Two central banks managed to shock The market by walking the walk The Old Lady jacked By fifteen, in fact Banxico then doubled the talk So, now that it’s all said and done C bankers, a new tale have spun The virus no longer Is such a fearmonger Inflation’s now job number one Talk, as we all know, is cheap, but from the two largest central banks, that’s mostly what we got. While Chairman Powell got a positive market response from his erstwhile hawkish comments initially, yesterday investors started to rethink the benefits of tighter monetary policy and decided equity markets might not be the best place to hold their assets. This is especially true of those invested in the mega-cap tech companies as those are the ones that most closely approximate an extremely long-duration bond. So, the NASDAQ’s -2.5% performance has been followed by weakness around the globe and NASDAQ futures pointing down -0.9% this morning. As many have said (present company included) the idea that the Fed will be aggressively tightening monetary policy in the face of a sharp sell-off in the stock market is pure fantasy. The only question is exactly how far stocks need to fall before they blink. My money is on somewhere between 10% and 20%. Meanwhile, Madame Lagarde continues to pitch her view that inflation remains transitory and that while it is higher than the target right now, by next year, it will be back below target and the ECB’s concerns will focus on deflation again. So, while the PEPP will indeed be wound down, it will not disappear as it is always available for a reappearance should they deem it necessary. And in the meantime, they will increase the APP by €40 billion/month while still accepting Greek junk paper as part of the mix. Even though inflation is running at 4.9% (2.6% core) as confirmed this morning, they espouse no concern that it is a problem. Perhaps the most confusing part of this tale is that the EURUSD exchange rate rallied on the back of a more hawkish Fed / more dovish ECB combination. One has to believe that is a pure sell the news result and the euro will slowly return to recent lows and make new ones to boot. One final word about the major central banks as the BOJ concluded its meeting last night and…left policy unchanged as universally expected. There is no indication they are going to do anything different for a long time to come. However, when you step away from the Big 3 central banks, there was far more action in the mix, some of it quite surprising. First, the BOE did raise the base rate by 15 basis points to 0.25% and indicated that it will be rising all throughout next year, with expectations that by September it will be 1.00%. The MPC’s evaluation that omicron would not derail the economy and price pressures, especially from the labor market, were reaching dangerous levels led to the move and the surprise helped the pound rally as much as 0.7% at one point. Earlier yesterday, the Norges Bank raised rates 25bps, up to 0.50%, and essentially promised another 25bp rise by March. Then, in the afternoon, Banco de Mexico stepped in and raised their overnight rate by 0.50%, twice the expected hike and the largest move since they began this tightening cycle back in June. It seems they are concerned about “the magnitude and diversity” of price pressures and do not want to allow inflation expectations to get unanchored, as central bankers are wont to say. Summing up central bank week, the adjustment has been significant from the last round of meetings with inflation clearly now the main focus for every one of them, perhaps except for Turkey, where they cut the one-week repo rate by 100 basis points to 14.0% and continue to watch the TRY (-7.0%) collapse. It is almost as if President Erdogan is trying to recreate the Weimar hyperinflation of the 1920’s without the war reparations. Will they be able to maintain this inflation fighting stance if global equity markets decline? That, of course, is the big question, and one which history does not show favorably. At least not the current crop of central bankers. Barring the resurrection of Paul Volcker, I think we know the path this will take. This poet is seeking his muse To help him define next year’s views Thus, til New Year’s passed Do not be aghast My note, you’ll not have, to peruse Ok, for my final note of the year, let’s recap what has happened overnight. As mentioned above, risk is under pressure after a poor performance by equity markets in the US. So, the Nikkei (-1.8%), Hang Seng (-1.2%) and Shanghai (-1.2%) all fell pretty sharply overnight. This morning, Europe has also been generally weak, but not quite as badly off as Asia with the DAX (-0.65%) and CAC (-0.7%) both lower although the FTSE 100 (+0.3%) is bucking the trend after stronger than expected Retail Sales data (+1.4%). Meanwhile, Germany has been dealing with soaring inflation (PPI 19.2%, a new historic high) and weakening growth expectations as the IFO (92.6) fell to its lowest level since January and is trending sharply lower. US futures are also pointing lower at this hour. Bond markets, meanwhile, are generally firmer although Treasury yields are unchanged at this time. Europe, though, has seen declining yields across the board led by French OATs (-2.6bps) and Bunds (-1.8bps) with the peripherals also doing well. Gilts are bucking this trend as well, with yields unchanged this morning. In the commodity space, oil (-1.75%) is leading the energy sector lower along with NatGas (-1.9%), but metals markets are going the other way. Gold (+0.5%, and back above $1800/oz) and silver (+0.7%) feel more like inflation hedges this morning, and we are seeing strength in the industrial space with copper (+0.45%), aluminum (+2.1%) and tin (+1.8%) all rallying. Lastly, looking at the dollar, on this broad risk-off day, it is generally stronger vs. its G10 counterparts with only the yen (+0.2%) showing its haven status. Otherwise, NZD (-0.5%) and AUD (-0.4%) are leading the way lower with the entire commodity bloc under pressure. As to the single currency, it is currently slightly softer (-0.1%) but I believe it has much further to run by year end. In the EMG bloc, excluding TRY’s collapse, the biggest mover has actually been ZAR (+0.6%) after it reported that the hospitalization rate during the omicron outbreak has collapsed to just 1.7% of cases being admitted. This speaks to the variant’s less pernicious symptoms despite its rapid spread. Other than that, on the plus side KRW (+0.25%) benefitted from central bank comments that they would continue to support the economy but raise rates if necessary. On the downside, CLP (-0.4%) is opening poorly as traders brace for this weekend’s runoff presidential election between a hard left and hard right candidate with no middle ground to be found. However, beyond those moves, there has been much less activity. There is no economic data today and only one Fed speaker, Governor Waller at 1:00pm. So, the FX market will once again be seeking its catalysts from other markets or the tape. At this point, if risk continues to be shed, I expect the dollar to continue to recoup its recent losses and eventually make new highs. As I mention above, this will be the last daily note for 2021 but the FX Poet will return with his forecasts on January 3rd, 2022, and the daily will follow afterwards. To everyone who continues to read, thank you for your support and I hope everyone has a happy and healthy holiday season. Good luck, good weekend and stay safe Adf
Investors seem somewhat concerned
That risk, in all forms, has returned
Thus, stocks are backsliding
While Jay is deciding
If QE should soon be adjourned
With the FOMC beginning its two-day meeting this morning, and PPI data due at 8:30am, it is clear that investors are taking a more precautionary view of the world today. Certainly, yesterday’s US equity market price action, where the major indices all closed on their session lows, has not helped sentiment, nor has the current market narrative of imminently tighter policy from the Fed. As such, it should be no great surprise that risk assets across the board are under pressure while more traditional havens have found some support.
But let us ask ourselves, is this current market (not Fed) narrative realistic? Again, I would contend the market expectations for tomorrow are that the Fed will double the pace of its QE tapering come January, which will have them finish QE by the end of March. And it is easy to see the merits of the argument given the persistence and magnitude of price gains seen over the past twelve to fifteen months. This is especially so given there is no obvious reason to believe prices will decline other than the economists’ mantra that supply will be created to fill the demand. (While this is certainly true in the long run, as Keynes pointed out back in 1923, in the long run we are all dead, so timing matters here.)
