Tag Archives: #Schnabel

Risk’s In Retreat

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In Germany, Covid’s widespread
And lockdowns seem likely ahead
But that hasn’t stopped
Inflation which popped
To levels the people there dread

The upshot is risk’s in retreat
As equities, traders, excrete
But bonds and the buck
Are showing their pluck
And havens now look mighty sweet

While Covid has obviously not disappeared, for a time it seemed much less important to investors and traders and so, had a lesser impact on price action.  But that was then.  During the past few weeks, Covid has once again become a much bigger problem despite the inoculation of large portions of the population in most developed countries.  Exhibit A is Austria, where they have imposed a full-scale vaccine mandate and have the police checking papers randomly to insure that anyone outside their home is vaccinated.  If you are found without papers, the penalty is prison.  However, Germany seems determined to catch up to Austria on this count, as the infection rate there climbs rapidly, and the healthcare system is getting overwhelmed.  There is talk that a nationwide lockdown is coming there as well, and soon.

Of course, what we learned during the first months of Covid’s spread was that when lockdowns are imposed, economic activity declines dramatically.  After all, in-person services all but end, and without government financial support, many people are unable to maintain their levels of consumption.  As such, the prospect of the largest economy in Europe going into a total lockdown is a pretty negative signal for future economic activity.  Alas for the authorities, the one thing that does not seem to be in retreat is inflation.  While Germany is contemplating a national lockdown, this morning it released its latest PPI data and in October, Producer Prices rose 3.8%, which takes their year-on-year rise to…18.4%!  This is the highest level since 1951 and obviously greatly concerning.  While some portion of these increased costs will be absorbed by companies, you can be sure that a substantial portion will be passed on to customers.  CPI is already at 4.6% and there is no indication that it is about to retreat.

And folks, this is Germany, the nation that is arguably the most phobic regarding inflation of any in the developed world.  Sure, Turkey and Argentina and Venezuela have bigger inflation problems right now.  So does Brazil, for that matter.  And many of these latter nations have long histories of inflation ruling the roost.  But ever since 1924, when the newly established Rentenbank helped break the Weimar hyperinflation, sound money and low inflation have been the hallmarks of German policy and politics.  So, the idea that any price index is printing in double digits, let alone nearly at 20% per annum, is extraordinary.  In fact, this is what makes yesterday’s comments from Isabel Schnabel, a German PhD economist and member of the ECB’s Executive Board, so remarkable.  For any German with sway over monetary policy to pooh-pooh the current inflation levels is unprecedented.  Even more remarkably, with Jens Weidmann leaving the role of Bundesbank President, Schnabel is on the short list to replace him.

This drama in Germany matters because if the Bundesbank, traditionally one of the most hawkish central banks, and the biggest counterweight to the ECB as a whole, is turning dovish, then the implications for the euro, as well as Eurozone assets, are huge.  If the Bundesbank will not be holding back Madame Lagarde’s push to do more, we can expect an expansion in QE from here and overall higher inflation going forward.  Both bonds and stocks will rally, as will the price of commodities in euros, while the euro itself will fall sharply.  In fact, this may be enough to offset any incipient dovishness from the Fed should Lael Brainerd wind up as Fed Chair.  It would certainly change medium and long-term views on the EURUSD exchange rate.  And you thought that the week before Thanksgiving would be quiet.

And so, it is a risk-off type day today.  While Asian equity markets managed more winners than losers (Nikkei +0.5%, Hang Seng -1.1%, Shanghai +1.1%), Europe is completely in the red (DAX -0.2%, CAC -0.3%, FTSE 100 -0.5%) and US futures are pointing down as well, with DJIA futures (-0.6%) leading the way.

Bond markets are behaving exactly as would be expected on a risk-off day, with Treasury yields falling 4.6bps while European Sovereigns (Bunds -5.5bps, OATs -5.4bps, Gilts -5.8bps) have rallied even further.  In fact, German 30-year bunds have fallen into negative territory again for the first time since August.

If you want to see risk being shed, look no further than oil (-3.1%) which is lower yet again and seems to have found a short-term top.  It seems the news of SPR releases as well as slowing growth prospects has been enough to halt the inexorable rally seen since April 2020.  Interestingly, a number of other commodities are performing quite well with NatGas (+1.1%), copper (+0.9%) and aluminum (+0.7%) all nicely higher.  Gold (+0.2%) continues to edge up as well, with more and more inflows given its haven status.  Somewhat surprisingly, Bitcoin (-4.7%, -10.5% in the past week) is not similarly benefitting, although the narrative of it being digital gold remains strong.  Perhaps it was simply massively overbought!

