monetary stimulus is helping the UK economy recover quite nicely.

It can be no surprise that bond markets are rallying sharply on this risk-off day, with Treasuries seeing yields fall by 3.7 basis points while all of Europe (Bunds -2.1bps, OATs -2.1bps, Gilts -3.8bps) are also seeing demand for haven assets.  This is even true for the PIGS where yields have fallen between 1 and 2 basis points.

On the commodity front, oil (-0.8%) continues to respond to concerns over slowing economic growth worldwide amid the spread of the delta variant, as does copper (-0.9%).  Both of these commodities are seen as the most sensitive to economic expectations.  Gold (+0.4% today, +6.2% from last week’s low) is performing the way many believe it should in times of stress.  As to the rest of the bloc, there are gainers and losers amid both base metals and agricultural products.

Finally, the dollar is on top of the world this morning, rallying against 9 of its G10 counterparts with only CHF (+0.1%) maintaining its status as a world haven.  Granted, the commodity currencies are the worst off, with CAD (-0.35%) also under pressure.  Interestingly, despite the positive UK data, the pound (-0.45%) is feeling the weight of the dollar today.

Emerging market currencies continue to struggle in general, although there are a couple of positive stories.  First up is PHP (+0.45%) which saw equity inflows as bargain hunters were seen following several days of equity market declines, and the central bank indicated no policy change was upcoming, an upgrade from concerns over further easing.  THB (+0.45%) was also stronger on the back of comments from the central bank governor as well as the fact that it had fallen so far lately, more than 6% in the past two months and back to 3-year lows, that there was a bout of profit taking.  On the downside, KRW (-0.65%) continues to be the region’s laggard as ongoing concern over chip stocks has encouraged more equity market selling (KOSPI -0.9%) and seen funds flow out of the country.  Adding to this pressure is the continued increase in Covid infections and that has been enough for the won to fall 3.4% in the past two weeks.

On the data front, this morning brings Retail Sales (exp -0.3%, +0.2% ex autos) as well as IP (0.5%) and Capacity Utilization (75.7%).  The Retail Sales data has been quite volatile lately, as each wave of Federal stimulus money has quickly found uses, but when that money has not been forthcoming, sales decline sharply.  I have seen estimates that we could see a MUCH worse than expected outcome here, something on the order of -2.5%, which would be of a piece with the weaker Michigan and Philly Fed data that we have seen lately.

This afternoon, Chairman Powell hosts a town hall meeting with educators, which does not seem like a venue for new information.  We also hear from the uber dove, Neel Kashkari.

While I understand tapering talk remains all the rage, I cannot help but look at what clearly appears to be a weakening economic impulse and wonder if by the time the Fed says they want to start tapering, the data are pointing in the wrong direction and it never comes to pass.  In that event, I feel the dollar, which has greatly benefitted from tapering talk, is likely to fall back, maybe quite a bit.  But that is still a few months away.  For now, it feels like the dollar remains numero uno.

Good luck and stay safe
Adf

Havoc Our Way

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It’s been fifty years to the day
Since Nixon brought havoc our way
He slammed down the sash
Where gold swapped for cash
That’s led to today’s disarray

Given the importance of this event, although it is often overlooked, I felt I had to mention the anniversary.  In truth, it was yesterday, August 15, 1971, when President Nixon closed the gold window, ending the Bretton Woods agreement that insured (allowed?) every nation to convert their dollars to gold and ushered in the current framework of fiat currencies.  Prior to his action, the global monetary system was based on the value of gold, which was exchangeable into US dollars (or perhaps the other way around) at $35.00/oz.  Each nation’s gold sat in cages in the vault at the Federal Reserve Bank of NY and would literally be physically moved from cage to cage in order to satisfy national debts amongst the countries. The problem for the US was that most of the movement was out of the US cage into other countries’, which represented the massive trade and current account deficits the US was running.  So, Nixon essentially told the world, holding dollars was the only choice.

Of course, the fiat currency regime has evolved into the current situation where the ability to print money is endless, and every government is happy for it to never end.  The strictures of a gold-backed currency are far too confining for the social programs deemed essential by virtually every government in the world today, which is why we will never go back.  The real question is, what lies ahead?