However, there are counterarguments also being made that will carry weight, especially with the political bent of the current administration. Specifically, the maximum employment piece of the Fed mandate, which Mr Powell highlighted last year when announcing the Fed’s new policy initiatives, remains an open question. It appears that the current Fed view is that NAIRU (full employment) is reached when the Unemployment Rate reaches 3.8%. The November NFP report showed Unemployment has declined to 4.2%, as measured, and recall that pre-pandemic, the Unemployment Rate had fallen to 3.5%, its lowest point in half a century. Thus, the new view is that full employment will only be reached at near historic lows. Yet, is that maximum employment in the current vernacular?
The Fed’s policy review used the terms “broad-based and inclusive” to describe maximum employment, by which they were considering not merely the statistical headline, but the makeup of the data when broken down by various subcategories, notably race. That November report indicated that the Unemployment rate for minorities was 6.7%, considerably higher than for the white cohort which saw Unemployment of just 3.7%. That disparity is at the heart of the question as to whether the Fed believes its employment mandate has been fulfilled.
You will not be surprised to know that there is vocal advocacy by some that the ratio that currently exists reflects bias and the Fed must do more to alleviate the problem, even at the expense of higher inflation. Nor would you be surprised that others make the case that rising inflation is a greater burden on the lower and middle classes, so seeking those last few jobs results in a significantly worse outcome for all, especially those for whom the policies are intended to help.
The point is it is not a slam-dunk that the Fed is going to be as aggressively hawkish as the current market narrative claims. While Chairman Powell clearly indicated that the pace of tapering would increase, do not be surprised if it rises from $15B/month to $20B or $25B/month rather than the baseline market assumption of $30B/month. If that is the case, then another repricing in markets will be coming, with risk assets getting a reprieve while the dollar is likely to suffer. While this is not my base case, I would ascribe at least a 30% probability to the idea that tomorrow’s FOMC is less hawkish than currently priced. Stay on your toes.
In the meantime, here is what has been happening since you all went home last evening. As mentioned, risk is under pressure with Asian equity markets (Nikkei -0.7%, Hang Seng -1.3%, Shanghai -0.5%) all following the US markets lower while European markets opened in a similar vein. However, it appears that recent omicron news regarding the efficacy of current vaccinations with respect to moderating illness has begun to turn sentiment around and we now see both the DAX and CAC flat on the day while the FTSE 100 (+0.4%) has risen, embracing the new omicron news along with better than expected employment data from the UK (Unemployment fell to 4.2% with Weekly Earnings rising 4.9%). Alas, US futures remain lower despite that Covid news, led by the NASDAQ (-0.6%).
Bond markets, which had earlier been modestly firmer (yields lower) have reversed course on the omicron news and we now see Treasury yields (+1.9bps) rising alongside the European sovereign market (Bunds +1.5bps, OATs +1.2bps, Gilts +2.3bps). It seems market participants continue to be whipsawed between concerns over tighter policy and positive omicron news.
Commodity prices, too, have begun to reverse course as early session declines have now been erased with oil (0.0%) back to flat on the day from a nearly 1% decline a few hours ago. While NatGas (-2.6%) in the US remains stable and under $4/mmBTU, the situation in Europe remains dire with prices rising another 3.6% as ongoing concerns over Nordstream 2 pressure the situation. In the metals’ markets, there is mostly red with precious (Au -0.1%) softer and base (Cu -0.1%, Al -0.7%) also under pressure. Agricultural products are falling as well today.
The dollar is on its back foot this morning as positivity permeates the markets with only NOK (-0.15%) softer in the G10, still feeling the lingering pain of oil while we see CHF (+0.35%) and EUR (+0.3%) lead the way higher. Much of this movement, I believe, is position related as there has been little data or commentary to drive things, and the broader dollar gains that we have seen over the past months are seeing some profit-taking ahead of the FOMC and ECB meetings in the event that my case above for a more dovish outcome occurs. Remember, too, given the market’s long dollar positioning, even a hawkish Fed could see a ‘sell the news’ result.
EMG currencies are showing similar trends with TRY (-3.3%) the true outlier as the lira quickly melts on ongoing policy concerns. But elsewhere, HUF (+0.8%) has gained as the central bank reduced its QE purchases and expectations of further rate hikes are rampant. CZK (+0.5%) is also benefitting from hawkish central bank news as the head there explained he saw rates closer to 4.0% than 3.0% next year (current 2.75%). After those stories, there is much less movement overall.
Data this morning showed the NFIB Small Business Optimism Index edge slightly higher to 98.4 while PPI (exp 9.2%, 7.2% ex food & energy) is due at 8:30. If the market takes hold of the latest omicron news, I would expect the equity market to turn around, but also the dollar as less Covid worries allows the Fed to be more hawkish. But really, all eyes are on tomorrow afternoon, so don’t look for too much movement in either direction today.
Good luck and stay safe
When most of us think of an APP
It’s something on phones that we tap
But Madame Christine,
The ECB queen,
Fears PEPP’s end would be a mishap
So, word is next week when they meet
Expansion of APP they’ll complete
Thus, PEPP they’ll retire
But still, heading higher
Are PIGS debt on their balance sheet
Over the next seven days we will hear from the FOMC, ECB and BOE with respect to their policies as each meets next week. Expectations are for the Fed to increase the speed at which they are tapering their QE purchases, with most pundits looking for that to double, thus reducing QE by $30 billion/month until it is over. Rate hikes are assumed to follow shortly thereafter. However, if they sound quite hawkish, do not be surprised if the equity market sells off and all of our recent experience shows that the Fed will not allow too large a decline in stock prices before blinking. Do not be envious of Chairman Powell’s job at this point, it will be uncomfortable regardless of what the Fed does.
As to the ECB, recent commentary has been mixed with some members indicating they believe continued support for the economy is necessary once the PEPP expires in March, and that despite internal rules prohibiting the ECB from buying non IG debt, they should continue to support Greece via the Asset Purchase Program. The APP is their original QE tool, and has been running alongside the PEPP throughout the crisis. Both the doves on the ECB and the punditry believe that any unused capacity from the PEPP will simply be transferred to the APP so there is more buying power, and by extension more support for the PIGS. However, we are hearing more from the hawks recently about the fact that QE has been inflating asset prices and inflation, and perhaps it needs to be reined in. When considering ECB activity, though, one has to look at who is running the show, just like with the Fed. And Madame Christine Lagarde has never given any indication that she is considering reducing the amount of support the ECB is providing to the Eurozone economy. Rather, just last week she explained that inflation’s path is likely to be a “hump” which will fall back down to, and below, their 2.0% target in the near future, so there is no need to be concerned over recent data.
Finally, the BOE finds itself in a sticky situation because of the relatively larger impact of the omicron variant in the UK versus elsewhere. While Governor Bailey had indicated back in October that higher rates were on the way, the BOE’s failure to act last month was a shock to the markets and futures traders are now far less certain that UK interest rates will be rising in order to fight rapidly rising prices there. Instead, there is increased discussion of the negative impact of omicron and the fact that the Johnson government appears to be setting up for yet another nationwide lockdown, something that will clearly reduce demand pressure. So, there is now only a 20% probability priced into the BOE raising rates to 0.25% next week from the current 0.10% level. This is not helping the pound’s performance at all.
And lastly, the PBOC
Adjusted a rare policy
Was raised to a bar
Two points o’er its prior degree
One last piece of news this morning was the PBOC announcement that they were raising the FX Reserve Ratio Requirement from 7% to 9% effective the same day the RRR for bank capital is being cut. This little-known ratio is designed to help the PBOC in its currency management efforts by forcing banks to increase their FX liquidity. This is accomplished by local banks buying dollars and selling renminbi. It is a clear sign that the PBOC was getting uncomfortable with the renminbi’s recent strength. Today is the second time they have raised the FX RRR this year with the first occurring at the end of May. Prior to that, this tool had not been used since 2007! Also, if you look at the chart, following this move in May, USDCNH rose 2.25% in the ensuing three weeks. Since the announcement at 6:10 this morning, USDCNH is higher by 0.5% already. It can be no surprise that the Chinese are fighting the strength of the yuan as it remains a key outlet valve for economic pressures. And while Evergrande is officially in default, as well as several other Chinese property developers, the PBOC maintains that is not a problem. But it is a problem and they are trying to figure out how to resolve it without flooding the economy with additional liquidity and without losing face.
