Tag Archives: #riskoff

More Havoc

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Said Jay, ‘don’t know why you believe
That just because people perceive
Inflation is higher
That we would conspire
To raise rates, that’s really naïve

Instead, interest rates will remain
At zero until we attain
The outcome we seek
Although that may wreak
More havoc than financial gain

“The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved.”  So said Federal Reserve Chairman Jerome Powell at his Senate testimony yesterday morning.  If that is not a clear enough statement that the Fed will not be adjusting policy, at least in a tightening direction, for years to come, I don’t know what is.  Essentially, after he said that, the growing fears that US monetary policy would be tightening soon quickly dissipated, and the early fears exhibited in the equity markets, where the NASDAQ fell almost 4% at its worst level, were largely reversed.

However, the much more frightening comment was the hubris he demonstrated regarding inflation, “I really do not expect that we’ll be in a situation where inflation rises to troubling levels.  Inflation dynamics do change over time, but they don’t change on a dime, and so we don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.” [author’s emphasis].  Perhaps he has forgotten the 2017 tax cut package or the $2.2 trillion CARES act or the $900 billion second stimulus package last December, but it certainly seems like we have been adding fiscal support for many years.  And, of course, if the mooted $1.9 trillion stimulus bill passes through Congress, that would merely be adding fuel to the fire.

If one wanted an explanation for why government bond yields around the world are rising, one needs look no further than the attitude expressed by the Chairman.  Bond investors clearly see the threat of rising prices as a much nearer term phenomenon than central bankers.  The irony is that these rising prices are the accompaniment to a more robust recovery than had been anticipated by both markets and central bankers just months ago.  In other words, this should be seen as good news.  But the central banks fear that market moves in interest rates will actually work against their interests and have made clear they will fight those moves for a long time to come.  We have heard this from the ECB, the BOE, the RBA and the RBNZ just in the past week.  Oh yeah, the BOJ made clear that continued equity market purchases on their part will not be stopping either.  History has shown that when inflation starts to percolate, it can rise extremely rapidly in a short period of time, even after central bank’s change their policies.  Ignoring this history has the potential to be quite problematic.

But for now, the central banks have been able to maintain their control over markets, and every one of them remains committed to keeping the monetary taps open regardless of the data.  So, while the longest dated debt is likely to continue to see rising yields, as that is the point on the curve where central banks generally have the least impact, the fight between inflation hawks and central banks at the front of the curve is very likely to remain a win for the authorities, at least for now.

Turning our attention to today’s session we see that while Asian equity markets were uniformly awful (Nikkei -1.6%, Hang Seng -3.0%, Shanghai -2.0%), part of the problem was the announcement of an increased stamp duty by the Hong Kong government, meaning the tax on share trading was going higher.  Look for trading volumes to decrease a bit and prices to lag for a while.  Europe, however, has shown a bit more optimism, with the DAX (+0.6%) benefitting from a slightly better than expected performance in Q4 2020, where GDP was revised higher to a 0.3% gain from the original 0.1% estimate.  While Q1 2021 is going to be pretty lousy, forecast at -1.5% due to the lockdowns, Monday’s IFO Survey showed growing confidence that things will get better soon.  Meanwhile, the CAC (0.0%) and FTSE 100 (-0.1%) are not enjoying the same kind of performance, but they are certainly far better than what we saw in Asia.  And finally, US futures are mixed as NASDAQ futures (-0.2%) continue to lag the other indices, both of which are flat at this time.  Rising bond yields are really starting to impact the NASDAQ story.

Speaking of bonds, Treasury yields, after a modest reprieve yesterday, are once again selling off, with the 10-year seeing yields higher by 2.6bps.  Similarly, Gilts (+2.6bps) are under pressure as inflation expectations rise in the UK given their strong effort in vaccinating the entire population.  However, both Bunds and OATs are little changed this morning, as the ECB continues to show concern over rising yields, “closely monitoring” them which is code for they will expand purchases if yields rise too much.

On the commodity front, oil continues to rally, up a further 0.5%, and we are seeing a bit of a bid in precious metals as well (gold +0.2%).  Base metals have been more mixed, although copper continues to soar, and the agricultural space remains well bid.  Food costs more.

As to the dollar, mixed is a good description today with NZD (+0.7%) the leading gainer after some traders read the RBNZ comments as an indication less policy ease was needed.  As well, NOK (+0.5) is benefitting from oil’s ongoing rally, with CAD (+0.25%) a lesser beneficiary.  On the flip side, JPY (-0.5%) is the laggard, as carry trades using the yen as funding currency are gaining adherents again.  I would be remiss if I did not mention the pound (+0.2%), for its 13th trading gain in the past 15 sessions, during which it has risen over 4.3%.

In the EMG bloc, it is the commodity currencies that are leading the way higher with RUB (+1.2%) on the back of oil’s strength on top of the list, followed by CLP (+0.7%) on copper’s continued rally, MXN (+0.7%), oil related, and ZAR (+0.5%) on general commodity strength.  The only notable loser today is TRY (-0.8%), after comments by President Erdogan that Turkey is determined to reduce inflation and cut interest rates.

On the data front, New Home Sales (exp 856K) is the only release, although we hear from Chairman Powell again, as well as vice-Chairman Clarida.  Powell’s testimony to the House is unlikely to bring anything new and he will simply reiterate that their job is not done, and they will maintain current policy for a long time to come.

It seems to me that the dollar is trapped in its recent trading range and will need a significant catalyst to change opinions.  If the US yield curve continues to steepen, which seems likely, and that results in equity markets repricing to some extent, I think the dollar could retest the top of its recent range.  However, as long as the equity narrative continues to play out, that the Fed will prevent any sharp declines and the front end of the yield curve will stay put for years to come, I think an eventual break down in the dollar is likely.  That will be accelerated as inflation data starts to print higher, but that remains a few months away.  So, range trading it is for now.

Good luck and stay safe
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Yield Hawks Reappear

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The market is starting to fear
Inflation is soon coming here
So, tech stocks got hammered
But nobody clamored
For bonds as yield hawks reappear

European markets are having a tough day as it appears investors want nothing to do with either stocks or bonds and only commodities have seen any demand.  Apparently, despite a strong desire for higher inflation, the ECB is not enamored of higher bond yields.  This was made abundantly clear yesterday when Madame Lagarde explained the ECB is “closely monitoring” the government bond market, with a special emphasis on German bunds.  Clearly, this was prompted by the fact that 10-year bund yields have risen nearly 25 basis points in less than a month, similar to the rise in 10-year Treasury yields and are now well above the ECB’s deposit rate.  As Banque de France Governor Villeroy noted, the ECB will ensure financing conditions remain favorable, and seemingly, -0.306% 10-year yields have been determined to be too tight.

This is a perfect indication of the difficulty that the central banks have brought upon themselves by constantly easing monetary policy into every market hiccup and then getting upset when investors don’t obey their every wish.  After all, if the underlying problem in Europe is that inflation is too low (a story they have been pushing for more than a decade) then one would think that rising bond yields, signaling rising inflation expectations would be a welcome sight.  Of course, the flaw is that rising bond yields often lead to declining share prices, something that apparently no major central bank can countenance.  Thus, the conundrum.  Essentially central banks want higher inflation but simultaneous low yields and high stock prices.  That’s not so much a goldilocks scenario as a Dungeons and Dragons fantasy where they are the Dungeon Master.  In other words, it cannot occur in the real world, at least for any extended period of time.