The ructions in China persist
As data last night, forecasts, missed
And President Xi
Continues to see
More targets that he can blacklist

As to the markets today, the single biggest story has been the release of Chinese data at significantly worse than expected levels.  The key figures showed Retail Sales (8.5%, exp 10.9%), IP (6.4%, exp 7.9%) and Fixed Asset Investment (10.3%, exp 11.3%).  The disappointing outcome has been attributed to the spread of the delta variant of Covid which has not only resulted in the closure of some key infrastructure points, notably two busy ports, but also weighed on many peoples’ willingness to travel during the typically busy summer vacation season.  Given the Chinese propensity for draconian measures in their effort to stop the spread of the virus, people are concerned they will get stuck some place with no ability to return home if there is a sudden lockdown.

The Wall Street response was immediate, with a number of economic forecasts for China taken lower by between 0.5%-0.7% for 2021 as a whole.  In addition, greater attention has been paid to the Chinese credit impulse (the amount of credit that is flowing into the economy from the banking system) which has been slowing rapidly since a peak in October.  This statistic tends to lead the Chinese economy’s performance by between 6 and 12 months, so it should be no surprise we are starting to see reduced output there.

Interestingly, despite the slowing growth story, the Xi government continues to attack its bellwether tech firms, the ones that have been growing the fastest.  It is becoming increasingly evident that President Xi is perfectly willing to sacrifice economic growth in an effort to consolidate his power even further.  Last night we again saw key government editorials about the evils of online gaming and how it should be curtailed even further.  Alibaba, one of the largest and most successful Chinese internet companies, remains squarely in Xi’s sights as he brings every potential threat to heel.  In the end, this is unlikely to help the Chinese economy writ large which from this poet’s perspective means we are likely to see a very gradual depreciation in the yuan as the currency market becomes a relief valve for domestic economic pressures.

The only other headline news has been the fall of Kabul to the Taliban in a remarkably swift 72 hours, with numerous stories about the evacuation as well as the political failures that led to this outcome.  Perhaps this is the impetus for today’s risk reduction, or perhaps it is the China story, or simply the ongoing spread of the delta variant; but whatever the reason, we are definitely seeing a bit of risk-off attitude across markets.

For instance, equity screens are all red with Asia ((Nikkei -1.6%, Hang Seng -0.8%, Shanghai 0.0%) and Europe (DAX -0.6%, CAC -1.0%, FTSE 100 -1.1%) clearly under pressure.  I’m sure Friday’s very weak Michigan Sentiment number (70.2, weakest since 2011) did not help anyone’s mood, and despite the fact that all three major US indices crept higher on the day Friday, by 0.1% or less, to new record highs, this morning all three are pointing lower by about -0.3%.

Bonds though are a bit more circumspect here, as while Treasury yields have edged lower by 0.3bps, all of Europe’s sovereign markets are selling off with yields rising.  Perhaps, investors have decided that the situation is so dire they don’t want any European paper at all!  So, bunds (+1.0bps), OATs (+1.4bps) and Gilts (+1.2bps) are all lower along side their respective equity markets.

Commodities, too, are softer this morning led by oil (-1.35%) and gold (-0.2%) with base metals (Cu -1.6%, Al -0.2%, Sn -0.3%) falling as well.  In fact, the only part of this bloc holding up is foodstuff, where the big three, corn, wheat and soybeans are all firmer.

Where, you may ask, is everybody putting their money if they are selling both stocks and bonds?  It seems the dollar is finding support against most currencies, except for the havens of JPY (+0.25%) and CHF (+0.2%).  Otherwise, the rest of the G10 is softer vs. the dollar, notably the commodity bloc where AUD (-0.5%), NOK (-0.45%) and CAD (-0.3%) are the laggards.  Similarly, in the EMG bloc, it is the commodity currencies that are under the most pressure with RUB (-0.3%), ZAR (-0.2%) and PHP (-0.35%).  In fact, the only currency with gains is TRY (+0.6%) which continues to benefit from the highest real yields on the planet.

The data story this week brings Retail Sales and Housing data as well as the FOMC Minutes on Wednesday.

Today Empire Manufacturing 28.5
Tuesday Retail Sales -0.2%
-ex autos 0.2%
IP 0.5%
Capacity Utilization 75.7%
Wednesday Housing Starts 1600K
Building Permits 1610K
FOMC Minutes
Thursday Initial Claims 365K
Continuing Claims 2800K
Philly Fed 24.0
Leading Indicators 0.7%

Source: Bloomberg

Retail Sales and the FOMC Minutes are likely to get the most attention, although any really big miss, like Friday’s Michigan data, could lead to further movements, so beware.  As well we hear from a few Fed speakers, with Chairman Powell talking tomorrow, but the subject does not appear to be the economy, then uber-dove Kashkari and his counterpart, the hawkish Kaplan later in the week.

