Tag Archives: #tapering

We’ll Be Behind

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The Chair and the Vice-Chair both said
Before we raise rates at the Fed
We’ll taper our buying
While we’re verifying
If growth can keep moving ahead

So, don’t look at forecasts ‘cause we
Care only for hard stats we see
Thus, we’ll be behind
The curve, but you’ll find
Inflation we’ll welcome with glee

The Fed has made clear they are driving the bus looking only in the rearview mirror.  This is a pretty dramatic change in their modus operandi.  Historically, given the widespread understanding that monetary policy works with a lag of anywhere from 6 months to 1 year, the Fed would base policy actions on their forecasts of future activity.  This process was designed to prevent inflation from rising too high or allowing growth to lag too far from trend.  One of the problems they encountered, though, was that they were terrible forecasters, with their models often significantly understating or overstating expectations of future outcomes.

So, kudos to Chairman Powell for recognizing they have no special insight into the future of the economy.  It is always difficult for an institution, especially one as hidebound as the Federal Reserve, to recognize its shortcomings.  This does beg the question, though, if they are going to mechanically respond to data with policy moves, why do they even need to be involved at all?  Certainly, an algorithm can be programmed to make those decisions without the added risk of making policy errors. Instead, the Fed could concentrate on its role as banking supervisor, an area in which they have clearly fallen behind.  But I digress.

Back in the real world, this change, which they have been discussing for some time, is truly important.  It seems to be premised on the idea that measured inflation remains far below their target, so running the economy ‘hot’ is a desirable way to achieve that target.  And running the economy hot has the added benefit of helping to encourage maximum employment in the economy, their restated goal on that half of the mandate.  It also appears to assume that they have both the tools, and the wherewithal to use them, in case inflation gets hotter than currently expected.  It is this last assumption that I fear will come back to haunt them.  But for now, this week’s CPI data did nothing to scare anybody and they are feeling pretty good.

One other thing they both made clear was that the timing of any rate hike was absolutely going to be after QE purchases are completed.  So, the tapering will begin at some point, and only when they stop expanding the balance sheet will they consider raising the Fed Funds rate.  Right now, the best guess is late 2023, but clearly, since they are data driven, that is subject to change.

There is a conundrum, though, in the markets.  Despite this very clear policy direction, and despite the fact that bond investors are typically quite sensitive to potential inflation, Treasury yields have seemingly peaked for the time being and continue to slide lower.  Certainly, the auctions this week, where the Treasury issued $120 billion in new debt were all well received, so concerns over a buyer’s strike were overblown.  In fact, overnight data showed that Japanese buyers soaked up nearly $16 billion in bonds, the largest amount since last November.  But, depending on how you choose to measure real interest rates, they remain somewhere between 0.0% and -1.0% based on either Core or Headline CPI vs. the 10-year.  Traditionally, headline has been the measure since it represents everything, and for a bond investor, they still need to eat and drive so those costs matter.

Summing this all up tells us 1) the Fed is 100% reactive to data now, so overshooting in their targets is a virtual given; 2) interest rates are not going to rise for at least another two years as they made clear they will begin tapering their QE purchases long before they consider raising interest rates; and 3) the opportunity for increased volatility of outcomes has grown significantly with this new policy stance since, by definition, they will always be reactive.  To my mind, this situation is one where the current market calm is very likely preceding what will be a very large storm.  If central banks handcuff themselves to waiting for data to print (and remember, hard data is, by definition, backwards looking, generally at least one month and frequently two months), trends will be able to establish themselves such that the Fed will need to respond in a MUCH greater manner to regain control.  Markets will not take kindly to that situation.  But that situation is not yet upon us, so the bulls can continue to run.