Finally, the dollar is clearly king this morning, rallying strongly vs all its G10 peers except the yen (+0.35%), with NOK (-1.1%) the biggest laggard on the back of oil’s decline, although the SEK (-0.9%) and EUR (-0.7%) are no slouches either.  The funny thing about the euro was it spent all day yesterday climbing slowly after touching new lows for the move.  However, this morning, it is below 1.13 and pressing those lows from Wednesday with no end in sight.

EMG currencies are also under pressure across the board with HUF (-1.6%) the worst performer as it has unwound the gains seen from yesterday’s surprising large rate hike, and is now suffering as Covid spreads rapidly and it may soon be a restricted zone for travel from Europe.  CZK (-1.1%) is next in line, as it too, is in the crosshairs of authorities to prevent travel there due to Covid.  In fact, the entire CE4 is the worst bloc, but we are also seeing further weakness in TRY (-0.6%) after yesterday’s rate cut, and RUB (-0.5%) with oil’s slide as the cause.

There is no data to be released today and only two Fed speakers, Waller and Clarida, with the latter losing his clout as he will soon be exiting the FOMC.  There continues to be a wide rift between the hawks and doves on the Fed, but as long as Powell, Brainerd and Williams remain dovish, and they have, the very modest steps toward tapering are all we are likely to see.  The problem is that while we are all acutely aware of inflation and the problems it brings, the FOMC is lost in its models and sees a very different reality.  Not only that, inflation diminishes the real value of the US’s outstanding debt and so serves an important purpose for the government.  While there continues to be lip service paid to inflation as a problem, policy actions show a willingness to tolerate higher inflation for a much longer time.  Alas, it will be topic number one with respect to markets for a long time to come.

For now, the dollar is performing well against all the major currencies, but there are many potential twists in our future.  As I have said before, payables hedgers should be picking levels to add to their hedges.

Good luck, good weekend and stay safe
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The Fed’s Nonchalance

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The view from the Fed’ral Reserve
When viewing the present yield curve
Is that higher rates
Show, here in the States
The ‘conomy’s showing some verve

Contrast that with Europe’s response
To rising yields, where at the nonce
Ms Schanbel’s the third
Of speakers we heard
All lacking the Fed’s nonchalance

All I can say about yesterday’s market activity was that we cannot be too surprised that the imbalances that have been building up for the past year (or more accurately 13 years) resulted in some significant market volatility across every asset class.  Perhaps the most interesting thing was that virtually every asset class was sold aggressively, with no obvious havens available.  Stocks fell, bonds fell, gold fell, the dollar fell, Bitcoin fell; just what did people buy with those proceeds?

But of more interest to me was the central bank responses we have seen to the recent rise in long-term yields around the world.  Arguably, this has been the catalyst to all the market activity, so remains the first place we need to look for answers.

And what did we hear?  Well, four separate FOMC members (Williams, Bostic, Bullard and George) explained that rising yields were a good thing as it shows confidence in the economic growth story.  And oh, by the way, yields are still quite low so they shouldn’t have a negative impact on the economy.  While they may well be sincere in those views, these comments smack more of whistling past the graveyard than wholehearted support of market price action.  After all, the one thing the Fed has demonstrated since the GFC in 2008 is that unrestrained market price action is the last thing they want to see.  Rather, they want to make sure they control the game and the market price action proceeds slowly and calmly in their preferred direction.  You know, like watching paint dry.

And of course, in the broad scheme of things, yields do remain quite low.  Even at yesterday’s high point, the 10-year Treasury was yielding only 1.61%, which is still in the lowest decile of yields during the 10-year’s history.  Interestingly, the ECB has not been quite as sanguine regarding bond yields, despite the fact that bond yields throughout the entire continent are much lower than US yields.  On Monday Madame Lagarde explained they were “closely monitoring” bond yields.  Yesterday, ECB Chief Economist, and the ECB member with the most policy chops, Philip Lane, explained they would use the flexibility of the PEPP to prevent any undue tightening in financial conditions.  Then this morning, Isabel Schnabel, an Executive Board member, was more forthright, explaining the ECB may need to boost policy support if real long-term yields rise too early in the recovery process.  In other words, since they don’t believe that inflation is coming, rising yields need to be stopped.

What if, however, all these central bankers are completely wrong about the future of inflation?  What if, they have been reading their own narrative and now believe that there is no inflation on the way, thus rates should never need to rise?  That, my friends, has the chance to lead to some serious policy errors going forward.

