Tag Archives: #riskoff

How They Debase

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The world’s central banks, as a whole
Have signaled they need to control
Not only the pace
Of how they debase
Their cash, but of digging for coal

Thus, now the Big 3 have explained
The policies they have ordained
Will fund, efforts, green
But not what is seen
Endorsing ‘brown’ growth unrestrained

Last night’s BOJ meeting resulted in exactly zero monetary policy surprises but did serve to confirm that the central banking community has decided to take on a task well outside their traditional purview; climate change.  While they left policy unchanged, as universally expected, they announced that they would be introducing a new funding measure targeting both green and sustainability-linked loans and bonds.  In other words, as well as purchasing JGB’s, equities and ETF’s, they are going to expand their portfolio into ESG bonds.  The interesting thing is that the universe of ESG bonds in Japan is not that large, so the BOJ is going to wind up buying non-JPY denominated assets.  In other words, they are going to be selling a bunch of newly printed yen and converting it into other currencies to achieve their new goals.  This sounds suspiciously like FX intervention, but dressed in more politically correct clothing.  The impact, however, is likely to be a bias for a somewhat weaker yen over time.  For those of you with yen assets, keep that in mind.

Meanwhile, we have already heard from both the Fed and ECB that they, too, are going to increase their focus on climate.  Here, too, one might question whether this is an appropriate use of central bank resources.  After all, it’s not as though the economy in either place is humming along with solid growth, low inflation and excellent future prospects based on strong productivity.  But hey, combatting climate change is far trendier than the boring aspects of monetary policy, like trying to address rapidly rising inflation without tightening policy and risking a crash in equity markets.

In the end, the only thing this shift in policy focus will achieve is longer-lasting inflation.  The effort to develop new and cleaner energy by starving current energy production of capital will result in higher prices for the stuff we actually use.  Over a long enough time horizon, this strategy can make sense; alas we live our lives in the here and now and need energy every day to do so.  Germany is the perfect example of what can happen when politics overrides economics. Electricity prices in Germany average $0.383 (€0.324) per kWh.  In the US, that number is $0.104 per kWh.  Ever since the Fukushima earthquake led to Germany scrapping their nuclear fleet of power reactors, the price of electricity there has more than tripled.  I fear this is in our future if monetary policymakers turn their attention away from their primary role.

Of course, higher inflation is in our future even if they don’t do this, and there is no evidence yet, at least from the Fed or ECB, that they are about to change the current monetary policy stance that is exacerbating that inflation.  However, almost daily we are seeing markets respond to data and comments from other countries that are far more concerned with the inflationary outlook.  Last week the RBNZ ended QE abruptly and indicated they may start raising rates soon.  Last night, CPI there jumped to 3.3%, the highest level since 2011 and above their target band.  It should be no surprise that NZD (+0.45%) rose after the print as did local yields as expectations for a rate hike accelerated.  In fact, I believe this is what the immediate future will look like; smaller countries with rising inflation will tighten monetary policy and their currencies will appreciate accordingly.

Turning to today’s markets, risk was under pressure overnight after a generally weak US session.  Led by the Nikkei (-1.0%), most of Asia was softer, but not all (Hang Seng 0.0%, Shanghai -0.7%, Australia +0.2%).  Europe, which had been higher on the opening has since drifted down and is now mixed with the DAX (0.0%) unchanged while the CAC (-0.5%) lags the rest of the continent and the FTSE 100 (+0.2%) has managed to hold its early gains.  US futures have also held onto small gains with all three indices up about 0.2%.

Bond markets are somewhat mixed as Treasuries (+2.5bps) sell off after yesterdays rally where yields fell 5bps.  However, European sovereigns are all in demand this morning with yield declines ranging from 1.0 to 1.8 basis points.  Commodity markets show crude slightly higher (+0.15%), gold under pressure (-0.7%) and base metals mixed (Cu -0.3%, Al +0.3%, Sn +0.7%).

In the FX markets, aside from kiwi, NOK (+0.25%) has rallied on oil’s rebound from its lows earlier this week, but the rest of the G10 is softer.  It should be no surprise JPY (-0.35%) is the worst performer, while the other currencies are simply drifting slightly lower, down in the 0.1% – 0.2% range.  In the EMG bloc, ZAR (+1.5%) is the big winner as it regains some of the ground it lost earlier in the week on the back of the rioting there.  The government has sent in the army to key hot spots to quell the unrest and so far, it seems to be working thus international investors are returning.  Otherwise, we see gains in RUB (+0.3%) and MXN (+0.3%), both of which benefit from oil and tighter monetary policy from their respective central banks.  On the downside, TWD (-0.4%) has been the worst performer in the bloc as dividend repatriation from foreign equity holders pressured the currency.  This is not a long-term issue.   Away from that, some of the CE4 are drifting lower alongside the euro but there has not been much other news of note.

On the data front this morning we see Retail Sales (exp -0.3%, +0.4% ex autos) as well as Michigan Sentiment (86.5).  After two days of Powell testimony, where he continued to maintain there would be no policy tightening and that inflation is transitory, today we hear from NY’s Williams, one of the key members of the FOMC, and someone who has remains steadfastly dovish.

The dollar’s recent strength seems to have reached its limit so I expect that we could see a bit of a pullback if for no other reason than traders who got long during the week will want to square up ahead of the weekend.

Good luck, good weekend and stay safe
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Progress, Substantial

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To everyone who thought the Fed
Was ready to taper, Jay said
‘Til progress, substantial,
Is made, no financial
Adjustments are reckoned ahead

If, prior to yesterday, you were worried that the Fed was getting prepared to taper its asset purchases, stop worrying.  It doesn’t matter what Dallas Fed President Kaplan, or even SF Fed President Daly says about the timing of tapering.  The only ones who matter are Powell, Clarida, Williams and Brainerd, and as the Chairman made clear once again yesterday, they ain’t going to taper anytime soon.

In testimony to the House Financial Services Committee Chairman Jay sent a clear message; nothing is changing until the Fed (read the above-mentioned four) sees “substantial further progress” on their twin goals of maximum employment and an average inflation rate of 2.0%.  Obviously, they have moved a lot closer on the inflation front, with many pundits (present company included) saying that they have clearly exceeded their goal and need to address that issue.  But for as much vitriol as is reserved for our previous president, both the Fed and Congress are clearly all-in on the idea that the 3.5% Unemployment Rate achieved during his term just before the pandemic emerged, which was the lowest in 50 years, is actually the appropriate level of NAIRU.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment and is the economic acronym for the unemployment rate deemed to be the lowest possible without causing increased wage pressures leading to rising inflation.  For the longest time, this rate was thought to be somewhere in the 4.5%-5.5% area, but in the decade following the GFC, as policymakers pushed to run the economy as hot as possible, the lack of measured consumerinflation, despite record low unemployment, forced economists to rethink their models.  Arguably, it is this change in view that has led to the fascination with MMT and the willingness of the current Fed to continue QE despite the evident froth in the asset markets.  Of course, now those asset markets are not just paper ones like stocks and bonds, but also housing and commodities.

