Lower Forever’s Outdated

A little bit later today
The FOMC will convey
Its thoughts about both
Inflation and growth
And when QE might fade away

The punditry’s view has migrated
Such that ‘Low Forever’s’ outdated
Instead, many think
That QE will shrink
By Christmas, when growth’s stimulated

Attention today is entirely on the Federal Reserve as they conclude their two-day meeting and release the latest statement at 2:00pm.  Thirty minutes later, Chairman Powell will begin his press conference and market activity will slow down dramatically as all eyes and ears will be focused on his latest musings.

What makes this situation so interesting is there is absolutely no expectation for a change to monetary policy today.  Fed funds will remain between 0.00% and 0.25% and asset purchases will continue at a pace of ‘at least’ $80 billion / month of Treasuries and $40 billion / month of mortgage backed securities.  So, what’s all the hubbub?

Recent economic data has been quite strong (Retail Sales +9.8%, Philly Fed at record high 50.2, Housing Starts +19.4%) and is forecast to continue to show strength going forward.  In addition, the first glimmers of rising prices are starting to be seen (Import Price Index +6.9%, Export Price Index +9.1%) which begs the question, how long can the Fed allow things to heat up before they start to remove monetary stimulus.  As the Fed has been in its quiet period for the past two weeks, we have not heard a peep regarding their thoughts in the wake of the most recent, very strong data.  Thus, with no new Fed guidance, the fertile minds of Wall Street economists have created a narrative that explains the continued robust US growth will lead the Fed to begin to remove policy accommodation by tapering asset purchases before the end of the year.  And they well could do so.

However, while Fed policy may or may not be appropriate, the one thing that has remained consistent throughout the Fed’s history is that when they say something, they generally stick to it.  And the last words we heard from Powell were that there was no reason to consider tapering until “substantial further progress” had been made toward their goals of maximum employment and average inflation of 2.0%.  No matter how great the data has been in the past two weeks, two weeks of data will not qualify as substantial.  In fact, I doubt two months will qualify.  If forced to anticipate a timeline for the Fed, it will not be before September, earliest, and more likely December that they will begin to lay the groundwork to potentially reduce asset purchases.  I think the market is way ahead of itself on this issue.

Consider, as well, this puzzle.  The market has pushed yields higher all year in anticipation of much faster growth and inflation generated by the combination of the end of lockdowns and federal stimulus money.  As federal spending continues to massively outstrip federal revenues, the Treasury continues to issue more and more new debt, also leading to higher yields.  Naturally, the higher the level of yields, the more expensive it is for the US government to service its debt which reduces its capacity to spend money on the things it is targeting with the new debt.  One of the key expectations of many of the same pundits calling for tapered purchases is yield curve control (YCC), which is exactly the opposite of tapering, it is unlimited purchasing of bonds.  So, how can we reconcile the idea of YCC with the idea of the Fed tapering purchases?  Personally, I cannot do so, it is one or the other.

Which brings us to what can we expect today?  Based on everything we have heard from Fed speakers in the past month, I believe talk of tapering is extremely premature and the Fed will not mention anything of the sort in the statement.  As well, I expect that Chairman Powell will be quite clear in the press conference when asked (and he will be asked) that the economy is not out of the woods and that they have much further to go before even considering altering monetary policy.

Arguably, this line of conversation should be risk positive, helping equities push higher and the dollar lower, but as we have seen for at least the past several months, the 10-year Treasury yield remains the absolute key driver in markets.  If supply concerns (too much supply) continue to grow and yields resume their march higher, I expect the dollar will rally and equities will come under pressure.  However, if the bond market is assuaged by Powell’s words, then I would expect a dollar decline and all other assets priced in dollars (stocks, bonds and commodities) to continue to climb in price.  We shall see starting at 2:00 today.

As to the markets leading up to the FOMC drama this afternoon, equities are generally firmer while bond yields are rising as well along with the dollar and base metals.  Overnight, the Nikkei (+0.2%), Hang Seng (+0.45%) and Shanghai (+0.4%) all had solid sessions.  Europe has seen gains through most markets (DAX +0.35%, CAC +0.5%, FTSE 100 +0.35%) although Sweden’s OMX (-1.3%) is significantly underperforming in what apparently is a hangover from yesterday’s mildly bearish economic views by the Riksbank.

Bond markets are uniformly lower this morning, with Treasury yields higher by 1.8 basis points after a 5 basis point rally yesterday.  In Europe, Gilts (+4.7bps) are the worst performers but we are seeing weakness of at least 3bps across the board (Bunds +3.2bps, OATS +3.3bps).  There has been precious little data released to explain these price declines, and if anything, the fact that German GfK Confidence (-8.8) was released at a much worse than expected level would have argued for lower rates.  By the way, that low print seems to be a consequence of the spread of Covid in Germany and reinstituted lockdowns.