At this point, risk remains under pressure and I sense that it has some room to run lower.  It has been more than 9 months since there has been a 5% drawdown in the equity market, an inordinately long period of time for pressures to build up.  This is not to say that a drawdown is coming, just that there is real instability underlying the market, so one is very possible.  And I sense that this risk-off event would be classic with the dollar gaining real ground against virtually everything.

Good luck and stay safe
Adf

A Small Crisis Grows

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Investors are starting to feel
That China has lost its appeal
So, capital flees
From all stocks, Chinese
As Xi brings exploiters to heel

While, thus far the impact’s been small
On markets elsewhere, please recall
That history shows
A small crisis grows
Quite quickly with each margin call

Giving credit where it is due, the Chinese have successfully distracted almost every market participant from tomorrow’s FOMC meeting.  The ongoing rout in Chinese equity markets (Shanghai -2.5%, Hang Seng -4.2%) has been fueled by the government’s hardline stance against several different industries that had become investor favorites.  If you think of the progression of events, it began with private financial firms (remember the Ant IPO that was squashed when Jack Ma was disappeared for a while?) and has continued as the evolution of the DC/EP (China’s digital yuan or CBDC) has forced the two big private payment firms, Alipay and WeChat Pay to fall into line and restrict their offerings going forward.

We have also seen the government address concerns over other tech companies and their capitalist intentions and actions, which has taken the form of questions over data security in Didi Global, the ride hailing app, and Meituan, the food service company.  After all, both of these companies are clarion calls for people to be independent, choosing their work schedule and effort, as opposed to toiling for a proper, state-owned firm.  Naturally, this is anathema to President Xi as he continues to remold the nation into his preferred view.

The latest attack has been on the private education industry, which while nominally teaching the approved curriculum, were clearly seen as an impediment to government control, and more importantly, the appropriate spread of communism.  Remember, the CCP rules the roost in China and President Xi is General Secretary of the Chinese Communist Party.  It was certainly dichotomous that an area of such immense social importance, that preached communism, would be offered by capitalist firms.

The takeaway here, though, is not that things are getting tougher for investors in China, but that history has shown that most financial crises start small and gather momentum.  While many of you may not remember the Asia crisis of 1997, it started as an issue solely confined to Thailand and the Thai baht.  Questions over the country’s ability to repay its creditors, especially as its USD reserves had shrunk and the dollar’s rally was becoming a major problem locally.  But Thailand is not a very large country from an economic perspective, and so it was initially thought this would amount to very little.  Within a month or two of the initial concerns, however, the entire region was in turmoil as it turned out virtually none of the countries there had sufficient USD reserves, and all had borrowed heavily in dollars and were having difficulty repaying those loans.  There was a huge swoon in markets, which ultimately led to Russia defaulting on its debt while Long Term Capital, a famed hedge fund of the time, wound up on the brink and was only saved by the Fed forcing the entire Wall Street community to put up money to save it.  (Ironically, Bear Stearns is the one bank that wouldn’t participate in that rescue and we know what happened to them 10 years later!)

Speaking of the GFC, this too, was seen as a minor problem at the start.  As the housing bubble inflated, the working assumption was that the entire national housing market could never fall all at once, so all of those mortgage-backed derivatives were created and sold as low risk, high return investments throughout the world.  When the first concerns were raised, none other than Fed Chair Bernanke explained that “…the troubles in the subprime sector on the broader housing market will likely be limited.”  We know how that worked out and of course, the problems quickly became global in nature and forced the first invocation of a new emergency program known as QE.

One last example of the ability of seemingly distant events to impact the entire global financial structure comes from China in 2015.  That summer, just 6 years ago, the PBOC surprised markets with a mini-devaluation of the yuan, about 2%, as a relief valve for an equity market that had started to come under pressure several months previously.  But once the PBOC acted, risk appetite disappeared and we saw a severe contraction in global equity markets, a huge bond rally and strength in the dollar as the haven of choice.

The point is that while you may consider the fact that the Chinese government is cracking down on companies that it considers to be ideologically impure, and that it will have nothing to do with your investments in the FANGMAN group of stocks, there is every chance that this action serves as the catalyst for, at the very least, a short-term price adjustment in equity indices around the world. After all, China’s growth has been a key pillar of the global growth scenario.  If that is slipping, there are likely to be problems everywhere.  Be warned and wary.

