Tag Archives: #riskon

Not the Plan

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It turns out the internet can
Stop working, though that’s not the plan
Thus, to be succinct
The people who linked
Their lives to it found nothing ran

Under the heading, ‘It’s amusing today but could be much worse’, it seems there is a downside to all the conveniences we were promised if we just linked all the mundane features of life to the internet so the IoT could work its magic.  When the IoT stops working, so do all those mundane features, like door locks using Ring, and Roomba® vacuums and smart refrigerators and washing machines.  And so, yesterday, when Amazon Web Services crashed for upwards of 9 hours along the East Coast, many people and businesses learned just how reliant they were on a single private company (albeit a big one) for maintaining the status quo of their lives.  Do not be surprised if the question arises as to whether the ‘cloud’ has become too important for the private sector to manage by itself and needs to be regulated as a utility going forward.

With omicron somewhat less feared
The bulls feel the way has been cleared
To add to positions
Which led to conditions
Where price rises were engineered

Markets, however, were completely unconcerned with any hiccups regarding the cloud and bulled ahead with spectacular gains yesterday as the NASDAQ led the way rising more than 3.0%.  While this author’s view is risk appetite is more closely correlated to views on / concerns over the tapering of QE and tighter Fed policy, the narrative has been very focused on omicron and the news that it seems to be more widespread but far less virulent and therefore will have a lesser impact on the recovering economy.  At least, that’s what the punditry is saying this morning as an explanation for yesterday’s massive risk-on rally.

And perhaps, that is an accurate viewpoint.  Perhaps last week’s selloff was entirely due to the uncertainty over just how impactful omicron would be on the global economy.  The problem is that doesn’t pass the smell test.  Consider that if omicron was really going to result in another wave of economic closures, the central bank response would likely be adding still more liquidity to the global system, much of which would find its way into equities.  In contrast, tighter monetary policy that reduces overall liquidity would have the opposite effect.  As such, it seems to me that sharp declines are more likely on fear of less liquidity than fear of the latest virus variant.  So, while markets are still pricing rate hikes for next year, they have clearly come to grips with the current expected pace of those hikes.  Now, if inflation continues to rip higher, and we see the latest CPI print on Friday, the sanguinity over the pace of rate hikes could well disappear.  Remember that there are many ‘fingers of instability’ weaving throughout the market construct, among them massive leverage and extremely high equity valuations.  Risk is a funny thing, it often isn’t a concern until, suddenly, it is the only concern.  Risk asset markets, while continuing to ascend, are also doing so on less and less breadth.  Again, I would contend that hedging remains a critical activity for the corporate set.

Looking around markets today, yesterday’s euphoria, while evident in Asia overnight, has not made its way to Europe.  Japan’s Nikkei (+1.4%) led the way in Asia despite GDP data printing at a much lower than expected -3.6% in Q3.  It seems to me any idea that the BOJ will consider reducing its support for the economy is misplaced.  If anything, I would anticipate increased support as the nation tries to dig itself out of its latest economic hole.  As to the rest of Asia, the Hang Seng (+0.1%) lagged as its tech sector continues to be undermined by Xi’s ongoing crackdown on Chinese tech behemoths, but Shanghai (+1.1%) with far less tech exposure, did fine.

Europe, on the other hand, is under a bit of pressure this morning with the DAX (-0.6%) leading things lower followed by the CAC (-0.3%) while the FTSE 100 is little changed on the day.  The big news in Germany is that Angela Merkel is officially out as Chancellor and Olaf Scholz was sworn in as the new leader of the nation.  I don’t envy his situation as energy prices are rising sharply and Germany is entirely reliant on Russia and Vladimir Putin for the natural gas necessary to stay warm this winter, while their export-led economy is so tightly tied to China’s performance, that the ongoing slowdown there will soften growth prospects.  But then again, as a Social Democrat, maybe that is exactly the position Scholz relishes.

Finally, US markets remain in euphoria mode with futures all pointing higher by another 0.4% at this hour with the S&P 500 less than 1% from its all-time high.

The bond market, this morning, is showing no clarity whatsoever.  Treasury yields, after backing up 5bps yesterday, are actually lower by 0.8bps despite the positive look from equities.  Bunds and OATs are little changed while Gilts (-1.4bps) are showing the most strength.  Perhaps of more interest are the PIGS, where yields are rising sharply (Italy +3.2bps, Greece +4.9bps) after comments from Latvian ECB member, Martin Kazaks, that there was little reason to continue with additional QE once PEPP expires in March.  I suspect the Greeks and Italians would have a different opinion!

Last week, commodity prices were under huge pressure, led by oil, which cratered in the wake of the Thanksgiving holiday.  This morning, WTI (+0.75%) and Brent (+1.0%) are continuing their strong rebound with both grades more than 12% off their recent lows.  NatGas (+3.9%), too, is rebounding but has much further to go to reach the peaks seen in October.  Metals market, on the other hand, are having a less interesting day with gold (+0.1%) and copper (+0.1%) just edging up a bit.

Turning to the dollar, it is broadly, but not universally weaker this morning with NOK (+0.6%) leading the way on the back of oil’s rebound, although the rest of the G10 gainers are far less impressive (AUD +0.2%, CAD +0.1%).  There are some laggards as well with GBP (-0.35%) falling after news that PM Johnson is about to impose new travel restrictions in the country.  Now, if the UK combines tightening monetary policy, at which the BOE has hinted, with omicron inspired restrictions, that is clearly a recipe for slowing growth, and a weaker pound and FTSE.  In fact, the pound has fallen to its lowest level in almost exactly 12 months this morning.  In the EMG space, only TRY (-1.3%) is really falling and that story is consistent.  On the plus side, though is THB (+0.6%), RUB (+0.4%) and ZAR and MXN (both +0.35%) as the commodity sector continues to perform well while Thailand powered ahead on reduced omicron fears.  So, the UK is reacting one way while the Thai government is going in the opposite direction!

On the data front, yesterday’s productivity and labor cost data were even more awful than forecast and Consumer Credit rose far less than anticipated and barely 56% as quickly as September.  This morning brings only the JOLTs report (exp 10469K) which means that with the lack of Fed speakers, the FX market will look elsewhere for drivers. As long as risk remains in vogue, I expect the dollar to remain under some pressure, but if the European equity impulse comes here, look for the dollar to recoup its losses before the day is over.

Good luck and stay safe
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No Longer Taboo

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The omicron variant seems
No longer to haunt people’s dreams
Thus, stocks are advancing
And markets financing
The craziest, wildest schemes

So, risk is no longer taboo
As narrative changes ensue
Chair Powell’s regained
Control, and contained
The fallout from his last miscue

Risk appetite is remarkably resilient these days as evidenced not only by yesterday’s US equity rally, but by the follow-on price action in Asia last night as well as Europe this morning.  In fact, it seems the rare market that has not rallied at least 2% this morning.  Naturally, this raises the question as to what is driving this sudden return to bullishness?  Is it a widening view that the omicron variant is not going to result in more draconian government lockdowns?  Well, based on the news that NYC has imposed new restrictions on people, requiring vaccinations for everyone aged 5 and older to enter any public building, that may not be the case.  Perhaps the news that Austria has established fines of €600 for the first time someone is found not to be vaccinated with an increasing scale and jail time in that person’s future if they do not correct the situation, is what is easing concern.

At this point, arguably, it is too early to truly understand the nature of the omicron variant and its level of virulence, although it is clearly highly transmissible.  Early indications are that it is not as deadly but also that none of the currently approved vaccines does much with respect to preventing either infection or transmission of this variant.  However, global equity investors have clearly spoken and decided that any potential issues are either likely to be extremely short-term or extremely mild.

Perhaps this renewed risk appetite has been whetted by the idea that the Fed’s tapering will be a net positive for the market.  On the surface, of course, that doesn’t seem to accord with the idea that it has been the Fed’s (and ECB’s) largesse of adding constant liquidity to the system that has been the major support for the equity rally.  I’m sure you all have seen the graph that shows the growth in the Fed’s balance sheet overlain on the price action in the S&P 500, where the two lines are essentially the same.  So, if more central bank liquidity has been the key driver of higher stock prices, how can reduced liquidity and threats(?) or indications of higher interest rates coming sooner help support stocks.  That seems to run contra to both that thesis as well as the idea that inflation is good for stocks, with the second idea suffering from the concept that tighter monetary policy is designed to fight inflation.