So, let’s take a look at the most recent inflation indicators we have seen, and consider the situation.  Last night, Tokyo CPI was released at -0.3% Y/Y, which while obviously low, was higher than last month and forecast.  Then, this morning French PPI printed positive (+0.4%) for the first time in more than a year while French CPI rose a more than expected 0.7% in February.  Meanwhile, German Import Prices rose a much more than expected 1.9% in January, the biggest jump since September 1990!  And finally, here in the States, the GDP is released with a price index which rose to 2.1%, a tick above expectations.  Now, none of this is a description of raging inflation, but boy, there does seem to be a decent amount of price pressure building in the system.  Perhaps, just perhaps, bond yields are rising on rising inflation concerns, whether economic growth is present or not.

This idea is important because a key ingredient for market forecasts this year has been the trajectory of real interest rates.  At face value, the combined comments of Fed and ECB speakers this week tells us that the Fed is going to allow long-term yields to continue to rise while the ECB is going to step in and stop the madness.  If that is actually how things play out, I assure you that the euro will be hard pressed to move any higher, and that a sharp decline could be in the offing.  In fact, that is true for virtually every currency, where the dollar may very well reassert itself if that is the interest rate scenario that plays out.

Of course, I don’t believe the Fed will allow yields to simply rise unabated, as the cost to the Federal government in increased interest payments will be extremely uncomfortable, so I still look for QE to be expanded and extended, perhaps as soon as the March meeting if yields continue to rally from here.  At 1.75% on the 10-year, the Fed will be feeling the pinch, especially if equity markets continue to suffer under a rising yield scenario.  Thus, I am still in the camp of the dollar eventually falling more sharply as rising inflation rates outstrip capped interest rates.  But the latest comments from the central banks have certainly raised the risk on that view!

Ok, we all know that yesterday was a rout in the markets.  This morning, is unfortunately, not looking much better. Asian equity markets last night followed the US lead and fell sharply (Nikkei -4.0%, Hang Seng -3.6%, Shanghai -2.1%) and European markets, which all fell yesterday, are lower again this morning (DAX -0.8%, CAC -1.1%, FTSE 100 -1.4%).  And, don’t be looking for a bounce in the US as futures are pointing lower as well, between -0.3% and -0.6% at this hour.

Bonds?  Well, Asian yields continued to rise, notably Australia’s ACGBs (+17.2bps), but most of Europe has reversed course this morning after the trio of ECB speakers seem to have calmed some jitters.  So, Bunds (-1.6bps) and OATs (-1.7bps) have seen modest rallies.  Gilts (+4.0bps), though, have had no commentary to support them and continue to sell off.  Treasury yields are lower by 4.1bps at this hour, which feels very much like a trading reaction (after all yields rose 26bps since Tuesday), but all eyes will be on this morning’s Core PCE data, which if it does print higher than the expected 1.4%, could well start the selling all over again.

Oil prices (-2.2%) are having their worst session in more than two months, but the uptrend remains intact.  Precious metals prices continue to suffer as well, as real yields rise alongside nominal yields, although base metals are holding in a bit better.

And finally, the dollar is stronger pretty much across the board this morning. With AUD (-1.5%) the worst G10 performer and the two havens (CHF and JPY) both lower by just -0.1%.  Down Under, the market finally forced the RBA’s hand regarding their YCC, and the RBA bought $A3 billion of 3-year notes to push yields back below their 0.10% target.  This had the additional impact of discouraging FX investors from owning the currency.  In fact, this is exactly what I would expect of the euro if (when) the ECB does the same thing.

On the EMG side of things, Asian markets last night tried to catch up with the routs seen in LATAM and EEMEA markets yesterday, with INR (-1.4%) and KRW (-1.4%) the leading decliners, but substantial weakness even in the more stable currencies like SGD (-0.3%) and CNY (-0.2%).  This morning, CLP (-0.9%) and MXN (-0.7%) are leading the way lower in this time zone.  And, of course, this is all the same story of shedding risk.

On the data front, a bunch more is coming starting with Personal Income (exp 9.5%), Personal Spending (2.5%) and the aforementioned Core PCE (1.4%) all at 8:30.  Then later in the morning we see Chicago PMI (61.0) and Michigan Sentiment (76.5), but I believe the PCE number is the most important.  Mercifully, there are no further Fed speakers today, but after all, we already know what they think.  Accommodation is going to be with us for a looooong time and higher yields are a sign of confidence, so no problem.

The wrinkle in the higher inflation argument is if the Fed truly does let yields run higher and other countries cap theirs, the stronger dollar will rein in price pressures.  And for now, that appears to be what the market is starting to believe.  I maintain the Fed will not allow yields to continue running higher unabated, but until they act, the dollar should perform well.  Maybe we do retest the 1,1950 level in the euro, and who knows, 107.00 USDJPY is not out of the question.

Good luck, good weekend and stay safe
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