OK, on to today’s activity where the Chinese rout continues to be ignored by Japan (Nikkei +0.5%), but continues to pressure European indices lower (DAX -0.4%, CAC -0.3%, FTSE 100 -0.4%) as well as US futures, all of which are down around -0.2% at this hour.

Bond markets are a bit more uniform this morning, led by Treasury yields (-2.9bps) although European sovereigns have not rallied as much, with most seeing yield declines of roughly 1 basis point.  (As an aside, yesterday’s price action, which saw US equity markets ultimately rebound, saw Treasuries give up their early gains and close with slightly higher yields on the day.)

In the commodity space, oil is essentially unchanged on the day, as is gold, with neither moving even 0.1%.  Copper is the biggest mover, falling 1.0%, although there is lesser weakness in other base metals.  Agricultural products are mixed with both Soybean and Corn higher by 1.0% while Wheat has slipped 0.4%.

As to the dollar, on this broadly risk-off day, it is broadly higher.  In the G10 bloc, the commodity currencies are the worst performers (NZD -0.7%, NOK -0.5%, AUD -0.4%) while the rest of the bloc has seen less pressure.  Naturally, JPY (+0.25%) is bucking the dollar trend in this type of session.  In the emerging markets, ZAR (-0.7%) is the laggard as traders digest the post-riot relief act from the government and give it two thumbs down.  The next biggest loser is CNY (-0.35%), although at this point, I’ve already described the reasons capital is leaving the country.  Otherwise, most of these currencies are lower, but the movement has been on the order of -0.1% to -0.2%, so not very dramatic.  There is one outlier on the plus side, KRW (+0.4%) which seems to have been on the back of exporters selling dollars after yesterday’s won decline to its lowest level in almost a year.  However, if CNY continues to weaken, I believe KRW will ultimately follow it.

On the data front this morning we see Durable Goods (exp 2.2%, 0.8% ex transport) as well as Case Shiller House Prices (16.33%) and Consumer Confidence (123.8).  The real information overload starts tomorrow with the FOMC and on through the rest of the week with Q2 GDP and Core PCE.

The dollar is back in risk mode.  If equities continue to suffer, look for the dollar to remain bid.  If they rebound, the dollar is likely to soften by the end of the day.

Good luck and stay safe
Adf

Time to Flee

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No longer will President Xi
Allow billionaires to run free
His edict last night
Proved his grip is tight
And showed traders t’was time to flee

The biggest story overnight was the continued crackdown by Chinese authorities on any private industry that has developed a measure of power in the Chinese economy.  While the tale of Didi Chuxing, the Chinese Uber, was seen as a warning, apparently, the government is becoming more impatient over the pace of adherence to the new view.  Briefly, Didi went public and then several days later the Chinese government forced them to remove their app from public availability and crushed their business under the pretext of data security.  Didi shares fell sharply.  Last night the government explained that private education companies, which were teaching the CCP curriculum, were to cease being profit-making companies “hijacked by capitalism”, and essentially will be forced to delist.  It can be no surprise that the prices of these shares fell dramatically, in one case by 98/%, as investors flee as quickly as possible.  This resulted in sharp declines across all indices there with the Hang Seng (-4.1%) and Shanghai (-2.35%) and led to a general risk-off tone.

Apparently, President Xi is no longer willing to accept that anybody else in China can have some measure of power or influence beyond his control.  Other changes involve the payment networks Alipay and Wechat, which are on the verge of being subsumed by China’s upcoming CBDC, the e-yuan.  Exclusive rights for things like music licenses are being removed and essentially, it appears that capitalism with Chinese characteristics is morphing into a full-blown state-owned economy.  We cannot be too surprised by this; after all, Xi Jinping has been ruling with an increasingly tighter grip on all segments of the economy and he is a clear adherent to strict communism.  Remember, the definition of communism is that all property is publicly (read government) owned.  We have not seen the last of this process so be careful going forward.

The ECB told us that they
Would no longer stand in the way
Of prices that rise
Until they surmise
That growth has made major headway

Now later this week from the Fed
Some pundits think, shortly ahead,
They’ll slow down their buying
Of bonds, as they’re trying,
To counter, inflation, widespread

Inflation (whether CPI or PCE), is a price series that demonstrates characteristics similar to every other price series like stocks or bonds or currencies.  There are trend movements, there are overshoots in both directions that tend to correct and there are periods of consolidation.  One of the best definitions of a trend is a series that makes either higher lows and higher highs, or conversely, lower highs and lower lows.  In other words, something that is trending higher will typically trade to a new high level and then after a period, pull back somewhat, a normal correction, before moving on to further new highs.  When the uptrend is in force, each high is higher than the last, and, more importantly, each low is higher than the last.  I make this point because I am concerned that when looking at the backgrounds of all the FOMC members, not one of them has any trading history.