On the commodity front, oil (+0.4%) is modestly firmer and remains well above the $60/bbl level.  While gold (-0.5%) and silver (-1.3%) are underperforming, we continue to see demand for industrial metals (Al +0.65%, Sn +1.8%) although copper (-0.15%) has given back a tiny amount of its recent gargantuan run higher.

The dollar is generally firmer vs. the G10 with GBP (-0.35%) today’s laggard followed by AUD (-0.25%) and JPY (-0.2%).  The market seems to have taken sides with the doves in the BOE as virtually every member spoke today and a majority implied that policy would remain accommodative despite expectations for faster growth.  Away from these 3 currencies, movements were extremely modest although leaned toward currency weakness.

EMG currencies are a bit more mixed, with a spread of gainers and losers this morning.  On the negative side, PLN (-0.5%) is in the worst shape as investors express concern over a judicial ruling due tomorrow on the status of Swiss franc mortgages that were taken out by Polish citizens a decade ago and have caused massive pain as the franc appreciated dramatically vs the zloty.  A negative ruling could have a major impact on Poland’s banking sector and by extension the economy.  Away from that, losses in CZK (-0.3%) and KRW (-0.2%) are next on the list, but it is hard to pin the movement to news.  On the positive side, TRY (+0.5%) continues to benefit from the perceived reduction in tension with the US while traders have seemingly embraced INR (+0.4%) on the idea that despite a horrific Covid situation, relief, in the form of massive vaccine imports, is on the way to help address the situation.

Ahead of the FOMC the only data point is the Advanced Goods Trade Balance (exp -$88.0B), but that is unlikely to have an impact.  Equity futures are biding their time as are most market participants as we all await Mr Powell.  Treasury yields continue to be the main driver in my view, so if they continue to rally, they are already 10bps clear of the recent lows, I expect the dollar will continue to regain some of its recent lost ground.

Good luck and stay safe
Adf

The Worry du Jour

The Treasury Sec and Fed Chair
This morning are set to declare
While things are improving
They’re not near removing
The stimulus seen everywhere

Meanwhile, other Fedsters explained
Inflation may not be constrained
Though they’re all quite sure
The worry du jour
Will pass and cannot be sustained

While last week was actually Fed week, with the FOMC meeting and Powell press conference already six days past, it is starting to feel like this week is Fed week.  We have so many scheduled appearances by a wide range of Fed governors and regional presidents, as well as by Chairman Powell, that the Fed remains the primary theme in the markets.  Now, in fairness, the Fed has been a dominant part of any market discussion for the past decade plus (arguably since the GFC in 2008), but I cannot remember a week with this many Fed speeches lined up.

Of course, the question is, will we learn anything new from all these speeches?  And the answer, sadly, is probably not.  Chairman Powell and his acolytes have made it clear that they are not going to raise the benchmark Fed Funds rate until somewhere in the late 2023/early 2024 timeframe, and in any case, not until they see actual data, not forecasts, that unemployment has fallen and prices are rising.  With that as a given, the only question unanswered is about the back end of the Treasury curve, where 10-year yields have risen more than 70 basis points so far in 2021, although are lower by about 5bps this morning.  With the 2-year Treasury note stuck at about 0.15%, the steepening of the yield curve has been dramatic so far, but it must be remembered that historically, when the yield curve starts to steepen, it has gone much further than the moves so far, with a 2yr-10yr spread of 275 basis points quite common.  Compared to the current reading of 150 basis points, and assuming the 2-year won’t be moving, that implies the 10-year Treasury could well move to a yield of 2.90%!

One of the key features driving equity market performance during the pandemic has been the promise of low rates forever, as any discounted cash flow analysis of a company’s future earnings was using a discount rate approaching 0.0%.  However, if 10-year yields rise that much (which implies 30-year yields will be somewhere in the 3.50%-4.0% area), it will be far more difficult to justify the current market valuations and we could well see some corrective price action in the stock market.  (That is a euphemism for stocks would tank!)  Now, if stocks were to correct lower, that would have an immediate impact on financing conditions, tightening them substantially, which in conjunction with rising back end yields would move the Fed away from its preferred stance of easy money.  Seemingly, it will be difficult for the Fed to allow that to occur and remain consistent with their stated objectives.

So, what might they do?  Well, this is the argument for yield curve control (YCC), that the Fed cannot simply allow the market to dictate financing terms during the recovery.  And it is the crux of the weaker dollar thesis.  But so far this week, as well as Chairman Powell, we have heard from governor Michelle Bowman and Richmond Fed president Tom Barkin, and not one of them has even hinted they are concerned with the rise in the back end.  As long as that remains the case, I expect that equity markets will have difficulty moving higher and I expect the dollar to benefit.  We have previously discussed the fact that the carrying costs of Treasury debt as a percentage of GDP is currently declining due to the dramatic decline in interest rates, and that Secretary Yellen has explicitly highlighted that issue as a reason to be unconcerned with additional borrowing.  Arguably, for as long as Yellen is okay with rising yields, the Fed will be okay as well.  But at some point, it certainly appears likely that a very steep yield curve will not fit well with the recovery thesis and the Fed will be forced to act.  However, until then, let us take them at their word and assume they are comfortable with the current situation.  We hear from nine more individual speakers this week across 18 different venues, including Powell and Yellen testifying to the House today and the Senate tomorrow, so by the end of the week, if there are even subtle shifts in view, we should have an idea.

