Lower Forever’s Outdated

A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away

The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated

Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm.  Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.

What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today.  Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities.  So, what’s all the hubbub?

Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward.  In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus.  As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data.  Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year.  And they well could do so.

However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it.  And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%.  No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial.  In fact, I doubt two months will qualify.  If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases.  I think the market is way ahead of itself on this issue.

Consider, as well, this puzzle.  The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money.  As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields.  Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt.  One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds.  So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases?  Personally, I cannot do so, it is one or the other.

Which brings us to what can we expect today?  Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement.  As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.

Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets.  If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure.  However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price.  We shall see starting at 2:00 today.

As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals.  Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions.  Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.

Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday.  In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps).  There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates.  By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.

On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level.  While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.

The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%).  The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth.  Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.

EMG currencies are a bit more mixed, with a spread of gainers and losers this morning.  On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty.  A negative ruling could have a major impact on Poland’s banking sector and by extension the economy.  Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news.  On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.

Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact.  Equity futures are biding their time as are most market participants as we all await Mr Powell.  Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.

Good luck and stay safe
Adf