But maybe, that is the key.  For the cognitive dissonant equity bull, loose policy and high inflation are good for equity markets because loose policy will keep the economy growing faster than inflation can reduce real returns.  On the other hand, tighter policy will fight inflation thus allowing lower nominal returns to remain competitive on a real basis.  Or something like that.  Frankly, it has become extremely difficult to understand the ever-changing rationales of equity bulls.  But that doesn’t mean they haven’t been right for a long time now, despite changes in underlying macroeconomic trends.

From its peak on November 22, to its bottom Friday, the S&P 500 fell about 5.25%, not even a correction, as defined in the current vernacular.  That requires a 10% pullback.  So, for all intents and purposes, this bull market has done nothing more than pause for a few days and is apparently trying to regain all its lost ground as quickly as possible.  Remember this, though, trees do not grow to the sky, nor do markets rally forever.  There continue to be numerous red flags as to the performance of equities; notably potentially tighter monetary policy, extremely high valuations, narrowing breadth of index performance and questions over future earnings growth amongst others.  And any of these, as well as the many potential issues that are not even currently considered, can be a catalyst for a more significant risk-off event.  In fact, the situation in the Treasury market, the curve is flattening quite rapidly, seems to be one clear warning that the future may not be as rosy as currently priced by the stock market.  Do not take for granted that risk appetite will remain this robust indefinitely and plan accordingly.

But today that is not a concern!  Risk is ON and in a big way.  After yesterday’s US rally, we saw all green in Asia (Nikkei +1.9%, Hang Seng +2.7%, Shanghai +0.2%) and Europe (DAX +2.1%, CAC +2.2%, FTSE 100 +1.2%) with US futures all higher between 1.0% (DOW) and 1.8% (NASDAQ).  In other words, all is right with the world!  Interestingly, one of the stories making the rounds today is about yesterday’s Chinese reduction in the RRR, but that was literally yesterday’s news, well known throughout the entire session.  I feel like there is something else driving things.

As to the bond market, while prices have fallen slightly, the movement is a lot less than would be expected given the strength of the equity rally.  Treasury yields are higher by just 0.2bps while Bunds (+1.5bps), OATs (+0.9bps) and Gilts (+2.4bps) are all responding a little more in line with what would normally be expected.  Data from Europe was slightly better than forecast with German IP (2.8%) and ZEW Expectations (29.9) both showing the economy there holding up better despite the ongoing lockdowns.  Asian bonds also saw yields climb a bit making the process nearly universal.

Commodity prices are following the risk narrative with oil (+2.8%) rallying sharply for the second consecutive day and now trading nearly 15% off the lows seen Thursday!  NatGas (+2.2%) is rebounding but still well below its highs seen in early October, while metals prices are all higher as well led by Cu (+0.7%) and Al (+1.2%) although both gold (+0.25%) and silver (+0.3%) are a bit firmer as well.

It will come as no surprise that the dollar is somewhat softer this morning given the environment as we see AUD (+0.7%), CAD (+0.5%) and NOK (+0.4%) all benefit from firmer commodity prices while the euro (-0.25%) is actually the laggard on the day, despite the rally in equities there.  Perhaps the single currency is gaining some haven characteristics.  In the emerging markets, TRY (+0.7%) is the leading gainer followed by THB (+0.6%) and BRL (+0.5%).  One can simply recognize the extreme volatility in the lira given the ongoing policy missteps, so a periodic rally should be no surprise.  As to the baht, it seems buyers are looking for China’s RRR cut to support the Chinese economy and by extension the Thai economy as well.  Brazil is a more straightforward commodity story I believe.  On the downside, CZK (-0.4%) and HUF (-0.3%) are the laggards as traders express mild concern that the central banks there may not keep up with rising inflation when they meet this week and next.

On the US data front, Nonfarm Productivity (exp -4.9%) and Unit Labor Costs (+8.3%) lead along with the Trade Balance (-$66.8B) at 8:30.  One cannot help but look at the productivity and labor cost data and wonder how equity markets can continue to rally.  Those seem to point to the worst of all worlds.  As to the Fed, they are in their quiet period ahead of next Wednesday’s meeting, so nothing to report there.

While I may not agree with its underpinnings, risk is clearly in vogue this morning and I don’t see any reason for that to change today.  In general, I would look for the dollar to continue to soften slightly, but also see limited scope for a large move.  All eyes have turned to the Fed next week and will be anxiously awaiting Chair Powell’s explanations for whatever moves they make.

Good luck and stay safe
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Slower than Planned

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There once was a firm, Evergrande
Whose ethos was just to expand
But its wanderlust
Led it to go bust
When China grew slower than planned

The aftermath now seems to be
Impacting the PBOC
They cut RRR
And could well do more
Inverse to Fed ending QE

As we begin a new week, and arguably the second to last where market liquidity will be close to its ordinary levels, the news of the day centers on the PBOC reducing its Reserve Ratio Requirement (RRR), as foreshadowed by Premier Li Keqiang last week.  While the official comments are focused on the government’s efforts to insure stable growth amid concerns over the omicron variant’s spread, it appears the reality may reach a little deeper.  Of more importance to market participants than the virus is the status of China Evergrande and the entire property sector in China.  It now appears that there is going to be an total restructuring of that company’s debt as it defaults on its remaining obligations.  Recall, Evergrande is was the largest property developer in China, and the most highly leveraged having total debts in excess of $300 billion as it expanded its business from purely property development to interests as far flung as theme parks, a soccer club and electric vehicles.  As of last night, it has notified creditors that a restructuring is on its way and that clearly has the PBOC a little concerned.

Property is the largest sector of the Chinese economy, representing more than 30%, and a key revenue source for most provinces and cities as they sell land to fund operations.  Evergrande was one of the largest purchasers, and so its slow-motion demise is being felt throughout the nation.  It is for this reason that the PBOC finds itself in a situation where it feels the need to add more liquidity to the economy, hence the RRR cut.  Interestingly, the problems here have not stopped the Chinese government’s crackdown on its tech sector, at least on the personal tech sector, as Didi Chuxing is being forced to delist from the NYSE and looks to reestablish its shares in Hong Kong.

From a vantage point some 7000 miles away, it appears that President Xi Jinping is moving quite rapidly in his efforts to completely control all aspects of the Chinese economy.  Do not be surprised to see every Chinese company listed outside Shanghai or Hong Kong to wind up moving that listing, nor to see further declines in those equity markets.  Capitalism with Chinese characteristics turns out to be socialism/communism after all, at least from the definitional perspective of the state controlling the means of production.  Whether this results in faster growth, or whether the rest of the world will even be able to determine that remains to be seen.  However, classical economics would suggest that the more internalization and the stricter the business regulations, the slower will be future growth.

Why, you may ask, is this important?  Well, first off it is reasonable to expect that ongoing liquidity injections in the Chinese economy are likely to eventually weaken the renminbi.  Second, if the growth trajectory of the Chinese economy is flattening, one of the few things the Chinese will be able to do to address that is weaken the currency to make its exporters more competitive.  The point is, while recent PBOC policy has been to maintain a strong and stable currency, and we have seen the renminbi appreciate more than 11% since it bottomed post-pandemic, the case for that trend to end and a weakening trend to develop appears to be growing.  For asset and receivables hedgers, careful consideration must be given to managing that risk.

With that in mind, let us turn to this morning’s activity.  Friday’s NFP report was mixed, with a weaker than expected headline number for jobs growth, but a much better than expected outcome in the Unemployment Rate as it appears more and more people are leaving large organizations and striking out on their own.  The upshot is labor market tightness is still with us and unlikely to ease in the short run.  Investors decided that was an equity market negative as it would encourage the Fed to taper policy even more quickly hence Friday’s equity sell-off.  At the same time, concerns over tighter policy slowing growth seem to have bond traders flattening the curve rapidly as they fear a Fed policy mistake of raising rates into slowing growth.  In other words, it’s all a mess!

