Tag Archives: #riskoff

Bears are All Thrilled

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Kuroda explained
The future is like the past
Ergo, rates unchanged

The BOJ concluded their latest policy meeting last night and the results were…nothing changed.  Well, that’s not strictly true.  Their economic and inflation forecasts were tweaked to arrive at a revised path to the same outcome.  So, instead of faster growth this year, they decided it would be delayed a year before falling back to its long-term 1.0% trend while inflation is now forecast to jump up to… 1.1% for the next two years, from a previous expectation of 1.0%. Now that’s precision!  Kuroda-san’s term expires in April 2023 and despite 12 years of extraordinarily easy money, with QE, YCC and NIRP all employed to drive inflation higher, at this time it seems likely that he will have failed dismally in his only task.  (As an aside, I would wager if you surveyed the Japanese population, there would be scant few demands for higher prices in their purchases.  Just sayin’.)  As to the yen, it is essentially unchanged on the day and when asked about the currency, Kuroda explained it should move stably (whatever that means), but that a weaker yen would ultimately be desired.  Plus ça change.

Excitement has started to build
And bond market bears are all thrilled
With One point Eight breached
The story they’ve preached
Is finally being fulfilled

Arguably, however, the biggest story today is that the US 10-year yield has finally traded above 1.80% (as I type it is +3.2bps at 1.816%) for the first time since before the pandemic in February 2020.  For those market participants who have been preaching that rising inflation would lead to higher yields, this is a clear milestone.  Regarding the transitory vs. persistent inflation narrative, this also indicates a growing number of investors are moving toward the persistent side of the argument.  The key question, of course, is why has this happened today?  Are there specific catalysts or was it simply time?

Perhaps the first place to look is the oil market, where WTI (+1.2%) has rallied more than $1.00/bbl and is trading back above $85/bbl for the first time since October 2014.  We all know that higher oil prices tend to have a very clear impact on both actual prices and price expectations.  Today’s oil rally seems to be the result of a few different issues.  First has been the news that there was a drone attack on oil facilities in the UAE raising the specter of market disruptions from the Middle East.  A background story there is that the amount of spare capacity available in OPEC+ members may also be somewhat overstated as evidenced by the fact that OPEC’s last production increase of 400K barrels per day fell short because several members simply couldn’t pump enough to meet their quotas.  Meanwhile, demand seems pretty robust as 1) the omicron variant is quickly becoming seen as akin to the common cold and so not too disruptive; and 2) with NatGas prices so high in Europe and Asia, utilities are turning to both oil and coal to power their countries adding to oil demand.

Of course, the other key feature of the US interest rate market is forecasting what the Fed is going to do this year and how that will impact things.  It is worth noting that while 10-year yields have jumped 3+ basis points this morning, 2-year yields are higher by more than 6 basis points and back above 1.0% for the first time since before the pandemic as well.  But that means that the yield curve continues to flatten, a harbinger of slower future growth.  Now, one might expect that slower future growth would help reduce inflationary fears and ordinarily that would be a good thought.  However, there is nothing ordinary about the current policy settings nor their recent history and it is those features that are likely to drive market sentiment for at least a little longer.

Remember, monetary policy works with “long and variable lags” which historically has been calculated as somewhere between 24 and 30 months.  This implies that whatever action the Fed takes next week will not start to impact the economy until 2024.  It also means that the actions they took at the beginning of the pandemic, about 22 months ago, are likely starting to be felt in the real economy.  Money supply rose >35% for many months throughout 2020 and the early part of 2021, and it is fair to expect that the impact of all that extra cash floating around has not yet completely been seen.  The point is that inflation remains built up in the system and is likely to be with us for quite some time to come.  With this in mind, it is easy to see why yields are rising.

And there is one more thing to add to the puzzle, QT.  Remember, too, comments from a number of FOMC members hinted at an increasing desire to start reducing the size of their balance sheet.  If they do follow through with that process, it seems likely that Treasury yields will move even higher across the curve as the only price insensitive buyer leaves the market.  The question then becomes, at what point do yields rise enough to make the Treasury uncomfortable when it comes to refinancing the current debt?  I make no claims that I know where that level lies, but I remain confident that as soon as carrying costs for debt start to climb as a percentage of GDP, QT is going to end.  Summing up, there is a lot happening and it feels like we may be at the beginning of some significant trend changes.

How has all this activity impacted markets today?  You will not be surprised to know that risk has been significantly reduced across the board.  Looking at equity markets, red is the predominant color on screens this morning with only one exception, Shanghai (+0.8%) as traders react to easing monetary policy and support for property markets in China.  Otherwise, it is not pretty (Nikkei -0.3%, Hang Seng -0.4%, DAX -1.0%, CAC -1.0%, FTSE 100 -0.6%).  US futures are also under severe pressure led by the NASDAQ (-1.8%) although both the DOW and SPX are lower by -1.0% at this hour.  It seems that rising yields are pretty bad for growth stocks and I believe that story has legs.

Global bond markets had all been much softer earlier in the session but have since recouped their losses so that European sovereigns are essentially unchanged at this hour.  The one outlier, again, in Asia was China, where CGB’s saw yields decline 4.4bps last night as investors pile in looking for further policy ease.

On the commodity front, we have already discussed oil, which is by far the most interesting thing out there.  NatGas in the US is little changed on the day and actually slightly lower in Europe.  Gold (-0.3%) has fallen which should be no surprise given the rise in yields across the curve, and copper (-0.85%) is also under pressure as the flatter curve and declining stocks hint at weaker future growth.