But that is the situation today, despite what appears to be very clear evidence that inflationary pressures are not just high, but longer lasting as well, the Fed has their story and they are sticking to it.  They made this clear to everyone last year with the new policy framework that specifically explains they will remain behind the curve on inflation because they will not adjust policy until they see real data, not surveys, that demonstrate growth is overheating.  Yet, given the Fed’s history, where they have often tightened policy in anticipation of higher inflation and thereby reduced growth, or even caused recessions, the market has learned to expect that type of response.  While I personally believe prudent policy would be to tighten at this time, I take Mr Powell at his word, they are not going to change anytime soon.  I assure you that of the dots in the last dot plot, Jay Powell’s was not one of the ones expecting interest rates to be 0.50% by the end of 2023.

One of the things that makes this so interesting is the difference of this policy with that of an increasing number of other central banks, where recognition of rising inflation is forcing them to rethink their commitment to ZIRP.  Earlier this week, the RBNZ abruptly ended QE and explained rates may rise before the summer is over.  Yesterday, the Bank of Canada reduced its QE purchases by another C$1 billion/week, furthering the progress they started in June, and Governor Macklem made clear that if inflation did persist, they would react appropriately.  Last night it was the Bank of Korea’s turn to explain that economic activity was picking up quickly and inflationary pressures alongside that which would make them consider raising the base rate at their next meeting.  Finally, all eyes are turning toward the BOE as this morning’s employment report showed that the recovery is still picking up pace and that wage growth, at a 7.3% Q/Q rise, is really starting to take off.  Market talk is now focused on whether the Old Lady will be the next to start to tighten.

In truth, the only three central banks that have made clear they are not ready to do so are the big 3, the Fed, ECB and BOJ.  The BOJ meets tonight with no changes to policy expected as they seem to be focused on what they can do to address climate change (my sense is they can have the same success on climate change as they have had on raising inflation, i.e. none).  Next week the ECB will unveil their new framework which seems likely to include the successor to the PEPP as well as their already telegraphed new symmetrical inflation target of 2.0%.  And then the Fed meets the following week, at which point they will work very hard to play down inflation in the statement but will not alter policy regardless.

As you consider the policy changes afoot, as well as the trajectory of inflation, and combine that with your finance 101 models that show inflation undermines the value of a currency in the FX markets, it would lead you to believe that the dollar has real downside opportunity vs. many currencies, just not the euro or the yen.  But markets are fickle, so don’t put all your eggs in that basket.

Turning to today’s activities, while Chinese equity markets performed well (Hang Seng +0.75%, Shanghai +1.0%) after Chinese GDP data was released at 7.9% for Q2, just a tick lower than forecast, and the rest of the data, Retail Sales and Fixed Asset Investment all beat expectations, the rest of the world has been much less exuberant.  For instance, the Nikkei (-1.15%) stumbled along with Australian and New Zealand indices, although the rest of SE Asia actually followed China higher.  Europe has been under pressure from the start this morning led by the DAX (-0.9
%) although the CAC (-0.75%) and FTSE 100 (-0.7%) are nothing to write home about.  US futures are also under pressure (Dow -0.5%, SPX -0.3%) although the NASDAQ continues to power ahead (+0.2%).

In this broadly risk-off session, it is no surprise that bond markets are rallying.  Treasuries, after seeing yields decline 7bps after Powell’s testimony, are down another 2bps this morning.  Similarly, we are seeing strength in Bunds (-1.4bps) and OATs (-1.1bps) although Gilts (+1.4bps) seem to be concerned about potential BOE policy changes.

On the commodity front, oil fell sharply after the Powell testimony and has continued its downward move, falling 1.8% this morning.  Gold, which had been higher earlier in the session is now down 0.15%, although copper (+0.6%) remains in positive territory.  At this point, risk has come under pressure across markets although there is no obvious catalyst.

It should not be surprising that as risk is jettisoned, the dollar is rebounding.  From what had been a mixed session earlier in the day, the dollar is now firmer against 9 of the G10 with NOK (-0.5%) the laggard although the entire commodity bloc is suffering.  The only gainer is the pound (+0.1%) which seems to be on the back of the idea the BOE may begin to tighten sooner than previously expected.

EMG currencies that are currently trading are all falling, led by ZAR (-0.7%), PLN (-0.5%) and HUF (-0.5%).  The rand is very obviously suffering alongside the commodity story, while HUF and PLN are under pressure as a story about both nations losing access to some EU funds because of their stance on issues of judicial and immigration policies is seen as a negative for their fiscal balances.  Overnight we did see strength in KRW (+0.6%) and TWD (+0.4%) with the former benefitting from the BOK’s comments on tightening policy while the latter saw substantial equity market inflows driving the currency higher.

Data today includes Initial (exp 350K) and Continuing (3.3M) Claims as well as Empire Mfg (18.0), Philly Fed (28.0), IP (0.6%) and Capacity Utilization (75.6%).  Yesterday’s PPI was also much higher than forecast, but that can be no surprise given the CPI data on Tuesday.  In addition, Chairman Powell testifies before the Senate Banking Panel today, with the same prepared testimony but a whole new set of questions.  (I did reach out to my Senator, Menendez, to ask why Chairman Powell thinks forcing prices higher is helping his constituents, but I’m guessing it won’t make the cut!)

And that’s the day.  Right now, with risk under pressure, the dollar has a firm tone.  But the background of numerous other central banks starting to tighten as they recognize rising inflation and the Fed ignoring it all does not bode well for the dollar in the medium term.

Good luck and stay safe
Adf

QE’s Paradigm

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Said Daly, this “pop” was expected
But basically, we have projected
This only will last
A few months, then pass
Thus, higher rates we have rejected

Said Bullard, it may well be time
To alter QE’s paradigm
By end of this year
It ought to be clear
That tapering is not a crime

And finally, today Chairman Jay
Is like to have something to say
‘Bout why rising prices
Do not mean a crisis
Is brewing and soon on the way

The one thing about writing this note on a daily basis is that you really get to see the topic du jour.  In fact, arguably, that is the purpose of the note.  When Brexit happened in 2016, it was likely the topic of 75% of my output.  Covid dominated last year for at least 3 months, where virtually every discussion referenced its impact.  And now we are onto the next topic which just will not go away.  In fact, if anything it is growing in importance.  Of course, I mean inflation.

By now you are all aware that June’s CPI reading was 5.4% on a headline basis and 4.5% ex food & energy with both readings substantially higher than forecasted by the punditry.  The monthly gains in both series was 0.9%.  Now my rudimentary math skills tell me that if I annualized 0.9%, I would wind up with an inflation rate of 11.4%.  I don’t know about you, but to me that number represents some real problems.  Of course, despite the reality on the ground, the FOMC cannot possibly admit that their policies are driving the economy into a ditch, so they continue to spin a tale of transitory price gains that are entirely due to short-term impacts on supply chains and gains relative to last year’s extremely depressed prices on the back of Covid inspired lockdowns.  And while, last year’s Covid-inspired lockdowns did have a major negative impact on prices, the idea that supply chain disruptions are short-term are more an article of faith, based on economic textbook theories, than a description of reality.