Hence, the comments by Lagarde and Villeroy, and the great expectations for those from Chairman Powell later this morning.  Exactly what can the central banking community do to achieve their desired goals?  Markets are beginning to question the narrative of central bank omnipotence, and those central banks are starting to fear that they will lose control over the situation.  As I have written before, at some point, the Fed, or ECB or some other central bank will implement some new program and the market will ignore it and continue on its merry way.  And when that is happening, that ‘way’ will be down.  At the end of the day, while central banks have shown they have extraordinary power to sway markets, they are not bigger than markets.

Back in the 1990’s, the term bond vigilantes was quite popular as a description of bond market traders who responded negatively to budget deficits and drove yields higher and stocks lower accordingly, thus keeping government spending in line.  In fact, that was the last time the US ran budget surpluses.  With the proposed $1.9 trillion stimulus bill still seemingly on its way, it is entirely possible that those long-dead vigilantes may be rising from the grave.  Back then, the Maestro would never consider capping yields or QE as a response, but the world is a different place today.  If bonds continue to sell off further, the $64 billion question is, how will the Fed respond?  It is this scenario, which could well be starting as we speak, that has brought the idea of YCC to the fore.  We have already seen tech stocks begin to suffer, weighing heavily on major indices, and those other harbingers of froth, Bitcoin and Tesla, have reversed course lately as well.  As I wrote last week, long tech stocks is like being short a Treasury bond put, as they will suffer greatly with higher yields.  At what point will the Fed decide yields are high enough?  Perhaps Chairman Powell will give us a hint today, but I doubt it.

Ahead of his testimony, here is what is happening in markets, where I would characterize things as inflation concerned rather than risk off.  Bond markets in Europe, as mentioned, are selling off sharply, with Bunds (+4.1bps), OATs (+4.8bps) and Gilts (+4.0bps) all feeling the pain of rising inflation expectations.  In fact, every country in Europe is seeing their bonds suffer today.  Treasuries, at this hour, are relatively flat, but continue to hover at their highest level in a year.  Interestingly, the first clue of central bank response came from Australia last night, where the RBA was far more aggressive buying the 10-year sector and pushed yields back down by 4.1bps.  However, their YCC on the 3-year is still in trouble as yields there remain at 0.12%.

Equity markets are almost universally weaker in Europe (only Spain is showing life at +0.6% as a raft of holiday bookings by frustrated UK citizens has seen strength in the tourist sector of the economy).  But otherwise, all red with the DAX (-1.1%) leading the way, followed by the FTSE 100 (-0.3%) and CAC (-0.2%).  Asia was a bit of a different story, as the Hang Seng (+1.0%) managed to benefit from ongoing inflows from the mainland, although Shanghai (-0.2%) was more in line with the global story.  The Nikkei was closed for the Emperor’s birthday.  As to US futures, tech stocks remain under pressure with NASDAQ futures lower by 1.5%, although SPU’s are down by just 0.5%.

Commodities are where its at this morning, though, with oil, after a powerful rally yesterday, up another 0.7% and over $62/bbl for WTI now.  Copper is up a further $200/ton and pushing to the all-time high of $9600/ton set back in 2010.  With all the talk of the elimination of combustion engine vehicles, it turns out EV’s need 3 times as much copper, hence the demand boost.  Meanwhile, the rest of the base metals are also performing well although precious metals are little changed on the day.  Of course, gold at flat is a lot better off than Bitcoin, which is down more than 16% on the day.

And lastly, the dollar, is having a mixed session.  The pound is the leading gainer, +0.2%, as plans for the reopening of the economy as the vaccine rate continues to lead the G10, has investors looking on the bright side of everything.  On the flip side, CHF (-0.45%) is the laggard on what appear to be market technical movements as price action has taken USDCHF above the top of a downtrend channel.  Otherwise, the G10 space is showing little movement in either direction.

As to emerging market currencies, after some terrible performances yesterday, BRL (+0.3%) and MXN (+0.3%) are opening firmer on a rebound along with CLP (+0.4%) following Copper prices higher.  However, the rest of the bloc is +/-0.2% which is the same thing as unchanged in this context.

On the data front, yesterday saw Leading Indicators a touch better than expected and two lesser followed Fed regional indices print strongly.  This morning Case Shiller home prices (exp 9.90%) and Consumer Confidence (90.0) are the highlights, neither of which is that high.  In fact, the true highlight comes at 10:00 when Chairman Powell testifies to the Senate Banking Committee.  It will be interesting to see if he touches on the recent rise in yields, especially expressing concern over their movement.  But more likely, in my view, is that he will simply agree that more fiscal stimulus is critical for the economy and that the Fed will continue to support the economy until “substantial further progress” is made on their objectives.

Adding it all up tells me that risk is going to continue under pressure for now, although given the magnitude of the move we have seen in bond yields, it would not be surprising to see them consolidate or reverse for a while in a trading correction.  As to the dollar, higher yields ought to prevent any sharp declines, but it still looks like we have seen the extent of the correction already and it will continue to trade in its recent range.

Good luck and stay safe
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Crash Landing

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The Narrative tells us the Fed
Will let prices rise up ahead
But if that’s the case
Then how will they pace
The rise in the 2’s-10’s yield spread

And what if this spread keeps expanding
Will stocks markets see a crash landing?
Or will Chairman Jay
Once more save the day
And buy every bond that’s outstanding?

Remember when the Narrative explained that record high traditional valuation measures of the stock market (like P/E or CAPE or P/S) were irrelevant because in today’s world, permanently low interest rates guaranteed by the Fed meant there was no limit for valuations?  That was soooo last month.  Or, remember when economists of all stripes explained that all the slack in the economy created by the government shutdowns meant that inflation wouldn’t reappear for years?  (The Fed continues to push this story aggressively as every member explains there is no reason for them to consider raising rates at any time in the remotely near future.)  This, too, at least in the bond market’s eyes, is ancient history.  So, something is changing in the market’s collective perception of the future, and prices are beginning to reflect this.

The bond market is the appropriate place to begin this conversation as that is where all the action is lately.  For instance, this morning, 10-year Treasury yields have risen another 2.4bps and are trading at their highest level in almost exactly one year, although remain far below longer-term averages.  Meanwhile, 30-year Treasuries have risen even more, and are now yielding 2.155%.  Again, while this is the highest in a bit more than a year, it is also well below longer term averages.  The point is, there seems to be room for yields to run higher.

Something else that gets a lot of press is the shape of the yield curve and its increasing steepness.  Today, the 2yr-10yr spread is 125bps.  This is the steepest it has been since the end of 2016, but nowhere near its record gap of 8.42% back in late 1975.  The Narrative tells us this is the reflation trade, with the bond market anticipating the reopening of the economy combined with a flood of new stimulus money driving business activity higher and prices along with that business.

Now, the question that has yet to be answered is how the Fed will respond to these rising yields.  We are all aware that Federal debt outstanding has been growing rapidly as the Treasury issues all that paper to fund the stimulus packages.  And we have all heard the argument that the size of the debt doesn’t matter because debt service costs have actually fallen over time as interest rates have collapsed with the Fed’s help.  The last part is true, at least over the past several years, where in 2020, it appears Federal debt service amounted to 2.43% of GDP, a decline from both 2018 and 2019, although modestly higher than 2017.  But, if the yield curve continues to steepen as 10yr through 30yr yields continue to rise, as long as the Treasury continues to issue debt in those maturities, the cost to the Federal government is going to rise as well.  The question is, how much can the government afford?  And the answer is, probably not much.  A perfect anecdote is that the increased interest cost of a 50 basis point rise in average Treasury yields will cost the government the same amount as funding the US Navy for a year!  If yields truly begin to rise across the curve, Ms Yellen will have some difficult choices to make.