As to the dollar, it is generally firmer this morning although not universally so.  SEK (-0.5%) is the laggard in the G10 on a combination of residual belief the Riksbank will remain relatively dovish and the beginnings of concern over election outcomes when the Swedes go to the polls in September.  After that, AUD (-0.4%) and NZD (-0.4%) are next in line, both suffering from weakness in metals and agricultural markets.  The rest of the bloc is softer by about 0.2% or so save CAD (+0.1%) which is benefitting from oil’s rise.

In the emerging markets, TRY (-0.8%) volatility continues to dominate, but INR (-0.45%), PHP (-0.45%) and HUF (-0.45%) are all under pressure as well.  The first two are feeling the effects of higher Treasury yields as well as concerns over potential CNY weakness after PBOC comments about preventing one-way trading (meaning continued strength).  As to HUF, it and the rest of the CE4 look simply to be displaying their relatively high betas with respect to the euro (-0.2%).

On the data front, Empire Manufacturing (exp 25.0) is today’s only number of note and we will need a big surprise in either direction to have a market impact.  Rather, today’s trend seems pretty clear, higher yields, weaker stocks and a stronger dollar.  Will it continue much longer?  That, of course, is the key question.

Good luck and stay safe
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Buying Will Stop

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It seems nearly every day now
Some Fed members make the same vow
First buying will stop
Next Fed funds will pop
Then asset run-off we’ll allow

Thus far markets have been subdued
Though some players now have construed
That buying the dip
Has lost all its zip
While selling all rallies is shrewd

Another day, another series of Fed speakers explaining that inflation is the primary focus, that when QE stops in March it may (read will) be appropriate to raise the Fed Funds rate by 0.25% and that the Fed has powerful tools to prevent inflation from getting out of hand.  While it is encouraging that they have finally figured out inflation is a problem, the fact that they still don’t understand it is a problem of their own making is somewhat disconcerting.  However, moving in the right direction is clearly a positive.

So, after Brainerd, Waller, Barkin and Evans all basically said the same thing, here is what we know.  It seems a virtual certainty that the Fed Funds rate will be raised at the March meeting with a very high likelihood of at least two more hikes as the year progresses.  Mr Waller even suggested more than four total this year, although that is clearly a minority view, right now, on the FOMC.  The problem is that 25 basis point increments every 12 weeks is not going to make much of a dent in inflation running at 7.0%.  And, even if inflation falls back down to 4.0%, it will still take more than three years for the Fed to even reach a point where real yields are back to 0.0%.   Not only that, when Waller was asked about 0.50% increments, he dismissed the idea as being destabilizing for markets.  (Yet again we can read between the lines and recognize that preventing an equity market decline remains the Fed’s primary focus regardless of recent comments on inflation.)

But back to the real yield story.  It is important to understand that negative real yields are not a bug in their plans, they are the feature.  Negative real yields are the only way for the US (and every overly indebted nation) to reduce the value of their debt without a technical default.  The Fed knows this playbook from their actions in the wake of WWII, where they capped yields at 2.50% and inflation ran at 10.0%.  A few years later, the debt/GDP ratio had fallen from 125% to 35% and the country’s finances were back in order.  That process worked then because the US economy dominated the global economy and essentially everything was manufactured here.  Given the dramatic changes that have taken place in the ensuing 80 years, it is not clear that the citizenry in the US will be quite as patient this time, but that is almost certainly the Fed’s plan.

If we assume that real yields are set to remain negative for a long time into the future, what are the likely impacts going to be?  First and foremost, real assets like commodities and real estate should perform well and maintain their value if not appreciate.  Bonds, on the other hand, will have a tougher time, although there are many things which may help support them, not least of which would be a reversal of policy by central banks.  Equities are going to find themselves segregated into companies that have businesses and are profitable and those that have benefitted from the ongoing monetary largesse of the central banks and may find that funding their businesses will get more difficult.  In other words, credit is going to matter going forward in this environment.  Finally, the dollar’s behavior will be contingent on just how other nations approach the real yield question.  For those countries that follow sound money policies, and seek to end financial repression, their currencies should benefit.  However, all signs are pointing, at this time, to the fact the US will not be considering sound money policies as they are short-term politically unpalatable, and the dollar will underperform going forward.  I apologize for the dour message on a Friday, but the constant Fed blather becomes difficult to tune out after a while.

Ok, here’s what we have seen overnight.  Yesterday’s tech rout in the US took equity markets lower across the board and that was followed in Asia as well (Nikkei -1.3%, Hang Seng -0.2%, Shanghai -1.0%).  Europe, too, is in the red with fairly solid declines in the DAX (-0.6%) and CAC (-0.6%) although the FTSE 100 (-0.1%) is outperforming after November GDP data showed surprisingly strong growth in the UK across both manufacturing and services. Meanwhile, US futures are hovering either side of unchanged although NASDAQ futures have recently turned down a bit more aggressively.

An interesting feature of today’s price action is that not only are stocks being sold, but so are bonds, and everywhere.  Treasury yields are higher by 3.0bps, although that is simply unwinding yesterday’s rally where yields fell a similar amount.  European sovereigns are also selling off with yields higher across the board (Bunds +2.4bps, OATs +2.4bps, Gilts +2.8bps).  While the positive news from the UK seems a rationale for the Gilt market, German GDP actually fell in Q4 bringing their Y/Y number down to 2.7% and one would have thought that might support Bunds.