In addition, the other key leg of the Fed thinking is that inflation expectations remain ‘well-anchored.’  Alas, I fear that anchor may have come loose and is starting to drift with the current of inflation prints to a higher level.  This was made evident in the NY Fed’s survey of inflation expectations released on Monday showing that people expected inflation to be 4.8% in one year’s time.  The Fed also likes to point to inflation breakevens in the market (the difference between nominal Treasury yields and their TIPS counterparts) and how those have fallen.  It is true, they are lower than we saw at the peak in mid-May (2.56%), but in the past week, they have risen 15 basis points, to 2.37%, and appear to be headed yet higher.

And this is not merely a US phenomenon.  For instance, just this morning CPI in the UK printed at 2.5%, rising a more than expected 0.4% from last month, and we have seen this occur around the world, as both developed countries (e.g. Germany, Canada and Spain) and developing nations (e.g. Brazil, India and Mexico) have all been suffering from prices rising faster than expected.  Now, there are some nations that are addressing the issue with monetary policy by tightening (Brazil, Mexico and Hungary being the latest).  But there are others that continue to whistle pass this particular graveyard and remain adamant there is no problem (US, UK Europe).

Chairman Powell testifies to the House today (my apologies for mistakenly explaining it would be yesterday) and it has the opportunity to be quite interesting.  While there will not doubt be a certain amount of fawning by some members of the committee, at least a few members have a more conservative bent and may ask uncomfortable questions.  I keep waiting to hear someone ask, ‘Chairman Powell, can you please explain why you believe my constituents are better off when paying higher prices for the items they regularly purchase?  After all, isn’t that what Fed policy to raise inflation is all about?’  Alas, I don’t expect anyone to be so bold.

In the end, based on a lot of history, Powell will never directly answer a question on inflation other than to say that it is transitory and that the current monetary policy settings are appropriate.  If pressed further, he will explain the Fed “has the tools” necessary to combat inflation, but it is not yet time to use them.  While it is possible he has a Freudian slip and reveals his true thinking, he has become pretty polished in these affairs and the audience is generally not sharp enough to throw him off his game.

To sum it all up, inflation is screaming higher rising rapidly and the Fed remains sanguine and unlikely to adjust their policies in the near future.  While Daly and Bullard, two doves who spoke yesterday, indicated that tapering QE would likely be appropriate at some point, there was no evident hurry in their views.  Consumer prices are going higher from here, count on it.

There are some nations, however, that are willing to address inflation.  We already see several raising rates and last night, the RBNZ explained they would be ending QE by next week.  This was quite a surprise to the market and so we saw 10-year yields in New Zealand jump 7.3 basis points while NZD (+1.0%) has been the best performing currency in the world as expectations are now that the RBNZ will begin raising rates by the end of the summer.  But that the Fed had this type of common sense.

Ok, enough ranting on inflation.  Let’s see how this string of higher CPI prints has been impacting markets.  On the equity front, it has not been a happy period.  Yesterday saw US markets sell off, albeit only in the 0.3%-0.4% range. But Asia was far worse (Nikkei -0.4%, Hang Seng -0.6%, Shanghai -1.1%) and Europe is entirely in the red as well (DAX -0.2%, CAC -0.25%, FTSE 100 -0.6%) with the UK leading the way lower after that CPI print.  US futures, though, have had enough of the selling and are very modestly higher at this time.  Perhaps they think Powell will save the day.

Did I mention the 30-year bond auction was a disaster yesterday?  Apparently, with inflation running at 5.4%, locking in a yield of 1.975% for 30-years does not seem very attractive to investors.  Hence, the abrupt move to 2.05% after the auction announcement, with a long tail.  While yields are a touch lower this morning (10-year -2.0bps, 30-year -2.6bps) that has more to do with the jettisoning of equity risk than a desire to earn large negative real returns.  In Europe, it should be no surprise that Gilt yields are higher, +3.6bps, after the CPI print, but the continent is largely unchanged on the day.

Oil prices have backed off a bit, falling 0.8% this morning, but WTI remains just below $75/bbl and the trend is still firmly higher.  Gold is perking up a bit as declining real yields always helps the barbarous relic and is higher by 0.5% with silver +0.8%.  Base metals, however, are in a different place with Cu (-0.75%) and Al (-0.5%) leading the way lower.  Foodstuffs are generally higher, which of course explains the ongoing unrest in a growing list of developing countries.

As to the dollar, it is broadly weaker vs. its G10 counterparts, with kiwi far and away the leader while the rest of the bloc is firmer by between 0.1%-0.3%.  That feels much more like a dollar consolidation than any other stories beyond NZD and GBP’s inflation print.  In the EMG bloc, the picture is more mixed with PHP (-0.6%) the laggard as capital continues to flow out of the country amid foreign reserve levels sinking.  The rest of the APAC bloc was also soft, but much of that came yesterday in NY’s session with little adjustment from those levels.  On the plus side, MXN (+0.3%) is the leading gainer and the CE4 are all higher by about 0.2%, but this remains dollar consolidation after a run higher.

Somewhat anticlimactically we are going to see PPI this morning (exp 6.7%, 5.1% ex food & energy), but given the CPI has already been released, it will have to be really special to have an impact.  The Fed’s Beige Book is released at 2:00 but the highlight will be the Chairman at noon.  Frankly, until then, I don’t expect very much at all, but the market will be hanging on every word he speaks.

Broadly, the dollar remains well bid.  Yesterday saw the market anticipate the Fed being forced to tighten sooner than previously expected.  Powell has the opportunity to squelch that view or encourage it.  While I believe he will lean toward the former, that is the key market risk right now.  If I were a hedger, I would think about getting things done this morning, not this afternoon.

Good luck and stay safe
Adf

Capitalism is Spurned

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When looking through history’s pages

It seems there are only two stages

At times capital

Has markets in thrall

At others, it’s all about wages

Four decades past Maggie and Ron

Convinced us, for things to move on

T’was capital needed

For growth unimpeded

But seemingly those days are gone

Instead, now the cycle has turned

As two generations have learned

That labor should take

The bulk of the cake

While capitalism is spurned

The upshot is that now inflation

Will percolate throughout the nation

While central banks claim

That prices are tame

Your costs will increase sans cessation

With markets fairly quiet this morning I thought it would be an interesting idea to step back to a more macro view of the current financial and economic framework as I strongly believe it is important to understand the very big picture in order to understand short term market activities.

A number of prominent historians and economists contend that both history and the economy are cyclical in nature although long-term trends underlie the process.  One might envision a sine wave overlaying an upward sloping line as a description.  Now the period and amplitude of the sine wave are open to question, but I would offer that a full cycle occurs in the timeframe of 80-100 years.  As per Neil Howe’s excellent book, The Fourth Turning, this encompasses four generations over which time each generation’s response to their upbringing and the events that occurred during those formative years result in fairly similar outcomes every fourth generation.

Ultimately, I believe it is valid to consider the cyclical nature in terms of the importance of the two key inputs to economic activity; capital and labor.  It is the combination of these two inputs that creates all the economic wealth that exists.  However, depending on the government regulatory situation and the societal zeitgeist, one will always dominate the other.