But this is not just a US phenomenon, it is a global phenomenon.  Yields throughout the developing world are rising pretty rapidly, despite central bank efforts to prevent just that from occurring.  As an example, we can look at Australia, where the RBA has established YCC in the 3yr space, ostensibly capping yields there at 0.10%.  I say ostensibly because as of last night, they were trading at 0.12%.  Now, 2 basis points may not seem like much, but what it shows is that the RBA cannot buy those bonds fast enough to absorb the selling.  And the problem there is it brings into question the RBA’s credibility.  After all, if they promise to keep yields low, and yields rise anyway, what is the value of their promises?  Oh yeah, Aussie 10yr yields jumped 16.9 basis points last night!  It appears that the RBA’s QE program is having some difficulty.

In fact, despite pressure on stocks throughout the world, bond yields are rising sharply.  In other words, the haven status of government bonds is being questioned right now, and thus far, no central bank has provided a satisfactory answer.  Perhaps, the bigger question is, can any central bank provide that answer?  As influential as they are, central banks are not larger than the market writ large, and if investor psychology changes such that bonds are no longer seen as worthwhile investments because those same central banks get their wished for inflation, all financial securities markets could find themselves in some difficult straits.  This is not to imply that a collapse is around the corner, just that the working assumption that the central banks can always save the day may need to be revised at some point.

So, can yields continue to go higher without a more substantive response from the Fed or ECB or BOE or RBA or BOC?  Certainly, all eyes will be on Chairman Powell to see his response.  My view has been the Fed will effectively, if not explicitly, try to cap yields at least out to 10 years.  If I am correct, the dollar should suffer substantially.  Again, this is not to say this is due this morning, just that as this story unfolds, that is the likely trend.

And what else is happening in markets?  Well beyond the bond market declines (Gilts +2.3bps, Treasuries now +4.1bps, even Bunds +0.5bps), European bourses are falling everywhere (DAX -0.6%, CAC -0.5%, FTSE 100 -0.7%) after weakness throughout most of Asia (Hang Seng -1.1%, Shanghai -1.5%, although Nikkei +0.5% was the outlier).  US futures? All red and substantially so, with NASDAQ futures lower by 1.3% although the other indices are not quite as badly off, between -0.5% and -0.7%.

Commodity prices, however, continue to rise, with oil (+1.0%) leading energy mostly higher while both base and precious metals are higher as well.  So, too, are prices of grains rising, as we continue to see the price of ‘stuff’ rise relative to the price of financials.

Finally, turning to the dollar, it is broadly stronger against its EMG counterparts, but more mixed vs. the G10.  In the former, MXN (-1.4%) and ZAR (-1.35%) are leading the way lower, although BRL is called down by more than 2.0% at the opening there.  But the weakness is pervasive in this space with APAC and CE4 currencies also suffering.  However, G10 is a bit different with AUD (+0.2%) leading the way higher on the back of the record high prices in tin and copper alongside the rising rate picture and reduced covid infection rates.  On the flip side, NOK (-0.3%) is the weakest of the bunch, despite oil’s rebound, which appears to be a reaction to strength seen late last week.  In other words, it is market internals, not news, driving the story there.

On the data front we do get a fair amount of new information this week as follows:

Today Leading Indicators 0.4%
Tuesday Case Shiller House Prices 9.90%
Consumer Confidence 90.0
Wednesday New Home Sales 855K
Thursday Durable Goods 1.0%
-ex transport 0.7%
Initial Claims 830K
Continuing Claims 4.42M
GDP Q4 4.2%
Friday Personal Income 9.5%
Personal Spending 2.5%
PCE Core 0.1% (1.4% Y/Y)
Chicago PMI 61.0
Michigan Sentiment 76.5

Source: Bloomberg

Beyond the data, with GDP and Personal Spending likely the keys, we hear from a number of Fed speakers, most importantly from Chairman Powell tomorrow and Wednesday as he testifies before the Senate Banking Committee and then the House Financial Services Committee.  The one thing about which you can be sure is that Congress will ask him to support their stimulus plan and that he will definitely do so.  It strikes me that will just push Treasury yields higher.  In fact, perhaps the March FOMC meeting is starting to shape up as a really important one, as the question of higher yields may need to be addressed directly.  We shall see.

For now, yield rises are outstripping inflation prints and so real yields are rising as well.  This is supporting the dollar and will undermine strength in some securities markets.  However, history has shown that the Fed is unlikely to allow real yields to rise too far before responding.  For now, the dollar remains in its trading range and is likely to stay there.  But as the year progresses, I continue to see the Fed stopping yields and the dollar falling accordingly.

Good luck and stay safe
Adf

Pent-Up Demand

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The one thing consistently heard
Is growth in H2 will be spurred
By pent-up demand
Throughout all the land
As people buy things they’ve deferred

But what if the virus has wrought
Some changes in what people sought
Perhaps now it’s saving
That people are craving
Not spending, as routinely thought

There appears to be one universal view regarding economic activity going forward; there is an enormous amount of pent-up demand for things that people have been craving since the onset of the widespread government lockdowns as a result of the spread of Covid-19.  This includes eating out, going to the gym, going to the movies and traveling on vacation.  And it seems pretty clear that there is some truth to this idea.  But given the trauma that governments around the world inflicted on their populations via the inconsistent messaging and lockdown mania, isn’t it possible that many people have reevaluated what they deem as most important?  I know that this author has certainly reconsidered what is really necessary to live a happy and fulfilling life, and I imagine I am not the only one.

But the point is, virtually every economist’s assumption in their econometric models is that there will be a substantial pick-up in activity, especially in those service sectors that have been decimated by the ongoing restrictions, in the second half of the year.  There is no doubt that savings rates are higher now than they were before the pandemic, with the latest BEA data showing a 13.7% rate at the end of 2020 vs. a 7.3% rate at the end of 2019.  But the 2019 data was below the long-term (75 year) average savings rate of 9.0%, and two-thirds the rate seen from the end of WWII to1989.  The point is recent profligacy by the American people is something of a historical anomaly.  While Americans never saved like some other cultures, where savings rates would hover in the 20% range, historically, people really did try to save some money.

The other thing to remember is the past twelve months have been remarkably traumatic to the entire nation, if not the entire world, with a generation of children having their educations disrupted and changed significantly.  As was evident in the wake of the Great Depression, an entire generation altered their behavior, as the Roaring 20’s morphed into the Depression.  The one thing that hasn’t changed is human nature, with peoples’ response to trauma informing their future activities.  This is all a long-winded way of saying that, perhaps, there isn’t nearly as much pent-up demand for things as is currently assumed.  Perhaps, the increase in savings rate is a way for people, in general, to feel a bit more secure about their situation.  While FOMO will never completely disappear, it certainly could wane.

With this in mind, it is possible to turn a more critical eye at forecasts for GDP growth around the world going forward.  For instance, the UK reported that Q4 GDP rose 1.0%, well above forecasts of a 0.5% increase, and insuring that despite likely negative growth in Q1, there will be no double-dip recession.  But BOE Chief Economist, Andy Haldane was positively effusive in his forecasts, saying, “A year from now, annual growth could be in the double digits.”  Wow is all I can say.  That is an optimistic point of view, but it is not an isolated one.  Here in the US, forecasts now indicate that GDP will grow 4.9% in 2021, well above trend and enough to offset 2020’s 3.5% decline.  And maybe they are right.  Certainly, equity markets are all-in on the idea.  However, I would be cautious in blindly accepting these numbers as gospel given no econometric model takes into account the changes wrought in perceptions by Covid-19.  I fear growth could be much less impressive as 2021 evolves which means markets will need to adjust their thinking.  Stay nimble!