Where, you may ask, are investors hiding if they are selling both stocks and bonds?  Commodities are looking better this morning with oil (+0.7%) continuing its recent rally although NatGas (-2.6%) remains beholden to the winter weather.  A warmer day here in the Northeast is undermining the price.  Precious metals (Au +0.1%, Ag +0.2%) are both on the right side of unchanged and most industrial metals are doing well (Cu -0.7%, Zn +1.9%, Sn +2.3%).  Agricultural prices are also beholden to the weather so are seeing a mixed bag this morning.

Finally, the dollar is mixed this morning, with an equal set of gainers and losers in both the G10 and EMG blocs.  JPY (+0.3%) is the leader in the clubhouse as the very obvious risk-off sentiment is encouraging repatriation of funds while AUD (-0.3%) is the laggard, seemingly on the back of the hawkish Fed comments (or perhaps on the fact that Novak Djokovic will not be playing in the Australian Open after all!)  In the emerging markets RUB (-0.6%) is the worst performer on the back of fears of further sanctions as the Ukraine situation continues to escalate, while INR (-0.35%) has also suffered overnight, this more on the talk of Fed hawkishness.  However, after those two, decliners have moved very little, certainly not enough to make a case about anything in particular.  On the plus side, CLP (+0.5%) and ZAR (+0.4%) are the leaders.  The peso is following yesterday’s strength with more as traders anticipate more hawkishness from the central bank while the rand is trading on the back of some key technical levels having been breached and pointing to yet more strength short-term.

Data this morning brings Retail Sales (exp -0.1%, +0.1% ex autos) as well as IP (0.2%), Capacity Utilization (77.0%) and Michigan Sentiment (70.0).  Yesterday’s PPI data did nothing to dispel the idea that inflation is well entrenched in the US economy regardless of what Fed members say in testimony or commentary.

Using the dollar index (DXY) as a proxy, the dollar has fallen 1.5% since this time last week.  Heading into this year, dollar bullishness was rampant as expectations for much tighter Fed policy were seen as likely to push the dollar higher.  However, the early price action is beginning to dispel that notion.  I have a feeling that we are going to see investors sell dollar rallies at the same time they sell equity rallies.  This is a huge sentiment change from the previous “buy the dip” mentality that had been prevalent since Ben Bernanke first introduced QE all those years ago.  Caveat emptor is the new watchword, for both stocks and the dollar.

Good luck, good weekend and stay safe
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Policy, Tighter

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Apparently, seven percent
Defined for Chair Jay the extent
Of just how high prices
Can rise in this crisis
Ere hawkishness starts to foment

But is it too little too late?
As he’s not yet out of the gate
Toward, policy, tighter
Despite a speechwriter
That claims he won’t fail his mandate

There is no shame in being confused by the current market situation because, damn, it is really confusing!  On the one hand we see inflation not merely rising, but fairly streaking higher as yesterday’s 7.04% Y/Y CPI reading was the highest since June 1982.  With that as a backdrop, and harking back to our Economics 101 textbooks, arguably we would expect to see interest rates at much higher levels than we are currently experiencing.  After all, in its simplest form, real interest rates, which are what drive investment decisions, are simply the nominal interest rate less inflation. As of today, with effective Fed Funds at +0.08% and the 10-year Treasury at 1.75%, the calculated real interest rates are -6.96% in the front end and -5.29% in the 10-year, both of which are the lowest levels in the post WWII era.  The conclusion would be that investment should be climbing rapidly to take advantage.  Alas, most of the investment we have seen has been funneled into share repurchases rather than capacity expansion.

With this in mind, it makes sense that dollar priced assets are rising in value, so stocks and commodities would be expected to climb, as would the value of other currencies with respect to the dollar.  However, the confusion comes when looking at the bond market, where not only are real yields at historically depressed levels, but there is no indication that investors are selling bonds and seeking to exit the space.

Our economics textbook would have us believe that negative real yields of this magnitude are unsustainable with two possible pathways to adjustment.  The first pathway would be nominal yields climbing as investors would no longer be willing to hold paper with such a steep negative yield.  Back in the 1990’s, the term bond vigilantes was coined to describe how the bond market would not tolerate this type of activity and investors would sell bonds aggressively thus raising the cost of debt for the government.  So far, that has not been evident.  The second pathway is that the inflation would lead to significant demand destruction and ultimately a recession which would slow inflation and allow bondholders to get back to a positive real yield outcome.  Not only would that be hugely painful for the economy, it will take quite a while to complete.

The problem is, neither of those situations appear to be manifest.  The question of note is, is the bond market looking at the current situation and pricing in much slower growth ahead?  Certainly, the punditry is not looking for that type of outcome, but then, the punditry is often wrong.  Neither is the Fed looking for that type of outcome, at least not based on their latest economic projections which are looking for GDP growth of 3.6%-4.5% this year and 2.0%-2.5% next with nary a recession in sight in the long run.

This brings us back to the $64 trillion question, why aren’t bonds selling off more aggressively?  And the answer is…nobody really knows.  It is possible that investors are still willing to believe that this inflationary spike is temporary, and we will soon see CPI readings falling and the Fed declaring victory, so bond ownership remains logical.  It is also possible that given the fact that the BBB bill was pulled and seems unlikely to pass into legislation, that Treasury issuance this year will decline such that the fact the Fed will no longer be purchasing new debt will not upset the supply/demand balance and upward pressure on yields will remain absent.  At least from a supply perspective.  The problem with this idea is that pesky inflation reading, which, not only remains at extremely high levels, but is unlikely to decline very much at all going forward.

Ultimately, something seems amiss in the bond market which is disconcerting as bond investors are typically the segment that pays closest attention to the reality on the ground.  While the hawkish cries from Fed members are increasing in number and tone (just yesterday both Harker and Daly said they expected raising rates in March made sense and 4 rate hikes this year would be appropriate), that implies Fed Funds will be 1.0% at the end of the year, still far below inflation and not nearly sufficient to slow those rising prices.