This is important because, my sense on the inflation story is that it is quite realistic that we see a slowdown in price growth in the next several months, where 5.4% headline CPI falls to 4.8% and 4.5% and so forth, as this price series goes through a correction just like the stock, bond and currency markets.  Of course, if this is what we see, it is almost guaranteed that Chairman Powell, and his band of merry men (and women) will be all over the tape crowing over the transitory nature of inflation.

Alas, my concern is that given what I believe is a strong uptrend in inflation, this retracement in CPI (and PCE) will stop at a higher level than the previous lows and set itself up for another, more powerful move higher.  In the meantime, the Fed will have waved away any concerns over inflation as they continue to pump unlimited liquidity into the system to run the economy as hot as possible.  After all, in their collective mind, they will have proven inflation is transitory.  However, the next leg higher in CPI and PCE is liable to be far more severe, occurring far more quickly than the Fed expects, and lead to a more permanent unanchoring of inflation expectations.

It will also put the Fed in an even tighter bind than they currently find themselves.  This is because if CPI prints 6%, or 7% or more, the market is far less likely to accept their jawboning as a reason to maintain low yields and high stock prices.  Rather, they will be forced to decide between addressing inflation, which means raising interest rates sharply and significantly impacting, in a very negative way, the real economy, as well as asset markets; or they will have to come up with some other way to measure inflation such that it is not rising at such a ferocious clip but is still seen as credible.  One of their dilemmas is that, politically, inflation is already becoming a problem for the Biden administration, and that is at 5%.  Be prepared for the Misery Index (a Ronald Reagan invention that was the sum of CPI and the Unemployment Rate) to become a popular meme from all of President Biden’s opponents going forward.

Oh yeah, if you think that letting inflation run hot like that is going to goose equity market returns, especially when starting from such incredibly steep valuations, you would be wrong.  History shows that when inflation rises above 5%, equity markets do not provide any type of real hedge.  Let me be clear that this is not going to play out by autumn 2021, but could very well be the case come summer or autumn 2022, a particularly difficult time for the incumbent party in Washington as mid-term elections will be upcoming and the party in power tends to get the blame for economic problems.

What about the dollar you may ask?  In this scenario, the dollar is very likely to suffer greatly, so keep that in mind as you look ahead to your hedging needs for next year and beyond.

In the meantime, the Chinese inspired sell-off has led to some risk concerns, but not (yet) a widespread sell-off.  For instance, the Nikkei (+1.0%) managed to rally in the face of the Chinese equity market declines although, outside Japan, the screens are basically all red in Asia.  European bourses are somewhat lower (DAX -0.4%, CAC -0.25%, FTSE 100 -0.25%) as they respond to the general negative tone in risk as well as a much weaker than expected German IFO reading of 101.2, well down from last month’s reading.  However, these levels are well off the session lows, as are US futures, which are down on the order of -0.25%, although were much lower earlier.

Bond markets are a little more mixed as Treasury yields fall 3.2bps (taking real yields to historic lows of -1.12%) but European sovereigns are more mixed with Bunds unchanged and OATs (+0.8bps) and Gilts (-0.8bps) not giving us any direction.

Commodity prices are mostly lower led by oil (-0.8%), although gold (+0.3%) is showing some positive haven characteristics.  Clearly, declining real yields are also supporting the precious metals.  Foodstuffs are softer (about which everyone except farmers are happy) and base metals are mixed with copper (+1.35%) leading the way higher although both Al (-0.4%) and Sn (-0.3%) are under pressure.

Finally, the dollar is not exhibiting its ordinary risk-off attitude this morning, as it is broadly softer vs. its G10 counterparts with only AUD (-0.1%) down on the day, arguably given concerns of changes with the Chinese economy.  But the rest of the bloc is marginally higher as I type led by SEK (+0.35%) and GBP (+0.3%), both of which are seeming to respond to reopening economies.

