Tag Archives: #supplychains

More Duration

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A governor, Fed, name of Waller
Who previously had been a scholar
Remarked that inflation
Might have more duration
Which could cause a weakening dollar

As well, he explained that his view
Was rate hikes just might soon ensue
Were that to transpire
Then yields would move higher
While equity losses accrue

In what can only be termed a bit surprising, Fed governor Chris Waller, the FOMC member with the shortest tenure, explained yesterday that he is “greatly concerned abut the upside risk that elevated inflation will not prove temporary.”  While refreshing, that is certainly a far cry from the narrative that the Fed has been pushing for many months.  Of course, if one simply looks at the inflation data, which has been trending sharply higher, it seems apparent that transitory is not an apt description.  As well, he is the first Fed member to be honest in the discussion about bottlenecks and supply chain issues as he commented, “bottlenecks have been worse and are lasting longer than I and most forecasters expected, and an important question that no one knows the answer to is how long these supply problems will persist.” [emphasis added].

During the entire ‘transitory inflation’ debate, the issue with which I most disagreed was the working assumption that these transportation bottlenecks and supply chain disruptions would quickly work themselves out.  It was as though the central bank community believed that because economic models explain that higher prices lead to increased production of those goods or services, the result was a magical appearance of additional supply to push prices back down.  Meanwhile, in the real world filled with regulations, restrictions and skill and resource mismatches and misallocations, these things can take a long time to correct themselves.  There is no little irony that government regulations regarding truck drivers have significantly reduced the supply of available truckers which has led to those very bottlenecks that are now bedeviling the economy (and government).  Alas, in the great Rube Goldberg tradition, rather than simplify processes to open up supply chains, it appears that government will be adding new regulations designed to offset the current ones which will almost certainly have other negative consequences down the road.

Finally, Governor Waller was refreshingly honest in his view of things like core inflation and trimmed-mean CPI or PCE calling them, “a way of manipulating data.”  Of course, that is exactly what they are.  Central banks have relied on these lower numbers as a rationale for continuing extraordinarily easy monetary policy despite the very clear rise in inflation.   And despite Mr Waller’s comments, the Powell/Yellen narrative remains inflation is not that high and anyway it’s transitory.

As it happens, though, the bond market seems to have been listening to Waller’s comments as it sold off pretty aggressively yesterday with yields backing up 4 basis points to their highest level since May.  While this morning Treasury yields are unchanged, it is becoming clear that a trend higher in yields is manifesting itself with the market clearly targeting the highs seen in March at 1.75%.

A fair question would be to ask if this price action is occurring elsewhere in the world and the answer would be a resounding yes.  For instance, UK Gilts, which today have actually fallen 3.1bps, are trending sharply higher over the past two months and are at their highest levels since early 2019.  Today’s UK CPI report showed inflation at 3.1%, which was a tick lower than forecast, but still well above their 2.0% target.  In addition, virtually the entire MPC has acknowledged that CPI is likely to rise above 4.0% by December with a very uncertain timeline to fall back.  Governor Bailey has made it clear that they will be raising interest rates at their next meeting in early November and there has been no pushback regarding the market pricing in 3 more rate hikes in 2022.

The upshot of all this is the carefully curated narrative by the Fed and its brethren is being destroyed by events on the ground and in addition to damage control, they are trying very hard to establish the new narrative.  However, it is not clear the market is going to be so willing to go along this time.  Too, all this price pressure is occurring with a backdrop of softening economic data, with yesterday’s Housing data the latest numbers to fall both from the previous month and below forecasts.  As I’ve written before, were I Chairman Powell, I wouldn’t accept renomination even if it is offered.  The Fed chair, when things hit the fan, will not have a very good time.

On the flip side of all this distress there is the equity market, which continues blithely along the trail of rallying on every piece of news, whether good or bad.  Now that we have entered earnings season, with expectations for a strong Q2 (after all, GDP grew at 6.8%), algorithms investors remain ready to buy more of whatever is hot.  Yesterday saw solid gains across all three US indices and we continue to see more strength than weakness overseas.  In Asia, for instance, the Nikkei (+0.15%) edged higher while the Hang Seng (+1.35%) had quite a good day although Shanghai (-0.2%) continues to suffer under the ongoing pressure from the Chinese real estate market.  Today another Chinese real estate developer, Sinic, defaulted on a bond and by the end of the week the 30-day grace period for Evergrande will end and we will see if there are more ramifications there.

As to the rest of the world, both Europe (DAX +0.1%, CAC -0.1%, FTSE 100 +0.1%) and US futures are essentially flat this morning.  The investor question is, can strong earnings offset tighter monetary policy?  While we shall see over the course of the next few weeks, I suspect that a more hawkish Fed, if that is what shows up, will be very difficult to offset for the broad indices.