And run they have, albeit not as quickly as they have been recently.  In Asia overnight, it was actually a mixed performance with the Nikkei (+0.1%) eking out a small gain while the Hang Seng (-0.4%) and Shanghai (-0.5%) both stumbled slightly.  Europe, on the other hand, is all green with gains ranging between 0.2% and 0.4% across the major markets.  US futures are actually looking even better, with gains of 0.45%-0.6% at this hour.  Earnings season started yesterday, and the big banks all killed it in Q1, helping the overall market.

Bond yields, meanwhile, are continuing to slide, with Treasuries (-1.9bps) continuing to show the way to virtually all Western bond markets.  Bunds (-1.6bps), OATs (-2.0bps ) and Gilts (-2.7bps) are rallying as well despite the generally upbeat economic news.  There was, however, one negative release, where the German economic Institutes have cut their GDP forecast by 1.0%, to 3.7%, after the third wave and concomitant lockdowns.

Oil prices, which have had a huge runup this week, have slipped a bit, down 0.5%, but the metals markets are all in the green with Au (+0.6%), Ag (+0.6%), Cu (+1.5%) and Al (+0.25%) all in fine fettle.

It can be no surprise that with Treasury yields lower and commodity prices generally higher, the dollar is under further pressure this morning.  In the G10, the commodity bloc is leading the way with NZD (+0.25%), CAD (+0.2%) and AUD (+0.2%) all performing well.  There are a few laggards, but the movement there is so small, it is hardly a sign of anything noteworthy.  The euro, for instance, is lower by 0.1%, truly unremarkable.  In the EMG bloc, RUB (-1.2%) is the biggest mover, suffering on the news that the Biden Administration is slapping yet more sanctions on Russia for their election meddling efforts.  After that, HUF (-0.4%) has suffered as the central bank maintains its rate stance despite quickening inflation readings.  On the plus side, ZAR (+0.65%) and MXN (+0.3%) are the leading gainers, both clearly benefitting from the commodity story today.

One thing to watch here is the technical picture as despite the slow-motion decline in the dollar since the beginning of the month, it is starting to approach key technical support levels with many traders looking for a breakout should we breach those levels.  We shall see, but certainly if Treasury yields continue to slide, the dollar is likely to slide further.

We have a bunch of data today led by Initial Claims (exp 700K), Continuing Claims (3.7M), Retail Sales (+5.8%, +5.0% ex autos) and then Empire Manufacturing (20.0), Philly Fed (41.5), IP (2.5%) and Capacity Utilization (75.6%).  The Retail Sales data is based on the second stimulus check being spent, and the Claims data is assuming strength based on the NFP from last month.    We also hear from a bunch more speakers, but Powell and Clarida are done, so it would be surprising to see anything new from this group of three.

All told, nothing has changed my view that as goes the 10-year Treasury yield, so goes the dollar.  That will need to be proven wrong consistently before we seek another narrative.

Finally, I will be taking a few, very needed, days off so there will be no poetry until I return on Thursday April 22.

Good luck, good weekend and stay safe
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Not If But When

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Eight years ago, when Chairman Ben
Suggested t’was not if but when
The Fed would reduce
Its purchase, profuse,
Of bonds, traders sold bonds, bought yen

But these days when taper’s discussed
The bond market doesn’t seem fussed
The reason could be
There’s now nobody
The market invests with its trust

Yesterday’s CPI data printed a tick higher than forecast indicating that, yes, prices are rising relative to last year.  The headline print of 2.6% was the beneficiary of a substantial rise in energy prices compared to last year, but the core price index indicated that both goods and services prices are rising in price.  One data point is not enough to make any claims in either direction, but it will certainly keep the discussion going for a while.  The market response was somewhat counterintuitive as by the end of the day, 10-year Treasury yields had fallen 6 basis points and the dollar was softer amid modestly firmer equity prices.  While the link between the dollar and Treasuries remains intact, the question is why would bonds rally (yields decline) if inflation was rising?