It seems to me there are three possible outcomes here; 1) bond investors get wise and sell long-dated Treasuries steepening the yield curve significantly; 2) the Fed gets far more aggressive, raising rates more than 100 basis points this year and pushes to invert the yield curve and drive a recession; or 3) as option 1) starts to play out, and both stocks and bonds start to decline sharply, the Fed decides that YCC is the proper course of action and caps Treasury yields while letting inflation run much hotter.  My greatest fear is that 3) is the answer at which they will arrive.

With all that cheeriness to consider, let’s look at how markets are behaving today.  Despite a modest equity rally in the US yesterday, risk has been less in demand since.  Asia (Nikkei -1.0%, Shanghai -1.2%, Hang Seng +0.1%) was generally lower and Europe (DAX 0.0%, CAC -0.5%, FTSE 100 -0.1%) is also uninspiring.  There has been virtually no data in either time zone, so this price action is likely based on growing concerns over the inflationary outlook.  US futures at this hour are basically unchanged.

As to the bond market, no major market has seen a move of even 0.5 basis points today with inflation concerns seeming to balance risk mitigation for now.

Commodity markets are mixed with oil (-0.1%) edging lower albeit still at its highest levels since 2014, while NatGas (-4.5%) has fallen as temperatures in the NorthEast have reverted back to seasonal norms.  Gold (-0.1%) has held most of its recent gains while copper (-0.7%) seems to have found a short-term ceiling after a nice rally over the past few sessions.

Finally, turning to the dollar, it is somewhat softer vs. most of its G10 brethren with NZD (+0.35%) leading the way, followed by CHF (+0.3%) and CAD (+0.2%) as demand for any other currency than the dollar begins to show up.  In EMG currencies, excluding TRY (-2.5%) which remains in its own policy driven world, the picture is more mixed.  RUB (-0.75%) has fallen in the wake of the news from Geneva that there was no progress between Russia, the US and NATO regarding the escalating situation in the Ukraine with the threat of economic sanctions growing.  BRL (-0.55%) is also under some pressure although this looks more like profit taking after a nearly 3% rally in the past two sessions.  On the plus side, THB (+0.5%) and PHP (+0.3%) are leading the way as they respond to the broadly weaker dollar sentiment.

Data today brings Initial (exp 200K) and Continuing (1733K) Claims as well as PPI (9.8%, 8.0% ex food & energy), but the latter would have to be much higher than expected to increase the pressure on the inflation narrative at this point. From the Fed we hear from Governor Brainerd as she testifies in her vice-chair nomination hearing, as well as from Barkin and Evans.  Given the commentary we have been getting, I expect that the idea of 4 rate hikes this year is really going to be cemented.

The dollar has really underperformed lately and quite frankly, it feels like it is getting overdone for now.  While I had always looked for the dollar to eventually decline this year, I did expect strength in Q1 at least.  However, given positioning seemed to be overloaded dollar longs, and with the Treasury market not participating in terms of driving yields higher, it is beginning to feel like a modest correction higher in the dollar is viable, but that the downtrend has begun.

Good luck and stay safe
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No Delay

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Investors have not yet digested
The truth of what Jay has suggested
There’ll be no delay
QT’s on the way
(Unless the Dow Jones is molested)

Given the change in tone from the Fed and a number of other central banks, where suddenly hawkishness is in vogue, the fact that risky assets (read stocks) have only given back a small proportion of their year-long gains is actually quite remarkable.  The implication is that equity investors are completely comfortable with the transition to positive real interest rates and that valuations at current nosebleed levels are appropriate.  The problem with this thesis is that one of the key arguments made by equity bulls during the past two years has been that negative real interest rates are a crucial support to the market, and as long as they remain in place, then stocks should only go higher.

But consider how high the Fed will have to raise interest rates to get back to real ZIRP, let alone positive real rates.  If CPI remains at its current level of 6.8% (the December data is to be released on Wednesday and is expected to print at 7.0%), that implies twenty-seven 0.25% rate hikes going forward!  That’s more than four years of rate rises assuming they act at every meeting.  Ask yourself how the equity market will perform during a four-year rate hiking cycle.  My take is there would be at least a few hiccups along the way, and some probably pretty large.  Consider, too, that looking at the Fed funds futures curve, the implied Fed funds rate in January 2026 is a shade under 2.0%.  In other words, despite the fact that we saw some pretty sharp movement across the interest rate markets last week, with 10-year yields rising 25 basis points and 2-year yields rising 13 basis points, those moves would just be the beginning if there was truly belief that the Fed was going to address inflation.

Rather, the evidence at this stage indicates that the market does not believe the Fed’s tough talk, at least not that they will do “whatever it takes” to address rising inflation.  Instead, market pricing indicates that the Fed will try to show they mean business but have no appetite to allow the equity market to decline any substantial amount.  If (when) stocks do start to fall, the current belief is the Fed will come to the rescue and halt any tightening in its tracks.  As I have written previously, Powell and his committee are caught in a trap of their own design, and will need to make a decision to either allow inflation to keep running hot to try to prevent an equity meltdown, or take a real stand on inflation and let the (blue) chips fall where they may.  The similarities between Jay Powell and Paul Volcker, the last Fed chair willing to take the latter stand, stop at the fact neither man had an economics PhD.  But Jay Powell is no Paul Volcker, and it seems incredibly unlikely that he will have the fortitude to continue the inflation fight in the face of sharply declining asset markets.