As to today’s session, risk is under some pressure with equity markets having fallen throughout Asia (Nikkei -0.6%, Hang Seng -1.3%, Shanghai -0.9%) and all red in Europe as well (DAX -0.6%, CAC -0.7%, FTSE 100 -0.5%).  US futures are also pointing lower with declines on the order of 0.3% – 0.5% across the major indices.  It is also worth noting that prices have been softening over the past hour or two, which is different price action than we have seen lately, where early losses tend to be erased.

Bond markets are clearly demonstrating their haven status this morning with European sovereigns all seeing yield declines (Bunds -3.5bps, OATs -3.3bps, Gilts -4.1bps) which is right in line with the Treasury story, where 10-year yields have fallen 6.5bps now.

Commodity prices are also under pressure, with oil (-3.75%) back below $60/bbl and testing some key technical support levels.  Meanwhile, base metals are softer (copper 1.4%, Aluminum -1.7%) although the grains are mixed.  Finally, gold has bounced back from early declines and is up a scant 0.1% at this hour.

Turning to the dollar, it is stronger pretty much across the board, with JPY (+0.3%) the only G10 currency able to gain, and simply demonstrating its haven characteristics.  Otherwise, NZD (-1.7%) is the laggard, followed by AUD (-1.0%) and NOK (-0.8%).  While the NOK is obviously being undermined by oil’s decline, the NZD story revolves around an announcement that the government is going to try to rein in housing price increases, which have seen prices rise 23% in the past year, as they try to stop a housing bubble.  (Of course, they could simply raise rates to stop it, but that would obviously impact other things.)  However, the result was an immediate assessment of declining inward investment, hence the kiwi’s decline.  But away from the yen, the rest of the space is down at least 0.4%, so this is broad-based and significant.

Emerging market currencies are similarly under virtually universal pressure, with major losses seen in RUB (-1.4%), ZAR -1.1%) and MXN (-1.0%).  Obviously, these are all impacted by the decline in oil and commodity prices and will continue to be so going forward.  The CE4 are all much weaker as well, showing their high beta to the euro (-0.45%) and I would be remiss if I left out TRY (-0.9%) which was actually higher earlier in the session on what appears to have been a dead-cat bounce.  TRY has further to fall, especially if risk is being unwound.

On the data front, New Home Sales (exp 870K) are the main release, although we also see the Richmond Fed Manufacturing Index (16), a less widely followed version of Philly or Empire State.  But really, I expect the day’s highlight will be the Powell/Yellen testimony, and arguably, the Q&A that comes after their opening statements.  While most Congressmen and women consistently demonstrate their economic ignorance in these settings, there are a few who might ask interesting questions.  But for now, there is no change on the horizon, so there is no cap on yields. While they are falling today, they have plenty of room to rise, and with them, so too the dollar.

Good luck and stay safe
Adf

The Fed’s Nonchalance

The view from the Fed’ral Reserve
When viewing the present yield curve
Is that higher rates
Show, here in the States
The ‘conomy’s showing some verve

Contrast that with Europe’s response
To rising yields, where at the nonce
Ms Schanbel’s the third
Of speakers we heard
All lacking the Fed’s nonchalance

All I can say about yesterday’s market activity was that we cannot be too surprised that the imbalances that have been building up for the past year (or more accurately 13 years) resulted in some significant market volatility across every asset class.  Perhaps the most interesting thing was that virtually every asset class was sold aggressively, with no obvious havens available.  Stocks fell, bonds fell, gold fell, the dollar fell, Bitcoin fell; just what did people buy with those proceeds?

But of more interest to me was the central bank responses we have seen to the recent rise in long-term yields around the world.  Arguably, this has been the catalyst to all the market activity, so remains the first place we need to look for answers.

And what did we hear?  Well, four separate FOMC members (Williams, Bostic, Bullard and George) explained that rising yields were a good thing as it shows confidence in the economic growth story.  And oh, by the way, yields are still quite low so they shouldn’t have a negative impact on the economy.  While they may well be sincere in those views, these comments smack more of whistling past the graveyard than wholehearted support of market price action.  After all, the one thing the Fed has demonstrated since the GFC in 2008 is that unrestrained market price action is the last thing they want to see.  Rather, they want to make sure they control the game and the market price action proceeds slowly and calmly in their preferred direction.  You know, like watching paint dry.

