Tag Archives: #treasuries

Likely to Fade

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The bond market’s making it clear

Inflation, while higher this year,

Is likely to fade

Just like Jay portrayed

While bottlenecks soon disappear






The data though’s yet to support





Inflation’s rise will be cut short





Perhaps CPI





Next week will supply





The data the Fed does purport





For the past month, virtually every price indicator in the G20 has printed higher than forecast, which continues a multi-month trend and has been a key support of the inflationist camp.  After all, if the actual inflation readings continue to rise more rapidly than econometric models indicate, it certainly raises the question if there is something more substantial behind the activity.  At the same time, there has been a corresponding increase of commentary by key central bank heads that, dammit, inflation is transitory!  Both sides of this debate have been able to point to pieces of data to claim that they have the true insight, but the reality is neither side really knows.  This fact is made clear by the story-telling that accompanies all the pronouncements.  For instance, the transitory camp assures us that supply-chain bottlenecks will soon be resolved as companies increase their capacities, and so price pressures will abate.  But building new plant and equipment takes time, sometimes years, so those bottlenecks may be with us for many months.  Meanwhile, the persistent camp highlights the idea that the continued rise in commodity prices will see input costs trend higher with price rises ensuing.  But we have already seen a significant retreat from the absolute peaks, and it is not clear that a resumption of the trend is in the offing.  The problem with both these stories is either outcome is possible so both sides are simply talking their books.





While I remain clearly in the persistent camp, my take is more on the psychological effects of the recent rise in so many prices.  After all, even the Fed is focused on inflation expectations.  So, considering that recency bias remains a strongly inbred human condition, and that prices have risen recently, there is no question many people are expecting prices to continue to rise.  At the same time, one argument that had been consistently made during the pre-pandemic days was that companies could not afford to raise prices due to competition as they were afraid of losing business.  But now, thanks to multiple rounds of stimulus checks, the population, as a whole, is flush with cash.  As evidenced by the fact that so many companies have already raised prices during the past year and continue to sell their wares, it would appear that the fear of losing business over higher prices has greatly diminished.





And yet…the bond market has accepted the transitory story as gospel.  This was made clear yesterday when both Treasury and Gilt yields tumbled 8 basis points while Bund and OAT yields fell 6bps.  That is not the behavior of a bond market that is worried about runaway inflation.  





So, which is it?  That, of course, is the $64 trillion question, and one for which nobody yet has the answer.  What we can do, though, is try to determine how markets may move in either circumstance.





If inflation is truly transitory it would seem that we can look forward to a continued bull flattening of yield curves with the level of rates falling alongside the slope of the yield curve.  Commodity prices will arguably have peaked as new production comes online and equity markets will benefit significantly from lower interest rates alongside steady growth.  As to the dollar, it seems unlikely to change dramatically as lower yields alongside lower inflation means real yields will be stable.





On the other hand, if prices rise persistently for the next quarters (or years), financial markets are likely to respond very differently.  At some point the bond market will become uncomfortable with the situation and yields will start to rise more sharply amid a steeper yield curve as the Fed will almost certainly remain well behind the curve and continue to suppress the front end.  Commodity prices will have resumed their uptrend as they will be a key driver in the entire inflationary story.  Energy, especially, will matter as virtually every other product requires energy to be created, so higher energy prices will feed into the economy at large.  Equity markets may find themselves in a more difficult situation, especially the high growth names that are akin to very long duration bonds, although certain sectors (utilities, staples, REITs) are likely to hold their own.  And the dollar?  If, as supposed, the Fed remains behind the curve, the dollar will suffer significantly, as real yields will decline sharply.  This will be more evident if we continue to see policy tightening from the group of countries that have already begun that process.





In the end, though, we are all just speculating with no inside knowledge of the eventual outcome.  It is for this reason that hedging is so important.  Well designed hedge strategies help moderate the outcome regardless of the eventual results, and that is a worthy goal in itself. Hedging can reduce earnings/cash flow volatility.





