The narrative now seems to be That tapering’s what we will see The meeting in June Is likely too soon By autumn, though, Jay may agree tran∙si∙to∙ry adjective not permanent. “transitory periods of medieval greatness” per∙sist∙ent adjective continuing to exist or endure over a prolonged period. “persistent rain will affect many areas” Forgive my pedanticism this morning but I couldn’t help but notice the following comment from former NY Fed President William Dudley. “The recent spike in US inflation is likely transitory for now – but it could become more persistent in the coming years as more people return to work.” Now, I don’t know about you, but I would describe the words ‘transitory’ and ‘persistent’ as antonyms. And, of course, we all know that the Fed has assured us that recent rises in inflation are transitory. In fact, they assure us multiple times each day. And yet, here is a former FOMC member, from one of the most important seats, NY Fed president, explaining that this transitory phenomenon could well be persistent. If you ever wondered why the term ‘Fedspeak’ was coined, it was because ‘doublespeak’ was already taken by George Orwell in his classic ‘1984’. Apparently, one does not regain one’s intellectual honesty when leaving a government institution where mendacity is the coin of the realm. However, let us now turn to today’s main story; tapering. The discussion on tapering of QE continues apace and the market is settling on a narrative that the Fed will reduce the amount of its monthly purchases by the end of the year. Certainly, there are a minority of Fed governors who want to get the conversation going in earnest, with St Louis’ James Bullard the latest. And this idea fits smoothly with the concept that the US economy is expanding rapidly with price pressures, even if transitory, building just as rapidly. Just yesterday, Elon Musk compared the shortage in microprocessors needed to build Teslas to the shortage of toilet paper at the beginning of the pandemic last year. (As an aside, one, more permanent, result of that TP shortage is that prices in my local Shop-Rite are significantly higher today than pre-pandemic, at least 40% higher, even though the shortage was transitory no longer persists.) The point is that the combination of shortages of specific items, bottlenecks in shipping and dramatically increasing demand fed by massive government stimulus programs are all feeding into higher prices, i.e. inflation. Even the most committed central bank doves around the world have noticed this situation, and while most are unwilling to alter policy yet, the discussion is clearly beginning. Last night, the RBA omitted their promise “to undertake further bond purchases to assist with progress goals,” despite maintaining their YCC target of 0.10% for 3-year AGB’s. As well, yesterday Fed Governor Lael Brainerd, arguably the most dovish FOMC member, explained, “while the level of inflation in my near-term outlook has moved somewhat higher, my expectation for the contour of inflation moving back towards its underlying trend in the period beyond the reopening remains broadly unchanged.” Apparently, Lael attended the Alan Greenspan school of Fedspeak. Add it all up and you get a market that is convinced that tapering is visible on the horizon and will begin before Christmas 2021. While I don’t doubt it is appropriate, as I believe inflation is not actually transitory, I am also skeptical that the Fed is ready to alter its policy until it sees data showing the employment situation has reached its newly formed goals. I fear that, as usual, the Fed will be late to the tightening party and the outcome will be a far more dramatic policy reversal and much bigger market impact (read stock market decline) than desired. How, you may ask, has this impacted markets today? The big winner has been the dollar, which is firmer against virtually all its counterparts this morning. For instance, NZD (-0.5%) is the laggard in the G10 space after RBNZ comments explaining the balance sheet will remain large for a long time. In other words, while they may stop buying new securities, they will replace maturing debt and so maintain a significant presence in their bond market. Meanwhile, CHF (-0.5%) is under pressure after SNB Vice-president Zurbruegg explained that the bank’s expansive monetary policy, consisting of NIRP and FX intervention is still necessary. The rest of the bloc is also softer, but not quite to that extent with AUD (-0.35%) under pressure from commodity price pullbacks and JPY (-0.35%) suffering after odd comments by a BOJ member that they would respond to any untoward JPY strength in the event the Fed does begin to taper. Emerging market currencies have also been under pressure all evening led by TRY (-0.9%) and KRW (-0.65%). The latter’s movement was a clear response to the PBOC setting its fixing rate for a weaker CNY than the market had anticipated, thus opening the way for a weaker KRW. Given the fact that South Korea both competes aggressively in some markets with Chinese manufacturers, and has China as its largest market, the intricacies of the KRW/CNY relationship are many and complex. But in a broad dollar on scenario, it is not too surprising to see both currencies weaken, and given KRW’s recent strong performance, it had much further to fall. But currency weakness in this bloc is across EEMEA, APAC and LATAM, which tells us it is much more about the dollar than about any particular idiosyncratic stories. In the rest of the markets, equities were mixed in Asia (Nikkei +0.45%, Hang Seng -0.6%, Shanghai -0.75%) while Europe is green, but only just (DAX +0.15%, CAC +0.3%, FTSE 100 +0.1%). US futures are either side of unchanged at this hour as the market tries to digest the tapering story. Remember, much of the valuation premium that exists in the US is predicated on lower forever interest rates. If they start to climb, that could easily spell trouble. Speaking of interest rates, they have edged lower in the session with 10-year Treasury yields down 0.3bps while in Europe, yields have fallen a bit faster (bunds -1.4bps, OATs -1.5bps, gilts -1.2bps). Certainly, there is no keen inflationary scare in this market as of yet. Interestingly, oil prices continue to rise, despite the stronger dollar, with WTI (+1.0%) trading to new highs for the move. But the rest of the commodity space finds itself under pressure this morning as the dollar’s strength takes its toll. Precious metals are softer (Au -0.25%, Ag -0.5%) as are base metals (Cu -0.8%, Al -0.5%) although the ags are holding up. But if dollar strength is persistent, I expect that commodity prices will remain on the back foot. On the data front, today brings only the Fed’s Beige Book this afternoon, as the ADP employment number is delayed due to the Memorial Day holiday Monday. As well, we hear from four Fed speakers, including three, Harker, Kaplan and Bostic, who have been in the tapering camp for several weeks now. However, until we start to see the Treasury market sell off more aggressively, I think tapering will be a nice talking point, but not yet deemed a foregone conclusion. As such, that link between Treasury yields and the dollar remains solid, with the dollar likely to respond well to further discussions of tapering and higher yields. We shall see if that is what comes to pass regardless of the current narrative. Good luck and stay safe Adf
The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt
In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere
It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions. For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm. Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year. Which means that the entire argument is based on dueling forecasts of the future beyond that. In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.
What is transitory? Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now. According to Merriam-Webster, it describes something of brief duration or temporary. Which begs the question, what is brief? Is 3 months brief? 6 months? Longer? Arguably, brief depends on the context involved. For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.
There continue to be strong arguments in favor of both sides of the argument. On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years. No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices. As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items. Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral. In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.
Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains. In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices. We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation. Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support. As they are wont to say, the Fed can’t print copper or corn. The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?
Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets. By now, you are all aware I remain in the inflationist camp and have been for a while. I cannot ignore the rising prices I see every time I go into a store. But the deflationists make excellent points. This argument discussion will rage for at least another two months and the July CPI release. Until then, the one thing that seems clear is that market volatility is likely to remain significant.
As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed. At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well. US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.
Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively. Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.
Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).
Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs. Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%). Much of this movement seems to be on the back of positioning rather than fundamental news. On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.
EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region. CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line. On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.
Not a ton of data this week, but here is what we see:
|Friday||Existing Home Sales||6.08M|
The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total. Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.
With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck. This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along. If you are in the deflationist camp, it’s the opposite. But remember, at a point in time, inflation will undermine the dollar’s value. Just not right away.
Good luck and stay safe