On to today’s session, which has seen another lackluster performance across markets.  With most of Asia closed for the New Year holiday, only the Nikkei (-0.15%) was trading and it displayed a general lack of interest.  European bourses are mixed with the DAX (-0.5%) a key underperformer while the CAC and FTSE 100 are both flat on the day.  Given the better than expected data from the UK, it would seem that performance is a bit disappointing, but there are ongoing Brexit travails which seem to be putting a damper on things.  US futures, meanwhile, had spent the bulk of the overnight session in the green, but are now all lower by about 0.2%.  It appears we may be seeing some risk being unloaded into the holiday weekend.

Bond markets are ever so slightly firmer this morning, with the biggest mover Italian BTP’s (-1.5bps) after the FiveStar party voted to support Super Mario for PM.  Otherwise, Treasury yields are essentially unchanged as are bunds and Gilts.

Oil (WTI -1.0%) is under pressure again today, for the second consecutive session, but the uptrend remains firmly in place.  This has all the hallmarks of a modest correction.  Gold, however, is under pressure as well, and has been lagging most other commodities.  Base metals are mixed as are agriculturals, which, again, tells you that there is no strong theme in the markets.

As to the dollar, it is broadly higher this morning, albeit not dramatically so.  In the G10, the commodity currencies are under the most pressure (NZD (-0.5%, AUD -0.3%, CAD -0.3%) but we are also seeing weakness in the two havens with both JPY and CHF softer by 0.3%.  In the emerging markets, RUB (-1.0%) is the weakest of the bunch after the central bank explained they won’t be cutting rates further amid concerns over new sanctions to be imposed by the EU as well as the ongoing spread of Covid.  But aside from the ruble, while most currencies in the bloc are softer, the movement has been relatively small, on the order of -0.1% to -0.3%, indicating this is really a dollar story.

On the data front, the only thing we see today is the preliminary Michigan Sentiment Survey (exp 80.9), which would need to be wildly different to change any views.  As well, we continue to lack Fed speakers, and the data has clearly not shown “substantial further progress” on the Fed’s efforts to support the economy, so policy changes are not in the air.

The dollar’s consolidation after a nearly year-long decline continues, although, as I mentioned yesterday, there seems little impetus for the dollar to extend its corrective rally.  Rather, it feels like we are going to see a little more market chop with no direction into the holiday weekend,

Good luck, good weekend and stay safe
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The Feathers of Hawks

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It seems like the feathers of hawks
Turn whiter when each of them talks
On Monday, Loretta
Said policy betta
Stay easy for pumping up stocks

For those of you not familiar with a word ladder, it is a type of puzzle where you start with a word, Hawk, for example, and change one letter in each step, while maintaining the order of the letters, to form another word and keep doing so until you arrive at the desired second word.  The object is to complete this task in as few moves as possible.  In this way, this morning’s task is to use a word ladder to turn hawk into dove (one possible answer below).

Once upon a time, in the economic community, there were two schools of thought as to how monetary policy would best serve a nation.  There were hawks, who believed that Ludwig von Mises and Friedrich Hayek had identified the most effective way for central banks to behave; namely minimalist activity and allowing the markets to work.  The consequences of this policy view were that economic cycles would exist but would be moderated naturally rather than allowing bubbles to inflate and interest rates would be set by the intersection of supply and demand.  On the other side of the debate were the doves, whose hero was John Maynard Keynes (although Stephanie Kelton of MMT fame is quickly rising up the ranks) and who believed that an activist central bank was the most effective.  This meant constant monetary interventions to support demand, alongside fiscal interventions to support more demand.  As to the consequences of this policy, like unsustainable debt loads, or rising inflation, they were seen as ephemeral and unimportant.

But that was soooo long ago, at least a full year.  In the interim, Covid-19 appeared as a deadly and virulent disease. While we have learned that it is particularly dangerous for the elderly and for those with comorbidities, there is also another group which has basically been made extinct, monetary hawks in public policy positions.  For the longest time, the two most hawkish members of the FOMC were Kansas City’s Esther George and Cleveland’s Loretta Mester.  However, at the very least, Ms. Mester has now shown that she coos like a dove as per her comments yesterday about US monetary policy, “We’re going to be accommodative for a very long time because the economy just needs it to get back on its feet.”

The global central bank community is all-in on the idea that ZIRP, NIRP and QE are the new normal, and as long as equity markets around the world continue to rally, they are not going to change their views.  In a related note, the BOJ is in the midst of continuing its policy review and the question of how they should describe their ETF purchases has come up.  It seems that while a number of board members would like to pare back the purchases, they are unwilling to explain that for fear the market would misinterpret their adjustments as a policy change and the result would be a sharp equity market sell-off.  And we know that cannot be tolerated!

The point is, no matter which central bank you consider, they have all reached the point where their previous actions have resulted in fragile markets and they appear to have lost the ability to change policy.  In other words, there is no end in sight to easy money, inflation be damned.

Which, of course, is exactly what we saw yesterday in markets, as equities rallied in the US, with all three major indices closing at new all-time highs.  Asian markets mostly followed through with the Nikkei (+0.4%), Hang Seng (+0.5%) and Shanghai (+2.0%) all nicely firmer, although Australia’s ASX (-0.9%) couldn’t find any love.  And perhaps, that is the story in Europe, as well, this morning, with various shades of red painting the screen.  The DAX (-0.5%) is the worst performer, with both the CAC (-0.1%) and FTSE 100 (-0.1%) more pink than red.  As to US futures, they find themselves in the unusual position of being negative at this hour, but only just, with all three indices looking at losses of between 0.1% and 0.2%.

Bond markets are clearly in more of a risk-off mood than a risk-on one, with Treasury yields lower by 2.2bps this morning and more than 4bps lower than the peak seen yesterday.  European markets have seen less movement, with yields in the major markets all down less than one basis point, hardly a strong signal, although notably, Italian 10-year yields, at 0.502%, have traded to a new historic low level.  Excitement over the prospect that Super Mario can fix Italy remains high.

On the commodity front, oil’s early gains have reversed, and it is now essentially flat on the day, although it remains within pennies of the highs set early this morning above $58/bbl.  Gold (+0.7%) is rebounding strongly, from the lows seen last Tuesday, with silver (+1.3%) even stronger.  Of course, all these non-fiat currency plays pale in comparison to Bitcoin (+17%) which exploded higher as the progenitor of one bubble (a certain EV maker in California) explained it bought $1.5 billion worth of Bitcoin for its Treasury reserves.

With this type of price action in commodities, as well as with the ongoing conversion of US monetary hawks into doves, it should not be surprising that the dollar is lower this morning, pretty much across the board.  In the G10 space, CHF and JPY are leading the way higher (+0.6% each) as investors seem to be running for havens not called the dollar.  But the euro (+0.45%) has also gained nicely and any thoughts that January’s price action was anything other than a short-term correction are now quickly fading away.  It will be interesting to see how the market responds to tomorrow’s CPI data, as that has the opportunity, if it prints higher than forecast, to alter views on real interest rates.  I have maintained that declining real yields will undermine the dollar, but I have to admit, I didn’t expect it to happen this early in the year.