If we look back 100 years to the Roaring Twenties, it was clear capital had the upper hand as the administrations of Warren Harding and Calvin Coolidge maintained a very laissez faire attitude to the economy and watched as large companies grew to dominate the economy.  Of course, the Great Depression ended that theme and resulted in FDR’s New Deal and ultimately the ensuing 40 years of government intervention in the economy alongside labor’s growing power.  Forty years on from the Depression saw the height of government interventionism with the ‘guns and butter’ strategy of LBJ, the Vietnam War, the Great Society and also, the seeds of the next change, the Summer of Love.  At that point, the economic effects of the government’s heavy hand were starting to have a negative impact, restricting growth and driving inflation higher.

Like day follows night, this led to a change in the zeitgeist and a change in the relationship between capital and labor.  The Reagan/Thatcher revolution arose at a time when people saw only the negatives of government and led to a reduction of government control and activity (on a relative basis), as well as the beginnings of the financialization of the economy.  Arguably, that peaked in the dot com bubble in 2001, or perhaps in the GFC in 2008, but certainly, ever since the latter, we have seen a significant adjustment in the relationship of the government and the governed.

My contention is that we are entering into a new period of labor’s ascendancy versus capital and increased government involvement in every facet of life.  While this has manifest itself in numerous ways, from the perspective of markets, what this means is that the heavy hand of central banks is going to weigh even more greatly on events than it has until now. The myth of the independent central bank is no longer even discussed.  Rather, central banks and finance ministries are now working hand in hand as partners in trying to manage their respective economies.  And ultimately, what that means is that QE has become a permanent part of the financial landscape as debt monetization is required in order to fund every new government initiative.  If this thesis is correct, the idea that the Fed may begin to taper its QE purchases starting next year seems highly unlikely.  Instead, as I have written before, it seems more likely they will increase those purchases as the latest ‘sugar high’ of fiscal stimulus wanes and the economy once again slows down.

Interestingly, the most salient comments made today appear to back up this thesis.  Madame Lagarde was interviewed on Bloomberg TV this morning and explained that a new policy shift would be forthcoming in the near future from the ECB.  Recognizing that the PEPP was due to expire come March and recognizing that the Eurozone economy was not growing anywhere near its desired rate, the ECB is already preparing for the PEPP’s successor.  In other words, QE will not end at its originally appointed time.  In addition, she explained that they would be adjusting their forward guidance as the previous model clearly did not achieve their goals.  (Might I suggest, QE Forever?  It’s catchy and sums things up perfectly!)

So, to recap; the broad cycles of history are turning through an inflection point and we are very likely to see capital’s importance diminish relative to labor going forward.  This means that profit margins will shrink amid higher wages and greater regulatory burdens.  Equity returns will suffer accordingly, especially on a real basis as price pressures will continue to rise.  However, debt monetization will prevent yields from rising, so negative real yields are also likely here to stay for a while.  As to currencies, their value will depend on the relative speed with which different countries adapt to the new realities, so it is not yet clear how things will turn out.  It is also largely why currencies have range-traded for so long, the outcome is not yet clear.

With that to consider as a background, I would offer that market activity remains fairly unexciting.  For now, the ongoing themes remain in place, so, central bank liquidity continues to be broadly supportive of asset markets and arguably will continue to be so for the time being.

Turning to today’s session shows that Asian equity markets followed Friday’s US lead by rallying nicely (Nikkei +2.2%, Hang Seng and Shanghai +0.6%) as markets continue to respond to the PBOC’s modest policy ease announced last week regarding the RRR reduction.  Europe, though, is a bit less bubbly this morning (DAX -0.1%, CAC -0.3%, FTSE 100 -0.6%).  Finally, US futures are mixed with the NASDAQ continuing its run higher (+0.2%) but the other two markets less happy with modest declines.

Bond markets, after selling off Friday in what was clearly a short-term profit taking act, have rallied back a bit this morning with yields declining in Treasuries (-1.5bps), Bunds (-1.5bps), OATs (-2.0bps) and Gilts (-2.0bps).

Commodity prices are under pressure, with oil (-1.4%) leading the way lower, but weakness across both precious (Au -0.45%) and base (Cu –1.4%) metals and most ags.  In other words, the morning is shaping up as a risk-off session.

This is true in the FX market as well with the dollar broadly firmer in both the G10 and EMG blocs.  Commodity currencies are the biggest laggards (NOK -0.6%, CAD -0.45%, AUD -0.4%) but the dollar is higher universally in the G10.  As to the EMG bloc, ZAR (-1.8%) is by far the worst performer as a combination of increased Covid spread and local violence after the imprisonment of former president Jacob Zuma has seen capital flee the nation.  However, here too, the bulk of the bloc is softer with the commodity currencies (MXN -0.5%, RUB -0.45%) next worse off.

While there is no data today, this week does bring some important news, including the latest CPI reading tomorrow:

Tuesday NFIB Small Biz Optimism 99.5
CPI 0.5% (4.9% Y/Y)
-ex food & energy 0.4% (4.0% Y/Y)
Wednesday PPI 0.5% (6.7% Y/Y)
-ex food & energy 0.5% (5.0% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 350K
Continuing Claims 3.5M
Philly Fed 28.0
Empire Manufacturing 18.0
IP 0.6%
Capacity Utilization 75.6%
Friday Retail Sales -0.4%
-ex autos 0.4%
Michigan Sentiment 86.5

Source: Bloomberg

On the Fed front, the highlight will be Chairman Powell testifying before the House on Tuesday and the Senate on Wednesday, with only a few other speakers slated for the week.

At this point, the market question is; will the dollar rally that has been quite impressive for the past weeks, albeit halted on Friday, continue, or have we seen the top?  Given the breakdown in the treasury yield – dollar relationship, my gut tells me the dollar has a bit further to go.

Good luck and stay safe

Adf

T’won’t be a Disaster

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The Minutes explained that the Fed

Continues, when looking ahead

To brush off inflation

And seek job creation

Though prices keep rising instead

Meanwhile, there’s a new policy






That came from Lagarde’s ECB





T’won’t be a disaster





If prices rise faster





So, nothing will stop more QE





There is no little irony in the fact that the one-two punch of the Fed and ECB reconfirming that ‘lower for longer’ remains the driving force behind central bank policy has resulted in a pretty solid risk-off session this morning.  After all, I thought ‘lower for longer’ was the driver of ongoing risk appetite.





However, that is the case, as yesterday the FOMC Minutes essentially confirmed that while there are two camps in the committee, the one that matters (Powell, Clarida, Williams and Brainerd) remain extremely dovish.  Inflation concerns are non-existent as the transitory story remains their default option, and although several members expressed they thought rates may need to rise sooner than their previous expectations, a larger group remains convinced that current policy is appropriate and necessary for them to achieve their goals of average 2% inflation and maximum employment.  Remember, they have yet to achieve the undefined ‘substantial further progress’ on the jobs front.  Funnily enough, it seems that despite 10 years of undershooting their inflation target, there are several members who believe that the past 3 months of overshooting has evened things out!  Ultimately, my take on the Minutes was that the market’s initial reaction to the meeting 3 weeks ago was misguided.  There is no hawkish tilt and QE remains the norm.  In fact, if you consider how recent data releases have pretty consistently disappointed vs. expectations, a case can be made that we have seen peak GDP growth and that we are rapidly heading back toward the recent trend levels or lower.  In that event, increased QE is more likely than tapering.