Ok, overnight saw weakness in Asia (Nikkei -0.4%, Hang Seng -1.8%, Shanghai -0.5%) following the US Friday narrative, while Europe has decided things are far better this morning with rallies across the board (DAX +0.3%, CAC +0.7%, FTSE 100 +0.9%).  On a relative basis these moves make sense given the terrible Factory Orders data from Germany (-6.9% in October) while UK Construction PMI surprisingly rose to 55.5.  Meanwhile, US futures are a bit schizophrenic this morning with the DOW (+0.6%) looking to rebound from Friday while the NASDAQ (-0.4%) seems set to continue to slide.

The bond market, which rallied sharply Friday (Treasury yields falling 10bps) is giving back some of those price gains with the 10-year yield higher by 5.2bps this morning.  European yields are also a higher, but by much less (Bunds +0.9bps, OATs +0.7bps, Gilts +1.2bps), which are also consolidative moves, just not quite as dramatic.

On the commodity front, oil continues to whipsaw with a sharp rebound today (+3.25%) although NatGas (-7.9%) is getting crushed on a combination of forecasts for warmer weather in the Northeast as well as lower LNG prices in Europe.  In the metals markets, gold (-0.2%) continues to trade just below $1800/oz, neither rallying alongside inflation nor collapsing.  Copper (+0.8%) seems to be following oil, but aluminum (-0.85%) and tin (-1.9%) both seem to be in a more fearful mode.

Turning to the FX markets, mixed is the best description as we have both substantial gainers and losers vs. the dollar.  In the G10, AUD (+0.5%), SEK (+0.5%) and NOK (+0.5%) are leading the way higher on the back of the better commodity sentiment.  Meanwhile, CHF (-0.5%) and JPY (-0.3%) are both under pressure on the same story plus the European risk appetite.  In the EMG bloc, ZAR (+0.7%) leads the way with CLP (+0.3%) next as the commodity story seems to be driving thing here too.  On the downside, TRY (-0.45%) continues its volatile trading while the other laggards are from both APAC and EEMEA but have not seen significant declines.

On the data front, it is inflation week with CPI on Friday the biggest number to watch.  Leading up to that is the following:

Tuesday Q3 Nonfarm Productivity -4.9%
Q3 Unit Labor Costs 8.3%
Trade Balance -$66.9B
Wednesday JOLTS Job Openings 10500K
Thursday Initial Claims 225K
Continuing Claims 1910K
Friday CPI 0.7% (6.7% Y/Y)
-ex food & energy 0.5% (4.9% Y/Y)
Michigan Sentiment 68.0

Source: Bloomberg

In addition to this data, we hear from the Bank of Canada on Wednesday, where expectations are for no rate movement although they have been amongst the most hawkish of the G10 central banks of late.  As to CPI, while it is not the Fed’s preferred gauge, Chairman Powell clearly feels the pressure and so next week we can expect to see just how much faster they are going to reduce QE purchases…at least for now.

There are so many cross-currents driving markets right now, it is very difficult to find a specific underlying theme in the short-term.  Longer term, nothing has changed my view that the Fed will halt their tapering/tightening script as soon as equity markets begin to decline a little more substantially.  At that point, I feel like the dollar may come under pressure, although during the decline, it should probably rally further.  Payables hedgers should be taking advantage of this relatively strong dollar as I don’t think it will last that long.

Good luck and stay safe
Adf

Transitory is Dead

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Said Jay, transitory is dead
And now when we’re looking ahead
To our consternation
It seems that inflation
Has climbed up to levels we dread

The market heard this and was stunned
Thus, equities quickly were shunned
The dollar was bought
And everyone thought
They’re better off buying the Bund

Finally!  It only took Chairman Powell 9 months to accept the reality on the ground that inflation is not likely to disappear anytime soon.  He officially ‘retired’ the word transitory as a description and confessed that inflation has been more persistent than he and the Fed had forecast.  The question that was not addressed is why the Fed thought that the supply chain bottlenecks were going to be short-lived to begin with.  After all, the primary use of ultra-cheap funding by the corporate community has been capital structure rebalancing (i.e. share repurchases) as that was the most efficient way to improve company valuations.  At least their stock market valuations.  Thus, there was never any evidence that investment was flowing toward areas that were bottle(necke)d up.

Ironically, this was partly Powell’s fault as his continued confidence that inflation was transitory, and bottlenecks would ease discouraged any company from making the investments to ease those very same bottlenecks.  Consider this, why would a company spend money to increase capacity if the benefits to be gained would be so short-lived?  And so, investments were not made, capacity remained the same and the bottlenecks persisted.

But now the Fed has acknowledged that inflation is a problem and Mr Powell has indicated that the pace of tapering QE ought to be increased.  The market read this as a doubling of the pace and so QE is now set to end in March, at least according to the punditry.  We will find out more precisely come the FOMC meeting in two weeks’ time.

Ultimately, the problem for Powell and the Fed is that a more aggressive timeline to tighten policy could potentially have a fairly negative impact on both stock and bond markets.  If that is the case, and there is no reason to believe it won’t be, Mr Powell may find himself in a similar situation as Q4 2018, when comments regarding the fact that the Fed was “nowhere near neutral” interest rates, which implied further tightening, resulted in a 20% decline in the S&P 500 Index and led to the infamous Powell Pivot on Boxing Day, when the Fed stopped tightening and began to ease policy.  Can Powell withstand a 20% decline in the S&P 500 today?  I doubt it.  10%?  Even that will be tough.  In essence, Powell now finds himself caught between President Biden’s growing concerns over inflation and the market’s likely concerns over tighter policy.  If nothing else, we should finally learn the Fed’s true master as this plays out.

So, with that in mind, let’s take a look at how markets have responded overnight.  While yesterday saw an immediate rejection of risk assets, the first bargain hunters have returned and equity markets were largely in the green overnight and on into this morning.  The Nikkei (+0.4%), Hang Seng (+0.8%) and Shanghai (+0.35%) all managed to rally amid mixed data (Japan’s PMI rising to 54.5, China’s Caixin PMI falling to 49.9) and despite ongoing concerns the omicron variant would lead to further lockdowns.

European bourses (DAX +1.4%. CAC +1.3%, FTSE 100 +1.3%) are all much firmer after the PMI data there was generally better than expected.  This is despite the fact that the OECD released its latest forecasts, slightly downgrading global growth for 2021 although maintaining its 2022 global growth forecast of 4.5%.  Pointed comments about the risks of the omicron variant accompanied the release as all the work was done before that variant became known.  Perhaps investors are looking at omicron and assuming it will delay tightening further, thus support equity values.  Finally, US futures are all pointing sharply higher this morning, at least 1.0% with NASDAQ futures +1.5% at this hour.

It should be no surprise, given risk is back in vogue, that bonds are selling off again.  The one thing that has been evident is that volatility in markets has increased and shows no signs of abating until there is a more coherent story and clarity on ultimate central bank policy.  This morning, Treasury yields (+3.6bps) have jumped as have Bunds (+2.7bps), OATs (+3.1bps) and Gilts (+5.6bps).  Perhaps more surprising is that Italian BTPs (+6.5bps) have been the worst performer on the continent as during a risk-on session, these bonds tend to outperform.  Asian bond markets performed in a similar manner as yields rallied everywhere there.

Commodity prices are at least making sense today as we are seeing strength virtually across the board.  Oil (+4.5%) is leading the energy space higher, although NatGas (-3.4%) remains disconnected and is the sole outlier.  Metals are firmer as both precious (Au +0.7%, Ag +0.2%) and industrial (Cu +0.45%, Al +0.7%, Sn +0.3%) see buying interest and agricultural prices are firmer as well.

The dollar, though, has less direction today with the G10 seeing commodity currencies stronger (NZD +0.35%, AUD +0.3%, CAD +0.25%) while financials are under modest pressure (CHF -0.2%, JPY -0.15%, EUR -0.15%).  Now, in fairness, none of these moves are that large and most likely they represent position adjustment more than anything else.  In the emerging markets, TRY (+1.8%) remains the most volatile, rising sharply (more than 8.5% at its peak) after the central bank announced they were intervening due to “unhealthy price formations” in the market.  It seems those price formations have been the result of President Erdogan continuing his campaign to lower interest rates in the face of soaring inflation.  But there were other gainers of note including MXN (+0.9%) backed by oil’s rebound, KRW (+0.8%) on the strength of stronger than forecast output data and CLP (+0.7%) on the rise in copper prices.