One possible answer is that the market had gotten far ahead of itself with respect to pricing in rising inflation.  Historically, inflation takes time to manifest itself as prices on many things are sticky, meaning they remain stable for a time amid broad pressures and then shift in a relatively large step, rather than a gradual daily or weekly increase.  We are all familiar with the situation when an item regularly purchased suddenly rises in price to catch up to the broad underlying price pressures.  But when taken over the totality of all goods purchased, while any given good or service may see prices rise in discrete steps, the index moves up in a relatively smooth manner.  This fact is why yesterday’s data are interesting, because the headline jump of 0.6% M/M certainly tests the definition of smooth.  Consider that a monthly increase of 0.6% would result in annual inflation of 7.4%, a level that even the Fed would consider too hot.  FYI, yesterday’s core print, which was actually 0.34%, would represent 4.2% core CPI over a year.  So, yes, the base effects were instrumental in the much higher Y/Y data, but the monthly increases were pretty high in any accounting.

And yet, the bond market ultimately rallied all day, having touched 1.7% in early European trading and closing the session at 1.615%.  If this wasn’t a classic case of buy the rumor, sell the news, I don’t know what is.  And, as we have seen consistently all year, the dollar dutifully followed yields lower while equity markets ultimately rallied, although the euphoria over the value trade seems to be waning.

Perhaps of more interest is the fact that we have now had 3 key central bankers, two from the ECB, Knot and Villeroy, and the Fed’s Bullard all start to discuss the idea of tapering bond purchases.  This seems incongruous given the adamant claims on both sides of the pond that current monetary policy is necessary and appropriate to ensure the respective economies return to form.  And yet each of these discussed how tapering of QE could begin before the year is out.  You may recall that Bullard wanted to tie the idea of tapering to the level of vaccinations in the economy, indicating that when 75% of the population is vaccinated, it could be time to start slowing purchases with the implication being the economy would then be able to stand on its own two feet.

This morning, Banque de France Governor Villeroy de Galhau explained that there could be an evolution in monetary policy at the ECB, which while remaining accommodative would shift the burden back to the APP (the original QE plan) from PEPP, which will ostensibly run its course in March 2022.  Last week, Knot, the Dutch Central Bank president expressed his view that the current expectations of robust growth in the second half of the year could be a signal to begin tapering asset purchases.  Now, understand that there were members from both central bank committees pushing back on the idea, but the fact remains that there is some consideration of tapering.  Today, we hear from Chairman Powell again, but we will not hear from Madame Lagarde until her press conference after the ECB meeting next week.

Adding up the disparate facts is quite difficult.  On the one hand, we have the first trial balloons floated regarding tapering of asset purchases as a response to the forecasts for extremely robust growth this year.  On the other hand, the market appears to have indicated that, at least for now, the idea of much faster growth leading to much higher inflation has run its course.  It strikes me that the market is unlikely to worry too much about these trial balloons until they hear from Powell and/or Lagarde.  Until then, it appears that a short period of higher inflation readings is on the cards and unless they really start to spike, that is unlikely to have a big impact on either equities or bonds.

Speaking of equities, yesterday saw the S&P 500 close at yet another new all-time high with the NASDAQ pushing back to within 1% of its February record.  Clearly, there is no inflation scare there.  Rather, all eyes are turning to the first earnings releases due today.  Overnight saw the Nikkei slide (-0.4%) but elsewhere in Asia equities rallied (Hang Seng +1.4%, Shanghai +0.5%).  European markets are mixed with the DAX (-0.1%) lagging while both the CAC (+0.4%) and FTSE 100 (+0.3%) continue to grind higher.  Apparently, Villeroy’s comments about tapering have not been seen as a danger.  US futures are modestly higher at this point, just 0.2% or so as the market bides its time ahead of Powell’s comments at noon.

In the bond market, after a big rally yesterday, the 10-year has seen yields back up slightly, by 1.1 bps, although European bonds are all looking at modest yield declines (Bunds -1.0bps, OATs -1.2bps, Gilts -0.3bps).  It has become pretty clear that the rush higher in yields has stalled for now, with important implications for all the other markets, especially the dollar.