Onward to today’s markets.  Starting with bonds, after yesterday’s huge rally, we continue to see demand as, though Treasury yields are unchanged, European sovereign yields have fallen by between 0.3bps (Gilts) and 1.5bps (Bunds), with the rest of the major nations somewhere in between.





Equity markets have been more mixed but are turning higher.  Last night saw the Nikkei (-1.0%) and Hang Seng (-0.4%) follow the bulk of the US market lower, but Shanghai (+0.7%) responded positively to news that the PBOC may soon be considering cutting rates to support what is a clearly weakening growth impulse in China.  (Caixin PMI fell to 50.3 in Services and 51.3 in Manufacturing, both far lower than expected in June.)  European markets have been in better stead with the DAX (+0.9%) leading the way and FTSE 100 (+0.5%) putting in a solid performance although the CAC (+0.1%) is really not doing much.  The big news here was the European Commission publishing their latest forecasts for higher growth this year and next as well as slightly higher inflation.  Finally, US futures markets are all pointing higher with the NASDAQ (+0.5%) continuing to lead the way.





Commodity prices are definitely higher this morning with oil (+1.5%) a key driver, but metals (Au +0.6%, Ag +1.0%, Cu +2.0% and Al +0.3%) all finding strong bids.  Agricultural products are also bid this morning and there is more than one analyst who is claiming we have seen the bottom in the commodity correction with higher prices in our future.





As to the dollar, it is somewhat mixed, but arguably, modestly weaker on the day.  In the G10, NZD (+0.4%), NOK (+0.3%) and AUD (+0.3%) are the leaders with all three benefitting from the broad-based commodity rally.  SEK (-0.25%) is the laggard as renewed discussion of moderating inflation pressures has investors assuming the Riksbank will be late to the tightening party thus leaving the krona relatively unattractive.





In the EMG bloc, ZAR (+0.5%), MXN (+0.35%) and RUB (+0.25%) are the leading gainers, with all three obviously benefitting from the commodity story this morning.  CNY (+0.25%) has also gained after investor inflows into the Chinese bond market supported the renminbi.  On the downside, KRW (-0.7%) and PHP (-0.6%) fell the most although the bulk of those moves came in yesterday’s NY session as the dollar rallied across the board and these currencies gapped lower on the opening and remained there.  Away from these, though, activity has been less impressive with few stories to drive things.





Two pieces of data today are the JOLTS Job Openings (exp 9.325M) and the FOMC Minutes this afternoon.  The former will simply serve to highlight the mismatch in skills that exists in the US as well as the fact that current policy with enhanced unemployment insurance has kept many potential workers on the sidelines.  As to the Minutes, people will be focused on any taper discussion as well as the conversation on interest rates and why views about rates changed so much during the quarter.





Our lone Fed speaker of the week, Atlanta Fed President Bostic, will be on the tape at 3:30 this afternoon.  To date, he has been in the tapering sooner camp, so I would expect that will remain the situation.  





Yesterday’s dollar rally was quite surprising given the decline in both nominal and real yields in the US.  However, it has hardly given back any ground.  At its peak in early April, the dollar index traded up to 93.4 and the euro fell to 1.1704.  We would need to break through those levels to convince of a sustained move higher in the dollar.  In the meantime, I expect that the odds are the dollar can cede some of its recent gains.





Good luck and stay safe





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			Hard to Explain
		


				

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For those who believe that inflation


Is soon to explode ‘cross the nation


It’s hard to explain


Why yields only wane


Resulting in angst and vexation


But there is a possible clue


That might help the bond bears’ world view


In Q1 Ms. Yellen


Had Treasury sellin’


More bonds than the Fed could accrue


However, that’s no longer true


As Powell, through all of Q2


Will buy more each week


Than Janet will seek


To sell.  Lower yields then ensue.