What does this mean for markets going forward?  As we remain in the early stages (after all, the Fed is still executing QE purchases, albeit fewer than they had been doing previously) tough talk and modest policy changes are likely to continue for now.  Equity markets are likely to continue their performance from the year’s first week and continue to slide, and I would expect that bond markets will remain under pressure as well.  And with the Fed leading the way vis-à-vis the ECB and BOJ, I expect the dollar should continue to perform fairly well against those currencies.

However, there will come a point when investors begin to grow wary of the short- and medium-term outlooks for risk assets amid a rising rate environment.  This will be highlighted by the fact that inflation will remain well above the interest rate levels, and in order to contain the psychology of inflation, the Fed will need to continue its tough talk.  Already, when looking at the S&P 500, despite being just 3% below its all-time highs, more that 50% of its components are trading below their 50-day moving averages (i.e. are in a down-trend) which tells you just how crucial the FAANG stocks are.  And none of those mega cap stocks will benefit from higher interest rates.  In the end, there is significant room for equity (and all risk asset) declines if the Fed toes the tightening line.

Looking at markets this morning shows that no new decisions have been taken as both equity and bond markets are little changed since Friday.  Perhaps investors are awaiting Wednesday’s CPI data to determine the likely path going forward.  Or perhaps they are awaiting the comments from both Powell and Brainerd, both of whom will be facing the Senate this week for confirmation hearings for their new terms.  However, we do continue to hear hawkish comments with Richmond Fed President Barkin explaining that a March rate hike would suit him, and ex-Fed member Bill Dudley explaining that there is MUCH more work to be done raising rates.

So, after Friday’s late sell-off in the US, equities in Asia rebounded a bit (Hang Seng +1.1%, Shanghai +0.4%, Nikkei closed) although European bourses are all modestly in the red (DAX -0.3%, CAC -0.4%, FTSE 100 -0.1%). US futures are also turning red with NASDAQ futures (-0.35%) leading the way down.

Meanwhile, bond markets are mixed this morning with Treasury yields edging higher by just 0.4bps as I type, albeit remaining at its highest levels since before the pandemic, while we are seeing modest yield declines in Europe (Bunds -1.0bps, OATS -1.5bps, Gilts -0.3bps).  The biggest mover though are Italian BTPs (-5.3bps) as they retrace some of their past two-week underperformance.

On the commodity front, oil (-0.2%) has edged back down a few cents although remains much closer to recent highs than lows, while NatGas (+4.4%) has jumped on the back of much colder weather forecasts in the US Northeast and Midwest areas.  Gold (+0.3%) continues to trade either side of $1800/oz, although copper (-0.2%) is under a bit of pressure this morning.

As to the dollar, it is mixed today with SEK (-0.4%), CHF (-0.35%) and EUR (-0.3%) all under pressure while JPY (+0.25%) is showing its haven bona fides.  This definitely feels like a risk move as there was virtually no data or commentary out overnight.  In the EMG space, RUB (+0.9%) is the leading gainer as traders continue to look for further tightening by the central bank despite the fact that real rates there are actually back to positive already.  INR (+0.35%) and IDR (+0.35%) also gained with the rupee benefitting from equity market inflows while the rupiah responded to word that the government would soon lift the coal export ban.  On the downside, the CE4 are in the worst shape, but those are merely following the euro’s decline.

There is a decent amount of data coming up this week as follows:

Tuesday NFIB Small Biz Optimism 98.5
Wednesday CPI 0.4% (7.0% Y/Y)
-ex food & energy 0.5% (5.4% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 200K
Continuing Claims 1760K
PPI 0.4% (9.8% Y/Y)
-ex food & energy 0.5% (8.0% Y/Y)
Friday Retail Sales -0.1%
-ex autos 0.2%
IP 0.2%
Capacity Utilization 77.0%
Michigan Sentiment 70.0

Source: Bloomberg

In addition to the data, we hear from seven Fed speakers and have the nomination hearings for Powell (Tuesday) and Brainerd (Thursday), so plenty of opportunity for more hawk-talk.

For now, I continue to like the dollar for as long as the Fed maintains the hawkish vibe.  However, I also expect that if risk assets start to really underperform, that talk will soften in a hurry.

Good luck and stay safe
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A Wrong Turn

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In Europe, the reading today
For CPI led to dismay
With prices still rising
Lagarde’s now revising
The timing for QE’s decay

Then later this morning we’ll learn
If Jay has a cause for concern
Should payrolls be strong
It will not be long
Til stock markets take a “wrong” turn

There seem to be three stories of note today with varying impacts on market behavior, and in the end, they are all loosely tied together.  Starting in Europe, CPI printed at a higher than forecast 5.0% in December, rising to a historic high for the Eurozone as currently constituted.  While energy prices were the largest driver of the data, even excluding those, CPI rose 2.6%, well above the current ECB target.  Given the series of remarkable energy policy blunders that have been made by the Europeans, one has to believe that it will be many more months before energy inflation has any chance of abating.  And as long as the continent remains reliant on Russia for its natural gas supplies, it will almost certainly be held hostage across other issues.  Remember, too, the more money spent on energy, where those funds leave the continent as they don’t really produce much of their own, the less money available for things like manufacturing and consumption of other goods.

The problem for the ECB is that the specter of slowing growth conflicts with their alleged desire to reduce QE and allow policy to “normalize”.  As we see in virtually every nation, the tension between addressing inflation and stifling growth is the crux of central bank decision making.  Madame Lagarde finds herself between the proverbial rock and hard place here.  As things currently stand, I fear the Eurozone is going to find itself in a position dangerously close to stagflation as the year progresses.  Do not be surprised if there are some major electoral changes this year.  PS, none of this is actually very good for the single currency, so keep that in mind as well.  While it has seemed to have stabilized over the past two months, another leg lower feels like it is still on the cards.  What Will Christine Do? History shows that central banks almost always err on the side of higher inflation, so do not be surprised if that is the case here as well.

