Cash Will Be Free

The Chairman was, once again, clear
The theory to which they adhere
Is rates shall not rise
Until they apprise
That joblessness won’t reappear

The market responded with glee
Assured, now, that cash will be free
The dollar got whacked
And traders, bids, smacked
In bonds, sending yields on a spree

It does not seem that Chairman Powell could have been any clearer as to what the future holds in store for the FOMC…QE shall continue, and Fed Funds shall not rise under any circumstance.  And if there was any doubt (there wasn’t) that this was the committee’s view, Governor Brainerd reiterated the story in comments she made yesterday.  The point is that the Fed is all-in on easy money until maximum employment is achieved.

What is maximum employment you may ask?  It is whatever they choose to make it.  From a numerical perspective, it appears that the FOMC is now going to be looking at the Labor Force Participation rate as well as the U-6 Unemployment Rate, which counts not only those actively seeking a job (the familiar U-3 rate), but also those who are unemployed, underemployed or discouraged from looking for a job.  As an example, the current Unemployment Rate, or U-3, is 6.8% while the current U-6 rate is 12.0%.  Given the current estimated labor force of a bit over 160 million people, that difference is more than 8 million additional unemployed.

When combining this goal with the ongoing government lockdowns throughout the country, it would seem that the Fed will not be tightening policy for a very long time to come.  There is, of course, a potential fly in that particular ointment, the inflation rate.  Recall that the Fed’s mandate requires them to achieve both maximum employment and stable prices, something which they have now defined as average inflation, over an indefinite time, of 2.0%.  As I highlighted yesterday, the Fed remains sanguine about the prospects of inflation rising very far for any length of time.  In addition, numerous Fed speakers have explained that they have the tools to address that situation if it should arise.

But what if they are looking for inflation in all the wrong places?  After all, since 1977, when the Fed’s current mandate was enshrined into law, the U-3 Unemployment Rate was the benchmark.  Now, it appears they have determined that no longer tells the proper story, so they have widened their focus.  In the same vein, ought not they ask themselves if Core PCE is the best way to monitor price movement in the economy?  After all, it consistently underreports inflation relative to CPI and has done so 86% of the time since 2000, by an average of almost 0.3%.  Certainly, my personal perspective on prices is that they have been rising smartly for a number of years despite the Fed’s claims.  (I guess I don’t buy enough TV’s or computers to reap the benefits of deflation in those items.)  But the word on the street is that the Fed’s models all “work” better with PCE as the inflation input rather than CPI, and so that is what they use.

Carping by pundits will not change these things, nor will hectoring from Congress, were they so inclined.  In fact, the only thing that will change the current thinking is a new Fed chair with different views, a reborn Paul Volcker type.  Alas, that is not coming anytime soon, so the current Fed stance will be with us for the foreseeable future.  And remember, this story is playing out in a virtually identical manner in every other major central bank.

Which takes us to the market’s response to the latest retelling of, ‘How to Stop Worrying (about prices) and Start Keep Easing.’ (apologies to Dale Carnegie).  It can be no surprise that after the Fed chair reiterated his promise to keep the policy taps wide open that equity markets around the world rallied, that commodity prices continued to rise, and that the dollar has come under pressure.  Oh yeah, bond markets worldwide continue to sell off sharply as yields, from 10 years to 30 years, all rise.

Let’s start this morning’s tour in the government bond market where yields are not merely higher, but mostly a LOT higher in every major country.  The countdown looks like this:

US Treasuries +7.5bps
UK Gilts +7.3bps
German Bunds +5.4bps
French OATs +5.9bps
Italian BTPs +8.0bps
Australian ACGBs +11.8bps
Japanese JGBs +2.5bps

Source: Bloomberg

Folks, those are some pretty big moves and could well be seen as a rejection of the central banks preferred narrative that inflation is not a concern.  After all, even JGB’s, which the BOJ is targeting in the YCC efforts has found enough selling pressure to move the market.  Suffice it to say that current yields are the highest in the post-pandemic markets, although there is no indication that they are topping anytime soon.

On the equity front, Asia looked great (Nikkei +1.7%, Hang Seng +1.2%, Shanghai +0.5%) but Europe, which started off higher, is ceding those early gains and we now see the DAX (-0.4%), CAC (0.0%) and FTSE 100 (+0.2%) with quite pedestrian showings.  Perhaps a bit more ominous is the US futures markets where NASDAQ futures are -1.0%, although the S&P (-0.3%) and DOW (0.0%) are not showing the same concerns.  It seems the rotation from tech stocks to cyclicals is in full swing.

Commodity prices continue to rise generally with oil up, yet again, by a modest 0.25%, but base metals all much firmer as copper leads the way higher there on the reflation inflation trade.  Precious metals, though, are suffering (Gold -1.0%, Silver -0.2%) as it seems investors are beginning to see the value in holding Treasury bonds again now that there is actually some yield to be had.  For the time-being, real yields have been rising as nominal yields rise with no new inflation data.  However, once that inflation data starts to print higher, and it will, look for the precious metals complex to rebound.

Finally, the dollar is…mixed, and in quite an unusual fashion.  In the G10, the only laggard is JPY (-0.25%) while every other currency is firmer.  SEK (+0.55%) leads the way, but the euro (+0.5%) is right behind.  Perhaps the catalyst in both cases were firmer than expected Confidence readings, especially in the industrial space.  You cannot help but wonder if the central banks even understand what the markets are implying, but if they do, they are clearly willing to ignore the signs of how things may unfold going forward.

Anyway, in the G10 space, currencies have a classic risk-on stance.  But in the EMG space, things are very different.  The classic risk barometers, ZAR (-1.8%) and MXN (-1.4%) are telling a very different story, that risk is being shunned.  And the thing is, there is no story that I can find attached to either one.  For the rand, there is concern over government fiscal pledges, but I am confused by why fiscal prudence suddenly matters.  The only Mexican news seems to be a concern that the economy there is slower in Q1, something that I thought was already widely known.  At any rate, there are a number of other currencies in the red, BRL (-0.3%), TRY (-0.9%) that would also have been expected to perform well today.  The CE4 is tracking the euro higher, and Asian currencies were generally modestly upbeat.

As to data today, we see Durable Goods (exp 1.1%, 0.7% ex transport), Initial Claims (825K),  Continuing Claims (4.46M) and GDP (Q4 4.2%) all at 8:30.  Beware on the Claims data as the deep freeze and power outages through the center of the country could easily distort the numbers this week.  On the Fed front, now that Powell has told us the future, we get to hear from 5 more FOMC members who will undoubtedly tell us the same thing.

While the ECB may be “closely monitoring” long-term bond yields, for now, the market does not see that as enough of a threat to be concerned about capping those yields.  As such, all FX eyes remain on the short end of the curve, where Powell’s promises of free money forever are translating into dollar weakness.  Look for the euro to test the top of its recent trading range at 1.2350 in the coming sessions, although I am not yet convinced we break through.

Good luck and stay safe