With the FOMC meeting on the near horizon, traders are loath to take large positions in case there is a major surprise.  At this point, the market appears to broadly believe that any tapering talk is not going to happen until the Jackson Hole meeting in August, so the hawks are not expecting a boost.  At the same time, there is virtually no expectation that the Fed would consider increasing QE, thus the doves remain reliant on the transitory inflation narrative.  As it stands, the doves continue to hold the upper hand as while last week’s CPI print was shockingly high,  there has been much written about the drivers of that number are all due to level off shortly, and inflation will soon head back to its old 1.5%-2.0% range.


One of the things to which the doves all point is the 10-year yield and how it has done nothing but decline since the beginning of the quarter.  Now, that is a fair point, but the timing is also quite interesting.  While pundits on both sides of the discussion continue to point to inflation expectations and supply chain breakages and qualitative measures, there is something that has gotten far less press, but could well account for the counterintuitive movement in Treasury yields amid much higher inflation prints: the amount of Treasuries purchased by the Fed vs. the amount of new Treasuries issued by the Treasury.


In Q1, the US government issued net $342 billion while the Fed bought $240 billion in Treasury securities as part of QE.  (Remember, the other $120 billion was in mortgage-backed securities).  Given that foreign government buying of Treasuries has virtually disappeared, it should be no surprise that yields rose in order to attract buyers.  Q2, however, has seen a very different dynamic, as the US government has only issued $70 billion this quarter while the Fed continues to buy $240 billion each quarter.  With a price insensitive buyer hoovering up all the available securities and more, it is no surprise that Treasury yields have fallen.  Why, you may ask, has the Treasury only issued $70 billion in new debt?  Two things are driving that situation; first, Q2 is the big tax payment quarter of the year, so lots of cash flows into the Treasury; and second, the Treasury at the end of last year had $1.6 trillion in cash in their General Account at the Fed, which is essentially the government’s checking account.  However, they have drawn those balances down by half, thus have not needed to issue as much debt.


It’s funny how the move in yields just might be a simple supply/demand story, but that is not nearly as much fun as the narrative game.  So, let’s take a glimpse into Q3 planned Treasury issuance, which is widely available on the Treasury’s own website.  “During the July – September 2021 quarter, Treasury expects to borrow $821 billion in privately-held net marketable debt, assuming an end-of-September cash balance of $750 billion.”  The Fed, of course, is expected to buy another $240 billion in Treasuries in Q3, however, that appears to be a lot less than expected issuance.  My spidey-sense is tingling here, and telling me that come July, we are going to start to see yields turn higher again.  Far from the idea of tapering, if yields are rising sharply akin to Q1’s price action, we could see the Fed increase QE!  After all, somebody needs to buy those bonds.  And while this will be going on in the background, what we will largely read about is the changes in the narrative and inflation expectations.  As Occam pointed out with his razor, the simplest explanation is usually the best.


If this, admittedly, rough analysis has any validity, it is likely to have some very big impacts on markets in general, and on the dollar in particular.  In fact, if yields do reverse and head higher, especially if we move toward that 2.0% 10-year yield (or further) look for the dollar to find a lot of support.


As to market activity today, things remain fairly quiet with the recent positive risk attitude intact, but hardly excessively so.  Starting with equities in Asia, the Nikkei (+0.75%) had a nice gain after a better than expected IP print but was lonely with a holiday in China and through much of the continent keeping other markets closed.  Europe is in the green, but the gains are mostly modest (DAX +0.2%, CAC +0.2%, FTSE 100 +0.4%) as a slightly better than expected IP print along with continued dovish comments from Madame Lagarde help underpin the equity markets there.  Meanwhile, US futures are also modestly higher, but the NASDAQ’s 0.3% rise is by far the largest.