With all that in mind, let’s see how markets have behaved. Yesterday’s ongoing rebound in US equity markets only partially carried over to Asia with the Nikkei (-0.5%) failing to be inspired although the Hang Seng (+1.1%) and Shanghai (+1.0%) both benefitted from PBOC comments regarding the resolution of Evergrande. European bourses are in the red, but generally not by that much (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%). There was little in the way of data released in the Eurozone or UK, but Schnabel’s comments about PEPP purchases inflating assets have put a damper on things. US futures, too, are sliding this morning with all three major indices lower by about -0.4% or so.
One cannot be surprised that bonds are rallying a bit, between the large declines seen yesterday and the growing risk-off sentiment, so Treasuries (-2.2bps) are actually lagging the move in Europe (Bunds -3.6bps, OATs -3.8bps, Gilts -4.7bps) and even PIGS bond yields have slipped. Clearly bonds feel like a better investment this morning.
After a 1-week rally of real significance, oil (-0.7%) is consolidating some of those gains and a bit softer on the day. NatGas (-0.7%) is also lower and we are seeing weakness in metals prices, both precious (Au -0.2%. Ag -0.7%) and industrial (Cu -1.4%). Foodstuffs are also under pressure this morning, but at this time of year that is far more weather related than anything else.
As to the dollar, it is broadly stronger this morning with the only G10 currency to gain being the yen (+0.1%) and the rest of the bloc under pressure led by NOK (-1.0%) and AUD (-0.45%) feeling the heat of weaker commodity prices. I must mention the euro (-0.3%) which seems to be adjusting based on the slight change in tone of the relative views of FOMC and ECB policies, with the ECB dovishness back to the fore.
EMG currencies are also mostly softer although there are a few outliers the other way. The laggards are ZAR (-1.0%) on the back of softer commodity prices and TRY (-0.9%) which continues to suffer from its current monetary policy stance and should continue to do so until that changes. We’ve already discussed CNY/CNH and see HUF (-0.5%) also under pressure as the 0.2% rise in the deposit rate was not seen as sufficient by the market to fight ongoing inflation pressures. On the plus side, the noteworthy gainer is CLP (+0.5%) which seems to be responding to the latest polls showing strength in the conservative candidate’s showing. Also, I would be remiss if I did not highlight BRL’s 1.5% gain since yesterday as the BCB raised rates by the expected 1.50% and hawkish commentary indicating another 1.50% rate rise in February.
On the data front, Initial (exp 220K) and Continuing (1910K) Claims are really all we see this morning, neither of which seem likely to have an FX impact. Tomorrow’s CPI data, on the other hand, will be closely watched.
The current narrative remains the Fed is quickening the pace of tapering QE in order to give themselves the flexibility to raise rates sooner given inflation’s intractable rise. As long as that remains the story, the dollar should remain well supported, and I think that can be the case right up until the equity markets respond negatively. Any sharp decline will be met with a dovish Fed response and the dollar will suffer at that point. Be prepared.
Good luck and stay safe
It seems the transition’s complete
As every Fed dove’s in retreat
From Powell to Daly,
And like Andrew Bailey,
They want to end QE tout de suite
Regarding the Fed’s hawks, Mester, George, Bostic and Bullard, we already knew they were ready to end QE. They have been saying so since much earlier this year, before two of their kettle were forced to resign
in disgrace (you remember Rosengren and Kaplan). Just yesterday, Cleveland’s Loretta Mester reiterated she was “very open” to quickening the tapering process in order to give the Fed the option to raise rates early next year if they deem it necessary. But of more interest has been the transition of the erstwhile dovish contingent with Mary Daly’s apparent desire to quicken the taper amongst the most surprising given her consistently dovish leanings. In fact, the only holdout that I can determine is Neel Kashkari from Minneapolis, who has yet to agree inflation is a problem. However, no one is more important than Chairman Powell, who over the past two days, in testimony to Congress, made it clear that come the FOMC meeting on December 15th, the pace of tapering will be increased.
At least, that is the view to which the market is turning. Equity market weakness, a flattening yield curve and rising volatility all demonstrate that investors and traders are beginning to adjust the strategies they have been following since QE1 in the wake of the GFC. This helps explain how the stock market could decline more than 1% two days in a row (!) and why it has fallen, already, nearly 5% from its all-time-high set back on November 22. While I am being somewhat facetious with respect to dramatizing the recent declines, there are many in the market who seem to believe these are unprecedented moves.
And it is this last issue which is likely to become a major concern for the Fed going forward. More than a decade of Fed easy money has taught people to buy every dip in asset prices. Post Covid Fed policy has encouraged people to lever up when they buy those dips and so margin debt has reached historic highs on both a nominal ($581 billion) and percentage of GDP (2.5%) basis. The problem here arises
if when stock prices decline, and margin calls are made. Just like the Fed is a price insensitive buyer of Treasuries, and index funds are price insensitive buyers of equities, margin calls result in price insensitive selling of equities. When this happens, equity prices can decline VERY quickly. Know, too, that exchanges can raise margin requirements intra-day, so if a decline starts at the open, they can raise margin requirements by lunchtime to protect their members. All this matters because the sudden hawkish tilt by the Fed could cause a very severe reaction in the financial markets. And if there is one thing about which we should all be sure, it is that a very sharp decline, anything over 10% in a short period, will be met with a change in behavior by those very same Fed hawks. Talk is cheap. Sticking to their guns because they are trying to address rampant inflation will make them all very unpopular, something which the current denizens of the Marriner Eccles building seem unlikely to be able to handle very well.
Is this the beginning of the end? I don’t believe so, especially as nothing has actually changed yet. However, when it comes to sentiment shifts, they can occur in a heartbeat, so do not rule anything out. Of more importance, though, is what we can expect if the shift comes.
In a classic risk-off scenario, where margin selling is rampant and equity prices are falling sharply, there is very likely to be contagion, so equities worldwide will decline. We are very likely to see Treasuries, Bunds and Gilts in demand, with yields there declining sharply. However, I would expect that the sovereign debt of the PIGS nations will more likely follow the equity market than Bunds, so spreads will widen. Commodity prices will come under severe pressure as this will be seen as a precursor to a recession. And the dollar will rise sharply vs. its EMG counterparts as well as the commodity bloc of the G10. JPY and CHF are both likely to do very well while the enigma is the euro, although my sense is the single currency would decline, just not as aggressively as, say, SEK. We are not at that point but be aware that the current market setup is such that the opportunity for a move of that nature is quite real. If you read Mark Buchanan’s terrific book, Ubiquity, you will recognize the “fingers of instability” described there as being present in every market. It just seems that those fingers are more prevalent currently. (If you haven’t read the book, I cannot recommend it highly enough.)
Ok, let’s take a tour of markets today. Yesterday’s late day US equity decline saw a continuation in Tokyo (Nikkei -0.65%) although the Hang Seng (+0.55%) managed to rally while Shanghai (-0.1%) was roughly flat. I believe HK benefitted from the word that China was going to force the tech companies listed in the US to delist likely driving them to the HK market. Europe, too, has been following that late day sell-off with the DAX (-1.3%) leading the major exchanges lower, followed by the CAC (-1.0%) and FTSE 100 (-0.8%). However, US futures are all pointing higher led by the DOW (+0.9%) as it seems two down days in a row are enough.