Data this morning brings ADP Employment (exp 525K), ISM Manufacturing (61.2) and Prices Paid (85.5) and at 2:00 this afternoon, the Fed releases the Beige Book.  Chairman Powell and Secretary Yellen testify to the House Financial Services Committee starting at 10:00, and remember, that was when the fireworks started yesterday.  I doubt we will see the same type of movement but be alert.

The dollar story has lost its conviction as previously, the thought of a more aggressive Fed would have led to a much firmer dollar.  However, we are not witnessing that type of price action here.  While I still believe that will impact the currency’s near-term movement, right now it appears that many currencies are trading on their own idiosyncratic issues without the benefit of the big picture.  If the Fed does taper more quickly and begin to raise rates, I do expect the dollar will benefit and we can see 1.10 or lower in the euro as there is absolutely no indication the ECB is going to follow suit.  However, I suspect that equity market pain will become too much for the Fed to tolerate, and that any dollar strength will be somewhat short-lived.  Payables hedgers should take advantage over the next few weeks/months, but if you are a receivables hedger, I think patience may be a virtue here.

Good luck and stay safe
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Future Pratfalls

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In Germany, and too, in Spain
The people are feeling the pain
Of prices exploding
And therefore corroding
Their standards of living again

Meanwhile from the ECB’s halls
The comments from those know-it-alls
Show lack of concern
As each of them spurn
The idea of future pratfalls

In trading, ‘the trend is your friend’ is a very common sentiment and an idea backed with strong evidence.  One can think of this as analogous to Newton’s first law, i.e. a body in motion stays in motion.  So, when the price action in some market has been heading in one direction over time, it tends to continue in that direction.  This is the genesis of the moving average as a trading tool as the moving average is what defines the trend.  I highlight this because the concept is not restricted to trading but is also evident in many other price series, notably inflation.  When one looks at the history of inflation, it tends to trend in one direction for quite some time with major reversals relatively infrequent.  That is not to say a reversal cannot occur, but if one does, it tends to be the result of a long period of adjustment, not a quick flip of direction.

And yet, when listening to both Fed and ECB speakers lately, they would have you believe that the currently entrenched trend higher for prices is the aberration and that in a matter of months they will be back to their old concerns about deflation being the biggest problem for the economy.  One has to wonder at what evidence they are looking to come to that determination as certainly the recent data does not point in that direction.  Just this morning Spanish CPI (5.6%) printed at the highest level since 1992 while Italian PPI (25.3%) printed at the highest level in its history.  From Germany, we have seen CPI prints from several of its states (Hesse 5.3%, Baden Wuerttemberg 4.9%, Bavaria 5.3%, Saxony 5.0%) with the national number (exp 5.5%) due at 8:00 this morning.

Still, none of this seems to be having an impact on the thoughts of ECB members with Lagarde, Schnabel, Villeroy and de Cos all out explaining that this is a temporary phenomenon and that by the middle of next year CPI will be back at their 2.0% target or lower.  Maybe it will be so, but as Damon Runyon so aptly explained, “The race is not always to the swift, nor the battle to the strong; but that is the way to bet.”  In other words, looking at the current trends, it seems far more likely that inflation remains high than suddenly turns around lower.  The biggest problem the central banks have now is that it has become common knowledge that inflation is rising, which means that individual behaviors are adjusting to a new price regime.  And if you listen to the central bank thesis that inflation expectations are a critical input, then they are really in trouble as inflation expectations are clearly rising.

At least the Fed has begun to discuss the idea of removing accommodation, although the Omicron variant of Covid may given them pause, but in Europe, it is not even on the table.  A discussion point that has been raised numerous times lately is the idea of a central bank policy error, either raising rates prematurely to battle phantom inflation or waiting too long to tighten policy and allowing inflation to become more entrenched.  While my money is on the latter, it is very clear that the ECB, at least, and still many Fed members, are far more concerned with the former.  Perhaps they are correct, and all these rising prices will quickly dissipate, and that would be great.  However, I am not counting on that outcome, nor should anyone else at this point until there is ANY proof the Fed or ECB are correct.

Meanwhile, Friday’s dramatic events seem to have been erased from memory as while there are still headlines regarding the Omicron variant, the collective market view appears to be that it is not going to result in another wave of lockdowns and therefore the economic impact will be relatively minor.  As such, we are seeing a reversal of fortune across most markets from their Friday price action.  It should be no surprise that the biggest change comes from oil (+4.75%) which has recouped about one-third of its losses and seems set to continue rebounding.  After all, if the consensus is that Omicron is not going to have much of an impact, then the supply/demand story hasn’t changed and that bodes well for oil prices moving higher.  Elsewhere in the commodity space NatGas (+7.4%) is rising sharply on the back of colder than normal weather, while metals prices (Au +0.1%, Ag +0.5%, Cu +1.7%, Al +1.2%) are all rebounding as well.

In the equity markets, Asia never got a chance to sell off like Europe and the US on Friday so caught up (down?) with the Nikkei (-1.6%) leading the way although the Hang Seng (-1.0%) also suffered.  Shanghai traded flat for the day.  Europe, however, which sold off sharply on Friday, with many markets down more than 4%, has rebounded somewhat this morning (DAX +0.7%, CAC +1.1%, FTSE 100 +1.2%) although these markets are obviously well lower than Thursday’s closing levels.  Finally, US equities sold off sharply in Friday’s abbreviated session, with all three indices down about 2.3% but this morning futures are all rebounding as well, up between 0.6% and 0.8%.

Bonds saw the most dramatic move on Friday, with Treasury yields tumbling 16 basis points while European yields all fell as well, albeit less dramatically.  This morning, with risk back in vogue, bonds are back under pressure with Treasuries (+6.8bps) leading the way but all of Europe (Bunds +2.7bps, OATs +1.5bps, Gilts +3.9bps) also seeing higher yields.

It should come as no surprise that the dollar is also reversing some of Friday’s price action with the commodity bloc doing well (SEK +0.4%, CAD +0.3%, AUD +0.3%) while the financials are under modest pressure (EUR -0.2%).  This movement is nothing more than a reaction to the Friday movement.  EMG currencies are seeing similar price action with the best performers the commodity bloc here (RUB +0.9%, ZAR +0.7%) while weakness has been seen in TRY (-3.45%) and CLP (-0.7%).  The former continues to suffer from President Erdogan’s comments about never raising interest rates to fight inflation while the peso is reacting to early polls showing the leftist, Gabriel Boric, leading ahead of the runoff presidential election in 3 weeks.

It is a week full of data culminating in Friday’s payroll report although it starts out slowly.

Tuesday Case Shiller Home Prices 19.35%
Chicago PMI 67.0
Consumer Confidence 110.7
Wednesday ADP Employment 525K
Construction Spending 0.4%
ISM Manufacturing 61.1
ISM Prices Paid 85.8
Fed Beige Book
Thursday Initial Claims 250K
Continuing Claims 2000K
Friday Nonfarm Payrolls 535K
Private Payrolls 525K
Manufacturing Payrolls 45K
Unemployment Rate 4.5%
Average Hourly Earnings 0.4% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
ISM Services 65.0
Factory Orders 0.5%

Source: Bloomberg

In addition to all that data, we hear from Chairman Powell (and Secretary Yellen) in front of the Senate and House on Tuesday and Wednesday as well as eight more Fed speakers during the week.  If I were a betting man, I would expect that the broad message will continue to be that while inflation is not a long-term problem, it is appropriate to continue to normalize monetary policy now.  And that will be the message right up until markets force them to make a choice by either selling off sharply and forcing an end to policy tightening or running to new highs dragging inflation expectations, as well as inflation, along with them.

Meanwhile, the dollar remains beholden to the latest whims.  If tightening is back on the table, then look for the dollar to resume its uptrend.  However, if Omicron, or something else, causes a change in the message, the dollar seems likely to pull back smartly.