As to the ECB, the long-awaited results of their policy review will be released this morning and Madame Lagarde will regale us with her explanations of why they are adjusting policies.  It appears the first thing is a change in their inflation target to 2.0% from ‘below, but close to, 2.0%’.  In addition, they are to make clear that an overshoot of their target is not necessarily seen as a problem if it remains a short-term phenomenon.  Given that last month’s 2.0% reading was the first time they have achieved that milestone in nearly 3 years, there is certainly no indication that the ECB will be backing off their QE programs either.  As of June, the ECB balance sheet, at €7.9 trillion, has risen to 67.7% of Eurozone GDP.  This is far higher than the Fed’s 37.0% although well behind the BOJ’s 131.6% level.  Perhaps the ECB has the BOJ’s ratio in mind as a target!





Adding up the new policy information results in a situation where…nothing has changed.  Easy money remains the default option and, if anything, we are merely likely to hear that as central banks begin to try to tackle issues far outside their purview and capabilities (climate change and diversity to name but two) there is no end in sight for the current policy mix. [This is not to say that those issues are unimportant, just that central banks do not have the tools to address them.]





But here we are this morning, after the two major central bank players have reiterated their stance that no policy changes are imminent, or if anything, that current ultra-easy monetary policy is here to stay, and risk is getting tossed aside aggressively.





For instance, equity markets around the world have been under significant pressure.  Last night saw the Nikkei (-0.9%), Hang Seng (-2.9%) and Shanghai (-0.8%) all fall pretty substantially.  While the Japanese story appears linked to the latest government lockdowns imposed, the other two markets seem to be suffering from some of the recent actions by the PBOC and CCP, where they are cracking down on international equity listings as well as the ongoing crackdown on freedom in HK.  European bourses are uniformly awful this morning with the DAX (-1.7%) actually the best performer as we see the CAC (-2.25%) and FTSE 100 (-1.9%) sinking even further.  Even worse off are Italy (-2.7%) and Spain (-2.6%) as investors have weighed the new information and seemingly decided that all is not right with the world.  As there has been no new data to drive markets, this morning appears to be a negative vote on the Fed and ECB.  Just to be clear, US futures are down uniformly by 1.4% at this hour, so the risk-off attitude is global.





Turning to the bond market, it should be no surprise that with risk being jettisoned, bonds are in high demand.  Treasury yields have fallen 6.5bps this morning, taking the move since Friday to 21bps with the 10-year now yielding 1.25%, its lowest level since February.  Is this really a vote for transitory inflation?  Or is this a vote for assets with some perceived safety? My money is on the latter.  European sovereigns are also rallying with Bunds (-4.1bps), OATs (-2.7bps) and Gilts (-4.8bps) all putting in strong performances.  The laggards here this morning are the PIGS, where yields are barely changed.





In the commodity space, yesterday saw a massive reversal in oil prices, with the early morning 2% rally completely undone and WTI finishing lower by 1.7% on the day (3.6% from the peak).  This morning, we are lower by a further 0.4% as commodity traders are feeling the risk-off feelings as well.  Base metals, too, are weak (Cu -1.75%, Al -0.3%, Sn -0.4%) but gold (+0.7%) is looking quite good as real yields tumble.





As to the dollar, in the G10 space, commodity currencies are falling sharply (NZD -0.75%, AUD -0.7%, CAD -0.6%, NOK -0.6%) while havens are rallying (CHF +0.9%, JPY +0.8%).  The euro (+0.45%) is firmer as well, which given the remarkable slide in USD yields seems long overdue.





Emerging market currencies are seeing similar behavior with the commodity bloc (MXN -0.75%, RUB -0.5%) sliding along with a number of APAC currencies (THB -0.65%, KRW -0.6%, MYR -0.5%).  It seems that Covid is making a serious resurgence in Asia and that has been reflected in these currencies.  On the plus side, the CE4 are all firmer this morning as they simply track the euro’s performance on the day.





On the data front, our last numbers for the week come from Initial (exp 350K) and Continuing (3.35M) Claims at 8:30 this morning.  Arguably, these numbers should be amongst the most important given the Fed’s focus on the job situation.  However, given the broad risk off sentiment so far, I expect sentiment will dominate any data.  There are no further Fed speakers scheduled this week, which means that the FX markets are likely to take their cues from equities and bonds.  Perhaps the correlation between yields and the dollar will start to reassert itself, which means if the bond market rally continues, the dollar has further to decline, at least against more haven type currencies.  But if risk continues to be anathema to investors, I expect the EMG bloc to suffer more than the dollar.





Good luck and stay safe





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			Quite Unforeseen
		


				

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When OPEC, a group of fifteen





Producers, all gathered in Wien





Nobody assumed





The meeting was doomed





To failure, t’was quite unforeseen










Alas, for the group overall





The UAE prince had the gall





To strongly demand





Their quota expand





The Saudis, though, wouldn’t play ball





The big story this morning revolves around the failure to agree, by OPEC+, on new production quotas going forward.  While expansion of output was on the agenda as each member was keen to take advantage of the rising price of crude and its products, it seems the UAE demanded a much larger share of the increase than the Saudis wanted to give.  Ordinarily, this type of horse trading takes place in the background as OPEC likes to show its unity, but for some reason, this particular situation burst into plain sight.  Undoubtedly there are many underlying issues between Saudi Arabia and the UAE, but right now, this is the one that matters.  The result has been that oil continues to rise sharply, up another 1.75% this morning taking the gains this year to nearly 60%.  As is frequently the case in a bullish commodity market, the price curve is in steep backwardation, with the front month contracts being significantly more expensive than the outer months.  This is an indication of a lack of short-term supply, something borne out by the continued drawdown of reserves in storage.





What makes this situation so interesting is the fact that the dollar has not fallen sharply while the price of oil has risen.  Historically, rising commodity prices go hand in hand with a weaker dollar, at least versus its counterpart currencies, but that is not really the case this time.  Thus, for those nations that import oil, their local costs have increased more than proportionally as the lack of dollar weakness means it costs much more local currency to procure each barrel.  For instance, since the start of 2021, the Japanese yen has weakened 6.8% and the Swiss franc has fallen 4.1% while oil’s price has soared.  Neither of these nations produces a drop of oil, so their energy costs have climbed substantially.  In the emerging markets, TRY (-14.1%), ARS (-12.2%), PEN (-8.0%) and THB (-7.0%) are the worst performers this year, none of whom have a significant oil industry and all of whom rely on imports for the bulk of their usage.  A weaker currency and higher oil prices are very damaging to those economies.





The question at hand is whether or not this internecine spat will end soon, with some sort of compromise, or if the UAE will stand its ground under increasing pressure.  One thing to consider is that the US shale producers are not likely to come to the market’s rescue in the near term, if ever, as it appears that even at these prices, the capital flowing into the sector to increase production has not expanded, and if anything, given the green initiatives and demands to stop funding fossil fuel production, is likely to decrease.  We may be approaching a scenario where the US, which continues to pump about 11 million barrels/day, will find itself in very good stead relative to many other developed nations that import a higher percentage of their energy needs.  Arguably, this will help the dollar, which means that for some countries, things are only going to get tougher.