EMG currencies are also firm this morning, led by ZAR (+0.6%) and RUB (+0.5%), on the back of commodity price rises, but with a pretty uniform strength throughout the CE4 and LATAM.  The one exception is BRL (-0.3%), the worst performing currency in the world this morning, as a lower than expected CPI print for January has traders shedding the belief that the central bank may be forced to raise rates any time soon.

On the data front, NFIB Small Business Optimism printed lower than last month and worse than expected at 95.0, not a good sign for the economy, but probably a boost for the view that more stimulus is coming.  At 10:00, we see JOLTs Job Openings (exp 6.4M), although that tends to be ignored.

The only Fed speaker today is St Louis’ Bullard, whose tendencies before Covid-19 were dovish, and he certainly hasn’t changed his views.  As such, and given that the market seems to have rejected the notion of a further USD correction higher, it looks like the dollar’s downtrend is getting set to resume.

Good luck and stay safe
Adf

One possible answer:  I would love to see others
Hawk
Hark
Hare
Have
Hove
Dove

No Bonds Will They Shed

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Chair Powell explained that the Fed
Cared not about bubbles widespread
Employment’s the key
And ‘til he can see
Improvement, no bonds will they shed

Meanwhile, cross the pond, Ollie Renn
Repeated the mantra again
The ECB will
Not simply stand still
And let euros outgain the yen

At the first FOMC meeting of 2021, Chairman Powell was very clear as to what was in focus, employment.  To nobody’s surprise, they left policy rates on hold and did not change the purchase metrics of the current QE program.  However, in the statement, they downgraded their outlook for the economy, which given the ongoing vaccination program seemed somewhat surprising.  However, the fact that vaccinations are taking longer to be administered than had been expected, seems to be driving their discussion.  He was also explicit that the Fed was set to continue their current program until such time as they achieve their twin goals of maximum employment and 2% average inflation.  Based on the recent rising trajectory of Initial Claims (expected today at 875K) and given even Powell described the fact that the Unemployment Rate likely significantly understates the true situation, it will be a very long time before the Fed even considers reducing their program.

When asked at the press conference following the meeting about potential bubbles in asset markets, with several questions specifically about GameStop stock (a truly remarkable story in its own right), the Chairman was also clear that employment was the thing that mattered, and the Fed was not focused on things like this.  He even explained that the Fed fully expected inflation data to rise this summer but would not waver from their course until maximum employment is achieved.  So, the message is clear, the balance sheet will continue to grow regardless of any ancillary issues that arise.

Keeping our focus on central banks, we turn to the ECB, where this morning it was Finnish Central Bank president Ollie Renn’s turn to explain to the markets that the ECB was carefully watching the exchange rate and its impact on inflation, and would use all the tools necessary to help boost inflation, including addressing a ‘too strong’ euro.  Kudos for their consistency as this was exactly the same message we heard yesterday from Klaas Knot, the Dutch central bank chief.  As well, during yesterday’s session there was an ECB statement that “markets [are] underestimating rate-cut odds.”  You may recall the Knot specifically mentioned the possibility of cutting interest rates by the ECB as well.  All told, there is a consistent message here as well, the euro is a key focus of the ECB and they will not allow it to trade higher unabated.  I have made this point for months, as the dollar bearish views became more entrenched, that the ECB would not sit idly by and allow the euro to rally significantly without responding.  This is the first response.

What are we to conclude from these two messages?  The conclusion I draw is that beggar thy neighbor policies continue to be at the forefront of monetary policy discussions within every major central bank.  While I’m sure they are not actually described in that manner, the results, nevertheless are just that, every central bank is committed to continuing to expand their balance sheet while adding accommodation to their respective economies, and so the relative impact remains muted.  In the end, nothing has changed my view that the Fed will cap yields, which right now are doing a good job of that all by themselves (10-year Treasury yields are -1bp today and back to 1.00%, their lowest level since the break higher on the Georgia election results), and that the dollar will suffer as real yields in the US plummet.  But again, that is Q2 or Q3, not Q1.

Perhaps, what is more interesting is that despite all this promised central bank largesse, yesterday was a massive risk-off session and today is following right in those footsteps.  Starting with equity markets, the bloodbath is universal.  Asia saw sharp declines (Nikkei -1.5%, Hang Seng -2.6%, Shanghai -1.9%) following the US selloff.  And it wasn’t just the main indices, literally every Asian market that was open yesterday fell, most by more than 1%.  European bourses are also all red this morning, but the magnitude of losses has been more muted.  Of course, they got to participate in yesterday’s sell-off, so perhaps that is not too surprising.  As I type, the CAC (-0.1%) is the best performer, with the DAX (-0.6%) and FTSE 100 (-1.0%) suffering more acutely.  Here, too, every market is in the red.  Interestingly, US futures are mixed, with DOW futures actually higher by 0.1%, but NASDAQ futures are down 0.7% after weaker than expected earnings and guidance from some of the Tech megacaps last night.

Bond markets are pretty much all in the green, with yields lower, but essentially, the entire space has seen yields decline just 1 basis point.  That is not really a sign of panic.  Perhaps, with yields so low, investors are beginning to understand that bonds no longer offer the hedge characteristics for risk that they have historically held.  In other words, is earning -0.64% to hold 10-year bunds really hedging negative outcomes in your equity portfolio?  A key part of the thesis that bonds are a haven is that you earn a stable return during tough times.  These days, that is just not the case, and the risk that yields normalize means the potential losses attendant to holding a bond portfolio at current yields is quite substantial.

Commodity prices are generally softer, but not by very much.  WTI (-0.4%) continues to consolidate its gains from Q4 but has basically gone nowhere for the past two weeks.  Gold (-0.2%), too, is treading water lately, although the technicians are starting to say it is in a mild downtrend.

And finally, the dollar is basically stronger once again this morning.  This is true vs. every G10 currency, with AUD (-0.7%) the worst performer, but all the commodity currencies (NZD -0.5%, CAD -0.4%) under pressure along with the havens (JPY -0.2%, CHF -0.2%).  This is simply another dollar up day, with risk still in question.  In the emerging markets, KRW (-1.35%) is by far the worst performer, suffering from the changing risk appetite as well as weaker than expected earnings from Samsung, the largest company in the country.  Capital exited the KOSPI and drove the won to its lowest level since early November.  But we are seeing weakness in the usual suspects with RUB (-0.6%), MXN (-0.4%) and BRL (-0.3%) all under some pressure.  The outlier here is ZAR (+0.2%) which after a very weak start alongside other commodity linked currencies, has rebounded on the news that the first Covid vaccines would be arriving by the end of the week.

There is a bunch of data this morning led by Initial Claims but also Q4 GDP (exp 4.2%), Leading Indicators (0.3%) and New Home Sales (870K).  This is the first reading for Q4, but the market is more intently focused on Q1 and Q2, so it is not clear the print will matter much.  Housing we know continues to perform extremely well, so the Claims data is likely the most important release, especially given Powell’s focus on employment.

As of now, risk remains on its heels, but it would not be that surprising if things turned around as Powell’s message of non-stop stimulus should encourage the bulls.  If that is the case, I would look for the dollar to cede some of its gains, but it is certainly not a signal to sell aggressively.