Good luck and stay safe
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Quite Insane

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There once was a concept, inflation
That frightened the heads of each nation
As prices would rise
They could not disguise
The fact it was just like taxation

But now, though it seems quite insane
Most governments try to explain
No need for dismay
Inflation’s okay
There’s no reason you should complain

The latest example is from
The UK, where people’s income
Continues to lag
Each higher price tag
And prospects for growth are humdrum

It certainly is becoming more difficult to accept the idea that the current inflationary surge being felt around the world is going to end anytime soon.  I keep trying to imagine why any company would cut prices in the current macroeconomic environment given the amount of available funds to spend held by consumers everywhere.  So called ‘excess’ savings, the amount of savings that are available to consumers above their long-term trend, exceed $3 trillion worldwide, with more than $2 trillion of that in the US alone.  If you run a company and are being faced with higher input costs (energy, wages, raw materials, etc.) and there has been no reduction in demand for your product, the most natural response is to continue to raise prices until you find the clearing price where demand softens.  It is a pipe dream for any central bank to expect that the current situation is going to resolve itself in the near future.

And yet…the major central banks (Fed, ECB, BOE and BOJ) continue to be committed to maintaining ultra-easy monetary policy.  For instance, today’s inflation data from the UK is a perfect case in point.  CPI rose a more than expected 4.2% Y/Y, more than double the BOE’s price target.  Core CPI rose 3.4%, also more than expected and RPI (Retail Price Index, the price series that UK inflation linked bonds track), rose 6.0%, the highest level since 1991.  And yet, the BOE is seemingly no closer to raising rates.  You may recall that despite what appeared to be clear signaling by the BOE they would be raising interest rates at their meeting earlier this month, they decided against doing so, surprising the market and leading to significant volatility in UK interest rate markets.  In fact, BOE Governor Bailey fairly whined afterwards that it was not the BOE’s job to manage the economy.  (If not, what exactly is their job?)  At any rate, the growing concern in the UK is that growth is slowing more rapidly while prices continue to rise.  This has put the BOE in a tough spot and will likely force a decision as to which issue to address.  The problem is the policy prescriptions for each issue are opposite, thus the conundrum.

The bigger problem is that this conundrum exists in every major economy.  The growth statistics we have seen have clearly been supported by the massive fiscal and monetary policy expansion everywhere.  In the US, that number is greater than $10 trillion or 40% of the economy.  The fear is that organic growth, outside the stimulus led measures, is much weaker and if policy support is removed too early, economies will quickly fall back into recession.  In fact, that is the most common refrain we hear from policymakers around the world, premature tightening will be a bigger problem.  Ultimately, a decision is going to need to be made by every central bank as to which policy problem is more important to address immediately.  For the past four decades, the only policy issue considered was growth and how to support it.  But now that inflation has made a comeback, it is a much tougher choice.  We shall see which side the major central banks choose over the coming months, but in the meantime, the one thing which is abundantly clear is that prices are going to continue to rise.

A reasonable question would be, how have markets responded to the latest data and comments?  And the answer is…no change in attitude.  Risk appetite remains relatively robust as the money continues to flow from central banks, although certain risk havens, notably gold, are finding new supporters as fears of significantly faster inflation grow.

So, let’s survey today’s markets.  Equities have had a mixed session with Asia (Nikkei -0.4%, Hang Seng -0.25%, Shanghai +0.45%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 -0.3%) all, save China, remaining near all-time highs (in the case of the Nikkei they are merely 31 year highs from after the bubble there), but certainly showing no signs of backing off.  US futures are showing similar price action with very modest movement either side of flat.

Bonds, as well, are little changed and mixed on the day with Treasuries (-0.5bps) catching a modest bid after having sold off sharply over the past week.  In Europe, the price action is similar with Bunds (-0.3bps), OATs (+0.2bps) and Gilts (-0.5bps) all within a few tics of yesterday’s closing levels.  I would have expected Gilts to suffer somewhat more given the UK inflation data, but these days, it appears that inflation doesn’t have any impact on interest rates.

Commodity prices are softer this morning led by oil (-1.3%) and NatGas (-1.75%), although European NatGas is higher by more than 7.3% this morning as Russia continues to restrict flows to the continent.  (I have a feeling that the politicians who made the decision to rely on Russia for a critical source of power are going to come under increasing pressure.)  In the metals markets, industrials are mostly under pressure (Cu -1.0%, Sn -0.1%, Zn -0.8%) but we are seeing a slight rebound in aluminum (+0.6%) and precious metals are doing fine (Au +0.6%, Ag +1.1%).  It seems that inflation remains a concern there.

As to the dollar, it has outperformed a few more currencies than not, with TRY (-1.25%) the biggest loser as the central bank there has clearly made the decision that growth outweighs inflation and is expected to cut interest rates further despite inflation running at nearly 20%.  Elsewhere in the EMG bloc, the losers are less dramatic with MYR (-0.3%) and CLP (-0.3%) the next worst performers.  On the plus side, RUB (+0.8%) is the clear leader, shaking off the decline in oil prices as inflows to purchase Russian bonds have been enough to support the ruble.  Otherwise, there are a handful of currencies that have edged higher, but nothing of note.

In the G10, the picture is also of a few more losers than gainers but no very large moves at all.  surprisingly, GBP (+0.1%) has done very little in the wake of the CPI data and actually SEK (+0.35%) is the best performer on the day.  However, given the krona’s recent performance, where it has fallen more than 4% in the past week, a modest rebound should not be much of a surprise.  Overall, the dollar has retained its bid as evidenced by the euro (-2.8%) and the yen (-2.0%) declining during the past week with virtually no rebound.  It appears that the market continues to believe the Fed is going to be the major central bank that tightens policy fastest and the dollar is benefitting accordingly.

This morning’s data brings Housing Starts (exp 1579K) and Building Permits (1630K), neither of which seem likely to move markets.  Yesterday’s Retail Sales and IP data were much stronger than expected, which clearly weighed on bond markets a bit, and supported the dollar, but had little impact elsewhere.  We hear from seven! Fed speakers today, as they continue to mostly double down on the message that they expect inflation to subside on its own and so it would be a mistake to act prematurely.  There is a growing divide between what the market believes the Fed is going to do and what the Fed says they are going to do.  When that resolves, it will have a large market impact, we just don’t know when that will be.

For now, you cannot fight the dollar rally, but I will say it is getting a bit long in the tooth and a modest correction seems in order during the next several sessions.  Payables hedgers should be picking spots and layering into hedges because the longer-term situation for the dollar remains far more tenuous.

Good luck and stay safe
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Hawks Now Despair

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The imminent news of the day
Is President Joe will convey
His choice for Fed chair
As hawks now despair
Lael Brainerd will soon lead the way

Her bona fides highlight her views
More policy ease she would choose
Inflation? No worry
But she’s in a hurry
For banks to put under the screws

The word from Washington is that President Biden will be announcing his selection for Fed chair imminently.  The very fact that the news was released using that phraseology implies to some (this author included) that we will have a new Fed Chair going forward, Lael Brainerd.  It is widely known that the President interviewed both Brainerd and Powell last week and ostensibly, Ms Brainerd accorded herself quite well.  It is also widely known that the progressive wing of the Democratic Party, which continues to gain sway over policy decisions, hates Chairman Powell and believes that not only would a Chairwoman Brainerd maintain policies to pay for their wish list, but that she would also be much tougher on the banking industry on a regulatory basis.

Of course, the key question is, can Brainerd win approval from a split Senate?  However, it is not clear that Powell could win approval either.  In Brainerd’s case, the vote would almost certainly be a straight party-line vote with Vice-president Harris casting the tiebreaker if necessary, although, it is quite possible that one or two of the very centrist Republican senators vote yea for her.  Powell, on the other hand, has enemies on both sides of the aisle, as there is a contingent of Republicans who believe he is to blame for the current inflation, while we also know there is a contingent of Democrats, led by Senator Warren, who despise him.  In other words, it doesn’t appear either is a slam dunk despite the fact both are currently on the Fed board and have been approved in the past.

Given we already know how markets have responded to the Powell Chairmanship, let us consider how a Chair Brainerd might be viewed.  Whether it is true or not, the current narrative is that Ms Brainerd would be more dovish than Powell, far less likely to complete the current tapering initiative and potentially seek reasons to further expand the Fed’s balance sheet.  If that were to be the case, one would have to be bullish financial assets with both stocks and bonds benefitting from that policy mix.  In addition, given the current inflationary impulse, and the likelihood that a Chair Brainerd continues to believe in the transitory theory, commodity prices are likely to continue their climb higher.  As to the dollar, based on this thesis, the dollar’s recent rise would likely come to an end, as the ongoing decline in real rates would undermine its value proposition.  You may wonder why bond prices would perform well despite rising inflation and the answer is simple, the ongoing QE purchases would support them, and a change in view regarding the timing of any tightening would likely see the short end of the curve rally, driving rates there much lower as well.