Oil prices are continuing their recent rebound, with WTI +1.6%, although the price action in the metals markets remains confusing.  Precious metals rallied sharply yesterday but are little changed this morning.  Base metals continue to trade both ways with Cu (+1.1%) leading the way higher, but Al (-0.3%) lagging.  It all seems very much like a consolidation period ahead of the next leg higher.

As to the dollar, after sliding all day yesterday alongside Treasury yields, it is continuing lower this morning.  The leading gainer is NZD (+0.8%) which has rallied based on the market’s interpretation that standing pat by the RBNZ last night was actually hawkish, which has helped drag AUD (+0.65%) higher as well.  Oil is supporting NOK (+0.45%) but the rest of the moves are far less significant.  EMG currencies are also performing well this morning, led by KRW (+0.85%) and TRY (+0.5%).  The won was a beneficiary of the generally falling dollar as well as foreign inflows into the KOSPI.  TRY, on the other hand, simply offers yields that are too high to resist for certain investors, despite rising inflation there.

The only data today is the Fed’s Beige Book, to be released at 2:00, but aside from Powell at noon, we hear from four other Fed speakers including vice-chairman Clarida at 3:45 this afternoon.  Come Friday, the Fed will enter their quiet period ahead of the next FOMC meeting, so it seems everyone wants to get their thoughts aired ahead of that.

In the end, the dollar remains beholden to 10-year Treasury yields, so we could be in for a period of very limited movement, if Treasuries have found a new home.  Unless we hear something new from the Chairman today, I expect we are looking at a period of quiet for the next two weeks.  The calm before the storm.

Good luck and stay safe
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Both Need Downgrading

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Excitement in markets is fading
With GameStop and silver both trading
Much lower today
As sellers convey
The message that both need downgrading

Well, it appears that the GameStop bubble is deflating rapidly this morning, which is only to be expected.  Short interest in the stock has fallen from 140% of market cap to just 39% as of yesterday’s close.  This means that there is precious little reason for it to rally again, as, if you recall, the company’s business model remains a bad fit for the times.  The top tick, last Thursday, was $483 per share.  In the pre-market this morning it is trading at $172, and I anticipate that before the end of the month, it will be trading back to its pre-hype $17-$18 level.  But it was fun while it lasted!

Meanwhile silver, yesterday’s story, has also fallen sharply, -4.7% as I type, as the mania there seems to have been more readily absorbed by a much larger market.  The conspiracy theory that the central banks and JP Morgan have been manipulating the price lower for the past several decades has always been hard to understand but was certainly more widespread than I expected.  The major difference between silver and GME though, is that silver has a real raison d’etre as an industrial metal, as well as a traditional store of wealth and monetary metal.  Last year silver’s price rose 46.5%, leading all precious metals higher.  And, in the event that inflation does begin to show itself again, something I believe is coming soon to a screen near you, there is a strong case to be made for it to rally further.  This is especially so given the ongoing debasement of all fiat currencies by central banks around the world as they print more and more each day.

Down Under the RBA stunned
The market and every hedge fund
Increasing QE
As they want to see
The Aussie increasingly shunned

While other major central banks stood pat in their recent policy meetings, the RBA last night surprised one and all by increasing the amount of QE by A$100 billion, at A$5 billion / month, meaning they will continue the program well into 2022.  As well, they explained that they would not consider raising rates until 2024 at the earliest as they work to push unemployment lower.  This means, the overnight rate will remain at 0.1% and YCC for the 3-year bond will also remain at that level.  Interestingly, the market had tapering on its mind, as ahead of the meeting AUD had rallied nearly 0.6%, with analyst discussions of tapering rampant.  As such, it is no surprise that the currency gave up those gains immediately upon the release of the statement, and has now fallen 0.25% on the day, the worst laggard in the G10.