In the EMG space, however, there are many more decliners than gainers, led by RUB (-0.45%) on the back of oil’s weakness, but also KRW (-0.4%) which is feeling the pinch of the change in tone from China.  This story is going to be the second biggest driver, after the Fed, for a while, I think.

Of course, this week brings the FOMC meeting, but also Q2 GDP and Core PCE, so there is much to look forward to here.

Today New Home Sales 800K
Tuesday Durable Goods 2.0%
-ex Transport 0.8%
Case Shiller Home Prices 16.2%
Consumer Confidence 124.0
Wednesday FOMC Rate Decision 0.00% – 0.25%
IOER 0.15%
Thursday Q2GDP 8.5%
Initial Claims 380K
Continuing Claims 3192K
Friday Personal Income -0.4%
Personal Spending 0.7%
Core PCE 0.6% (3.7% Y/Y)
Chicago PMI 63.3
Michigan Sentiment 80.8

Source: Bloomberg

Obviously, the Fed is the big story as the data that comes before will not be seen as critical.  The GDP print will be quite interesting, but it is widely accepted that this is the peak and we will be slowing down from here.  However, Friday’s Core PCE number will really be scrutinized as another high print will make Powell’s task that much harder with respect to convincing people that inflation is transitory, especially if their favorite indicator keeps running higher.  Ultimately, I expect we will see a short-term retracement on the rate of inflation before the next leg up and that is the one about which we should all be concerned.

As to today’s market, if equity markets manage to shake off their concerns over Chinese activities, the dollar seems likely to continue with today’s soft tone.  If not, though, look for a rebound.

Good luck and stay safe
Adf

Far From Benign

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Was yesterday’s market decline
A flash or a longer-term sign
Of things gone astray
That might well give way
To outcomes quite far from benign

Is this the end?  Have we seen the top in the equity markets?  That seems to be the question being asked this morning as both traders and investors try to determine if the first risk-off session in a number of months is the beginning of a trend, or merely a symptom of some short-term position excesses.  While Asian markets (Nikkei -1.0%, Hang Seng -0.85%, Shanghai -0.1%) continued along the theme of greater problems to come, Europe is not quite as worried, at least not in the equity space.  Interestingly, despite the rebound in Europe (DAX +0.1%, CAC +0.4%, FTSE 100 +0.3%) European sovereign debt has continued its rally with yields there lower by a pretty consistent 3 basis points across the board.

Meanwhile, after a tremendous rally in the Treasury market yesterday, where 10-year yields fell 10 basis points and the 2yr-10-yr spread flattened to below 100bps, buyers are still at large with the 10-year declining a further 1.2bps as I write.

It seems the narrative that is beginning to take hold is that the economic rebound from the Covid recession has reached its peak and that going forward, growth will quickly revert to trend.  This newer narrative has been reinforced by the spread of the delta variant of Covid throughout Asia and Europe (and the US, although lockdowns don’t seem to be on the agenda here) and the renewed closures being imposed around the world.  For instance, half of Australia has been put back under lockdown, as has New Zealand and growing parts of Southeast Asia including Singapore and Indonesia.  Europe, too, is feeling the pressure with rising caseloads n the UK, Spain and France resulting in calls for further restrictions.   The upshot of this is that earnings will struggle to rise as much as previously expected and that inflation pressures will quickly abate, and the concept of transitory inflation may be proven correct.

Chair Powell and friends are quite sure
Inflation, we won’t long endure
But pundits abound
Who’ll gladly expound
On why it’s the problem du jour

This brings us back to the big question hanging over markets, is inflation transitory or persistent?  Certainly, the recent trend in the data might argue for persistence as we continue to see higher prints than both the previous period as well as than forecasted.  As long as that is the case, it will be more and more difficult for the central banks to declare victory.  While commodity futures markets are well off their highs, a broad index of basic materials prices, things where there are no futures markets, is at all-time highs and rising.  Wages continue to rise as well, as the disconnect between the number of unemployed people and the number of job openings is forcing business to increase pay to get workers to come on board.  All of these things point to continued higher prices going forward, as do surveys of both consumers and businesses who virtually all agree higher prices are in our future.

However, the evidence from the bond market, the market that is historically seen as the most attuned to inflationary pressures, would argue that the inflation scare has passed.  With yields tumbling, US 10-year yields are more than 60 basis points off their late March highs, and the yield curve flattening.  All indications are that bond investors are sanguine over the inflation threat and are actually more worried about deflation.