Turning to the States, it is payroll day with the following forecasts:

Nonfarm Payrolls 447K
Private Payrolls 405K
Manufacturing Payrolls 35K
Unemployment Rate 4.1%
Average Hourly Earnings 0.4% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.9%

Source: Bloomberg

With the market and investors still absorbing what seemed to be an even more hawkish set of FOMC Minutes than anticipated, where they extensively discussed QT, this has all the trademarks of a ‘good news is bad’ set-up, such that a strong print (>600K) will result in a bond and stock market sell-off as investors flee duration assets.  Remember, too, the ADP number printed at 807K, nearly double expectations and the highest since May21.  Since that release, forecasts have risen by about 50K and whispers even more.  The point is that if US data really starts to show significantly more strength, expectations are going to grow for more rate hikes this year as well as a quicker pace of allowing the balance sheet to shrink.  And that, my friends, will not be a good look for risky assets.

There once was a firm, Evergrande
In China, that bought tons of land
In order to build
Apartment blocks filled
With people, but now must disband

The problem for China is they
Explained, when this firm went astray
Twas under control
And they would cajole
Investors, their sales, to delay

Finally, before we move on to today’s markets, I would be remiss if I didn’t point out a change of tone from China overnight, one that was not officially announced but is true nonetheless.  You may remember back in September when we first heard about China Evergrande and the fact that the second largest property developer in that country, and the most indebted, was having trouble repaying its loans.  Initially there was talk by the doomsayers that this was China’s Lehman moment, and everything would unravel quickly.  Of course, that did not happen, although what we have seen since is a slower unraveling of that company and many others in the sector.  It turns out that when your business model is premised on borrowing excessive amounts of money to build apartment blocks in ghost cities, there could be problems down the line.

At any rate, the PBOC was adamant that everything was under control and that, anyway, China Evergrande’s borrowings weren’t that big compared to China’s GDP.  (That always sounded an awful lot like Bernanke’s comments regarding subprime mortgages.)  More recently, the PBOC imposed three ‘red lines’ regarding the ability of property developers to borrow money as they were really trying to squeeze the speculation out of the property market, but without causing the bubble to actually burst, simply deflate.  These rules, though, meant that Evergrande, and the other very weak companies in the space, suddenly had no source of funding.  Well, last night it was discovered that the PBOC has actually instructed banks to lend to property companies more aggressively.  Apparently the PBOC’s red lines have as much value as Qaddafi’s or Obama’s, in other words, none.  It can be no surprise that the PBOC has reversed course given the potential problems that exist in the Chinese property sector.  Just beware as things there remain opaque and in flux, although I doubt the renminbi is set to move dramatically soon.

Ok, quickly, after yesterday’s US equity fizzle, where markets slid slightly, Asia was mostly the same although the Hang Seng (+1.8%) did manage to rally sharply after it became clear Evergrande would get more funding.  Europe has done essentially nothing, despite a generally weak mix of data (German IP -0.2%, French IP -0.4%) as investors seem to be waiting for the payroll number to assess the Fed’s actions.  US futures are little changed at this hour as well.

We are seeing similar lack of activity in the bond market as here, too, investors await the payroll numbers.  Yesterday saw essentially no change in the 10-year Treasury yield although shorter maturity bonds did see yields rise a couple of ticks as the market continues to look for rate hikes sooner rather than later.  Europe is also biding its time to see what comes from NFP, with no major markets having moved even 1 basis point from yesterday’s levels.

Oil prices continue to rise (+0.75%) with WTI now above $80/bbl for the first time in two months.  But we are seeing strength throughout this space with NatGas (+1.4%) and Uranium (+3.5%) showing all energy is bid.  In fairness, the Uranium story is squarely on the back of the uprising in Kazakhastan where some 40% of global uranium is mined.)  On the metals front, both precious (Au +0.2%, Ag +0.2%) and base (Cu +0.3%, Al +0.5%, Zn +2.7%) are all in favor with only agricultural prices under pressure today.

As to the dollar, it is somewhat softer but not universally so.  SEK (+0.4%) and NOK (+0.3%) are the leading gainers in the G10 with oil helping the latter while the former continues to benefit from perceptions of still strong economic activity despite the latest wave of omicron.  However, other than these, movement is 0.1% or less in either direction, signifying absolutely nothing.  EMG currencies, though, have definitely seen more strength with ZAR (+0.7%), RUB (+0.7%) and CLP (+0.5%) all responding positively to the commodity rally.

And that is really it for the day.  My take on the NFP data is that good news (i.e. a strong print) will be a negative for risk assets as estimates will be that the Fed needs to move that much quicker to alleviate the inflation pressures.  That means a classic risk-off scenario of stronger dollar, stronger yen and weaker equities.  Bonds, however, are likely to see curve flattening more than higher rates, as the front end will be sold aggressively while the back lags appreciably.

Good luck, good weekend and stay safe
Adf

Somewhat Bizarre

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Apparently, no one expected
The Fed, when they last met, detected
Their actions thus far
Were somewhat bizarre
And so, a new stance was erected

Not only would they halt QE
But also, a shrinkage they see
In balance sheet sizing
So, it’s not surprising
The bond market filled bears with glee

“…it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated.”
“… participants judged that the appropriate timing of balance sheet runoff would likely be closer to that of policy rate liftoff than in the Committee’s previous experience.”
“Many participants judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode.”

