To taper, or not, is the new
Discussion. What will the Fed do?
One group sees next winter
As when the Fed printer
Will slow down if forecasts come true
But yesterday doves answered back
It’s premature to take that tack
There’s no need to shrink
QE, the doves think
‘Til growth has absorbed all the slack
Remember just last month when the Fed tightened the wording in the FOMC statement to explain they would buy “at least $80 billion per month” of Treasuries and “at least $40 billion per month” of agency mortgage-backed securities “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” This was clearly more specific than their previous guidance of buying securities at “the current pace” to achieve the same ends. It would be easy to read that December statement and conclude that reducing asset purchases was quite a long way off in the future, arguably years. This is especially so when considering the fact that the US government cannot afford for interest rates to rise very far given the extraordinarily large amount of debt they have outstanding and need to service. After all, it is much easier to service debt when interest rates are 0.25% than when they are 2.5%.
Granted, the first Covid vaccine had just been approved the weekend before that meeting, so the question of how it would be rolled out was still open, but it had to be clear that the vaccine was going to become widely available in the following months. And yet, the statement seems to imply QE could increase going forward if there was to be any change at all. Yet here we are just four weeks later, and we have heard a virtual chorus of Fed regional presidents explaining that tapering purchases may be appropriate before the end of the year. In the past seven days, Chicago’s Evans, Philly’s Harker, Dallas’s Kaplan and Atlanta’s Bostic all said tapering purchases would be appropriate soon, with Harker explaining it could easily be this year.
That’s pretty powerful stuff, if the Fed is truly considering changing its stance on policy and the ramifications are huge. Arguably, if the Fed truly announced they were going to be reducing purchases, the bond market would sell off much harder than recently, the stock market would sell off quite hard and the dollar would reverse course and rally sharply. But of those three reactions, the only thing ongoing is the steepening of the yield curve, with stocks continuing their slow move higher and the dollar, while consolidating for the past week, hardly on a tear.
Naturally, there is a counterpoint which was reiterated by St Louis’s Bullard and Boston’s Rosengren yesterday, and earlier this week by Cleveland’s uber-hawk, Loretta Mester and Fed vice-Chair Richard Clarida, that there is no sign a taper is appropriate any time soon, and that the Fed will have the printing presses running at full tilt until the pandemic is behind us.
So, which is it? Well, that is the question that will be debated in and by the markets for the foreseeable future, or at least until the Fed tells us. This week, we will hear from nine more Fed speakers, including Chairman Powell, but then the quiet period starts and there will be no word until the FOMC meeting two weeks from today. The list of speakers spans the spectrum from hawkish to dovish, but arguably, all eyes will be on Powell. Many analysts have highlighted the 2013 Taper Tantrum, which resulted after then Fed Chair Bernanke mentioned that the Fed would not be buying bonds forever. The market response then was to drive 10-year Treasury yields from 1.62% on May 1 2013 to 2.99% on September 15 2013! I find it incredibly hard to believe that the current Fed will allow anything like that at all. As I pointed out earlier, the US government simply cannot afford that outcome, and the Fed will prevent it from happening. The implication is that at some point soon, the Fed is going to discuss yield curve control, likely as a method to help finance all the mooted infrastructure spending that is supposed to be coming from the new Administration and Congress. Or something like that. But they will not allow yields to rise that much more, they simply can’t.
How has this
argument discussion played out in the markets today? The picture has been mixed, at best, with perhaps a tendency to reduce risk becoming the theme. Looking at equities, the Nikkei (+1.0%) was the outstanding performer overnight, while we saw marginal declines in the Hang Seng (-0.2%) and Shanghai (-0.3%). European bourses, which had been slightly higher earlier in the session, have slipped back to either side of unchanged with the DAX (-0.15%) and FTSE 100 (-0.1%) a touch lower while the CAC (+0.1%) has edged higher. The CAC has been supported by the news that Alimentation Couche-Tarde is bidding for Carrefours, the French grocery store chain, and a key member of the index. In truth, this performance is a bit disappointing as well, given comments from ECB member Villeroy that they would be supporting the economy with easy money as long as necessary, and that they were carefully watching the exchange rate of the euro. (more on this later). Finally, US futures, which had been slightly higher earlier in the session, are all slightly lower now, but less than 0.1% each.
As to the bond market, safety is clearly in demand, at least in Europe, where yields have fallen by between 1.8bps (Gilts) and 2.7bps (Bunds) with most other markets somewhere in between. Treasuries, meanwhile, have edged higher by just a tick with the yield a scant 0.3bps lower at this time. As I said, this is going to be the battle royal going forward.
In the commodity space, oil is basically unchanged this morning, holding on to recent gains, while gold is also unchanged, holding on to recent losses.
And finally, the dollar is somewhat higher this morning, seeming to take on its traditional role of haven asset. It should be no surprise the euro (-0.3%) is under pressure, which is exactly what the ECB wants to see. Remember, the other sure thing is that the ECB cannot afford for the euro to rally very far as it will negatively impact the Eurozone export community as well as import deflation, something they have been trying to fight for years. Elsewhere in the G10, SEK (-0.95%) is the worst performer after the Riksbank announced they would be selling SEK 5 billion per month to buy foreign currency reserves, and coincidentally weaken their currency. And they will be doing this until December 2023, which means they will be creating an additional SEK 180 billion in the market, a solid 13.5% of GDP. Look for further relative weakness here. But beyond SEK, the rest of the G10 has seen lesser moves, all of a piece with broad dollar strength.
In the emerging markets, CLP (-2.1%) is today’s big loser after announcing that they, too, would be selling CLP each day to increase their FX reserves to the tune of 5% of the Chilean economy. Of course, liquidity in CLP is far worse than that in SEK, so a larger move is no surprise. Regardless, we can expect continued pressure on this peso for a while. But away from this story, the overnight session saw modest strength in most APAC currencies led by IDR (+0.5%) and KRW (+0.4%), while the morning session has seen CE4 currencies suffer alongside the euro, and LATAM currencies give up some ground as well. BRL (-0.6%) seems to be responding to the extremely high inflation print seen yesterday, while HUF (-0.7%) is reacting to the news of an increase in QE there as the central bank expanded its corporate bond purchases to HUF 1.15 trillion from HUF 750 billion previously.
On the data front, today brings CPI (exp 0.4% M/M, 0.1% core) and the afternoon brings the Fed’s Beige Book. With the inflation story gaining traction everywhere, all eyes will be on the data there. If we see a higher than expected print, the pressure will increase on the Fed, but so far, they have been quite clear they are unconcerned with rising prices and are likely to stay that way for quite a while. Ultimately, I fear that is one of the biggest risks out there, rising inflation.
Looking ahead, I believe the dollar’s consolidation of its losses will continue but would be surprised if it rallied much more at all. Rather, a choppy day seems to be in store.
Good luck and stay safe