The argument on this side remains that temporary bottlenecks have resulted in price pressures during the reopening of economies from the Covid lockdowns.  Economists’ models point to those very price pressures as the impetus for increased supply and, thus, lower prices in the future.  The problem is that the timeline for increasing supply is very different across different products.  Perhaps the most widely known shortage is semiconductors which has led to reductions in the production of cars, washing machines and consumer electronics.  But it takes at least 2 years to build a semiconductor factory, so it is quite possible the shortage will not be alleviated anytime soon.  Similarly, with mined raw materials, it takes multiple years to open up new mines, so shortages in copper or tin may not be alleviated for a number of years yet.  Of course, if growth is slowing, demand for these items will diminish and price pressures are likely to fade as well.

Let’s consider a few things about which we are certain.  First, securities prices do not travel in a straight line, and in fact, there are many short-term reversals involved in long-term trends.  Thus, if inflation is indeed persistent, the recent bond rally may well be the result of short-term factors and position reductions.  Recall, higher yields were the consensus Wall Street forecast three months ago, with expectations for the 10-year to be yielding between 2.0% and 2.5% in December.  Large fund managers were on board with that idea and built large positions, which take time to unwind.  It is entirely possible we are seeing the last throes of those position adjustments right now.

Another thing about which we are (pretty) certain is that during the Fed’s quiet period, we will not hear from any Fed speakers.  This means that in the event the market really does continue yesterday’s declines and starts to accelerate, the Fed will be hamstrung in their ability to try to jawbone things back to a smoother path.  Would Powell break the quiet period if markets fell 5% or 8% in a day?  My sense is he might, but that is exactly the type of thing that markets like to test.

Finally, let’s not forget that markets are hugely imperfect forecasters of the future.  After all, it was only 3 months ago when markets were forecasting much greater inflation while anticipating no change in Fed policy until 2024.  So, just because the current market view points to a potential slowing of economic growth and reduced inflation pressures, the economy behaves independently of the markets, and may well show us that the views from March were, in fact, correct.

Having already touched on equity and bond markets, a quick look at the FX markets shows that the dollar continues to power ahead vs. its G10 counterparts with NOK (-0.7%) and NZD (-0.65%) the laggards this morning.  NOK continues to suffer from oil’s remarkable 7.5% decline yesterday, while New Zealand is suffering on renewed lockdown fervor, and this after the RBNZ just last week explained they were about to tighten policy!  But we are seeing weakness in the pound (-0.45%) and AUD (-0.35%) both of which seem to be Covid shutdown related, while JPY (0.0%) is the only currency holding up in the bloc today despite further negative news regarding the Olympics and athletes contracting Covid as well as sponsors pulling out.

Emerging markets have been more varied with losers in Asia (SGD -0.35%, KRW -0.25%) on the back of Covid lockdowns, while gainers have included TRY (+0.4%), INR (+0.35%) and RUB (+0.3%).  The ruble seems to be reacting to the end of oil’s decline, unlike NOK, while INR saw equity market inflows driving the currency higher.  TRY, which is on holiday today, is benefitting from a higher inflation reading than expected and expectations of further policy tightening by the central bank there.

On the data front today we see Housing Starts (exp 1590K) and Building Permits (1696K).  We all know the housing market remains hot, so these data points are unlikely to move markets.  Rather, watch carefully for a continuation of yesterday’s risk off session and a stronger dollar.  I have a feeling that this morning’s price action is more pause than trend.

Good luck and stay safe
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Bears’ Great Delight

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As Covid renews its broad spread
Investors have started to shed
Their risk appetite,
To bears’ great delight,
And snap up more havens instead

Risk is off this morning on a global basis.  Equity markets worldwide have fallen, many quite sharply, while haven assets, like bonds, the yen and the dollar, are performing quite well.  It seems that the ongoing increase in Covid infections, not only throughout emerging markets, but in many developed ones as well, has investors rethinking the strength of the economic recovery.

The latest mutation of Covid, referred to as the delta variant, is apparently significantly more virulent than the original.  This has led to a quickening of the pace of infections around the world.  Governments are responding in exactly the manner we have come to expect, imposing lockdowns and curfews and restricting mobility.  Depending on the nation, this has taken various forms, but in the end, it is clearly an impediment to near-term growth.  Recent examples of government edicts include France, where they are now imposing fines on anyone who goes to a restaurant without a vaccine ‘passport’ as well as on the restaurants that allow those people in.  Japan has had calls to cancel the Olympics, as not only will there be no spectators, but an increasing number of athletes are testing positive for the virus and being ruled out of competition.