And of course, in the broad scheme of things, yields do remain quite low.  Even at yesterday’s high point, the 10-year Treasury was yielding only 1.61%, which is still in the lowest decile of yields during the 10-year’s history.  Interestingly, the ECB has not been quite as sanguine regarding bond yields, despite the fact that bond yields throughout the entire continent are much lower than US yields.  On Monday Madame Lagarde explained they were “closely monitoring” bond yields.  Yesterday, ECB Chief Economist, and the ECB member with the most policy chops, Philip Lane, explained they would use the flexibility of the PEPP to prevent any undue tightening in financial conditions.  Then this morning, Isabel Schnabel, an Executive Board member, was more forthright, explaining the ECB may need to boost policy support if real long-term yields rise too early in the recovery process.  In other words, since they don’t believe that inflation is coming, rising yields need to be stopped.

What if, however, all these central bankers are completely wrong about the future of inflation?  What if, they have been reading their own narrative and now believe that there is no inflation on the way, thus rates should never need to rise?  That, my friends, has the chance to lead to some serious policy errors going forward.

So, let’s take a look at the most recent inflation indicators we have seen, and consider the situation.  Last night, Tokyo CPI was released at -0.3% Y/Y, which while obviously low, was higher than last month and forecast.  Then, this morning French PPI printed positive (+0.4%) for the first time in more than a year while French CPI rose a more than expected 0.7% in February.  Meanwhile, German Import Prices rose a much more than expected 1.9% in January, the biggest jump since September 1990!  And finally, here in the States, the GDP is released with a price index which rose to 2.1%, a tick above expectations.  Now, none of this is a description of raging inflation, but boy, there does seem to be a decent amount of price pressure building in the system.  Perhaps, just perhaps, bond yields are rising on rising inflation concerns, whether economic growth is present or not.

This idea is important because a key ingredient for market forecasts this year has been the trajectory of real interest rates.  At face value, the combined comments of Fed and ECB speakers this week tells us that the Fed is going to allow long-term yields to continue to rise while the ECB is going to step in and stop the madness.  If that is actually how things play out, I assure you that the euro will be hard pressed to move any higher, and that a sharp decline could be in the offing.  In fact, that is true for virtually every currency, where the dollar may very well reassert itself if that is the interest rate scenario that plays out.

Of course, I don’t believe the Fed will allow yields to simply rise unabated, as the cost to the Federal government in increased interest payments will be extremely uncomfortable, so I still look for QE to be expanded and extended, perhaps as soon as the March meeting if yields continue to rally from here.  At 1.75% on the 10-year, the Fed will be feeling the pinch, especially if equity markets continue to suffer under a rising yield scenario.  Thus, I am still in the camp of the dollar eventually falling more sharply as rising inflation rates outstrip capped interest rates.  But the latest comments from the central banks have certainly raised the risk on that view!

Ok, we all know that yesterday was a rout in the markets.  This morning, is unfortunately, not looking much better. Asian equity markets last night followed the US lead and fell sharply (Nikkei -4.0%, Hang Seng -3.6%, Shanghai -2.1%) and European markets, which all fell yesterday, are lower again this morning (DAX -0.8%, CAC -1.1%, FTSE 100 -1.4%).  And, don’t be looking for a bounce in the US as futures are pointing lower as well, between -0.3% and -0.6% at this hour.

Bonds?  Well, Asian yields continued to rise, notably Australia’s ACGBs (+17.2bps), but most of Europe has reversed course this morning after the trio of ECB speakers seem to have calmed some jitters.  So, Bunds (-1.6bps) and OATs (-1.7bps) have seen modest rallies.  Gilts (+4.0bps), though, have had no commentary to support them and continue to sell off.  Treasury yields are lower by 4.1bps at this hour, which feels very much like a trading reaction (after all yields rose 26bps since Tuesday), but all eyes will be on this morning’s Core PCE data, which if it does print higher than the expected 1.4%, could well start the selling all over again.

Oil prices (-2.2%) are having their worst session in more than two months, but the uptrend remains intact.  Precious metals prices continue to suffer as well, as real yields rise alongside nominal yields, although base metals are holding in a bit better.

And finally, the dollar is stronger pretty much across the board this morning. With AUD (-1.5%) the worst G10 performer and the two havens (CHF and JPY) both lower by just -0.1%.  Down Under, the market finally forced the RBA’s hand regarding their YCC, and the RBA bought $A3 billion of 3-year notes to push yields back below their 0.10% target.  This had the additional impact of discouraging FX investors from owning the currency.  In fact, this is exactly what I would expect of the euro if (when) the ECB does the same thing.

On the EMG side of things, Asian markets last night tried to catch up with the routs seen in LATAM and EEMEA markets yesterday, with INR (-1.4%) and KRW (-1.4%) the leading decliners, but substantial weakness even in the more stable currencies like SGD (-0.3%) and CNY (-0.2%).  This morning, CLP (-0.9%) and MXN (-0.7%) are leading the way lower in this time zone.  And, of course, this is all the same story of shedding risk.