With the FOMC meeting behind us, Fed speakers are going to be inundating us with their views for the next month, so be prepared for a lot more discussion on this topic.  Remember, before the quiet period ahead of the January meeting, four regional presidents were talking taper, with two seeing the possibility of that occurring late in 2021.  Chairman Powell, however, tried to squelch that theory in the statement and press conference.   Yesterday, uber-dove Neel Kashkari expressed his view that it is “..key for Fed to keep foot on monetary policy gas.”  Meanwhile, Raphael Bostic and Eric Rosengren both harped on the need for additional fiscal stimulus to revive the economy, with Bostic once again explaining that tapering when economic growth picks up will be appropriate, although giving no timeline.  (He was one of the four discussing a taper ahead of the meeting.)  We have seven more speakers this week, some of them multiple times, so there will certainly be headline risk as this debate plays out in public.

But for now, markets are sanguine about the possibility of central bank tightening in any way, shape or form, as once again, risk is being embraced across the board.  Starting in Asia, we saw green results everywhere (Nikkei +1.0%, Hang Seng +1.2%, Shanghai +0.8%), with the same being true in Europe (DAX +1.1%, CAC +1.6%, FTSE 100 +0.5%).  US futures are pointing in the same direction with gains on the order of 0.75% at 7:00am.

Bond markets are also on board the risk train, with yields rising in Treasuries (+2.9 bps) and throughout Europe (Bunds +2.7bps, OATs +2.2bps, Gilts +3.1bps).  Part of this positivity seems to be coming from the release of Eurozone Q4 GDP data, which was not quite as bad, at -0.7% Q/Q (-5.1% Y/Y) as forecast.  That outcome, though, was reasonably well known ahead of time as both Germany and Spain printed Q4 GDP at +0.1% in a surprise last week.  Unfortunately, the ongoing lockdowns throughout Europe, which have been extended into March in some cases, point to another quarter of economic contraction in Q1, thus resulting in a second recession in short order on the continent.  With that in mind, while we have not heard much from ECB speakers lately, it is certainly clear that there is no taper talk in Frankfurt at this time.

Which takes us to the currency markets.  The G10 bloc is split with EUR (-0.25%) matching AUD’s futility, while the rest of the European currencies are all modestly lower.  Commodity currencies, however, are holding their own led by CAD (+0.35%) which is benefitting from oil’s rally (+1.3%), although NOK (+0.1%) has seen less benefit.  EMG currencies, however, lean toward gains this morning, with MXN (+0.8%), BRL (+0.6%) and RUB (+0.6%) leading the way, each benefitting from higher commodity prices.  Even ZAR (+0.5%) is higher despite the lagging in precious metals.  But that story is far more focused on ZAR interest rates, which are an attractive carry play in a risk on scenario.  The laggards in this bloc are basically the CE4, tracking the euro, and even those losses are minimal.

While there is no data this morning in the US, we do have important statistics coming up later in the week as follows:

Wednesday ADP Employment 50K
ISM Services 56.7
Thursday Initial Claims 830K
Continuing Claims 4.7M
Nonfarm Productivity 4.0%
Unit Labor Costs -3.0%
Factory Orders 0.7%
Friday Non Farm Payrolls 60K
Private Payrolls 100K
Manufacturing Payrolls 31K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B
Consumer Credit $12.0B

Source: Bloomberg

So, plenty to see, but will we learn that much?  Obviously, all eyes will be on the payroll data, which given the rise in Initial Claims we have seen during the past month seems unlikely to surprise on the high side.  As such, anticipating sufficient data exuberance to get the Fed doves to talk about tapering seems remote.

Adding it all up leaves the current short dollar squeeze in place, with an opportunity, I think, for the euro to trade back below 1.20 for a time, but nothing we have seen or heard has changed my view that the dollar will fall in the second half of the year.  For those of you with payables, hedging sooner rather than later should be rewarded over time.

Good luck and stay safe
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