Turning to the bond market this morning, Treasury yields have backed up 0.8bps, but remain well below the 1.50% level which was seen as key support.  As per the above, I imagine that it will be a month before the real fireworks begin.  In Europe, while we did hear from Lagarde, we also heard from uber-hawk Robert Holtzmann, Austria’s central bank president, who was adamant that barring another Covid related shutdown, the PEPP will end in March.  Italian BTP’s were the most impacted bond from those comments with yields rising 2.0bps, while the main markets are seeing virtually no movement this morning.


In the commodity space, there is a real dichotomy today with oil (+0.7%) continuing its recent rally while gold (-1.1%) has fallen sharply.  Base metals have been mixed with relatively modest movement, but agricultural prices have fallen sharply (Soybeans -0.8%, Wheat -2.6%, Corn -2.8%) which appears to be a response to improved weather conditions.


Finally, the dollar has no real direction this morning.  NOK (+0.35%) is the leading gainer in the G10 on the back of oil’s rally but after that, there is a mix of gainers and losers, none of which have moved 0.2% implying no real new driving forces.  In the EMG bloc, last night saw KRW (-0.5%) catch up to Friday’s dollar rally, and this morning we see ZAR (-0.45%) as the worst performer on what seems to be market technicals, with traders beginning to establish new ZAR shorts after a very strong rally during the past year.  Some think it has gone too far.  But really, the FX market is not terribly interesting right now as we all await the Fed on Wednesday.


On the data front, there is some important information coming as follows:






Tuesday
Retail Sales
-0.6%





-ex autos
0.4%





PPI
0.5% (6.2% Y/Y)





-ex food & energy
0.5% (4.8% Y/Y)





IP
0.6%





Capacity Utilization
75.1%




Wednesday
Housing Starts
1640K





Building Permits
1730K





FOMC Decision
0.00% – 0.25%




Thursday
Initial Claims
360K





Continuing Claims
3.42M





Philly Fed
31.0





Leading Indicators
1.3%






Source: Bloomberg


So, while tomorrow will see much discussion regarding the growth narrative after Retail Sales, the reality is everybody is simply focused on the Fed on Wednesday.  Until then, I expect range trading.  After that…


Good luck and stay safe


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			How Long Can They Wait?
		


				

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While prices worldwide are all rising
Most central banks keep emphasizing
That they have no fear
And later this year
Their efforts will be stabilizing

But every time data’s released
It seems that inflation’s increased
How long can they wait
Ere they contemplate
It’s time QE should be deceased?

It has been another extremely dull day in financial markets as participants await the next catalyst, arguably coming tomorrow in the form of either a surprise from the ECB, a low probability event, or a surprise from the US CPI release, a higher probability event.  And yet, even if CPI surprises, will it really have much market impact?

For inspiration on the potential impact of a surprising outcome, let us quickly turn to China, where last night inflation data was released with PPI rising 9.0% Y/Y, its highest print since 2008, although CPI rose a less than expected 1.3%.  However, for the world overall, Chinese PPI is of much greater importance as it offers clues to what Chinese manufacturers may be charging for the many goods they sell elsewhere in the world.  If they start raising prices, you can be sure that prices elsewhere will be rising as well.  But the market response to this much higher than expected result was a collective yawn.  Chinese bond yields actually fell 1 basis point while the renminbi slipped 0.2%.  Chinese equities rose 0.3% in Shanghai to complete the triumvirate of markets demonstrating no concern over rising prices.

Is that what we can expect if tomorrow’s CPI data prints at a higher than expected number, perhaps even above 5.0%?  The first thing to note is that the Treasury market is certainly not demonstrating concern, at least in the classical sense of selling off into a rising inflationary situation.  In fact, yields are now back to their lowest level, 1.50%, since early March, the period during which yields were rising rapidly and eventually touched the early-April highs of 1.75%.  But here we are 25 basis points lower and the market seems to have completely bought into the Fed narrative of transitory inflation.  (As an aside, perhaps someone can explain to me why, if inflation is transitory and the Fed need not respond to the recent rises, there is a growing consensus that the Fed is going to start to taper QE purchases.  After all, the implication of transitory inflation is that current policy is fine as is, why change it and rock the boat?)