On the data front, a bunch more is coming starting with Personal Income (exp 9.5%), Personal Spending (2.5%) and the aforementioned Core PCE (1.4%) all at 8:30.  Then later in the morning we see Chicago PMI (61.0) and Michigan Sentiment (76.5), but I believe the PCE number is the most important.  Mercifully, there are no further Fed speakers today, but after all, we already know what they think.  Accommodation is going to be with us for a looooong time and higher yields are a sign of confidence, so no problem.

The wrinkle in the higher inflation argument is if the Fed truly does let yields run higher and other countries cap theirs, the stronger dollar will rein in price pressures.  And for now, that appears to be what the market is starting to believe.  I maintain the Fed will not allow yields to continue running higher unabated, but until they act, the dollar should perform well.  Maybe we do retest the 1,1950 level in the euro, and who knows, 107.00 USDJPY is not out of the question.

Good luck, good weekend and stay safe
Adf

Yield Hawks Reappear

The market is starting to fear
Inflation is soon coming here
So, tech stocks got hammered
But nobody clamored
For bonds as yield hawks reappear

European markets are having a tough day as it appears investors want nothing to do with either stocks or bonds and only commodities have seen any demand.  Apparently, despite a strong desire for higher inflation, the ECB is not enamored of higher bond yields.  This was made abundantly clear yesterday when Madame Lagarde explained the ECB is “closely monitoring” the government bond market, with a special emphasis on German bunds.  Clearly, this was prompted by the fact that 10-year bund yields have risen nearly 25 basis points in less than a month, similar to the rise in 10-year Treasury yields and are now well above the ECB’s deposit rate.  As Banque de France Governor Villeroy noted, the ECB will ensure financing conditions remain favorable, and seemingly, -0.306% 10-year yields have been determined to be too tight.

This is a perfect indication of the difficulty that the central banks have brought upon themselves by constantly easing monetary policy into every market hiccup and then getting upset when investors don’t obey their every wish.  After all, if the underlying problem in Europe is that inflation is too low (a story they have been pushing for more than a decade) then one would think that rising bond yields, signaling rising inflation expectations would be a welcome sight.  Of course, the flaw is that rising bond yields often lead to declining share prices, something that apparently no major central bank can countenance.  Thus, the conundrum.  Essentially central banks want higher inflation but simultaneous low yields and high stock prices.  That’s not so much a goldilocks scenario as a Dungeons and Dragons fantasy where they are the Dungeon Master.  In other words, it cannot occur in the real world, at least for any extended period of time.

Hence, the comments by Lagarde and Villeroy, and the great expectations for those from Chairman Powell later this morning.  Exactly what can the central banking community do to achieve their desired goals?  Markets are beginning to question the narrative of central bank omnipotence, and those central banks are starting to fear that they will lose control over the situation.  As I have written before, at some point, the Fed, or ECB or some other central bank will implement some new program and the market will ignore it and continue on its merry way.  And when that is happening, that ‘way’ will be down.  At the end of the day, while central banks have shown they have extraordinary power to sway markets, they are not bigger than markets.

Back in the 1990’s, the term bond vigilantes was quite popular as a description of bond market traders who responded negatively to budget deficits and drove yields higher and stocks lower accordingly, thus keeping government spending in line.  In fact, that was the last time the US ran budget surpluses.  With the proposed $1.9 trillion stimulus bill still seemingly on its way, it is entirely possible that those long-dead vigilantes may be rising from the grave.  Back then, the Maestro would never consider capping yields or QE as a response, but the world is a different place today.  If bonds continue to sell off further, the $64 billion question is, how will the Fed respond?  It is this scenario, which could well be starting as we speak, that has brought the idea of YCC to the fore.  We have already seen tech stocks begin to suffer, weighing heavily on major indices, and those other harbingers of froth, Bitcoin and Tesla, have reversed course lately as well.  As I wrote last week, long tech stocks is like being short a Treasury bond put, as they will suffer greatly with higher yields.  At what point will the Fed decide yields are high enough?  Perhaps Chairman Powell will give us a hint today, but I doubt it.

Ahead of his testimony, here is what is happening in markets, where I would characterize things as inflation concerned rather than risk off.  Bond markets in Europe, as mentioned, are selling off sharply, with Bunds (+4.1bps), OATs (+4.8bps) and Gilts (+4.0bps) all feeling the pain of rising inflation expectations.  In fact, every country in Europe is seeing their bonds suffer today.  Treasuries, at this hour, are relatively flat, but continue to hover at their highest level in a year.  Interestingly, the first clue of central bank response came from Australia last night, where the RBA was far more aggressive buying the 10-year sector and pushed yields back down by 4.1bps.  However, their YCC on the 3-year is still in trouble as yields there remain at 0.12%.

