There once was a kettle of hawks
Who regularly gave earnest talks
When prices would rise
They would then surmise
T’was time to forget Goldilocks
But now they’re a bevy of doves
The type every borrower loves
Who, if prices rose
Would never propose
That they would give rates, up, a shove
While today’s activity roster includes the Bank of England rate decision (no change) and QE target (possible change), I want to review yesterday’s Fedspeak as I believe it is crucial to continue our understanding of the policy evolution.
Three Fed regional presidents spoke; Chicago’s Mike Evans, a known dove; Boston’s Eric Rosengren, historically slightly more hawkish than centrist; and Cleveland’s Loretta Mester, historically one of the most hawkish Fed members. All three made clear that they are unconcerned over the almost certain rise in inflation in the short-term, with all three convinced this is a ‘transitory’ phenomenon that will work itself out by the end of 2022. Rosengren was particularly colorful in his description as he compared his view of general price increases upcoming to the situation right at the beginning of the pandemic shutdowns regarding toilet paper. “My view is that this acceleration in the rate of price increases is likely to prove temporary,” he said. He continued, “Toilet paper and Clorox were in short supply at the outset of the pandemic, but manufacturers eventually increased supply, and those items are no longer scarce. Many of the factors raising prices this spring are also likely to be similarly short-lived.”
Now, I don’t know about you, but I would beg to differ with his assessment, specifically on the two items he mentioned, toilet paper and Clorox. While there is no question that both items are readily available today as opposed to the situation twelve months ago, it is also very clear that the prices of both items have risen substantially. In fact, my anecdotal evidence from the local Shop-Rite is that prices of these two items have risen at least 35% in the past twelve months, and there is no evidence that these prices are going to decline anytime soon. After all, as a manufacturer, why would you reduce prices if customers are still buying your product? So, while supply has improved, it has done so at the expense of higher prices. In my book, this is the very definition of inflation.
Regarding the topic of tapering, Evans was dismissive of the idea at all and surprisingly, Mester showed no interest in the discussion in the near term. Rosengren, however, did indicate that it was possible the situation by the end of this year could warrant a discussion, although he would sooner halt purchases of mortgage bonds than Treasuries as he mentioned the possibility that housing prices could get ‘frothy’. Ya think? A quick look at the recent Case Shiller House Price Index shows it has risen by nearly 12% in the past year nationwide, the fastest level since March 2006, right in the middle of the housing bubble whose bursting caused the GFC. Perhaps this is what is meant by “frothy” in Chairman Powell’s eyes.
From London, the market’s awaiting
The Old Lady’s econ re-rating
While wondering if
She’ll offer a sniff
Of when QE might start abating
The UK’s post-pandemic growth trajectory has been far closer to the US than of the EU as PM Johnson’s government has done an excellent job of getting a large proportion of its population inoculated allowing for a reopening of the economy. Recent data has been strong and as more restrictions are eased; prospects continue to be relatively bright. Not dissimilar to the Fed’s situation, the Bank of England will find themselves raising their GDP growth forecasts while maintaining their ongoing monetary policy support. Or will they? There is talk in the market that the BOE may well discuss the initial timing of tapering purchases while they upgrade their forecasts. Precedent was set last week when the Bank of Canada did just that, not merely discussing tapering, but actually cutting the amount of purchases by 25%. Will the BOE follow suit?
Analyst expectations are that they will not change policy at all and explain it in the same manner as the Fed, that while inflation in the near-term may rise above their 2.0% target, this will be a temporary phenomenon and is no cause for concern. However, any hint that tapering may be coming sooner than the current program’s target end date later this year is likely to be quite supportive of the pound, so keep that in mind. That said, ahead of the meeting, the pound is essentially unchanged on the day at 1.3900.
Stronger growth forecasts, as well as strong earnings numbers, continue to support equity markets, although while they are not falling, rallies have been modest at best. In fact, there is growing concern that the tech sector, which has clearly been the leader in the post pandemic equity rally, is starting to falter more seriously. Last night saw gains in the Nikkei (+1.8%) and Hang Seng (+0.8%) but a modest decline in Shanghai (-0.2%) on its return from Golden Week. Europe, despite strong German Factory Orders (+3.0%) and Eurozone Retail Sales (+2.7%) has been unable to make any real headway (DAX 0.0%, CAC 0.0%, FTSE 100 +0.2%). US futures are similarly lackluster, with all three major indices higher by 0.1% at this hour. Could it be that economic and earnings strength is fully priced in at these levels?
**BOE leaves policy unchanged, as expected**
Bond markets, on the other hand, are holding their own overall. While Treasury yields are unchanged on the day, they slid 2.5bps yesterday and are now closer to their recent lows than highs. In Europe, sovereigns are showing the smallest of rallies with yields in both Bunds and OATs lower by 0.5bps while Gilt yields are unchanged. At this point, it appears that bond traders and investors are starting to believe the central banks regarding the idea of transitory inflation. While that would be a wonderful outcome, I fear that there is far more permanent inflation scenario unfolding.
Commodity prices are mixed this morning with oil (-0.75%) soft but metals, both base and precious firmer. In fact, iron ore has reached record high levels, rising 6.5% this week, and approaching $200/ton. Again, rising input prices are not disappearing.
As to the dollar, it is generally softer this morning, albeit not substantially so. In the G10, CHF (+0.4%) is the leading gainer but the European currencies are all solidly higher, between 0.2% and 0.3%, although the pound’s move occurred just since the BOE announcement. However, commodity currencies have underperformed here and are little changed on the day.
In the emerging markets, THB (-0.45%) was the laggard after the central bank left rates on hold amid a surge in reported Covid infections. KRW (-0.25%) was next worst as there were a surprisingly large amount of equity outflows from the KOSPI. On the positive side, IDR (+0.8%) was the biggest mover as Indonesia saw significant equity inflows as well as increased interest in the carry trade. ZAR (+0.7%) is benefitting from the rise in gold (+0.25%) as well as the metals complex generally. Otherwise, while gains have been broad-based, they have been shallow.
This morning’s data brings Initial Claims (exp 538K), Continuing Claims (3.62M), Nonfarm Productivity (4.3%) and Unit Labor Costs (-1.0%). However, all eyes are turned to tomorrow’s NFP report, which despite a slightly softer than expected ADP Employment number yesterday (742K, exp 850K), has seen the forecast rise to essentially 1.0 million.
Treasury bond yields have lost their mojo for now and have been able to ignore any signs of imminent inflation. It seems that the Fed chorus of transitory inflation is having the desired impact and preventing yields from running away higher. As long as Treasury yields remain under control, especially if they drift lower, then the dollar will remain under modest pressure. So far, nothing has occurred to change that equation.
Good luck and stay safe