Another story that has been getting increasing play is about the growing short positions in Treasury bonds and how regardless of tomorrow’s data, we could see a short squeeze and lower yields.  Now, when I look at the CFTC data, I do see that last week open positions fell by nearly 50K contracts, but the overall outstanding position remains net long ~55K and there has been no discernible pattern of building short positions, so I’m not sure where that story has come from.  

So, when considering what we know about the current situation, near-term inflation pressures but central bank certitude it is transitory and recent price action indicating limited concern over inflation, it tells me that a high CPI print, currently forecast at 4.7%, will have no impact of note on the bond market.  As such, it seems unlikely that a high CPI print will have much impact on any market.  We will need to see a series of high prints, and they will need to continue at least through October or November before, it seems, anybody is going to believe that inflation may be more than a transitory phenomenon.  Unfortunately, we will all suffer equally due to the fact that prices are going to continue to rise, regardless of what the Fed or BLS tells us.

Turning to today’s session, price action has been generally similar to yesterday’s session, which means that there have been continued small movements in markets with strong trends difficult to identify.  For instance, equity markets overnight showed the Nikkei (-0.3%) and Hang Seng (-0.1%) both slipping a bit while Shanghai (+0.3%) managed to eke out a gain.  Hardly conclusive evidence of a theme.  Europe, however, is a bit softer, with the DAX (-0.5%) and FTSE 100 (-0.6%) both under a bit of pressure although the CAC (0.0%) has gone nowhere at all.  The German story is one of weaker than expected data, this time a smaller trade surplus with declines of both imports and exports indicating growth there is not quite so robust.  Meanwhile, Brexit issues between the EU and UK have arisen again over Northern Ireland, and this seems to be weighing on sentiment there.  As to US futures markets, they are very little changed at this hour.

Bond markets are clearly not concerned over inflation with Treasury yields down 2.7 basis points and similar declines in Europe (Bunds -2.6bps, OATs -3.0bps, Gilts -2.0bps).  Looking further afield, Italian BTPs have seen yields decline by 5 basis points with Spain and Portugal both falling 4bps or more.  It seems clear the market believes the ECB is going to continue to actively support the European government bond market.

On the commodity front, oil continues to rally with WTI (+0.4%) back over $70/bbl.  Something to consider regarding oil is that as ESG initiatives continue to grow in importance, and many of them are attacking the fossil fuel industry, seeking to prevent funding, there will be less and less exploration for and drilling of new oil sources.  But the transition to eliminating fossil fuels from the economy will take many years, (I’ve seen credible estimates of 30-50 years) meaning demand will not disappear, even if supply shrinks.  It seems pretty clear what will happen to the price of oil in this situation.  Do not be surprised if the previous high of $147/bbl is eclipsed in the coming years.

As to the rest of the commodity space, precious metals are a bit softer while base metals are more mixed today (Cu -0.9%, Al -0.15%, Ni +0.3%).  And finally, the grains are giving back some of their recent gains with all three down about 1.0%.

Finally, in FX, the dollar is broadly softer, but the movement has been very modest.  In G10 space, NOK (+0.3%) is the leader along side CAD (+0.3%) as they both follow oil’s rise.  After that, though, the movement is between 0.0% and 0.2%, with no stories to discuss.  In the Emerging Markets, HUF (+0.6%) is the big winner, as CPI continues to print above 5.0% and the central bank is tipped to raise rates at its meeting tomorrow.  But aside from that, there are more winners than losers although they are all just modest gains on the order of 0.1%-0.2%.  Weakness was seen in some APAC currencies overnight, but that, too, was very modest.

There is no important data to be released today, nor are there any Fed speakers, so my take is the market will continue to trade on the back of the Treasury market movement.  If yields continue to slide, look for the dollar to stay under some pressure.  If they reverse, I think the dollar will as well.

Good luck and stay safe
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