As an aside, there is another commodity that has been performing pretty well despite the dollar’s strength, gold.  Here, too, history has shown that a rising dollar price of gold is highly correlated with a weaker dollar on the foreign exchange markets.  But that is not the current situation, as after a very short-term drop in the wake of the FOMC meeting’s alleged hawkishness, gold has rebounded while the dollar has retained virtually all of its gains from the same meeting.  My sense is that there are larger underlying changes in market perception, one of which is that inflation expectations are becoming embedded.





Of course, that is not evident in the bond market, where Treasury yields remain in their downtrend that began in early May in the wake of the massively disappointing NFP report that month.  Since then, yields have fallen more than 20 basis points and show no sign of slowing down.  Oddly, if the market was pricing in a tapering by the Fed, I would have anticipated bond yields to rise somewhat, so this is simply another conundrum in the market right now.  





Turning to the overnight session, one might argue we are looking at a very modest risk-off session.  Equity markets have been desultory with Asia (Nikkei +0.15%, Hang Seng -0.25%, Shanghai -0.1%) not showing much activity while European bourses (DAX -0.4%, CAC -0.3%, FTSE 100 -0.15%) are a bit softer.  Arguably, the European markets have responded to much weaker than expected German data with Factory Orders falling -3.7% ad the ZEW Expectations Survey falling to 63.3, well below the expected 75.2 reading.  Questions about whether or not the global economy has peaked are starting to be asked as stimulus measures fade away.  By the way, US futures are essentially unchanged at this hour.





While today’s Treasury movement has been nil, we are seeing yields decline across Europe with Bunds (-1.5bps), OATs (1.9bps) and Gilts (-1.1bps) all seeing a bit of demand on the back of waning risk appetite.  Remember, too, that the inflation impulse in Europe remains far less substantial than that in the US.





Aside from oil (+1.75%) and gold (+0.8%), the rest of the commodity bloc is also pretty firm this morning with Copper (+1.5%) and Iron ore (+1.6%) leading the base metals higher.





Finally, in the FX market, the best way to describe things would be mixed.  The RBA met last night and was more hawkish than anticipated.  They not only indicated they were going to reduce the amount of QE purchases when the current program comes up for renewal, but they appear to be ending YCC as well, explaining that they would not be supporting the November 2024 bonds when they become the 3-year maturity.  Not surprisingly, we saw AUD (+0.6%) rally, which dragged NZD (+0.8%) up even more as traders speculate the RBNZ is going to raise rates as well.  Away from that, though, the bulk of the G10 bloc was softer led by NOK (-0.55%), which given oil’s continued rise makes little sense.  At this point, I will chalk it up to trading technicals as I see no strong rationale.  As to the rest of the bloc, modest declines are the name of the game.





Emerging markets have also seen similar mixed price action with ZAR (+0.25%) the leading gainer on the back of gold’s strength while HUF (-0.65%) is the laggard as the market awaits comments from the central bank regarding its green policy ideas.  The next weakest currency in this bloc is PHP (-0.5%) as the central bank confirmed it would not be reducing stimulus until it had further confidence the economy there would be picking up.





On the data front, there are only a few releases due although we do see the FOMC Minutes tomorrow.





TodayISM Services63.5
WednesdayJOLTs Job Applications9313K
 FOMC Minutes 
ThursdayInitial Claims350K
 Continuing Claims3325K





Source: Bloomberg





Aside from this limited information, we hear from just one Fed speaker tomorrow.  Perhaps the market will have the opportunity to make up its own mind about where things are going to go.





At this point, the Fed narrative remains that inflation is transitory and that they will continue to support the economy going forward.  However, there is a group of FOMC members who clearly believe that it is time to cut back on QE.  That will be the major discussion for the next several months, to taper or not, and if so, how quickly it will occur.  My view continues to be that the core of the Fed is not nearly prepared to taper QE purchases as they know that the ongoing expansion of Federal debt will require the Fed to remain an active part of the market lest things get more concerning for bond traders.





As to the dollar, it remains in its trading range having reached the top of that range last week.  I would not be surprised to see a bit of dollar weakness overall, if for no other reason than the dollar is likely to slip back toward the middle of its range.





Good luck and stay safe





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			Filled with Frustration
		


				

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The Beige Book explained ‘round the nation


That growth was up, as was inflation


As well, we all learned


Of job offers spurned


And businesses filled with frustration


Meanwhile, round the world, PMI’s


Of Services were no surprise


As nations reopen


Most people are hopin’


The world will, at last, normalize


Ahead of tomorrow’s NFP report in the US, one which given last month’s extraordinary miss will be closely scrutinized by both investors and the Fed, most markets appear to be biding their time in narrow ranges.  This was largely true yesterday and so far, remains the case in the Asian and European sessions.  This lull in activity offers an excellent time to consider the supporting data that we have received in the past twenty-four hours, as well as the remainder due this morning.


Starting with the Fed’s Beige Book yesterday, the report highlighted the features of the economy we have been hearing about for the past several months.  The lifting of Covid inspired restrictions has led to strong increases in demand for products and services ranging from houses and cars to hotels and restaurants.  Business owners indicated that a combination of supply chain bottlenecks and increased demand have been forcing prices higher and that they saw no reason for that to end soon.  They also continue to comment on their inability to hire the workers necessary to satisfy demand, especially in lower wage segments of the economy.  The anecdote I feel best illustrates the issue came from St Louis where a job fair held by a dozen restaurants to fill more than one hundred open positions drew only twelve candidates!  It certainly appears as though the ongoing extra Federal unemployment benefits being offered through September are discouraging a lot of people from going back to work.


One of the underlying beliefs regarding the Fed’s transitory inflation story is that supply chain interruptions will quickly resolve themselves.  And it is not just the Fed that believes this will be the case, but virtually every other economist as well.  But I wonder, what prompts their faith in that outcome?  After all, with available labor scarce, who is going to relink those chains?  Consider, as well, industries like mining and extraction of raw materials.  Shortages of copper and iron ore require the reopening of mines or excavating new ones.  One of the impacts of Covid was that not only were current operating mines closed, but capex was drastically cut, so there is a significant disruption in the exploration process.  Add to that the rise of ESG as a business objective, which will, at the very least slow, if not prevent, the opening of new sources of these raw materials, and it becomes quite easy to believe that these bottlenecks will remain for more than just a few months.  In fact, it would not be surprising if it was several years before the supply/demand balance in many commodities is achieved.  Given the current assessment is a lack of supply, you can be certain that prices will continue to rise far longer than the Fed will have you believe.