Perhaps not surprisingly, the bond market is behaving in a split fashion as well, with Treasury yields (+3.4bps) rising while European sovereigns (Bunds -1.2bps, OATs -2.0bps, Gilts -1.4bps) all slipping as risk is shed on the Continent.
The rebound thesis is alive and well in oil markets with WTI (+0.4%) edging higher, although it is off its early session highs. NatGas (+0.15%) is a touch firmer while precious metals are mixed (Au -0.3%, Ag +0.4%). Mixed also defines the industrial space with copper (+0.5%) doing well while aluminum (-0.6%) is under a bit of pressure. One thing that is universal today, though is the ags, all of which are higher by between 0.5% and 1.5%.
Finally, mixed describes the dollar as well, with half the G10 rising and the other half falling on the session. NOK (-0.35%) is the laggard, while GBP (+0.3%) is the leader. However, given the relatively modest movement, and the lack of news or data, there can be many things leading to these movements. In the EMG bloc, ZAR (+1.1%) is the leader despite (because of?) the omicron variant spreading so rapidly there. Information on the issue of omicron’s impact remains very difficult to come by, but the market appears to be taking the stance that it will not be a very big deal as the rand has rallied 3.5% from its lows seen last week when the news first hit. Away from that, RUB (+0.7%) and MXN (+0.7%) are the next best performers although both are outperforming their key export, oil. On the downside, TRY (-1.2%) continues to fall with no end in sight. Yesterday, President Erdogan sacked his FinMin and replaced him with a new, more pliant deputy, in order to be certain the central bank will continue cutting interest rates in the face of quickly rising inflation. This currency has much further to fall. Away from this, the decliners have been far less impressive led by THB (-0.4%) as local traders see concerns over the impact of the omicron variant.
On the data front, Initial (exp 240K) and Continuing (2003K) Claims are on the docket as all eyes turn to tomorrow’s NFP report. Yesterday’s ADP data was right on expectations which will give comfort to those looking for 545K in the NFP tomorrow.
Bostic, Quarles, Daly and Barkin take the stage today on behalf of the Fed and I would expect to hear more about a faster taper from all of them as this is clearly the new message. Looking at the dollar with all this in mind, it still appears to be following the 10-year trade more than the 2-year trade. As such, if the curve continues to flatten, I would look for the dollar to continue to consolidate its recent gains.
One last thing, I will be out tomorrow so there will be no poetry. However, my take is the NFP data is likely to be in line with expectations so not have much impact overall.
Good luck, good weekend and stay safe
There once was a narrative told
Explaining the Fed still controlled
The market’s reaction
Thus, making sure stocks ne’er got sold
But that was before Omicron
Evolved and put more pressure on
The future success
Of Fed’ral largesse
With no real conclusion foregone
So, later this morning we’ll hear,
When Janet and Jay both appear,
In front of the Senate
If they’ve still the tenet
That all will be well by next year
Perhaps all is not right with the world. At least that would be a conclusion easily drawn based on market activity this morning. Once again, risk is being shed rapidly and across the board. Not only that, but the market is completely rethinking the idea of tighter monetary policy by the Fed with the growing conclusion that it is just not going to happen, at least not on the timeline that had been assumed a few short days ago.
It seems that the Omicron variant of Covid is proving to be a bigger deal in investor’s eyes than had been originally assumed. When this variant was first identified by South African scientists, the initial belief was it was more virulent but not as acute as the Delta variant. So, while it was spreading quite rapidly, those who were infected displayed milder symptoms than previous variants. (If you think about the biology of this, that makes perfect sense. After all, every organism’s biologic goal is to continue to reproduce as much as possible. If a virus is so severe that its host dies, then it cannot reproduce very effectively. Thus, a more virulent, less severe strain is far more likely to remain in the world than a less virulent, more deadly strain, which by killing its hosts will die off as well.)
In the meantime, financial markets have been trying to determine just what type of impact this new strain is going to have on economies and whether it will induce another series of lockdowns slowing economic activity, or if it will be handled in a different manner. And so far, there is no clear conclusion as evidenced by the fact that we saw a massive sell-off in risk assets Friday, a major rebound yesterday and another sell-off this morning. If pressed, I would expect lockdowns to come back into vogue as despite questions over their overall efficacy, their imposition allows government officials to highlight they are ‘doing something’ to prevent the spread. Additional bad news came from the CEO of Moderna, one of the vaccine manufacturers, when he indicated that the nature of this variant would likely evade the vaccines’ defense.
So, story number one today is Omicron and how this new Covid variant is going to impact the global economy. Ironically, central bankers around the world must be secretly thrilled by this situation as the focus there takes the spotlight off their problem, rapidly rising inflation.
For instance, after yesterday’s higher than expected CPI prints in Spain and Germany, one cannot be surprised that the Eurozone’s CPI printed this morning at 4.9%, the highest level since the Eurozone was born in 1997, and far higher than any of the 40 economist forecasts published. Madame Lagarde wasted no time explaining that this was all temporary and that by the middle of next year inflation would be back to its pre-pandemic levels, but it seems fewer and fewer people are willing to believe that story. Do not mistake the run to the relative safety of sovereign bonds as a vote of confidence in the central bank community. Rather that is simply seen as a less risky place to park funds than the equity market, which by virtually every measure, remains significantly overvalued.
This leads to the third major story of the day, the upcoming testimony by Chairman Powell and Treasury Secretary Yellen in front of the Senate Banking Committee. The pre-released opening comments focus on Omicron and how it can be a risk for both growth and inflation thus once again trying to divert attention from Fed policies as a problem by blaming exogenous events beyond their control. Of course, this story will resolve itself starting at 10:00, so we will all listen in then.
Ok, with all that as prelude, a quick tour of markets shows just how much risk is in disfavor this morning. Overnight in Asia we saw broad weakness (Nikkei -1.6%, Hang Seng -1.6%) although once again Shanghai was flat. Europe is completely in the red (DAX -1.45%, CAC -1.25%, FTSE 100 -1.0%) and US futures are also pointing lower (DOW -1.2%, SPX -1.0%, NASDAQ -0.5%).
Meanwhile, bond markets are ripping higher with Treasuries (-5.1bps) leading the way as yields fall back to levels last seen in early September. In Europe, Bunds (-2.1bps), OATs (-2.2bps) and Gilts (-4.0bps) are all seeing demand pick up with the rest of the Continent all looking at lower yields despite rising inflation. Fear is clearly a powerful motivator. Even in Asia we saw JGB’s (-1.9bps) rally as did Australian and New Zealand paper.
Commodity markets are having quite a day with some really mixed outcomes. Oil (-2.5%) is back in the red after yesterday’s early morning rebound faded during the day, and although oil did close higher, it was well of the early highs. NatGas (-5.0%) is falling sharply, which at this time of year is typically weather related. On the other hand, gold (+0.5%) is bouncing from yesterday and industrial metals (Cu +1.4%, Al +1.6%, Sn +2.7%) are in clear demand. It seems odd that on a risk-off day, these metals would rally, but there you have it.
Finally, the dollar can only be described as mixed this morning, with commodity currencies under pressure (NOK -0.4%, CAD -0.25%) while financial currencies (EUR +0.5%, CHF +0.5%, JPY +0
4%) are benefitting on receding expectations for a tighter Fed. PS, I’m sure the risk off scenario is not hurting the yen or Swiss franc either.