Commodities have taken a breather today with oil (-1.2%) and NatGas (-1.3%) slipping and dragging most other things down with them.  So, copper (-1.3%) and aluminum (-1.1%) are feeling that pain although gold (+0.7%) and silver (+1.25%) are both benefitting from either the inflation narrative or the fact that the dollar is arguably somewhat softer.

Speaking of the dollar, it is best described as mixed today, with a range of gainers and losers versus the greenback.  In the G10, NOK (-0.45%) is the worst performer, clearly suffering on the back of oil’s decline, with the pound (-0.3%) next in line after CPI printed a tick lower than expected and some thought that might dissuade the BOE from raising rates (it won’t).  But other than those two, everything else is +/- 0.15% which is indicative of nothing happening.

EMG currencies are also mixed with the biggest winners INR (+0.6%) and KRW (+0.4%) both benefitting from equity market inflows amid hopes for stronger growth.  After that, the gainers have been modest at best with nothing really standing out.  On the downside, RUB (-0.2%) following oil and CNY (-0.2%) have been the worst performers.  China is interesting as the PBOC set the fix for a much weaker than expected renminbi as it is clearly becoming a bit uncomfortable with the currency’s recent appreciation (+1.9% in past two months before last night).  Remember, for a mercantilist economy like China, excessive currency strength is an economic problem.  Look for the PBOC to continue to push against further strength.

On the data front, only the Fed’s Beige Book is released this afternoon, but we do hear from 5 more FOMC members.  Remember, nobody expected Waller’s comments to be market moving, so we must keep our antenna up for something else.

In fact, my sense is that the Fed is going to try very hard to reestablish the narrative they want regarding inflation and the future of interest rates.  That implies we are going to hear more and more from Fed speakers.  The risk is that the divide at the Fed between hawks and doves will widen to a point where no consistent narrative is forthcoming.  At that point, markets are likely to pay less attention to the comments and more to the data and expectations.  If forward guidance loses its strength, the Fed will be in a much worse position and market volatility is likely to increase substantially.  However, we have not yet reached that point.  In the meantime, the dollar is searching for its next catalyst.  Until then, consolidation of recent gains continues to be the most likely outcome.

Good luck and stay safe
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Filled with Frustration

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The Beige Book explained ‘round the nation

That growth was up, as was inflation

As well, we all learned

Of job offers spurned

And businesses filled with frustration

Meanwhile, round the world, PMI’s

Of Services were no surprise

As nations reopen

Most people are hopin’

The world will, at last, normalize

Ahead of tomorrow’s NFP report in the US, one which given last month’s extraordinary miss will be closely scrutinized by both investors and the Fed, most markets appear to be biding their time in narrow ranges.  This was largely true yesterday and so far, remains the case in the Asian and European sessions.  This lull in activity offers an excellent time to consider the supporting data that we have received in the past twenty-four hours, as well as the remainder due this morning.

Starting with the Fed’s Beige Book yesterday, the report highlighted the features of the economy we have been hearing about for the past several months.  The lifting of Covid inspired restrictions has led to strong increases in demand for products and services ranging from houses and cars to hotels and restaurants.  Business owners indicated that a combination of supply chain bottlenecks and increased demand have been forcing prices higher and that they saw no reason for that to end soon.  They also continue to comment on their inability to hire the workers necessary to satisfy demand, especially in lower wage segments of the economy.  The anecdote I feel best illustrates the issue came from St Louis where a job fair held by a dozen restaurants to fill more than one hundred open positions drew only twelve candidates!  It certainly appears as though the ongoing extra Federal unemployment benefits being offered through September are discouraging a lot of people from going back to work.

One of the underlying beliefs regarding the Fed’s transitory inflation story is that supply chain interruptions will quickly resolve themselves.  And it is not just the Fed that believes this will be the case, but virtually every other economist as well.  But I wonder, what prompts their faith in that outcome?  After all, with available labor scarce, who is going to relink those chains?  Consider, as well, industries like mining and extraction of raw materials.  Shortages of copper and iron ore require the reopening of mines or excavating new ones.  One of the impacts of Covid was that not only were current operating mines closed, but capex was drastically cut, so there is a significant disruption in the exploration process.  Add to that the rise of ESG as a business objective, which will, at the very least slow, if not prevent, the opening of new sources of these raw materials, and it becomes quite easy to believe that these bottlenecks will remain for more than just a few months.  In fact, it would not be surprising if it was several years before the supply/demand balance in many commodities is achieved.  Given the current assessment is a lack of supply, you can be certain that prices will continue to rise far longer than the Fed will have you believe.