Good luck and stay safe
Adf

You’d Better Think Twice

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If you thought Lagarde doesn’t care
About how her euros compare
To dollars in price
You’d better think twice
‘Cause she is acutely aware

This morning, her colleague, Klaas Knot
Was clear when explaining they’ve got
The tools they may need
To help them succeed
In cooling a euro that’s hot

With the FOMC meeting on tap for later today, the market is mostly biding its time until they hear if anything will be changing at the Mariner Eccles Building.  However, that seems highly unlikely at this time given the following factors:  first, the last we heard from Chairman Powell was that now is not the time to consider removing any policy accommodation, even if things seem to be looking up; and second, it is not clear that things are looking up.  While certainly there are some parts of the economy that are doing well, notably housing and manufacturing, the service sector remains under severe pressure as lockdowns pervade the country.  True, it appears that some of the more draconian lockdowns may be coming to an end, but the hit to the employment situation has been turning much worse.  Recall, the December NFP data printed at a much worse than expected -140K, and Initial Claims data has been running higher lately than back then.  Too, remember that the Fed modified their mandate to seek to achieve “maximum employment” which means declining NFP data is more likely to drive further policy ease than tightness.

So, in truth, today’s FOMC meeting is likely to be a pretty dull affair, with limited market expectations for any movement of any sort.  On the other hand, the ECB, which met last week and took no further action, remains concerned about the euro’s strength.  I have been quite clear in my warnings that the ECB would not allow the euro to trade higher without a response as they simply cannot afford that outcome.  Remember, the ECB’s playbook (and in truth, most central bank playbooks) defines the reaction function for specific conditions.  According to the book, too low inflation requires lower interest rates and a weaker exchange rate.  In fact, one of the primary reasons to lower interest rates is to weaken the exchange rate.  The idea is that a weak currency can help import inflation while simultaneously helping the competitive stance of that nation’s export community.  The problem with this strategy is that it was designed to be used in isolation.  So, if one country is behaving in that manner, it has a chance to succeed.  Unfortunately, the Covid pandemic has resulted in virtually every country trying to use these tools at the same time, thus canceling out each other’s efforts.

Of course, one player is much larger than the others, namely the Fed.  The Fed’s ability to ease policy seems to be outstripping that of the ECB, and every other country as well.  Adding to that has been the extraordinary fiscal policy ease we have seen here, which has been larger than elsewhere, and with the still robust expectations of another $1.9 trillion of fiscal support coming, has been one of the defining features of the bearish dollar outlook.

Which brings us to this morning’s comments from Klaas Knot, the Dutch Central Bank President and ECB Governing Council member.  He was quite clear in explaining the ECB has the necessary tools, including interest rate cuts, to prevent any further strengthening of the euro which could undermine inflation.  “That is something we, of course, monitory very, very carefully.  It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going.”  In other words, euro bulls need to understand the ECB is not going to sit by and watch the single currency rally unabated.  It should be no surprise that the market responded to these comments by selling off the single currency, which is now down 0.4% on the day.  Adding to the bearish euro scenario was the release of the German GfK Consumer Confidence survey, which printed at -15.6, its third lowest reading in history, trailing only the May and June readings post the start of the Covid crisis last year.  Once again, I will reiterate my view, while eventually the dollar will decline more sharply as real yields in the US fall into further negative territory later this year, for now, the dollar’s decline seems to be on hold.

Ok, let’s quickly look at markets.  Risk is starting to become more suspect as the morning wears on, with European equity markets now all sharply in the red vs. their earlier little changed price action.  In the wake of the Knot comments, the DAX (-1.55%), CAC (-1.0%) and FTSE 100 (-0.8%) have all sold off hard.  Asian markets, which had closed before the comments, had a more mixed day, with the Nikkei (+0.3%) recouping a little of yesterday’s losses, but the Hang Seng (-0.3%) and Shanghai (+0.1%) doing little overall.  As to US futures, the DOW (-0.9%) and SPU (-1.0%) lead the way down with the NASDAQ (-0.25%) still outperforming after some pretty good earnings data last night from Microsoft.

It should be no surprise that bond markets have found a bid, with Treasury yields lower by 1.4bps, while Bunds (-1.4bps) and OATs (-1.0bps) are also now trading higher.  Again, earlier in the session, yields had actually crept a bit higher, so this reversal of risk attitude is growing.

Commodity markets are being impacted as well, with oil back to flat on the day from early session gains of 0.5% and gold is actually lower by 0.5%.  Only the ags remain well bid, as I guess everyone needs to eat, even during a pandemic.

Finally, the dollar is stronger across the board, with the strength becoming more evident after the Asian close.  In the G10, NOK (-0.9%) is the leading decliner as oil prices have turned, but we are seeing weakness throughout the commodity bloc (AUD -0.6%, NZD -0.4%, CAD -0.4%) as well.  In fact, even the havens are weaker today with both JPY and CHF off by 0.2%.  Today is just a dollar positive day.  In the EMG bloc, the few green spots on the chart are all APAC currencies with very modest gains (KRW +0.2%, TWD +0.1%).  On the other hand, all the markets that are currently open are showing sharp declines led by ZAR (-0.9%), MXN (-0.85%) and RUB (-0.8%).  It is remarkable how closely these three currencies trade to each other.  But really, everything else is weak as well.  There are no specific stories of note here, it is just a day to reduce risk.

On the data front, this morning brings Durable Goods (exp 1.0%, 0.5% ex transport) and then the FOMC statement at 2:00 followed by the Powell press conference at 2:30.  It seems unlikely that the market will react to the Durables data, so things seem to be shaping up as a dollar up day, at least until we hear from Jay.  However, I don’t foresee the dollar exploding higher, just continuing this drift, at least vs. the G10.  EMG is always a different story, so be careful there.

Good luck and stay safe
Adf

If Things Cohere

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Said Madame Lagarde, it’s not clear
If the PEPP need extend past next year
It could be the case
We’ll slow down the pace
Of purchases if things cohere

Yesterday’s ECB meeting presented mixed messages to the market as it has become evident there is a growing split between the hawks and doves.  While policy was left unchanged, as universally expected, the question of the disposition of the PEPP was front and center.  Once again, Madame Lagarde indicated that they would continue supporting the economy, but that the need to utilize the entire amount of authorized spending power could be absent.  Despite the fact that she admitted Q1 GDP growth would likely be negative, thus causing a second recession, she would not commit to full utilization, let alone any additional monetary stimulus.  Rather, she discussed “financing conditions” which need to remain “favorable” for the ECB to be happy.  Alas, there is no definition of what those conditions are, nor how to track them.   She mentioned a number of indicators they monitor including; bank lending, credit conditions, corporate yields, and sovereign bond yields, but not which may have more or less importance nor how they combine them.  There doesn’t appear to be an index of any sort although as part of their ongoing strategic review, they are investigating whether or not to create one.  In the end, though, it appears they are very keen to insure they don’t get pinned down to a mechanical reaction function based on either economic or financial indicators.  Instead, they will continue to wing it.

As to the growing split, it is becoming evident that the hawkish contingent, almost certainly led by Germany but likely including the Frugal Four, has been pushing back on any additional stimulus as they already see sufficient money in the system.  Remember, German DNA has been informed by the hyperinflation of the Weimar Republic in the 1930’s and Bundesbankers, like Jens Weidmann, everywhere and always see the specter of too much money leading to a recurrence of that outcome.  While that hardly seems like a possible outcome in the current situation, especially with most European countries extending lockdowns through February now, thus further stressing the economy, they know that debt monetization is the first step toward hyperinflation. And while the ECB will never explicitly monetize the debt, they can pretty easily do it implicitly.  All that has to happen is for them to permanently reinvest the proceeds of maturing sovereign debt into the same securities, and that money will be permanently in the system.