Emerging market currencies are demonstrating a broader based strength with TRY (-1.6%) really the only major loser as further turmoil engulfs the central bank there and expectations for lower interest rates and higher inflation drive locals to get rid of as much lira as possible. Otherwise, PLN (+0.8%) is leading the way higher as expectations for the central bank to raise rates grow with talk now the rate hike will be greater than 50 basis points. But MYR (+0.8%) and CZK (+0.75%) are also showing strength with the ringgit simply rebounding after a 10-day down move as bargain hunters stepped in, while the koruna has benefitted from hawkish comments from the central bank governor. It appears that most EMG central banks are taking the inflation situation quite seriously and I would look for further rate hikes throughout the space.
Aside from the Powell/Yellen testimony, this morning brings Case Shiller House Prices (exp 19.3%), Chicago PMI (67.0) and Consumer Confidence (111.0). As well, two other Fed speakers, Williams and Clarida, will be on the tape, but it is hard to believe they will get much notice with Powell front and center.
The dollar appears to be back following the interest rate story, which means that if expectations of Fed tightening dissipate, the dollar will likely fade as well, at least versus the financial currencies. Commodities have a life of their own and will continue to dominate those currencies beholden to them. The tension between potential slower growth and rising inflation has not been solved, and while my view is the Fed will allow inflation to burn still hotter, keep in mind that if they do act to tighten policy, the dollar should find immediate support.
Good luck and stay safe
Whatever we all used to think
‘Bout how growth might rapidly shrink
If Covid spread quicker
Prepare for the kicker
A new strain that spreads in a blink
While the plan was to let you all digest your Thanksgiving meals in peace, unfortunately, the news cycle is not prepared to cooperate. Risk is waaaayyyyy off this morning as news of a new strain of Covid, B.1.1.529, has been identified in South Africa, but also in Botswana and Israel, albeit only a literal handful of cases so far, but whose attributes may be that it is not going to be able to be addressed by vaccines. So the market reaction has been to sell any risk asset they hold, which has resulted in a serious risk-off session with equity markets around the world much lower (Nikkei -2.5%, Hang Seng -2.7%, Shanghai -0.6%, DAX -3.0%, CAC -3.75% and the FTSE 100 -2.9%), bond markets ripping higher with yields tumbling (Treasuries -9.6bps, Bunds -5.5bps, OATs -5.1bps, Gilts -10.5bps and even JGBs -1.5bps) and oil getting trashed (-5.3%). Aside from bonds, the only other things higher this morning are gold (+1.0%) and the yen (+1.1%). That’s not strictly true, the euro has performed better than you might have expected, rallying 0.7%, although most EMG currencies are under real pressure, as are the commodity linked G10 currencies like CAD (-0.9%), AUD (-0.55%) and NOK (-0.4%).
US futures are also pointing sharply lower (DOW -2.0%, SPX -1.6%, NASDAQ -1.0%), so be prepared for some red on the screens here as well. The emerging consensus is that lockdowns are coming back, with Belgium imposing some overnight already, and travel bans are back with Israel and the UK already banning flights from South Africa.
Aside from the obvious health concerns that we will all be reevaluating; the point of this note is to discuss the impact on markets. Well, the idea that the Fed is going to be raising rates more rapidly has been tossed aside, with talk that tapering is not only not going to accelerate, but potentially stop. So, they will have reduced purchases by $15 billion/month and that will be it. Recall, just Wednesday there were two 25 basis point rate hikes priced into Fed funds futures curves by the end of 2022, with a third due for February 2023. Already one of those rate hikes has been priced out and if the news doesn’t improve soon, I would look for the others to go away as well. If we are entering a new phase of Covid restrictions, the question will be how much more money governments around the world are going to throw at the problem, not when they are going to start removing accommodation.
So, the quick analysis is that inflation will quickly fall to the wayside as a concern around the world as governments everywhere react to this latest medical risk. Of course, at this point, it no longer matters why prices are rising, it is simply the fact they are rising and that expectations for them to continue get further entrenched that is the problem. Reading through comments from various companies in their recent earnings calls shows that most of them are anticipating raising prices to cover costs as frequently as quarterly. Once again, this implies that holding ‘stuff’ rather than paper assets is going to be the best protection one can have for a while yet.
It is still too early to estimate how this new Covid strain will ultimately impact economies which is entirely dependent on government responses. But if recent history is any guide, I would expect that the playbook remains; more fiscal spending, more monetizing of debt and higher inflation amidst platitudes of just how much those governments care about you, their citizens.
Also, do not be surprised if all those best laid plans of companies returning to offices get waylaid once again.
In the end, the reason companies hedge their FX exposure is to help reduce the variance in earnings, whether by moderating cash flow swings or balance sheet revaluation. It is because markets respond to news of this nature in such extreme measures that hedging makes sense and that is not about to change.
But also, B.1.1.529 is yet another nail in the coffin of just-in-time manufacturing processes. Just-in-case is going to become the new normal, with higher inventories in order that manufacturers and retailers can satisfy client demand, and that is a permanent change in pricing. Any thoughts that inflation is going to go back down to sub 2% for an extended period are going to run headlong into reality over the next year, and it won’t be pretty.
To sum it up; risk is worthless today, hold havens. As to all the tomorrows, prices will tend higher for a much longer time regardless of what bond markets seem to indicate. Those markets no longer offer signals as in the past due to central bank interference.
And with those cheery thoughts, enjoy Black Friday and a full edition will be out on Monday.
Good luck, good weekend and stay safe
In Europe, the maximum nation
Is facing the scourge of inflation
And so, they are calling,
To help it start falling,
For less money accommodation
But others in Europe reject
The idea inflation’s unchecked
T’would be premature
To tighten, they’re sure
As QE they want to protect
It appears there is a growing rift in the ECB as we are beginning to hear more opposing views regarding the nature of inflation and correspondingly as to the prescription to address the issue. On the one hand, the hawks have been sharpening their talons with Germany’s Schnabel, Slovenia’s Vasle and Spain’s de Guindos having all warned of inflation’s surprising persistence and explaining that the risk is to the upside for higher inflation still. Meanwhile, this morning we had an erstwhile Hawk, Austria’s Holzmann, and an uber-dove, Italy’s Panetta pushing back on that view and insisting that the inflation that has been afflicting Europe is being driven by “purely temporary factors” and that premature withdrawal of stimulus would be a mistake.
The surprising feature of this discussion is that the Spanish voice is hawkish while the Austrian is dovish. Perhaps what that tells us is that, just like in the US, inflation has become a bigger political problem in Spain and the Socialist PM, Pedro Sanchez, is feeling the heat from the population there. This would not be surprising given inflation is running at 5.4%, the highest level since the introduction of the euro in 1999. Arguably, the fact that Robert Holzmann seems to be siding with the transitory camp is also quite the surprise, but as they say, politics makes strange bedfellows. In the end, as long as Madame Lagarde remains at the helm, the doves remain in control. As such, these comments sound very much like posturing for particular audiences.
Turning to other news, Germany is at the center of the most interesting stories today as local politics (the formation of a new government…finally) as well as data (IFO Expectations fell to 94.2) seem to be driving the euro bus, and with the euro, the rest of the markets. A brief look at the proposed government shows a coalition of the Social Democrats (SPD), the Greens and the Free Democratic Party (FDP) which is a pro-growth, free markets group. This unprecedented grouping of 3 parties remains tenuous, at best, if only because the underlying belief sets are very different. It remains unclear how a party whose focus is on less government (FDP) is going to work effectively with a party whose focus is on bigger government (SPD). Olaf Scholz will be the new PM, a man with long experience in politics and a widely respected name. As I said before, politics makes strange bedfellows!