As to the overnight session, we were regaled with the Services PMI data from around the world.  In Asia we saw Australia solid, at 58.0, and right in line with last month, while Japan, 46.5, did show a marginal increase, but remains well below the growth-contraction line of 50.0.  China’s Caixin data, at 55.1, was disappointing vs. expectations as well as lower by 1.2 points compared to April’s reading.  Is the Chinese economy beginning to roll over?  That is a question that is starting to be asked and would also explain the PBOC’s sudden concern over a too-strong renminbi.  In a strong economy, a rising currency is acceptable, but if things are not as good, currency strength is an unwelcome event.  Finally, the last major Asian nation reporting, India, showed awful data, 46.4, demonstrating the huge negative impact the recent wave of Covid infections is having on the economy there.


The European story was a bit better overall, with Germany (52.8 as expected), France (56.6 as expected), Italy (53.1 better than expected) and the Eurozone (55.2 slightly better than expected) all demonstrating the recovery is underway on the continent.  As well, the UK continues to burn brightly with a 62.9 reading, more than a point higher than forecast.  And don’t forget, later this morning the US releases both the PMI data (exp 70.1) as well as ISM Services (63.2) both demonstrating that the US economy remains the global leader for now.  With that in mind, it is kind of odd that the dollar is so hated, isn’t it?


The other data coming this morning will give us our first hints at tomorrow’s NFP with ADP Employment (exp 650K) released 15 minutes before both Initial (387K) and Continuing (3.614M) Claims.  As well, at 8:30 we see Nonfarm Productivity (5.5%) and Unit Labor Costs (-0.4%), which on the surface would indicate there are no wage pressures at all but continue to be distorted by the past year’s data outcomes.


As to the market situation, while equity markets in Asia were mixed (Nikkei +0.4%, Hang Seng -1.1%, Shanghai -0.4%), Europe has turned completely red (DAX -0.5%, CAC -0.4%, FTSE 100 -0.9%) despite the solid PMI data.  This feels far more like some profit taking ahead of tomorrow’s data as well as the upcoming ECB meeting next week.  US futures are also under pressure, with all three major indices lower by between 0.5% and 0.75%.


What is interesting about the market is that despite the selloff in stocks, we are seeing a selloff in bonds as well, with Treasury yields higher by 1.5bps and European sovereigns all higher by at least 1 basis point (Bunds +1.1bps, OATs +1.4bps, Gilts +2.7bps).  This, of course, begs the question, if investors are selling both stocks and bonds, what are they buying?


The answer is not clear at this point.  Oil (WTI -0.1%) while outperforming everything else, is still down on the day, as are gold (-0.65%) and silver (-1.4%).  Base metals?  Well, copper (-1.0%) is clearly not the winner, although aluminum (+0.25%) is the only green spot on the screen.  Well, that and agricultural products with Soybeans (+1.25%), Wheat (+1.0%) and Corn (+0.85%) all quite strong this morning, punctuating the idea that food inflation is running at its highest level in more than a decade according to a just released UN report.  That is something I certainly see every week at Shop-Rite and I imagine so does everyone else.


Finally, a look at the FX market shows the dollar is having a pretty good day all around.  In the G10, the pound (+0.1%) is the only currency to hold its own vs. the greenback, with the rest of the bloc lower by between 0.2% and 0.4%.  Frankly, this simply looks like a risk-off session as investors are selling both stocks and bonds across the G10, and no longer need to hold the local currencies.  In the EMG bloc, the story is largely the same, with only INR (+0.25%) rising and the rest of the bloc under some pressure.  The rupee movement seems to be more technical as alongside weak PMI data, the RBI meeting, coming up tonight, is expected to see policy remain unchanged with a dovish bias given the ongoing Covid problems in the country.  On the downside, while most currencies are lower, aside from TRY (-0.5%) on slightly lower inflation, therefore less need to maintain high rates, the rest of the bloc’s declines are only on the order of -0.2%.  Finally, I would be remiss if I didn’t mention yesterday’s price action in LATAM currencies, where we saw significant strength in BRL (+1.5%) and CLP (+1.1%) which has been a broad continuation of funds flowing back into the region.


We have a few more Fed speakers today, but they all say exactly the same thing all the time, it seems, that they are thinking about considering starting a discussion on tapering.  In this vein, there was a big announcement yesterday that the Fed would be unwinding one of the emergency bond buying programs, the secondary market corporate program, and selling out the $13 billion of bonds and ETF’s they own.  Of course, that is such a tiny proportion of their balance sheet, and of that market in truth, it seems unlikely to matter at all.


My observation lately has been that NY tends to go against the prevailing trend for the day during its session, meaning on a day like today, when the dollar is well bid as NY arrives, I would look for a bit of dollar selling.  We shall see, but in fairness, all eyes are really on tomorrow.


Good luck and stay safe


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			Somewhat Dismayed
		


				

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The ECB’s somewhat dismayed

That risk appetite, as conveyed

By stocks is excessive

And has made a mess of

Their plans.  Now they’re really afraid


It is interesting that two of the most memorable battle cries in financial markets were coined by men of the driest character and background.  We all remember the beginning of the Eurozone debt crisis, not ten years ago, when the so-called doom loop created by banks in a given country owning excessive amounts of their own government’s debt and when that debt became suspect (Portugal, Italy, Greece, Spain) the banks in those nations went to the wall.  The ECB was forced to step in to save the day, and did so, but things did not calm down until Super Mario Draghi, then ECB President (and now Italian PM) uttered his famous, off-the-cuff, remark of the ECB doing “whatever it takes” to save the euro.


Less of us were involved in the markets in December 1996 when then Fed Chair Alan Greenspan uttered the other famous market expression, “irrational exuberance” while speaking about the inflating of the tech bubble (which inflated for another 3 ½ years) and questioning if prices at that time had run too far ahead of sensible valuations.


In hindsight, both of the problems about which these catch phrases were created were the result of policy failures on the part of governments (debt crisis) or the central bank itself (tech bubble), but in neither case was the speaker able to take an objective view, thus calling out forces beyond their control as the cause of the problem.


Since then, both phrases have become part of the financial lexicon as shorthand for a situation that exists and the willingness of central bankers to address a problem.  This leads us to this morning’s release by the ECB of their Financial Stability Review where a subsection was titled “Financial markets exhibited remarkable exuberance as US yields rose. (author’s emphasis)”  Arguably, the title pales in comparison to ‘irrational exuberance’, but more importantly, it highlights, once again, the inability of a central bank to recognize that the folly of their own policies is what is driving the problems in markets and economies.


Ostensibly they are concerned that a mere 10% decline in US equity markets could result in “…a significant tightening of euro-area financial conditions, similar to around a third of the tightening witnessed after the coronavirus shock in March 2020.”  Wow!  A 10% decline?  If one were looking for a prime example of a fragile economy, clearly the Eurozone is exhibit A.  Once again, what we see is a central bank that is unwilling, or unable, to recognize that the fallout from its own policies is the underlying problem while seeking an alternative scapegoat explanation in order to present themselves in the best possible light.  After all, if the US markets decline, its not the ECB’s fault!


Inadvertently, perhaps, but clearly, the ECB has outlined one truth; given the synchronicity of central bank policies around the world, all economies are more tightly linked together and will rise and fall together.  Although there are those who claim particular markets have better prospects than others, the reality has become that correlations between equity markets around the world are very high, with the only real question how equities correlate to bonds.  It is this last issue where we have seen significant changes lately.  For quite a long time, the correlation between the S&P 500 and the 10-year US Treasury was positive, meaning that both bond and stock prices rallied and fell together.  However, since about February 2021, that relationship has turned around and is now solidly negative, with bond prices rising and stock prices falling.  It is this latter relationship that is the classic risk-on / risk-off meme, something that had gone missing for years.  Apparently, it is coming back, and that terrifies the ECB.