Equity markets are almost universally weaker in Europe (only Spain is showing life at +0.6% as a raft of holiday bookings by frustrated UK citizens has seen strength in the tourist sector of the economy).  But otherwise, all red with the DAX (-1.1%) leading the way, followed by the FTSE 100 (-0.3%) and CAC (-0.2%).  Asia was a bit of a different story, as the Hang Seng (+1.0%) managed to benefit from ongoing inflows from the mainland, although Shanghai (-0.2%) was more in line with the global story.  The Nikkei was closed for the Emperor’s birthday.  As to US futures, tech stocks remain under pressure with NASDAQ futures lower by 1.5%, although SPU’s are down by just 0.5%.

Commodities are where its at this morning, though, with oil, after a powerful rally yesterday, up another 0.7% and over $62/bbl for WTI now.  Copper is up a further $200/ton and pushing to the all-time high of $9600/ton set back in 2010.  With all the talk of the elimination of combustion engine vehicles, it turns out EV’s need 3 times as much copper, hence the demand boost.  Meanwhile, the rest of the base metals are also performing well although precious metals are little changed on the day.  Of course, gold at flat is a lot better off than Bitcoin, which is down more than 16% on the day.

And lastly, the dollar, is having a mixed session.  The pound is the leading gainer, +0.2%, as plans for the reopening of the economy as the vaccine rate continues to lead the G10, has investors looking on the bright side of everything.  On the flip side, CHF (-0.45%) is the laggard on what appear to be market technical movements as price action has taken USDCHF above the top of a downtrend channel.  Otherwise, the G10 space is showing little movement in either direction.

As to emerging market currencies, after some terrible performances yesterday, BRL (+0.3%) and MXN (+0.3%) are opening firmer on a rebound along with CLP (+0.4%) following Copper prices higher.  However, the rest of the bloc is +/-0.2% which is the same thing as unchanged in this context.

On the data front, yesterday saw Leading Indicators a touch better than expected and two lesser followed Fed regional indices print strongly.  This morning Case Shiller home prices (exp 9.90%) and Consumer Confidence (90.0) are the highlights, neither of which is that high.  In fact, the true highlight comes at 10:00 when Chairman Powell testifies to the Senate Banking Committee.  It will be interesting to see if he touches on the recent rise in yields, especially expressing concern over their movement.  But more likely, in my view, is that he will simply agree that more fiscal stimulus is critical for the economy and that the Fed will continue to support the economy until “substantial further progress” is made on their objectives.

Adding it all up tells me that risk is going to continue under pressure for now, although given the magnitude of the move we have seen in bond yields, it would not be surprising to see them consolidate or reverse for a while in a trading correction.  As to the dollar, higher yields ought to prevent any sharp declines, but it still looks like we have seen the extent of the correction already and it will continue to trade in its recent range.

Good luck and stay safe
Adf

Crash Landing

The Narrative tells us the Fed
Will let prices rise up ahead
But if that’s the case
Then how will they pace
The rise in the 2’s-10’s yield spread

And what if this spread keeps expanding
Will stocks markets see a crash landing?
Or will Chairman Jay
Once more save the day
And buy every bond that’s outstanding?

Remember when the Narrative explained that record high traditional valuation measures of the stock market (like P/E or CAPE or P/S) were irrelevant because in today’s world, permanently low interest rates guaranteed by the Fed meant there was no limit for valuations?  That was soooo last month.  Or, remember when economists of all stripes explained that all the slack in the economy created by the government shutdowns meant that inflation wouldn’t reappear for years?  (The Fed continues to push this story aggressively as every member explains there is no reason for them to consider raising rates at any time in the remotely near future.)  This, too, at least in the bond market’s eyes, is ancient history.  So, something is changing in the market’s collective perception of the future, and prices are beginning to reflect this.

The bond market is the appropriate place to begin this conversation as that is where all the action is lately.  For instance, this morning, 10-year Treasury yields have risen another 2.4bps and are trading at their highest level in almost exactly one year, although remain far below longer-term averages.  Meanwhile, 30-year Treasuries have risen even more, and are now yielding 2.155%.  Again, while this is the highest in a bit more than a year, it is also well below longer term averages.  The point is, there seems to be room for yields to run higher.

Something else that gets a lot of press is the shape of the yield curve and its increasing steepness.  Today, the 2yr-10yr spread is 125bps.  This is the steepest it has been since the end of 2016, but nowhere near its record gap of 8.42% back in late 1975.  The Narrative tells us this is the reflation trade, with the bond market anticipating the reopening of the economy combined with a flood of new stimulus money driving business activity higher and prices along with that business.

Now, the question that has yet to be answered is how the Fed will respond to these rising yields.  We are all aware that Federal debt outstanding has been growing rapidly as the Treasury issues all that paper to fund the stimulus packages.  And we have all heard the argument that the size of the debt doesn’t matter because debt service costs have actually fallen over time as interest rates have collapsed with the Fed’s help.  The last part is true, at least over the past several years, where in 2020, it appears Federal debt service amounted to 2.43% of GDP, a decline from both 2018 and 2019, although modestly higher than 2017.  But, if the yield curve continues to steepen as 10yr through 30yr yields continue to rise, as long as the Treasury continues to issue debt in those maturities, the cost to the Federal government is going to rise as well.  The question is, how much can the government afford?  And the answer is, probably not much.  A perfect anecdote is that the increased interest cost of a 50 basis point rise in average Treasury yields will cost the government the same amount as funding the US Navy for a year!  If yields truly begin to rise across the curve, Ms Yellen will have some difficult choices to make.