Of course, this is speculation regarding speculation of a particular outcome.  However, based on the market’s previous responses to these types of policy stimuli, I would contend they are reasonable.  Regardless, this all depends on any announcement.

One thing to note is that the case for a dollar decline is relatively strong in the event the market perception changes regarding further Fed policy tightness.  The dollar has been benefitting from the perception that the Fed is leading the way among the major central banks, with respect to removing policy ease.  If that perception were to change, so will the trajectory of the greenback.

Turning to the markets this morning, after a lackluster day in the US yesterday, where the major indices barely moved, we saw a mixed performance in Asia (Nikkei +0.1%, Hang Seng +1.3%, Shanghai -0.3%) as China continues to feel downward pressure from the real estate sector there.  Europe, on the other hand, is having a better day (DAX +0.5%, CAC +0.4%, FTSE 100 +0.2%) despite growing concerns over NatGas supplies due to some delays in NordStream 2 approvals.  It seems that a combination of ongoing dovish comments from Madame Lagarde and a new analysis by Capital Economics indicating interest rates in Europe will not rise before 2025, have inspired more risk-taking.  Meanwhile, US futures, which had been lower earlier in the session, have now edged back to essentially unchanged on the day.

In the bond market, yesterday saw some very aggressive selling with Treasury yields rising 5 basis points and pretty much dragging the entire space with them.  This morning, however, things have reversed with Treasury yields (-1.9bps) down along with Bunds (-1.9bps), OATS (-2.0bps) and Gilts (-2.0bps).  As long as there is belief in the QE process, bonds will retain a bid.  As an aside, there was an interesting article yesterday from MNI reporting on the fact that Italy and the other PIGS are seeking a permanent change in EU lending rules to insure that they get more money with less strings, as has been occurring during the Covid inspired emergency.  This has all the signs of a new policy that will be enacted, permanently increasing the amount of support that Southern Europe receives from the EU, and likely, over time to build tensions.  I would look for PIGS spreads vs. Bunds to narrow on this conversation, but it will not help the euro.

As to commodities, this morning most are in the green led by oil (+0.4%) which is continuing yesterday’s late day rally although prices are still much lower on the week.  NatGas (+2.8%) is clearly rising in concert with the European story on Nordstream 2 while gold (+0.6%) and silver (+0.85%) continue to confound by rising sharply alongside the dollar.  Ags are a little softer as are base metals (Al -1.6%, Zn -0.9%), so the message from this market is just not clear.

Turning to the dollar, it is broadly stronger this morning with SEK (-0.3%) and CHF (-0.3%) the laggards in the G10 although GBP (+0.25%) and NOK (+0.2%) are both firmer.  Going backwards, NOK is clearly being supported by oil prices while the pound is benefitting from modestly positive employment news amid a spate of releases there.  As to the losers, there is really no news in either currency which implies the general dollar bullish framework continues to be the key driver.  In the emerging markets, TRY (-1.4%) is today’s worst performer as investors fear further rate cuts despite rapidly rising inflation.  Interestingly, RUB (-0.5%) is also under pressure despite oil’s rebound as concerns over rising inflation in Russia are also impacting investment decisions.  CLP (-0.5%) is the other laggard here as a combination of broad dollar strength and concerns over inflation seem to be undermining the peso.

On the data front, we see Retail Sales (exp 1.5%, 1.0% ex autos) as well as IP (0.9%) and Capacity Utilization (75.9%) this morning.  We get the Fed train rolling with five speakers this morning ranging from the most hawkish (George) to the most dovish (Daly).  However, I believe all eyes will be on the Chairmanship story, not comments from underlings.

The dollar broadly continues to rally with the euro having traded to its lowest level since July 2020 and there is nothing that indicates this trend is going to change soon.  While there are good reasons to expect the dollar to eventually decline, right now, higher is the direction of travel so keep that in mind for your hedging.  However, for those with a longer-term view, looking into 2023 and 2024, current levels may well look attractive if payables are the exposure.

Good luck and stay safe
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Damnified

Posted on by

The market has turned its attention
To Brainerd’s potential ascension
As Chair of the Fed
Thus, bond bulls imbed
The view QE gets an extension

This adds to the growing divide
Twixt nations who’ve identified
Inflation as bad
From those who are mad
Their laxness have been damnified

The dollar is under some pressure this morning as bonds rally (yields decline) and commodity prices pick up further.  If equity markets were higher this would be a classic risk-on session, alas, that picture is mixed, and anyway, whatever movement there is has been modest at best.  (It’s almost as if equity bulls are getting tired at all-time highs with record valuations.)

What, then, you may ask, is driving today’s price action?  I give you Lael Brainerd PhD, current Fed governor, former Under Secretary of International Affairs at the US Treasury, and the woman most likely to be our next Federal Reserve Chair.  The news broke that President Biden interviewed her for the role and there is a growing belief that in the current political zeitgeist, a Democratic woman favored by the progressive wing of the party will be much more palatable than a Republican man with a mixed track record on issues like FOMC membership trading improprieties.  It doesn’t hurt that she has been an unrequited dove since her appointment by President Obama in 2014, nor that she has been vocal on the need for more stringent regulatory control over the big banks.

As markets are discounting instruments, ostensibly looking forward a number of months to where things will be rather than where they currently sit, there is a growing belief that a Chairwoman Brainerd will be loath to continue tapering asset purchases and far more comfortable allowing inflation to run even hotter in her desire to achieve an even lower unemployment rate.  Hence, the idea that fed funds rate hikes will be coming sooner has been pushed back further.  In the wake of last week’s very surprising BOE meeting, where the widely anticipate rate hike was delayed, and the Fed’s own extremely dovish tapering message, the idea that a change at the Fed will lean even more dovish than now is music to bond bulls’ ears.  And so, as we survey the largest economies, the US seems to be turning more dovish, the Eurozone continues to burnish its dovish bona fides and the BOJ…well the BOJ is unlikely to ever tighten policy again.

However, as we look elsewhere in the world, the story is very different.  Central banks all over, from smaller G10 nations to large EMG group members have clearly articulated that inflation is a major concern with no clear end in sight and that tighter monetary policy is in order.  In the G10, Canada appears on the cusp of tightening, Norway has done so already and promised another hike next month.  New Zealand has ended QE and raised rates, Australia has given up on YCC and Sweden is hinting at a rate rise coming soon.  The noteworthy link is these are all small, relatively open economies with trade a key part of the mix and rising prices are very evident.

But do not forget the EMG space where we have seen far more dramatic moves already and are almost certain to see more of the same going forward.  The Czech Republic hiked rates 125bps last week, far more than expected, while Russia has already raised rates 2.50% in the past 9 months with no signs of slowing down.  Meanwhile, Polish central bankers are previewing more rapid rate hikes despite a larger than expected 75 basis point move last week.  In LATAM, Brazil has already raised rates 5.25% and is in no mood to stop with inflation running above 10% there.  Mexico, too, is up 0.75% from its lows while Chile (+2.25%), Colombia (+0.75%) and Peru (+1.75%) have all reacted strongly to rising inflation.

The point is this dichotomy between the G3 and the rest of the world seems unlikely to continue forever.  There seem to be two likely scenarios to close this interest rate gap, neither of them to be hoped for; either the G3 will finally blink, recognize inflation is real and raise rates far more rapidly than currently expected, or the transitory story will be correct as the economic imbalances will drive a massive crash with economic growth slowing dramatically into a severe recession and no reason to raise interest rates.  In the first case, financial assets will almost certainly suffer greatly while commodities should perform well.  In the second case, everything will suffer greatly with cash regaining its title as king.

Like I said, neither is a pleasant outcome, but neither is about to happen yet either.  So, looking at today’s activity, the growing assumption of a more dovish Fed (remember that vice-chairs Clarida and Quarles will be out within months as well) has led to lower yields and a somewhat softer dollar along with ongoing higher commodity prices.