The timing of the report’s release could not have been better as this morning is a very clear risk-off session.  Yesterday afternoon, US equity markets sold off pretty sharply in the last half-hour of the session.  That sell-off has persisted throughout Asia (Nikkei -1.3%, Shanghai -0.5%, Hong Kong was closed) and Europe (DAX -1.3%, CAC -1.1%, FTSE 100 -1.1%).  US futures are also in the red (Dow -0.6%, SPX -0.8%, Nasdaq -1.2%), so the concerns are global in nature.


A bit more interestingly is the bond market’s behavior, where it appears that owning sovereign paper from any nation is unpopular today.  Treasury yields have backed up 2 basis points and we are seeing higher yields throughout Europe as well (Bunds +1.3bps, OATs +0.5bps, Gilts +2.1bps).  Apparently, the bond market concerns stem from the UK’s inflation report which showed that while CPI rose, as expected to 1.5%, RPI (Retail Price Index) rose much more than expected to 2.9% Y/Y.  While both are designed to be measures of average price increases over time, the RPI considers housing prices and mortgages.  Not surprisingly, given the explosion in housing prices, RPI is much higher and rising faster.  It also may represent a more accurate representation of people’s cost of living.  (Here’s a thought experiment: what would US RPI be right now given CPI just jumped to 4.2%?)  At any rate, it appears investors are shunning both stocks and bonds this morning.


Are they buying commodities?  Not on your life!  Prices in this sector are down across the board led by WTI (-1.8%) but seeing Gold (-0.6%) and Silver (-2.0%) suffering along with base metals (Cu -2.4%, Al -0.9%, Zn -0.85%) and foodstuffs (Soy -0.8%, Wheat -1.7%, Corn -0.3%).  Oh yeah, bitcoin, which many believe is a hedge of some sort, is lower by 16% in the past 24 hours and more than one-third in the past week.


So, what are investors buying?  Pretty much the only thing higher today is the dollar which has rallied vs. every currency we track.  In the G10, NZD (-0.9%) is the laggard followed by NOK (-0.8%) and AUD (-0.7%) with the strong theme there being weakness in the commodity sector.  But the European currencies are all under pressure as well, with EUR (-0.2%) and GBP (-0.3%) suffering.  Even JPY (-0.4%) is not holding up its end of the risk-off bargain, declining vs. a robust dollar.


Emerging markets are seeing similar activity with every currency flat to down led by TRY (-0.6%), ZAR (-0.45%) and MXN (-0.4%), all suffering from commodity weakness.  CE4 currencies are also under pressure, following the euro down while APAC currencies had less angst overnight, sliding on the order of 0.2%.


On the data front, today only brings the FOMC Minutes from the April meeting, which will be scrutinized to see how much discussion on tapering took place, if any, but let’s face it, other than Robert Kaplan of Dallas, it seems pretty clear from everybody else that has spoken, that it is not a current topic of conversation.  As it happens, we will hear from 3 more Fed speakers (Bullard, Quarles and Bostsic) as well, but all of them have been on message since the meeting so don’t look for any changes.


Certainly, based on today’s price action, the idea that 10-year yields are driving the dollar remains alive and well.  If yields continue to back up, the dollar will remain bid, and after all, given its recent decline, it has room to move as a simple correction.  I continue to look at 1.2350 as the critical level in the euro, and by extension the dollar writ large.  A break above there opens the chance for a much more substantial dollar decline.  But that does not appear to be on the cards for today.


Good luck and stay safe

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			To ZIRP They’ll Adhere
		


				

			Posted on  by 		

			


		

		
The sides of the battle are set

Will shortfalls, inflation, beget

Or is it the call

That prices will fall

Because of those trillions in debt


In circles, official, it’s clear

That no one believes past this year

Inflation will heighten

And so, they won’t tighten

But rather, to ZIRP they’ll adhere


It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions.  For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm.  Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year.  Which means that the entire argument is based on dueling forecasts of the future beyond that.  In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.


What is transitory?  Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now.  According to Merriam-Webster, it describes something of brief duration or temporary.  Which begs the question, what is brief?  Is 3 months brief?  6 months?  Longer?  Arguably, brief depends on the context involved.  For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.


There continue to be strong arguments in favor of both sides of the argument.  On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years.  No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices.  As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items.  Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral.  In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.


Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains.  In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices.  We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation.  Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support.  As they are wont to say, the Fed can’t print copper or corn.  The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?


Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets.  By now, you are all aware I remain in the inflationist camp and have been for a while.  I cannot ignore the rising prices I see every time I go into a store.  But the deflationists make excellent points.  This argument discussion will rage for at least another two months and the July CPI release.  Until then, the one thing that seems clear is that market volatility is likely to remain significant.


As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed.  At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well.  US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.


Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively.  Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.


Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).


Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs.  Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%).  Much of this movement seems to be on the back of positioning rather than fundamental news.  On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.


EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region.  CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line.  On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.


Not a ton of data this week, but here is what we see:






Today
Empire Manufacturing
23.9




Tuesday
Housing Starts
1705K





Building Permits
1770K




Wednesday
FOMC Minutes





Thursday
Initial Claims
455K





Continuing Claims
3.64M





Philly Fed
41.9




Friday
Existing Home Sales
6.08M






Source: Bloomberg


The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total.  Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.


With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck.  This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along.  If you are in the deflationist camp, it’s the opposite.  But remember, at a point in time, inflation will undermine the dollar’s value.  Just not right away.


Good luck and stay safe

Adf

			

	
	



				
					


	

		

			Don’t Get Carried Away
		


				

			Posted on  by 		

			


		

		
The data released yesterday

Had Fed speakers try to downplay

The idea that prices

Are causing a crisis

They said, don’t get carried away


But markets worldwide have all swooned

As traders are highly attuned

To signals inflation

In every location

Will quickly show that it’s ballooned


Wow!  That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected.  To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase.  Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%.  To give some context, the core 0.9% gain was the highest print since 1981.  It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.


The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible.  His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out.  As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month.  That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.


House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down.  The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live.  The statistics show that there is the smallest inventory of homes available in decades.  As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material.  And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace.  A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know.  As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining.  However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI.  That, my friends, will be harder to pass off as transitory.


The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates.  However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control.  While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.


The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money.  Rising inflation is the last thing equity markets can abide, so these declines can not be surprising.  The question, of course, is will they continue?  A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story.  It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels.  A loss of confidence that the past is prologue could well see a very sharp correction.


Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session.  It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move.  While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between.  Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.


Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months.  The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.


Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative.  We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%).  At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.


This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy).  Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday.  In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory.  I guess they hope if they say it often enough, people may begin to believe them.  But that is hard to do when the prices you pay for stuff continues to rise.


Treasuries remain the key.  If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher.  If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.


Good luck and stay safe

Adf