On the economic side, this morning’s IFO data was quite disappointing, with Expectations falling back to levels seen in the beginning of the year and reaching a point that foretells of a recession coming. Adding this to the imminent lockdown scenario (Germany’s Covid caseload jumped by 54K yesterday, with a significant surge ongoing), leaves quite the negative impression for the German economy. In fact, given this news, it becomes harder for the hawks to make their case as the central bank model continues to believe that slowing growth will slow inflation. (And while that would be true for demand-pull inflation, the whole cost-push framework is different.) At any rate, the result is a day where risk is being shed and havens sought. This is especially so in Germany, where the DAX (-0.6%) is the weakest performer in Europe, while Bunds (-1.7bps) have rallied despite a terrible auction outcome as investors adjust asset mixes. And the euro? Down a further 0.3%, trading just above 1.1200, although it appears that there is further to run.
What about the rest of markets? Well, the Nikkei (-1.6%) fell sharply as investors in Japan expressed concern that the Fed would begin to tighten, and it would have negative impacts throughout the world. At least that is what they claim. China, on the other hand saw much less movement with the Hang Seng (+0.1%) and Shanghai (+0.1%) seeing a mix of gainers and losers internally thus offsetting for the index as a whole. The rest of Europe is generally softer (CAC -0.2%, Spain’s IBEX -0.3%), although the FTSE 100 is basically unchanged on the day. And after a mixed day yesterday, US futures are pointing modestly lower, -0.2% or so across the board.
As to the rest of the bond market, Treasuries (-2.4bps) are finally rallying after seeing a dramatic 12 basis point rise in the past three sessions. We have also seen OATs (-0.7bps) rally slightly and Dutch bonds (-1.6bps) all the havens. It should not, however, be surprising that Italian BTPs (+1.2bps) and Greek bonds (+3.9bps) are being sold as they remain risk assets in full.
On the commodity front, oil, which has been suffering from the SPR release story, seems to have absorbed that risk and after rebounding yesterday is flat this morning. While still below $80/bbl, my sense is this has further to run higher. NatGas (-0.25%) is a touch lower in the US as is gold (-0.1%). However, the industrial metals are performing far better (Cu +0.7%, Al +0.7%, Sn +0.4%).
Lastly, the dollar is generally having a good day again, as risk appetite wanes. NZD (-0.6%) is the weakest G10 currency after the market was disappointed in their actions last night, only raising the base rate by 0.25% while the whisper number was 0.5%. SEK (-0.4%) is the next laggard, with the krona continuing to suffer on the view that the Riksbank will remain reluctant to tighten policy at all in the face of actions by the Fed and potentially the BOE. The rest of the bloc is generally softer with only the haven, JPY (+0.1%), showing any strength.
In the EMG space, we need to look away from TRY (+5.6%) which is retracing some of yesterday’s remarkable decline, as it is destined for extreme volatility in the near future. But elsewhere, there is actually a mixed result with BRL (+0.6%) and PHP (+0.5%) leading the gainers while THB (-0.7%) and RUB (-0.3%) lag the space. The real is benefitting from the central bank announcement it will be auctioning off 14K contracts in the FX markets, part of their intervention process, while the Philippine peso has benefitted from further investment inflows to the local stock market. On the flipside, the baht seems to be suffering from concerns that the lockdowns in Europe will reduce tourism there during the high season, while the ruble continues to suffer from concerns over potential military activity and the further negative impacts of sanctions that could follow.
Given tomorrow’s Thanksgiving holiday, all the rest of the week’s data will be released today:
|Core PCE||0.4% (4.1% Y/Y)|
|New Home Sales||800K|
As the GDP data is a revision, it will not garner much attention. Rather, all eyes will be focused on Core PCE, as if recent form holds, it will print higher than expectations, further forcing the Fed debate. And of course, the Minutes will be parsed intently as traders try to divine just how quickly things may change next month, especially since Chairman Powell and Governor Brainerd have both been clear that inflation is their primary concern now.
At this point, there is nothing to stand in the way of the dollar and I expect that it will continue to grind higher for a while. The hallmark of the move so far this month, where the single currency has fallen 3.0%, is that it has been remarkably steady with a majority of sessions showing modest declines. That pattern seems likely to continue for now unless there is a change from either the Fed or the ECB, neither of which seems likely. Hedge accordingly.
Have a wonderful Thanksgiving holiday and poetry will return on Monday November 29th.
Good luck, good weekend and stay safe
The President’s finally decided
That Lael and Jay have now divided
The tasks at the Fed
And both of them said
Inflation just won’t be abided
The bond market took in the news
And quickly adjusted its views
Thus, interest rates rose
While gold felt the throes
Of pain as goldbugs sang the blues
By now, we all know that Chairman Powell has been reappointed to his current role as Fed Chair and Governor Brainerd has been elevated to Vice-Chair. The underlying belief seems to be that the Biden administration was not prepared for what would likely have been a much more difficult confirmation fight to get Brainerd as Chair and decided to husband whatever political capital they still have left to fight for their spending legislation. Arguably, the most interesting part of the process was that both Powell and Brainerd, in their remarks, indicated that fighting inflation was a key priority. As Powell said, “We will use our tools both to support the economy and strong labor market, and to prevent higher inflation from becoming entrenched.” Now that is a wonderful sentiment, and of course, directly in line with the Fed’s Congressional mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” Alas for them both, the tools necessary for the different pieces of the mandate tend to be opposite in their nature.
However, the market response was clear as to its broad belief that tighter Fed policy is on the horizon. Between those comments and what we heard last week from Governor Waller, vice-Chair Clarida and St Louis Fed President Bullard, it seems clear that the meeting in December is going to be all about the timing of the tapering. While the progressive wing of the Democratic party remains steadfast in their belief in the power of MMT to deliver prosperity for all, it appears that the reality on the ground, namely that inflation is exploding higher, has become too big a problem to ignore for President Biden.
Here’s the thing. The traditional tool for fighting rising inflation is to raise interest rates above the rate of inflation to create positive real yields. Now, depending on how you define inflation; CPI, PCE, the core version of either, or the trimmed mean version of either, given where all of those measures currently stand, the minimum amount of rate increases is going to be 300 basis points, with a chance that it could be 400 or more. Now, ask yourself how an economy that is leveraged to the hilt (total debt/GDP > 895%) will respond to interest rates rising by 300 or 400 basis points. How about the stock market, with its current Shiller CAPE (cyclically adjusted P/E) above 39 compared to a median of 15.86 over the past 150 years? How do you think that will respond to the interest rate curve rising by 300 or 400 basis points? The picture is not pretty.
It remains to be seen just how much pain the Fed and the Administration can stand if the Fed actually does start to tighten policy more aggressively in the face of rapidly rising inflation. Consider that in Q4 2018, the last time the Fed was trying to ‘normalize’ policy by allowing the balance sheet to run down slowly while also raising interest rates, stocks fell 20% and the result was the ‘Powell Pivot’ on Boxing Day that year, where the Chairman explained that tightening policy wasn’t actually that critical at the time and would end immediately. At that time the same measure of debt/GDP was ‘merely’ 763% and the CAPE was 29. We have much further to fall today, and I expect that when/if that starts to happen, the Fed will not blithely continue tightening policy to fight inflation. Remember the idea that the Fed has painted themselves into a corner? Well, this is the corner in which they have painted themselves. They need to raise rates to fight inflation but doing so is likely to provoke a severely negative market, and potentially economic, reaction.