Equities, however, remain mixed overall, albeit starting to edge higher in the session.  In Asia, the picture was mixed with the Nikkei (-0.75%) falling on the back of yen strength, while the Hang Seng (+0.2%) and Shanghai (+0.2%) both managed to edge higher.  Europe, which had been mixed to lower earlier in the session has started to turn green with the DAX (+0.2%), CAC (+0.3%) and FTSE 100 (+0.1%) all in positive territory. US futures are generally little changed ahead of this morning’s PPI data, (exp 8.6%, 6.8% ex food & energy) but really with the market focusing on tomorrow’s CPI data.

As mentioned, bonds are having a good day, with Treasuries (-3.1bps) falling back to Friday’s low yields, while European sovereigns (Bunds -3.5bps, OATs -3.7bps, Gilts -1.3bps) all rally as well.  In Europe, the curves are flattening pretty aggressively, hardly a vote of confidence in future activity.

Oil prices (+0.45%) are once again firmer although NatGas (-1.6%) has slipped as warm weather in the mid-Atlantic and Midwest states reduces near term heating demand.  Precious metals, which have been rallying nicely of late are little changed on the day but industrial metals (Cu +0.5%, Al +0.1%, Sn +0.3%) are all a bit firmer.  Agricultural products continue to rise as food inflation worldwide continues to grow.

Finally, the dollar, which had been broadly softer earlier in the session on the dovish discussion, has rebounded slightly, although is hardly rocking.  In the G10, the largest moves have been 0.25% in either direction (AUD -0.25%, JPY +0.25%) however, there have been limited stories to drive perceptions.  Given the yen’s recent bout of significant weakness, this appears to be a corrective move rather than a new direction.  As to Aussie, it too seems more technical than fundamental in nature.

Emerging markets, however, have seen more movement led by THB (+0.8%) and KRW (+0.5%) on the news that both economies are reopening amid a decline in Covid infections and the allowance of more inbound tourist traffic.  RUB (+0.45%) seems to be benefitting from oil’s rise as well.  On the downside, ZAR (-0.6%) fell after a report that foreign holdings of South African sovereign debt fell to its lowest level in 10 years.

On the data front, aside from the PPI, we have already received the NFIB Small Business Optimism number at a disappointing 98.2 (exp 99.5) indicating that the growth impulse in the US is still under pressure.  In addition, there are 4 more Fed speakers today after yesterday’s warnings from Vice-chair Clarida that inflation may be a problem going forward.

For now, the dollar seems to be under modest pressure as it consolidates the latest leg of a slow move higher.  If the Fed tapering is going to diminish, the dollar bulls are going to have a harder road to hoe going forward.  As such, much will depend on who is our next Fed chair.

Good luck and stay safe
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Qui Vive!

Posted on by

“Inflation, inflation, inflation”
Lagarde explained might have duration
That’s somewhat extended
Before it has ended
But truly tis an aberration

Yet traders have come to believe
That Madame Lagarde is naïve
Though she’s been dogmatic
That rates will stay static
Investors are shouting qui vive!

It appears that, if anything, the gathering storm of interest rate hikes has done nothing but strengthen in my absence.  Inflation continues to be THE hot topic in markets, and central banks are finding themselves in uncomfortable positions accordingly.  Some, like the RBA, BOC and BOE, have either given up the ghost on the transitory idea and are moving or preparing to do so in order to address what has clearly become a much bigger problem.  Others, notably the ECB, remain ostrich-like and refuse to accept the idea that their policy responses to the pandemic induced government shutdowns and fiscal policy boosts have actually been quite inflationary.  In the face of the ever-increasing inflation numbers around the world, investors are flattening yield curves aggressively, with 2-year yields skyrocketing while 10-year and beyond yields drift lower.  At this point, yield curve inversion remains only a distant possibility, but one that is far more likely than had been the case just two weeks ago.  Ultimately, the market’s collective concern is that despite a slowing growth impulse, central banks will be forced to respond to the inflation data thus crimping future growth.  The major risk is they will ultimately slow growth with only a limited impact on prices thus exacerbating the situation.  Right now, it is not that much fun to be a central banker.

A quick recap shows that last week, Madame Lagarde pooh-poohed the idea that the market knew what it was doing by driving rates higher.  She whined that traders were not listening to the ECB’s forward guidance, which she claims shows rates are in no danger of being raised anytime soon.  However, futures traders in Europe are pricing in a 10bp rate hike by next summer, shortly after the PEPP expires.  Meanwhile, 10-year Bund yields, which have been negative since May 2019, have rallied to -0.10% and seem on the verge of returning to positive territory.  Of course, 2-year Bund yields have risen 30bps in the past 3 months as that curve flattens as well.  (As an aside, the FX market had a little hiccup here as well, with the euro rallying sharply after the Lagarde comments, only to give all that back and then some on Friday in the wake of higher than forecast PCE data from the US which has traders betting on more than 50bps of Fed Funds hikes in 2022 and another 100 basis points in 2023.

With that as backdrop, we have two major and one lesser central bank meetings this week, the RBA tonight, the FOMC on Wednesday and the BOE on Thursday.  While we will discuss the latter two at further length over the next several days, the current thinking is that the Fed will announce the timing of the tapering of QE while the market has the BOE as a 50-50 proposition to actually raise the base rate by 0.15%, returning it to 0.25%.

Beyond the central bank drama, we continue to see troubling economic statistics with US GDP growth slowing to 2.0% in Q3, a far cry from its 6.7% Q2 rate, while Chinese Manufacturing PMI fell to 49.2 and German Retail Sales fell -2.5% in September.  On the whole, the stagflation story continues to be the hottest ticket around both anecdotally and based on Google Trends.

As you can see, there is much to be discussed as the week progresses, but for now, let’s take a look at today’s markets.  Despite all the concerns over stagflation, which should theoretically be awful for equities, the US stock market knows no top and that continues to pull most other markets along for the ride.  In fact, last night, the only real issues were in China where the Hang Seng (-0.9%) and Shanghai (-0.1%) suffered as yet another Chinese real estate development company (Yango Group) is on the verge of defaulting on its debts.  However, the Nikkei (+2.6%) rallied strongly on the back of the LDP’s surprising retention of a majority (albeit reduced) of the Diet in weekend elections.  In Europe, though, there is nothing holding back equity investors with all markets in the green (DAX +0.85%, CAC +1.0%, FTSE 100 +0.5%) as bad data is ignored.  While Q3 earnings have been solid, it does seem that prospects going forward are more limited, however investors seem unconcerned for now.  And don’t worry, US futures are all firmly in the green, higher by around 0.4% at this point in the morning.

Given the risk on attitude that we have seen this morning, it is no surprise that bonds are selling off with yields backing up a bit.  Treasury yields (+2.3bps) are a bit higher but still well off the highs seen two weeks’ ago.  Across Europe, sovereign yields (Bunds +1.4bps, OATs +1.7bps and Gilts (+3.0bps) are also firmer in sync with the risk attitude as we see the entire continent’s bonds come under pressure.  One other noteworthy mover were Australian bonds (-18.3bps) which retraced 2/3 of the yield spike from last week as the market prepares for the RBA meeting tonight. You may recall that the RBA had been implementing YCC in the 3yr, seeking to hold that yield at 0.10%.  However, as inflation rose, so did that yield, finally spiking last week as market participants decided the RBA would change tactics, and the RBA did not push back.  Governor Lowe has his work cut out for him this tonight in explaining what the RBA will be doing next.

Turning to commodities, oil prices (+0.5%) are rising this morning and seem to be getting set to break the recent highs and start a new leg toward, dare I say it, $100/bbl.  Overall, however, the commodity complex is directionless today with NatGas (-1.4%) lower, gold (+0.2%) higher, copper (-0.1%) lower, the ags mixed as well as the other non-ferrous metals.  In other words, today seems to be far more noise than signal.

Finally, the dollar, too, seems confused today, with both gainers and losers abounding in both the G10 and EMG spaces.  In the G10, NOK (+0.25%) is the leader as it responds to oil’s rally, while JPY (-0.3%) is the laggard, I assume responding to the election results and the broader positive risk sentiment.  The rest of the bloc is well within those bounds and other than the data mentioned, doesn’t seem to have much short-term direction.