Consider, because of the ECB’s construction, with 19 central bank members, the way policy is promulgated is that each national central bank is instructed to purchase sovereign bonds issued by their own country in a given amount. So, the Banca d’Italia buys BTP’s and the Bundesbank buys bunds.  If instructions from the ECB council are to replace maturing debt with newly issued debt constantly, then the country never has to repay the bond, and therefore, the money injection is permanent, i.e. debt monetization.  It seems likely, this is the hawks’ major concern.  It is almost certainly why they insist on repeating the idea that full utilization of the PEPP is not a given, and why Lagarde cannot follow her instincts to throw more money at the second recession.  But of course, this is anathema to the hawks, who want to see the collective ECB balance sheet slowly wound down.  In the end, this tension will inform the ECB’s actions going forward, which implies, to me, that the ECB will be less dovish than some other central banks, namely the Fed, and which implies the euro could well head somewhat higher over time.

And perhaps, despite a clear risk-off theme for today’s trading activity, that is why the euro is retaining a better bid than its G10 brethren.  As equity markets around the world pare back some of their recent gains (Nikkei -0.4%, Hang Seng -1.6%, Shanghai -0.4%, DAX -0.85%, CAC -1.2%, FTSE 100 -0.7%), the clear message is risk is to be reduced heading into the weekend.  And yes, US futures are all pointing lower as well, between -0.5% and -0.8%.  Meanwhile, bond markets are playing their part, true to form, on this risk-off day, with Treasury yields lower by 1.9bps, Bunds by 2.0bps and Gilts by 2.5bps.  However, Italian BTPs have seen yields climb 3.6bps as the market responds to this newly created concern that the ECB will not be supporting Italy as they had in the past.  Add to that the ongoing political concerns in Italy, where PM Conte has just indicated he may be forced to call a new election, and the fact that today’s PMI data showed the recent lockdowns have really been crushing the economy there, and BTP’s are behaving like the risk asset they truly are, rather than the haven asset they aspire to be.

Commodity prices are under pressure across the board this morning, led by oil (-2.5%) but seeing the same in gold (-1.1%) and the entire agricultural bloc, with prices down between 0.8% (cotton) and 2.4% (soft red wheat).

This brings us back to the dollar, which is broadly higher this morning in both G10 and EMG space.  The euro (+0.1%) is the star performer today, as per the above discussion, but beyond that and the CHF (+0.05%), the rest of the bloc is weaker.  NOK (-0.8%) leads the way down with the rest of the commodity bloc (AUD -0.7%, NZD -0.5%, CAD -0.5%) not quite as badly impacted.  At the same time, EMG currencies are also under broad pressure led by RUB (-1.4%) on weaker oil, MXN (-1.0%) and BRL (-1.0%) both on weaker commodities and general risk aversion, and ZAR (-0.9%) as its main export, gold, falls. As to the positive side of the ledger, only minor East European currencies, BGN and RON (both +0.05%), have managed to eke out any gains, apparently tracking the euro ever so slightly higher.

The data picture has not helped inspire any risk taking this morning as preliminary PMI data for January showed weakness throughout.  As we have seen, manufacturing continues to hold up fairly well, but services have seen no respite.  Of all those countries reporting today, the UK was in the worst shape (PMI Services 38.8, down from 49.4) but the Eurozone as a whole (Services 45.0) was no great shakes.  It is abundantly clear that Europe is in the midst of a double-dip recession.  On the US calendar, the preliminary PMI data is released (exp Manufacturing 56.5, Services 53.4) and then Existing Home Sales (6.56M) at 10:00.  One thing we learned yesterday is that the housing market in the US remains quote robust.

But, with the Fed still in its quiet period until the meeting next Wednesday, and Yellen’s testimony done and dusted, FX is going to be reliant on other markets for direction.  If risk continues to be shed, the dollar should be able to hold its own, and even edge a bit higher.  But if equity markets manage to reverse course, then the dollar could well head back lower.

Good luck, good weekend and stay safe
Adf

Sh*t Out of Luck

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Consensus remains that the buck
This year is just sh*t out of luck
Though lately it’s jumped
It soon will be dumped
Or so say the bears run amok

This will be a holiday-shortened note to match our holiday shortened session today.  The broad theme in markets this morning is one of risk avoidance, with most European equity markets lower (CAC -0.4%, FTSE 100 -0.3%, DAX 0.0%), following the Nikkei (-1.0%) although we did see strength in China with both the Hang Seng (+1.0%) and Shanghai (+0.8%) putting in solid sessions.  The Chinese market activity comes on the heels of their latest data which showed that GDP in 2020 grew 2.3%, slightly better than forecast and certainly the only major economy that will show positive growth for the year.  Interestingly, the other data released was not quite as robust with Retail Sales rising a less than forecast 4.6%, down from November and investment activity rising more slowly than anticipated, both Fixed Asset (2.9%) and Property (7.0%).  However, no matter how you slice it, the Chinese economy seems to have weathered the pandemic better than most.

One of the interesting things we have seen of late is the seeming breakdown in the correlation between stocks and bonds.  Whereas the risk meme had generally been stocks falling led to haven asset buying, so Treasuries and the big 3 European government bonds would rally, that is not today’s story.  While the Treasury market is closed today, looking across Europe, despite the weakness in stocks, we are seeing weakness in bonds, with Bund (+1.2bps), OAT (+1.8bps) and Gilt (+0.8bps) prices all sliding a bit on the day.  The news from the PIGS is worse, with yields rising between 1.9 and 2.8 basis points, although given those assets are more risk than haven, this is no real surprise.

There have been three main stories out of Europe this morning, the election of a new CDU party leader in Germany, Armin Laschet, who will replace the retiring Angela Merkel.  However, there is concern that he is a weak candidate for Chancellor and may face a challenge amid slumping popularity ratings.  A weak German Chancellor is not a Eurozone positive, keep that in mind.  The second story is the French dismissal of the unsolicited bid for Carrefour, the largest grocery chain in the country.  Once again, they have proven they have little interest in a free market and will name any company critical to the national interest to prevent the loss of control.  And finally, in Italy, it appears PM Giuseppe Conte is losing his grip on power after a key ally, Matteo Renzi, took his party out of the ruling coalition.  The broader concern there is that if an election is called, Matteo Salvini, the head of the League, a right-wing party with nationalist tendencies could win the election outright, and wreak significant havoc on the Continent with respect to issues like monetary and fiscal policy, immigration and even addressing Covid.

However, at this point, the bulk of that news is fairly noncommittal and almost certainly not having a real impact on the FX markets…yet.  Rather, the story that caught my eye was that Janet Yellen, whose vetting by the Senate for her role as Treasury Secretary takes place tomorrow, will reputedly say she believes the dollar’s value should be determined by the market and that the Treasury will neither speak to it, nor attempt to weaken it directly in any manner.  Of course, the disingenuous part of that statement is that her other policies, which when combined with the Fed’s activity, will almost certainly drive real yields to greater and greater depths of negativity, will undermine the dollar without her having to ever mention the currency once.

Ironically, for now, the dollar continues its rebound from its nadir on January 6th, just three days into the year.  In fact, in the G10, it is stronger against the entire bloc except JPY (+0.1%), with the commodity bloc leading the way lower (NO -0.45%, AUD -0.45%, CAD -0.4%).  You won’t be surprised to know commodities are pulling back a bit as well today (WTI -0.3%).  In the EMG space, the screen is largely red as well, led by RUB (-0.85%) and ZAR (-0.65%) with only BRL (+0.15%) showing any support on the day.  That support seems to be emanating from a survey of Brazilian economists who are calling for a return to growth in 2021 alongside rising interest rates, with the Selic rate (their overnight rate) forecast to rise 125 basis points this year and a further 150 basis points next year to get back to 4.75%.  If that is the case, BRL will certainly find significant support as expectations remain that dollar rates are not going to rise at all.