These were the words from the FOMC Minutes of the December meeting that roiled markets yesterday afternoon.  Arguably there were more as well, but these give the gist of the issue.  Suddenly, the Fed sounds so much more serious about their willingness to not only taper QE quickly, and not only begin to raise the Fed Funds rate, but also to actually shrink their balance sheet.  If the Fed does follow through on this, and finishes QE by March, starts raising the Fed Funds rate and also begins to reduce the size of the balance sheet, then you can expect that the global risk appetite is going to be pretty significantly reduced.  In fact, I would contend it is the last of these steps that is going to undermine risk assets, as balance sheet reduction will likely result in higher long-term bond yields and less liquidity available to flow into risky assets.  As I have highlighted in the past, in 2018, the last time the Fed was both raising interest rates and shrinking the balance sheet, the resulting 20% equity market decline proved too much to withstand.  Are they made of sterner stuff this time?

One other thing to note was that while omicron was mentioned in the Minutes, it was clearly not seen as a major impediment to economic growth in the economy.   The fact that, at least in the US, there doesn’t appear to be any appetite/willingness for complete lockdowns implies that the nation is beginning to move beyond the pandemic fear to a more relaxed attitude on the issue.  Granted there are still several city and state governments that are unwilling to live and let live, but for the nation writ large, that does not seem to be the case.  From an economic perspective, this means less demand interruptions but also, likely, less supply interruptions.  The inflationary impact on this change in attitude remains uncertain, but the underlying inflationary trends remain quite strong, especially housing.  Do not be surprised to see CPI and PCE peak in Q1, but also do not be looking for a return to 2.0% levels anytime soon, that is just not in the cards.

And really, that was the driving force in yesterday’s market activity and is likely to be the key feature going forward for a while.  We will certainly need to pay close attention to Fed comments to try to gauge just how quickly these changes will be coming, and we will need to pay attention to the data to insure that nothing has changed in the collective view of a strong employment situation, but in the US, at least, this is the story.

The question now is how did other markets respond to the Minutes and what might we expect there?  Looking at equities, the picture was not pretty.  Following the release, US equity markets sold off sharply with the NASDAQ falling 3.3% on the day and both the Dow (-1.1%) and S&P500 (-1.9%) also suffering.  Activity in Asia was also broadly weaker with the Nikkei (-2.9%) and Australia’s ASX (-2.75%) both sharply lower although Chinese stocks were less impacted (Hang Seng +0.7%, Shanghai -0.25%).  The story there continues to revolve around the property sector and tech crackdowns, but recall, both of those markets had been massively underperforming prior to this Fed news.  As to Europe this morning, red is the color of the day (DAX -1.0%, CAC -1.2%, FTSE 100 -0.5%) as the data mix showed continued high inflation in Germany with every Lander having reported thus far printing above 5.1%.  As to US futures, they are not buying the bounce just yet in the NASDAQ (-0.5%), but the other two indices are faring a bit better, essentially unchanged on the day.

It can be no surprise that the bond market is under further pressure this morning as the Fed has clearly indicated they are biased to not only stop new purchases but allow old ones to mature and not be replaced.  (There is no indication they are considering actually selling bonds from the portfolio.  That would be truly groundbreaking!)  At any rate, after the Minutes, yields jumped an additional 3bps and have risen another 2.8bps this morning.  This takes the move in 10-year yields to 23 basis points since the beginning of the week/year.  Technically, we are pushing very significant resistance levels in yields as these were the highs from last March.  If we do break higher, there is some room to run.  As well, the rise in Treasury yields is driving markets worldwide with European sovereigns all selling off (Bunds +3.5bps, OATs +4.2bps, Gilts +5.5bps) and similar price action in Asia, where even JGB’s (+2.0bps) saw yields rise. Real yields have risen here, although as we have not seen an inflation print in the US since last month, that is subject to change soon.

On the commodity front, the picture is mixed today with oil (+1.2%) higher while NatGas (-1.2%) continues to slide on milder weather.  Uranium (+3.9%) has responded to the fact that Kazakhastan is the largest producer and given the growing unrest in the country, concerns have grown about its ability to deliver on contracts.  With yields higher, gold (-0.6%) and silver (-2.2%) are both softer as are copper (-1.4%) and aluminum (-0.5%).  Clearly there are growing concerns that higher interest rates are going to undermine economic growth.

Finally, in the FX markets, the broader risk-off tone is manifesting itself as a generally stronger dollar (AUD -0.7%, NZD -0.6%, NOK -0.35%) with only the yen (+0.25%) showing strength in the G10.  In the EMG bloc, the picture is a bit more mixed with laggards (THB -0.9%, CLP -0.7%, MYR -0.5%) and some gainers (ZAR +0.8%, RUB +0.7%, HUF +0.5%).  Rand is the confusing one here as the ruble is clearly benefitting from oil’s rise and the forint from bets on even more aggressive monetary policy.  However, I can find no clear rationale for the rand’s strength though I will keep looking.  On the downside, THB is suffering from an increase in the lockdown levels while MYR appears to be entirely dollar driven (higher US rates driving dollar demand) while the peso seems to be suffering from concerns over fiscal changes regarding the pension system.

On the data front, this morning brings Initial Claims (exp 195K), Continuing Claims (1680K) and the Trade Balance (-$81.0B) at 8:30 then ISM Services (67.0) and Factory Orders (1.5%, 1.1% ex transport) at 10:00.  But tomorrow’s payroll report is likely to have far more impact.  And the Fed calendar starts to fill out again with Daly and Bullard both on the slate for today and seven more speakers over the next week plus the Brainerd vice-chair hearings.