EMG currencies have shown a bit more movement, with TRY (+0.7%) the leader followed by CZK (+0.45%).  The Turkish story seems confused as the two data points showed PMI falling compared to last month and Inflation rising, neither of which would seem to benefit the lira, but there you go!  Meanwhile, the Czech budget deficit is expected to shrink somewhat as traders push the currency higher.  On the downside, there are a few more from which to choose as THB (-0.8%) is the worst performer followed by KRW (-0.7%) and ZAR (-0.6%).  The baht suffered as international investors sold stocks and bonds locally and repatriated currency.  Korea’s won seemed to suffer on broader based dollar strength despite decent export data, but talk is the future looks dimmer as growth around the world slows.  Meanwhile, the rand fell over ongoing concerns that the SARB, when it meets later this month, will disappoint on the rate rise front.

It is, of course, a big data week between the Fed and Friday’s NFP report:

Today ISM Manufacturing 60.5
IS Prices Paid 82.0
Wednesday ADP Employment 400K
ISM Services 62.0
Factory Orders 0.0%
FOMC Rate decision 0.00%-0.25%
Thursday Initial Claims 275K
Continuing Claims 2136K
Nonfarm Productivity -3.2%
Unit Labor Costs 6.9%
Trade Balance -$79.9B
Friday Nonfarm Payrolls 450K
Private Payrolls 400K
Manufacturing Payrolls 28K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.8%

Source: Bloomberg

Obviously, the FOMC on Wednesday is the primary focus closely followed by Friday’s payroll report.  Before then, tonight’s RBA meeting will have the market’s attention and we cannot forget the BOE on Thursday.  All in all, it could be quite an eventful week.  As to the dollar, for now, especially against the euro, it feels like there is further room for appreciation as the market continues to see the Fed as far more hawkish than the ECB.  Quite frankly, I think both sides of that discussion will be comfortable with the outcome as a stronger dollar should help check inflation while a weaker euro can help rekindle the export engine.  Look for it to continue.

Good luck and stay safe
Adf

Costs are Aflame

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The central banks of the G10
Are starting to realize the ‘when’
Of interest rate rises
To forestall a crisis
Is sooner than they thought back then

Inflation breakevens keep rising
While companies are proselytizing
That they’re not to blame
As costs are aflame
Thus CB’s, their plans, are revising

It is difficult to scan a news source these days without seeing a story of how some company or another is raising their prices by X% due to increased shipping/raw material costs/labor costs.  And the reporter doesn’t really have to look that hard for the typical anecdotes that accompany this type of story since the situation has become increasingly prevalent.  Just this morning I read about Unilever, WD-40 and P&G all explaining that prices have not only already risen but would be rising further in the months ahead.  Obviously, this does not bode well for the transitory narrative, which is in its death throes.  That being said, it is still not the universal opinion of all Fed members.  For instance, yesterday NY Fed president John Williams exclaimed that long-term inflation expectations have risen to levels “consistent with the 2% goal.”  Now, I’m not sure what long-term expectations he is looking at, but yesterday, the 5-year/5-year inflation rate in the US Treasury market closed at 2.915%, its highest level since the series began in 2002.  The 19-year history of this measure shows an average of 1.85%, which seems more in line with Williams’ comments.  But one must be willfully blind to look at the chart of this series and claim inflation expectations remain sedate.

The risk for the central banks that maintain inflation is not a growing issue is loss of whatever credibility they have remaining.  And the upshot is, markets are not listening to them anymore and have begun to price in more aggressive rate hikes around the world.  In the US, the first rate hike is priced for next July, right about the time the Fed previously expected to finish tapering.  And there is a second hike priced in before the end of 2022.  In the UK, the first hike is priced for this December with three more expected by next September.  Even in the Eurozone, a full hike is priced in by the end of next year, something that not a single ECB banker has expressed, and in fact, several have categorically denied.

At the same time, longer term yields are rising as well, with 10-year Treasuries up to 1.68% even after having fallen 2.1 bps in the overnight session.  German bunds, while still negative (-0.09%) are at their highest level since May 2019, which was the last time their yield was at 0.0%.  And we are seeing similar price action across Gilts, OATs and Australian GBs.  (The latter despite the fact that the RBA remains adamant that they will not be raising interest rates until 2024.  Methinks they will have some crow to eat on that subject.)

The problem for central banks, and their respective governments, is that given the extraordinary amount of debt outstanding, higher yields can quickly become a problem.  So, ask yourself how can a central bank prevent rising yields without raising front end rates or expanding their balance sheets further?  You will not like this answer but here is a taste of what could be coming our way; regulatory changes that force institutions to buy government bonds.  Consider the ease with which central banks could require commercial banks to expand the ratio of government bonds in their asset portfolio, or insurance companies or pension funds or all three.  Financial repression can take form in many ways, and this would likely be the first step.  After all, for the average person, this is a relatively esoteric process and would not likely be widely understood hence would not cause an uproar.  Of course, all those insurance company and pension fund portfolios that needed to replace stock holdings with bonds would result in some pretty big selling pressure in the equity market, which would get a little more press.  But central banks wouldn’t get the blame as they are one step removed from the process.  In their eyes, this would be a win-win.

The implication is not that this is imminent, just that it is a possible pathway in the future, and one that seems more and more likely as inflation drives yields higher.  However, for now, the market is still of the belief that central banks will be forced to raise rates and are pricing accordingly.  Given the widespread nature of this belief set, the relative impact on currencies remains muted.  However, if US rates continue to lead the way higher, I think the dollar will continue to see the most support.

Ok, a quick look at today shows that despite the gathering inflation clouds, risk is in vogue with equities generally higher and bonds generally softer.  Last night saw modest gains in the Nikkei (+0.35%) and Hang Seng (+0.4%) although Shanghai (-0.35%) continues to feel the pain of the property situation in China. (As an aside, Evergrande made a surprise partial payment on the USD bond coupon that had been overdue and was about to trigger a default. So, it lives to default another day.)  Europe, too, is having a generally positive session with the CAC (+1.1%) leading the way higher but strong gains in the DAX (+0.7%) and FTSE 100 (+0.55%).  Here, the data released was the preliminary PMI data, which was best described as mixed compared to forecasts, but broadly softer compared to last month, and continues to trend lower.  The outlier here was the UK, which had stronger PMI data, but much weaker than expected Retail Sales data, so perhaps offsetting news.  As to US futures markets, the are either side of unchanged at this hour after this week’s rally.

Bond markets throughout the continent are seeing selling pressure with yields rising (Bunds +1.7bps, OATs +1.6bps) but Gilts (-0.8bps) have a bid along with Treasuries (-2.1bps).  The trend, though remains for higher yields as investors respond to rising inflationary forecasts.  Central banks have their work cut out for them if they want to maintain control of these markets.

In the commodity markets, oil (+0.4%) and NatGas (+0.8%) are back in the green as are copper (+0.75%) and gold (+0.55%).  In fact, pretty much the entire complex including industrial metals and agricultural products are all firmer this morning.

Finally, the dollar is softer across the board in the G10, with AUD (+0.45%) the leading gainer on the back of the commodity picture, followed by SEK (+0.35%) and NOK (+0.35%) which are similarly well situated.  The pound (+0.05%) is the laggard as the Retail Sales data seems to have undermined some bullish views.  In the emerging markets, there are two outliers, one in each direction.  The only loser of the day is TRY (-1.0%) which continues to suffer from yesterday’s surprising 200bps rate cut.  Meanwhile, RUB (+1.4%) has been the leading gainer after the Bank of Russia surprised the market with a 75bp rate hike, much larger than the 25bp-50bp that had been forecast.  Adding that to the price of oil has been an unalloyed positive.  Away from those two, however, gains are modest with ZAR (+0.35%) the next best performer following commodity prices higher.

Preliminary PMI data is the only thing on the docket data wise this morning, but Chairman Powell speaks at 11:00 as the final speaker before the quiet period begins.  Given the differences we heard from Williams and Waller, it will be very interesting to see if Powell is more concerned about inflation or employment.

As such, I expect a muted morning ahead of Powell’s comments and then the opportunity for some activity if he substantially changes the narrative.  My sense is that any change would be hawkish and therefore a dollar positive.

Good luck, good weekend and stay safe
Adf

PS, I will be out of the office next week so no poetry again until November 1st.