As to the overnight session, we were regaled with the Services PMI data from around the world.  In Asia we saw Australia solid, at 58.0, and right in line with last month, while Japan, 46.5, did show a marginal increase, but remains well below the growth-contraction line of 50.0.  China’s Caixin data, at 55.1, was disappointing vs. expectations as well as lower by 1.2 points compared to April’s reading.  Is the Chinese economy beginning to roll over?  That is a question that is starting to be asked and would also explain the PBOC’s sudden concern over a too-strong renminbi.  In a strong economy, a rising currency is acceptable, but if things are not as good, currency strength is an unwelcome event.  Finally, the last major Asian nation reporting, India, showed awful data, 46.4, demonstrating the huge negative impact the recent wave of Covid infections is having on the economy there.

The European story was a bit better overall, with Germany (52.8 as expected), France (56.6 as expected), Italy (53.1 better than expected) and the Eurozone (55.2 slightly better than expected) all demonstrating the recovery is underway on the continent.  As well, the UK continues to burn brightly with a 62.9 reading, more than a point higher than forecast.  And don’t forget, later this morning the US releases both the PMI data (exp 70.1) as well as ISM Services (63.2) both demonstrating that the US economy remains the global leader for now.  With that in mind, it is kind of odd that the dollar is so hated, isn’t it?

The other data coming this morning will give us our first hints at tomorrow’s NFP with ADP Employment (exp 650K) released 15 minutes before both Initial (387K) and Continuing (3.614M) Claims.  As well, at 8:30 we see Nonfarm Productivity (5.5%) and Unit Labor Costs (-0.4%), which on the surface would indicate there are no wage pressures at all but continue to be distorted by the past year’s data outcomes.

As to the market situation, while equity markets in Asia were mixed (Nikkei +0.4%, Hang Seng -1.1%, Shanghai -0.4%), Europe has turned completely red (DAX -0.5%, CAC -0.4%, FTSE 100 -0.9%) despite the solid PMI data.  This feels far more like some profit taking ahead of tomorrow’s data as well as the upcoming ECB meeting next week.  US futures are also under pressure, with all three major indices lower by between 0.5% and 0.75%.

What is interesting about the market is that despite the selloff in stocks, we are seeing a selloff in bonds as well, with Treasury yields higher by 1.5bps and European sovereigns all higher by at least 1 basis point (Bunds +1.1bps, OATs +1.4bps, Gilts +2.7bps).  This, of course, begs the question, if investors are selling both stocks and bonds, what are they buying?

The answer is not clear at this point.  Oil (WTI -0.1%) while outperforming everything else, is still down on the day, as are gold (-0.65%) and silver (-1.4%).  Base metals?  Well, copper (-1.0%) is clearly not the winner, although aluminum (+0.25%) is the only green spot on the screen.  Well, that and agricultural products with Soybeans (+1.25%), Wheat (+1.0%) and Corn (+0.85%) all quite strong this morning, punctuating the idea that food inflation is running at its highest level in more than a decade according to a just released UN report.  That is something I certainly see every week at Shop-Rite and I imagine so does everyone else.

Finally, a look at the FX market shows the dollar is having a pretty good day all around.  In the G10, the pound (+0.1%) is the only currency to hold its own vs. the greenback, with the rest of the bloc lower by between 0.2% and 0.4%.  Frankly, this simply looks like a risk-off session as investors are selling both stocks and bonds across the G10, and no longer need to hold the local currencies.  In the EMG bloc, the story is largely the same, with only INR (+0.25%) rising and the rest of the bloc under some pressure.  The rupee movement seems to be more technical as alongside weak PMI data, the RBI meeting, coming up tonight, is expected to see policy remain unchanged with a dovish bias given the ongoing Covid problems in the country.  On the downside, while most currencies are lower, aside from TRY (-0.5%) on slightly lower inflation, therefore less need to maintain high rates, the rest of the bloc’s declines are only on the order of -0.2%.  Finally, I would be remiss if I didn’t mention yesterday’s price action in LATAM currencies, where we saw significant strength in BRL (+1.5%) and CLP (+1.1%) which has been a broad continuation of funds flowing back into the region.

We have a few more Fed speakers today, but they all say exactly the same thing all the time, it seems, that they are thinking about considering starting a discussion on tapering.  In this vein, there was a big announcement yesterday that the Fed would be unwinding one of the emergency bond buying programs, the secondary market corporate program, and selling out the $13 billion of bonds and ETF’s they own.  Of course, that is such a tiny proportion of their balance sheet, and of that market in truth, it seems unlikely to matter at all.

My observation lately has been that NY tends to go against the prevailing trend for the day during its session, meaning on a day like today, when the dollar is well bid as NY arrives, I would look for a bit of dollar selling.  We shall see, but in fairness, all eyes are really on tomorrow.

Good luck and stay safe

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