Now, while we are all waiting for that shoe to drop, let’s take a look at how markets responded to the news. The first thing to note is the bond market, where 10-year yields rose 9 bps yesterday and that trend has continued this morning with yields higher by another 2.3bps. With the 10-year currently yielding 1.65%, all eyes are on the 1.75% level, the peak seen in March, and the level many see as a critical technical level, a break of which could open up much higher yields. It should not be surprising that we have seen higher yields elsewhere as well, with European sovereigns (Bunds +5.9bps, OATs +5.7bps, Gilts +4.8bps) responding to three factors this morning; the US market movement, better than expected preliminary PMI data across the continent and hawkish comments from both Isabel Schnabel and Klaas Knot, two ECB members. You may recall last week when I described some Schnabel comments as apparently dovish, and a potential capitulation of the remaining hawks on the ECB. Apparently, I was mistaken. Today she was much clearer about the risks of inflation being to the upside and that they must be considered. If the hawks are in flight, bonds have further to decline.
In the equity markets, yesterday’s news initially brought a rally in the US, but by the end of the day, as bond yields rose, the NASDAQ, which is effectively a very long duration asset, fell 1.25%, although the rest of the US market fared far better. The overnight session saw a more modest reaction with the Nikkei (+0.1%) and Shanghai (+0.2%) edging higher although the Hang Seng (-1.2%) suffered on weaker consumer and pharma stocks. Europe has rebounded from its worst levels but is still lower (DAX -0.7%, CAC -0.25%, FTSE 100 0.0%) despite (because of?) the PMI data. I guess hawkish monetary policy trumps good economic data, a harbinger of what may be on the horizon. At this hour, US futures are little changed, so perhaps there is good news in store.
News that the Biden administration is releasing 30 million barrels of oil from the SPR along with releases by India and South Korea has weighed on oil prices (WTI -1.5%) although NatGas (+4.8%) is not following along for the ride. Gold (-0.5%) got clobbered yesterday and is down 2.7% from Friday’s closing levels. Clearly, inflation fighting by the Fed is not seen as a positive. As to the rest of the metals complex, it is generally higher as expectations grow that demand around the world is going to pick back up.
Finally, in the FX market, the truly notable mover today is TRY (-11.2%!) which appears to be starting to suffer from a true run in the wake of President Erdogan’s praise of the recent interest rate cut and claiming that Turkey is fighting an “economic war of independence.” It seems he’s losing right now. Relative to that movement, nothing else seems substantial although MXN (-0.8%) is feeling pressure from declining oil prices while other EMG currencies slid on the broad strong dollar theme. In the G10, NZD (-0.5%) is the weakest performer as long positions were cut ahead of the RBNZ meeting next week, but the bulk of the bloc is modestly lower as US interest rates continue to power ahead.
On the data front, we see the preliminary PMI data (exp 59.1 Mfg, 59.0 Services) and that’s really it. Yesterday’s Existing Home Sales were better than expected, but really, today’s markets will continue to be driven by interest rates and views on how the Fed is going to behave going forward. Taking Powell at his word means that tighter policy is coming which should help the dollar amid a broader risk-off sentiment. Plan accordingly.
Good luck and stay safe
In Germany, Covid’s widespread
And lockdowns seem likely ahead
But that hasn’t stopped
Inflation which popped
To levels the people there dread
The upshot is risk’s in retreat
As equities, traders, excrete
But bonds and the buck
Are showing their pluck
And havens now look mighty sweet
While Covid has obviously not disappeared, for a time it seemed much less important to investors and traders and so, had a lesser impact on price action. But that was then. During the past few weeks, Covid has once again become a much bigger problem despite the inoculation of large portions of the population in most developed countries. Exhibit A is Austria, where they have imposed a full-scale vaccine mandate and have the police checking papers randomly to insure that anyone outside their home is vaccinated. If you are found without papers, the penalty is prison. However, Germany seems determined to catch up to Austria on this count, as the infection rate there climbs rapidly, and the healthcare system is getting overwhelmed. There is talk that a nationwide lockdown is coming there as well, and soon.
Of course, what we learned during the first months of Covid’s spread was that when lockdowns are imposed, economic activity declines dramatically. After all, in-person services all but end, and without government financial support, many people are unable to maintain their levels of consumption. As such, the prospect of the largest economy in Europe going into a total lockdown is a pretty negative signal for future economic activity. Alas for the authorities, the one thing that does not seem to be in retreat is inflation. While Germany is contemplating a national lockdown, this morning it released its latest PPI data and in October, Producer Prices rose 3.8%, which takes their year-on-year rise to…18.4%! This is the highest level since 1951 and obviously greatly concerning. While some portion of these increased costs will be absorbed by companies, you can be sure that a substantial portion will be passed on to customers. CPI is already at 4.6% and there is no indication that it is about to retreat.
And folks, this is Germany, the nation that is arguably the most phobic regarding inflation of any in the developed world. Sure, Turkey and Argentina and Venezuela have bigger inflation problems right now. So does Brazil, for that matter. And many of these latter nations have long histories of inflation ruling the roost. But ever since 1924, when the newly established Rentenbank helped break the Weimar hyperinflation, sound money and low inflation have been the hallmarks of German policy and politics. So, the idea that any price index is printing in double digits, let alone nearly at 20% per annum, is extraordinary. In fact, this is what makes yesterday’s comments from Isabel Schnabel, a German PhD economist and member of the ECB’s Executive Board, so remarkable. For any German with sway over monetary policy to pooh-pooh the current inflation levels is unprecedented. Even more remarkably, with Jens Weidmann leaving the role of Bundesbank President, Schnabel is on the short list to replace him.
This drama in Germany matters because if the Bundesbank, traditionally one of the most hawkish central banks, and the biggest counterweight to the ECB as a whole, is turning dovish, then the implications for the euro, as well as Eurozone assets, are huge. If the Bundesbank will not be holding back Madame Lagarde’s push to do more, we can expect an expansion in QE from here and overall higher inflation going forward. Both bonds and stocks will rally, as will the price of commodities in euros, while the euro itself will fall sharply. In fact, this may be enough to offset any incipient dovishness from the Fed should Lael Brainerd wind up as Fed Chair. It would certainly change medium and long-term views on the EURUSD exchange rate. And you thought that the week before Thanksgiving would be quiet.
And so, it is a risk-off type day today. While Asian equity markets managed more winners than losers (Nikkei +0.5%, Hang Seng -1.1%, Shanghai +1.1%), Europe is completely in the red (DAX -0.2%, CAC -0.3%, FTSE 100 -0.5%) and US futures are pointing down as well, with DJIA futures (-0.6%) leading the way.
Bond markets are behaving exactly as would be expected on a risk-off day, with Treasury yields falling 4.6bps while European Sovereigns (Bunds -5.5bps, OATs -5.4bps, Gilts -5.8bps) have rallied even further. In fact, German 30-year bunds have fallen into negative territory again for the first time since August.
If you want to see risk being shed, look no further than oil (-3.1%) which is lower yet again and seems to have found a short-term top. It seems the news of SPR releases as well as slowing growth prospects has been enough to halt the inexorable rally seen since April 2020. Interestingly, a number of other commodities are performing quite well with NatGas (+1.1%), copper (+0.9%) and aluminum (+0.7%) all nicely higher. Gold (+0.2%) continues to edge up as well, with more and more inflows given its haven status. Somewhat surprisingly, Bitcoin (-4.7%, -10.5% in the past week) is not similarly benefitting, although the narrative of it being digital gold remains strong. Perhaps it was simply massively overbought!