I’m a bit surprised the dollar isn’t stronger in the wake of the new Fed attitude, but perhaps that is a testimony to the fact there are many who still don’t believe they will follow through.  However, for now, I expect the dollar will continue to benefit from this thesis, albeit more gradually than previously believed, but if we do see risk appetite diminish sharply, look for a little less tightening enthusiasm from Mr Powell and friends, and that will change sentiment again.

Good luck and stay safe
Adf

A Visit from Chair Jay

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With Apologies to Clement Clarke Moore

Tis the first day of trading in Aught Twenty-Two
And everyone’s asking just what will come true
Will Jay and his brethren, the taper, complete?
Or when stocks start falling, will they beat retreat?
Will Omicron’s spread lead to waves of despair?
Or will people choose to live life and not care?
And what of stock markets, will their recent rise
Have legs? Or will problems lead to their demise?
To these and more questions I’ll try to respond
With forecasts for currencies, stocks and the bond

To start, let’s consider, with brush strokes quite broad
How policymakers’ decisions are flawed
Consider inflation and how it is tracked
To most it is real but to Jay, just abstract
This led to the idea of average inflation
A policy blunder condemned to damnation
So, late to the party, the Fed shall arrive
Thus, CPI next year will still be ‘bove Five

While interest rates then ought most certainly rise
Jay can’t let that happen, and so we surmise
Despite all the talk of the taper to come
By Christmas this year they’ll have grown QE’s sum
And so, ten-year yields, when this year’s finally done
Will print on your screen at percentage of One

And what about stocks after last year’s huge gains
Are more in the future?  Or will we feel pains?
Alas, what I fear is though real rates will sink
So too, GDP, will not grow, though not shrink
Instead, when the history’s written next year
A stagnant economy will bring no cheer
Thus, stocks will deflate, though I don’t think crash land
But don’t be surprised if we fall ‘neath Four Grand

Let’s turn now to things you can see and can feel
Commodities, which unlike stocks, are quite real
For oil the first thing to note is the lack
Of funding, which has caused a drilling cutback
The thing is demand has not fallen in sync
Thus, causing the policymakers to blink
And rather than forcing the drillers to freeze
Instead, are now begging, drill more pretty please
But in the meantime, ere those new wells are sunk
One Hundred per barrel is near a slam-dunk

The barbarous relic we also must view
As many believe it contains value, true
Though there’s now a camp that claims it’s been replaced
By Bitcoin and Ether and feel gold’s a waste
But whether a hodler or gold bug are you
Their trends will diverge throughout Aught Twenty-Two
In gold’s case there will be strong growth in demand
And at year’s end it will have flown ‘bove Two Grand
But Bitcoin has shown with stonks it’s correlated
As they fall, so too, will Bitcoin be deflated
Come Christmas next do not be very surprised
If Bitcoin, to $30K, has been revised

And finally, let ‘s turn to foreign exchange
Where this year I think we shall see quite a range
At first while belief remains Jay is a hawk
More strength in the dollar is likely a lock
But as things progress and the ‘conomy slows
Then Jay will be forced to adjust the Fed’s prose
From hawkish to dovish is what we will get
And H2 next year will, the dollar, beset

The euro, at first, will, new lows, likely test
But when it comes clear that QT’s not progressed
As well as the fact that Lagarde’s ECB
Has quietly lessened their rampant QE
Investors will find that when euros are sought
At year’s end, One-Thirty is where they’ll be bought

A similar story in England abounds
Where tightening money will strengthen their pounds
The Old Lady, sited on Threadneedle Street
Will not, on inflation, decide to retreat
Instead, rates will rise there four times through this year
And Sterling, One-Sixty, on screens will appear

From here let’s head east to the nation whose Wall
Was built in an effort, the Huns, to forestall
In modern times, though, their economy’s grown
With output that spans T-shirts to the iPhone
With exports remaining the key to success
A weaker renminbi will help reduce stress
The thing is the goal of the President, Xi
Is not really growth but a strong currency
The upshot is when this year comes to an end
Five-Ninety renminbi we’ll all comprehend

A bit further east lies a nation of isles
Which taught us that Zen leads to healthy lifestyles
This nation, despite lacking metals or oil
Grew rich on the sheer dint of well-designed toil
Its yen has developed a clear reputation
For safety since the GFC dislocation
So, this year when growth disappoints round the earth
One Hundred and Five yen the buck will be worth

Our eastward excursion is not yet complete
As Canada’s Loonie moves to the front seat
Up north they have already started the shift
From policy ease to a much tighter drift
Responding to prices that have been on fire
And trying to stop them from going still higher
Thus, don’t be surprised when the CAD follows rates
And reaches One-Ten come the year’s final dates

And lastly let’s make a right turn and head toward
The nation where all that tequila is poured
Already, Banxico is fighting the fight
To hold back inflation with all of its might
The problem for them is inflation’s a bear
And so hard to halt when it’s rampant elsewhere
So, this year despite all the central bank’s drive
To Twenty-Two look for the peso to dive.

Now let’s turn to something of greater import
How much I appreciate all your support
As we begin yet one more year in this game
There’s one thing I must very clearly exclaim
May Twenty-Two be a year of, tidings, glad
With happiness, health and no cause to be sad

Have a very happy and healthy Twenty Twenty-Two!

Walking the Walk

Posted on by 
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

Somewhat Concerned

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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
Adf

A Mishap

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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
FX RRR
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
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