On the data front, it is a pretty light week, and remember, there are no Fed speakers either.

Thursday ECB meeting -0.5%
Initial Claims 923K
Continuing Claims 5250K
Philly Fed 11.3
Housing Starts 1560K
Building Permits 1603K
Friday Existing Home Sales 6.55M

Source: Bloomberg

While the Fed doesn’t meet until next week, we do hear from the Bank of Canada (exp no change), BOJ (no change) and the ECB (no change) this week, although as you can tell from the forecasts, there is no anticipated movement on policy at this time.  So, adding it all up, it feels to me like the dollar’s short-term momentum remains modestly firmer, although this has not changed my longer-term view that the Fed will be forced to cap nominal yields and as real yields decline, so will the dollar.  But that is more of a summer phenomenon I believe, late Spring at the earliest.

Good luck and stay safe
Adf

Truly Sublime

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The Chairman said, now’s not the time
To offer a new paradigm
More debt we will buy
Til we certify
The data is truly sublime

Then later, with, kudos, widespread
The new president clearly said
He’d give out more dough
To soften the blow
We’ll suffer from lockdowns ahead

It appears that the question of whether or not the Fed will consider tapering bond purchases by the end of this year has been answered…No!  Yesterday, Fed Chair Powell made it crystal clear that it was way too early to consider the idea of reducing QE purchases, and that eventually, if such time arrives, the Fed would be signaling their actions well in advance of any changes.  This is broadly the message that we heard from vice-Chairman Clarida two days ago, as well as from Governor Brainerd and some of the more dovish regional presidents.  Thus, the comments of the four regional presidents from earlier this week, indicating that tapering could happen as soon as the end of 2021, are likely to seem diminished in the eyes of the market, and the idea of a much more rapid sell-off in Treasuries needs to be rethought.

Beyond that specific question, the Chairman waxed about the good job the Fed has been doing, all the tools they have available to address any future issues, and, remarkably, that the record high levels of debt in the non-financial sector are really no big deal at all given the current level of interest rates.  Low rates obviously allow more debt to be serviced easily.  The problem, of course, is that if rates do rise in the future, servicing that debt will not be so easy, and the ramifications for the economy would be quite negative.  This is the primary factor in the thought that the Fed may never raise rates again, because doing so would result in significant economic stress throughout the country, and truly, the world.

The market response to Powell’s comments was modest at best, with the dollar softening a bit, while equity and bond markets didn’t really react at all.  Then last night, President-elect Biden made his first policy speech promising a new approach to things.  But one thing that is clearly not set to change is the political view that spending more money is always the right action.  He thus unveiled a $1.9 trillion spending program designed to address the ongoing economic impacts of Covid and the concurrent lockdowns around the country.  As well, he talked about another $3 trillion program for longer term needs like infrastructure and environmental issues that need to be addressed.

Interestingly, the market appears a bit disappointed in this proposed spending bill, and not because it is going to increase the debt load.  Rather, it appears expectations were high for more immediate spending to help goose the economy and by extension, the profit profile of the market.  However, the combination of Fed confirmation only that they would not be tightening, rather than expanding programs, and the disappointing cash outlay in the Biden proposal has forced a bit of reconsideration about the future trajectory of the economy and equity markets.  After all, if the Fed is not adding to the size of its balance sheet, where is the money going to come from to support buying more stocks?  Of course, it could simply be that the Friday before a holiday weekend has encouraged a bit of profit-taking by traders, who will be back in force on Tuesday, but whatever the cause, this morning is opening with a clear risk-off tone.

Looking at equity markets in Asia, the Nikkei (-0.6%) was the laggard, but Shanghai (0.0%) and the Hang Seng (+0.3%) hardly inspired.  Meanwhile, European screens are filled with red, led by the CAC (-0.95%) but seeing both the DAX and FTSE 100 falling -0.8%.  It is interesting to note that there was a bit of data this morning which arguably could have been construed as positive, yet clearly has not been seen that way.  UK November GDP fell only -2.6% M/M, a better than expected performance, especially given the ravages of Covid on that economy. While IP was a bit softer than forecast Services was clearly better, which for the UK economy will be crucial going forward.  The other data point showed French CPI at 0.0% in December, which remarkably, helps raise the Eurozone number!  But equity investors are having none of it today, and shedding positions into the weekend.  As to US futures markets, they are pointing lower as well, between -0.35% and -0.5% at this hour.

One cannot be surprised that Treasury prices are rallying given the risk stance, with the 10-year up ¼ of a point and yields lower by 2.7bps.  While I continue to believe that there is a near term cap in yields, at least at 1.1%, the idea of the bond offering safety makes a bit more sense than when the yield was 0.7% like most of the summer.  Remember, part of the safety of the bond is that it pays a steady income stream.  As to European markets, the big 3 are essentially unchanged at this hour, although all of them have rallied from early session lows where yields had climbed a bit.  This behavior is a bit unusual as I would have expected increased demand for these havens, but markets can be perverse on a regular basis.

Oil prices are under pressure this morning, with WTI lower by 1.3%, although that remains simply a consolidation of the large move higher we had seen over the past two plus months.  As to gold, it is little changed on the day, firmly in the middle of its recent trading range.

Finally, the dollar is definitely the beneficiary of today’s risk stance, rising against most currencies, with only the havens of JPY (+0.1%) and CHF (+0.05%) managing to eke out any gains.  However, the commodity bloc is weak; NOK (-0.6%), AUD (-0.6%) and CAD (-0.5%), and the euro (-0.3%) and pound (-0.45%) are under pressure as well.  There doesn’t need to be a more specific story than risk-off to explain these movements.

Emergers, too, are broadly under pressure led by the commodity linked currencies there.  ZAR (-0.9%), BRL (-0.8%) and CLP (-0.6%) are leading the charge lower, although pretty much every currency in the space has fallen except IDR (+0.3%).  The story here was that exports climbed a more than expected 14.6% leading to a larger trade surplus.  The indication that the economy could weather then Covid storm better than many peers has increased the attractiveness of the rupiah, especially given the yield there, which is amongst the highest in the world these days at 3.75%.

On the data front, yesterday saw much worse than expected Initial Claims data, a potential harbinger of weaker data to come.  This morning brings PPI (exp 0.8% Y/Y, 1.3% Y/Y -ex food & energy), Retail Sales (0.0%, -0.2% -ex autos), Capacity Utilization (73.6%), IP (0.5%), and Michigan Sentiment (79.5).  So, lots of things, but really Retail Sales is the one that matters most here, I think.  Certainly, yesterday’s Claims data has put the market on notice that things slowed down in Q4 and are likely starting Q1 in the same state.  However, do not be too surprised if a bad number is met with a rally as expectations grow that the Fed could, in fact, step up the pace of purchases.  We shall see.

Beyond that, Minneapolis Fed president Kashkari, the uber-dove, is the last Fed speaker before the quiet period begins ahead of the January 27 meeting.  But we already know he is going to say not enough is being done.

As long as risk remains on the back foot, the dollar can certainly maintain its modest bid here.  However, if things turn around, notably if equities climb into the green, look for the dollar to give up its gains.  At this point, the dollar’s strength does not seem to be built on a strong foundation.

Good luck, good weekend and stay safe
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