Finally, the dollar is clearly king this morning, rallying strongly vs all its G10 peers except the yen (+0.35%), with NOK (-1.1%) the biggest laggard on the back of oil’s decline, although the SEK (-0.9%) and EUR (-0.7%) are no slouches either. The funny thing about the euro was it spent all day yesterday climbing slowly after touching new lows for the move. However, this morning, it is below 1.13 and pressing those lows from Wednesday with no end in sight.
EMG currencies are also under pressure across the board with HUF (-1.6%) the worst performer as it has unwound the gains seen from yesterday’s surprising large rate hike, and is now suffering as Covid spreads rapidly and it may soon be a restricted zone for travel from Europe. CZK (-1.1%) is next in line, as it too, is in the crosshairs of authorities to prevent travel there due to Covid. In fact, the entire CE4 is the worst bloc, but we are also seeing further weakness in TRY (-0.6%) after yesterday’s rate cut, and RUB (-0.5%) with oil’s slide as the cause.
There is no data to be released today and only two Fed speakers, Waller and Clarida, with the latter losing his clout as he will soon be exiting the FOMC. There continues to be a wide rift between the hawks and doves on the Fed, but as long as Powell, Brainerd and Williams remain dovish, and they have, the very modest steps toward tapering are all we are likely to see. The problem is that while we are all acutely aware of inflation and the problems it brings, the FOMC is lost in its models and sees a very different reality. Not only that, inflation diminishes the real value of the US’s outstanding debt and so serves an important purpose for the government. While there continues to be lip service paid to inflation as a problem, policy actions show a willingness to tolerate higher inflation for a much longer time. Alas, it will be topic number one with respect to markets for a long time to come.
For now, the dollar is performing well against all the major currencies, but there are many potential twists in our future. As I have said before, payables hedgers should be picking levels to add to their hedges.
Good luck, good weekend and stay safe
The surge in inflation has shocked
Officials who’ve tried to concoct
A tale that high prices
Don’t mean there’s a crisis
But lately those views have been mocked
Just yesterday, CPI showed
Inflation’s begun to explode
Will Powell respond?
Or is he too fond
Of QE, his bonds to unload?
I am old enough to remember when rising used car prices and their impact on inflation were considered an aberration, and thus transitory. Back in the summer of…’21, better known as the good old days, when CPI prints of 5.4% were allegedly being distorted by the temporary impact of the semiconductor shortage which significantly reduced new car production and drove demand into used vehicles. However, we were assured at the time that this was an anomaly driven by the vagaries of Covid-19 inspired lockdowns and that it would all soon pass. In fact, back in the day, the Fed was still concerned about deflation.
Well Jay, how about now? Once again, I will posit that were I the current Fed Chair, I wouldn’t accept renomination even if offered as I would not want to be at the helm of the Fed when inflation achieves 1970’s levels while growth slows. And, as inflation has become topic number one across the country, so much so that President Biden stated, “Reversing inflation is a top priority,” the Fed is set to be in the crosshairs of every pundit and politician for the next several years. One can’t help but consider that both vice-chairs, Clarida and Quarles, leaving ASAP is analogous to rats fleeing a sinking ship. The Fed, my friends, has a lot of problems ahead of them and it remains unclear if they have the gumption to utilize the tools available to stop the growing momentum of rising inflation.
And that is pretty much the entire market story these days; inflation – how high will it go and how will central banks respond. Every day there is some other comment from some other central banker that helps us evaluate which nations are serious about addressing the problem and which are simply paying lip service as they allow, if not encourage, rising inflation in order to devalue the real value of their massive debts.
As such, we get comments from folks such as Austria’s central bank chief, and ECB Governing Council member, Robert Holzmann, who explained that all ECB asset purchases could end by next September. While that is a wonderful sentiment, at least for those who believe inflation is a serious problem, I find it very difficult to believe that the rest of the ECB, where there reside a large cote of doves, are in agreement. In fact, the last we heard from Madame Lagarde was her dismissal of the idea that the ECB might raise rates anytime soon, admonishing traders that their pricing for rate hikes in the futures markets was incorrect.
The takeaway from all this is the following; listen to what central bank heads say, as a guide to their actions. While not always on target (see BOE Governor Andrew Bailey last week), generally speaking if the central bank chief has no urgency in their concern over an issue like inflation, the central bank will not act. Given the pace of inflation’s recent rises, essentially every central bank around the world is behind the curve, and while some EMG banks are trying hard to catch up, there is no movement of note in the G10. Look for inflation to continue to rise to levels not seen since the 1960’s and 1970’s.
So, how are markets digesting this news? Not terribly well. At least they didn’t yesterday, when equity markets fell around the world along with bond markets while gold and the dollar both soared. However, this morning we have seen a respite from the past several sessions with equity markets rebounding in Asia (Nikkei +0.6%, Hang Seng +1.0%, Shanghai +1.1%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 +0.4%) albeit with Europe lagging a bit. US futures are also firmer led by the NASDAQ (+0.7%) but with decent gains in the other indices. Of course, the NASDAQ has been the market hit hardest by the sharp rally in bond yields, so on a day where the Treasury market is closed thus yields are unchanged, that makes a little sense.
Speaking of bonds, yesterday saw some serious volatility with 10-year Treasuries eventually settling with yields higher by 11bps. Part of that was due to the 30-year Treasury auction which wound up with a more than 5 basis point tail and saw 30-year yields climb 14bps on the day. But not to worry, 5-year yields also spiked by 13bps, so it was a universal wipe-out. This morning, in Europe, early bond losses (yield rises) have retreated and the big 3 markets, Bunds, OATs and Gilts, are little changed at this hour. But the rest of Europe is not so lucky, especially with the PIGS still under pressure. I guess the thought that the ECB could stop buying bonds at any time in the future is not a welcome reminder for investors there.
Commodity prices, too, were whipsawed yesterday, with oil winding up the day lower by more than 4% from its morning highs. This morning, that trend continues with WTI (-0.9%) continuing lower on a combination of weakening growth expectations and rising interest rates. NatGas has rebounded slightly (+2.5%) but is now hovering around $5/mmBTU, which is more than $1 lower than we saw during October. It seems that some of those fears have abated. Gold, however, continues to rally, up another 0.4% today and about 4% in the past week. Perhaps it has not entirely lost its inflationary magic.
And finally, the dollar continues to perform very well after a remarkable performance yesterday. For instance, yesterday saw the greenback rally vs every currency, both G10 and EMG, with many seeing declines in excess of 1%. ZAR (-2.6%) led the EMG rout while NOK (-1.65%) was the leader in the G10 clubhouse. But don’t discount the euro having taken out every level of technical support around and falling 1%. This morning that trend largely continues, with CAD (-0.55%) the worst performer on the back of oil’s continued weakness, but pretty much all of the G10 under the gun. In the emerging markets, however, there are some notable rebounds with ZAR (+1.5%) and BRL (+1.0%) both rebounding from yesterday’s movements. The South African story has to do with the budget, which forecast a reduction in borrowing and maintaining a debt/GDP ratio below 80%, clearly both positive stories in this day and age. The real, on the other hand, seems to be benefitting from views that the central bank is going to tighten further as inflation printed at a higher than expected 10.67% yesterday, and the BCB has been one of the most aggressive when it comes to responding to inflation.
With the Veteran’s Day holiday today (thank you all for your service), banks and the Fed are closed, but markets will remain open until 12:00 and then liquidity will clearly suffer even more greatly. There is no data nor speakers due, so I expect the FX market to follow equities for clues about risk. In the end, the dollar is on a roll right now, and I don’t see a reason for that to stop in the near term. Later on? Perhaps a very different story.
Good luck and stay safe