But this is not just a US phenomenon, it is a global phenomenon.  Yields throughout the developing world are rising pretty rapidly, despite central bank efforts to prevent just that from occurring.  As an example, we can look at Australia, where the RBA has established YCC in the 3yr space, ostensibly capping yields there at 0.10%.  I say ostensibly because as of last night, they were trading at 0.12%.  Now, 2 basis points may not seem like much, but what it shows is that the RBA cannot buy those bonds fast enough to absorb the selling.  And the problem there is it brings into question the RBA’s credibility.  After all, if they promise to keep yields low, and yields rise anyway, what is the value of their promises?  Oh yeah, Aussie 10yr yields jumped 16.9 basis points last night!  It appears that the RBA’s QE program is having some difficulty.

In fact, despite pressure on stocks throughout the world, bond yields are rising sharply.  In other words, the haven status of government bonds is being questioned right now, and thus far, no central bank has provided a satisfactory answer.  Perhaps, the bigger question is, can any central bank provide that answer?  As influential as they are, central banks are not larger than the market writ large, and if investor psychology changes such that bonds are no longer seen as worthwhile investments because those same central banks get their wished for inflation, all financial securities markets could find themselves in some difficult straits.  This is not to imply that a collapse is around the corner, just that the working assumption that the central banks can always save the day may need to be revised at some point.

So, can yields continue to go higher without a more substantive response from the Fed or ECB or BOE or RBA or BOC?  Certainly, all eyes will be on Chairman Powell to see his response.  My view has been the Fed will effectively, if not explicitly, try to cap yields at least out to 10 years.  If I am correct, the dollar should suffer substantially.  Again, this is not to say this is due this morning, just that as this story unfolds, that is the likely trend.

And what else is happening in markets?  Well beyond the bond market declines (Gilts +2.3bps, Treasuries now +4.1bps, even Bunds +0.5bps), European bourses are falling everywhere (DAX -0.6%, CAC -0.5%, FTSE 100 -0.7%) after weakness throughout most of Asia (Hang Seng -1.1%, Shanghai -1.5%, although Nikkei +0.5% was the outlier).  US futures? All red and substantially so, with NASDAQ futures lower by 1.3% although the other indices are not quite as badly off, between -0.5% and -0.7%.

Commodity prices, however, continue to rise, with oil (+1.0%) leading energy mostly higher while both base and precious metals are higher as well.  So, too, are prices of grains rising, as we continue to see the price of ‘stuff’ rise relative to the price of financials.

Finally, turning to the dollar, it is broadly stronger against its EMG counterparts, but more mixed vs. the G10.  In the former, MXN (-1.4%) and ZAR (-1.35%) are leading the way lower, although BRL is called down by more than 2.0% at the opening there.  But the weakness is pervasive in this space with APAC and CE4 currencies also suffering.  However, G10 is a bit different with AUD (+0.2%) leading the way higher on the back of the record high prices in tin and copper alongside the rising rate picture and reduced covid infection rates.  On the flip side, NOK (-0.3%) is the weakest of the bunch, despite oil’s rebound, which appears to be a reaction to strength seen late last week.  In other words, it is market internals, not news, driving the story there.

On the data front we do get a fair amount of new information this week as follows:

Today Leading Indicators 0.4%
Tuesday Case Shiller House Prices 9.90%
Consumer Confidence 90.0
Wednesday New Home Sales 855K
Thursday Durable Goods 1.0%
-ex transport 0.7%
Initial Claims 830K
Continuing Claims 4.42M
GDP Q4 4.2%
Friday Personal Income 9.5%
Personal Spending 2.5%
PCE Core 0.1% (1.4% Y/Y)
Chicago PMI 61.0
Michigan Sentiment 76.5

Source: Bloomberg

Beyond the data, with GDP and Personal Spending likely the keys, we hear from a number of Fed speakers, most importantly from Chairman Powell tomorrow and Wednesday as he testifies before the Senate Banking Committee and then the House Financial Services Committee.  The one thing about which you can be sure is that Congress will ask him to support their stimulus plan and that he will definitely do so.  It strikes me that will just push Treasury yields higher.  In fact, perhaps the March FOMC meeting is starting to shape up as a really important one, as the question of higher yields may need to be addressed directly.  We shall see.

For now, yield rises are outstripping inflation prints and so real yields are rising as well.  This is supporting the dollar and will undermine strength in some securities markets.  However, history has shown that the Fed is unlikely to allow real yields to rise too far before responding.  For now, the dollar remains in its trading range and is likely to stay there.  But as the year progresses, I continue to see the Fed stopping yields and the dollar falling accordingly.