A quick look at hugely imperfect data from Worldometer shows that 8 of the 10 nations with the most reported new cases yesterday are emerging markets, led by Indonesia and India.  But perhaps of more interest is that the largest number of new cases reported was from the UK.  Today is ‘Freedom Day’ in the UK, where the lockdowns have ended, and people were to be able to resume their pre-Covid lives.  However, one has to wonder if the number of infections continues to rise at this pace, how long it will be before further restrictions are imposed.  Clearly, market participants are concerned as evidenced by the >2.0% decline in the FTSE 100 as well as the 0.45% decline in the pound.

While this story is not the only driver of markets, it is clearly having the most impact.  It has dwarfed the impact of the OPEC+ agreement to raise output thus easing supply concerns for the time being.  Oil (WTI – 2.75%) is reacting as would be expected given the large amount of marginal supply that will be entering the market, but arguably, lower oil prices should be a positive for risk appetite.  As I indicated, today is a Covid day.  The other strong theme is in agricultural products where prices are rising in all the major grains (Soybeans +0.6%, Wheat +1.4%, Corn +1.7%) as the weather is having a detrimental impact on projected crop sizes.  The ongoing drought and extreme heat in the Western US have served to reduce estimates of plantings and heavy rains have impacted crops toward the middle of the country.

With all that ‘good’ news in mind, it cannot be surprising that risk assets have suffered substantially, and havens are in demand.  For instance, Asian equity markets were almost universally in the red (Nikkei -1.25%, Hang Seng -1.85%, Shanghai 0.0%), while European markets are performing far worse (DAX -2.0%, CAC -2.0%, FTSE MIB (Italy) -2.9%).  US futures are all pointing lower with the Dow (-1.0%) leading the way but the others down sharply as well.

Bonds, on the other hand, are swimming in it this morning, with demand strong almost everywhere.  Treasuries are leading the way, with yields down 4.7bps to 1.244%, their lowest level since February, and despite all the inflation indications around, sure look like they are headed lower.  But we are seeing demand throughout Europe as well with Bunds (-2.4bps, OATs -2.0bps and Gilts -3.6bps) all well bid.  The laggards here are the PIGS, which are essentially unchanged at this hour, but had actually seen higher yields earlier in the session.  After all, who would consider Greek bonds, where debt/GDP is 179% amid a failing economy, as a haven asset.

We’ve already discussed commodities except for the metals markets which are all lower.  Gold (-0.35%) is not performing its haven function, and the base metals (Cu -1.7%, Al -0.1%, sn -0.7%) are all responding to slowing growth concerns.

Ahh, but to find a market where something is higher, one need only look at the dollar, which is firmer against every currency except the yen, the other great haven.  CAD (-1.2%) is the laggard today, falling on the back of the sharp decline in oil and metals prices.  NOK (-0.9%) is next in line, for obvious reasons, and then AUD (-0.7%, and NZD (-0.7%) as commodity weakness drags them lower.  The euro (-0.25%) is performing relatively well despite the uptick in reported infections, as market participants start to look ahead to the ECB meeting on Thursday and wonder if anything of note will appear beyond what has already been said about their new framework.  In addition, consider that weakness in commodities actually helps the Eurozone, a large net importer.

In the EMG space, it is entirely red, with RUB (-0.75%) leading the way lower, but weakness in all regions.  TRY (-0.7%), KRW (-0.7%), CZK (-0.55%) and MXN (-0.5%) are all suffering on the same story, weaker growth, increased Covid infections and a run to safety and away from high yielding EMG currencies.

Data this week is quite sparse, with housing the main theme

Tuesday Housing Starts 1590K
Building Permits 1700K
Thursday Initial Claims 350K
Continuing Claims 3.05M
Leading Indicators 0.8%
Existing Home Sales 5.90M
Friday Flash PMI Mfg 62.0
Flash PMI Services 64.5

Source: Bloomberg

The Fed is now in their quiet period, so no speakers until the meeting on the 28th.  Thursday, we hear from the ECB, where no policy changes are expected, although further discussion of PEPP and the original QE, APP, are anticipated.  So, until Thursday, it appears that the FX markets will be beholden to both exogenous risks, like more Covid stories, and risk sentiment.  If the equity market remains under pressure, you can expect the dollar to maintain its bid tone.  If something happens to turn equities around (and right now, that is hard to see) then the dollar will likely retreat in a hurry.

Good luck and stay safe
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