Good luck and stay safe
Adf

Desperate Straits

When yield curve control was designed
Its goal was a rate be defined
Which can’t be exceeded
With bonds bought as needed
To help governments in a bind

Lagarde, though, when looking ahead
Must work at controlling the spread
So BTP rates
Don’t reach desperate straits
Vs. bunds, an outcome she would dread

Ahead of the inauguration of President Biden, the market has turned its focus to Europe and the ongoing situation in Italy.  Prime Minister Giuseppe Conte has been struggling to lead a fractious coalition from the left and was just subject to no-confidence votes in both houses of the Italian government.  (They have a House and Senate similar to the US.)  This occurred when one of his former allies, Matteo Renzi, split from the coalition triggering the vote.  Renzi leads the Viva Italia party, a center-left group focused on progressive reforms to the Italian government, and it appears Conte has become a little too status quo for his taste.  While Conte was able to cobble together a majority in the lower house, today’s vote in the Senate was less successful, with a majority of votes cast, but no majority in the Senate overall.  This means he has a minority government whose stability has now been called into question.  Estimates are that he has two weeks to develop a majority or the President may call for parliament to be dissolved and new elections held.

As this story has unfolded, investors have been focused on the bond market, specifically the spread between Italian BTP’s and German bunds.  This spread is seen as a key metric, by both the market and the ECB, as to the health of the European economy overall.  The narrower that spread, the healthier the situation.  This is based on the idea that investors are not demanding as great a yield premium to fund Italy’s debt as they are Germany’s.

A quick history shows that for the first eight years of the euro’s existence, that spread hovered between 25 and 45 basis points, with investors not particularly concerned by Italy’s profligate ways.  The GFC awakened many to the potential risks in Italy and the spread ballooned as high as 160 basis points at that time.  But that was nothing compared to the Eurozone bond crisis in 2012, when Greece was on the ropes and the term PIGS was invented.  At that time, Italian yields peaked at 5.525% higher than German yields.  The second time this level was reached, in July 2012, led to Mario Draghi’s famous words, “whatever it takes” regarding the ECB’s will to save the euro.  Since that time, the spread has only ever edged below 1.0% briefly, lately reaching a peak of 2.8% at the beginning of the Covid crisis and currently trading around 1.14%.

The point here is that the ECB watches this spread very carefully.  But now, it appears they are interested in more than merely watching the spread.  Rather, they want to control it.  Yield curve control (YCC) is currently ongoing in both Japan and Australia and has generated a good deal of discussion in the US.  But those three central banks have a single government rate to manage.  The ECB has no such luck, and so they need to find other ways to control things.  Hence, their newest idea is Yield spread control (YSC), where the ECB will buy whatever amount of bonds are necessary to prevent a particular spread from rising above a particular level.  Obviously, this means they will be looking at the bonds of the PIGS, as those are the nations with the biggest outstanding issues.  The problem Lagarde has is the ECB, by law, is not allowed to finance government spending, and QE in Europe was designed to be implemented along the lines of the ECB buying bonds in proportion to national economic size.  But this will require something completely different, as in order to prevent that spread from widening beyond whatever level they choose, the ECB will need to purchase an unlimited number of Italian BTP’s.  As such, this idea is not without controversy, but do not be surprised to hear about it tomorrow when the ECB meeting ends.  While it may not be implemented right away, it does appear they are actively considering the idea.

At this point you are likely asking yourself why you care about this esoteric concept.  And the answer is because it will have an impact on the value of the euro, and therefore the dollar, going forward.  Given the current draconian lockdowns throughout Europe and the significant negative impact they will have on the Eurozone economy, and combine that with a political morass in the 3rd largest economy in the Eurozone, and you have a recipe for a more severe downturn in a double dip recession in Europe.  As the ECB has already used up its basic toolkit of extraordinary measures, it needs to develop new ones if it is to keep the money flowing.  And that is the point.  Especially after yesterday’s testimony by Janet Yellen, where it is clear that the Treasury is not going to slow down spending and the Fed will be right there buying up those new bonds, the ECB is growing concerned that the dollar could fall much further.  They have recently been reminding us that they are paying attention to the exchange rate, and while intervention is not likely in the cards, a new easing policy that results in lower yields and a correspondingly weaker euro just might be.  One has to be impressed with central bank creativity when it comes to spending/printing more money.

But for now, investors remain sanguine to the risk inherent in this strategy and continue to add risk to their portfolios.  This can be seen in the continued rallies in equity markets around the world.  For instance, last night saw strength throughout Asia, except for the Nikkei (-0.4%).  Europe, this morning is showing far more green than red (DAX +0.5%, CC +0.3%. FTSE 100 -0.1%) and US futures, following yesterday’s tech inspired rally, are all higher again this morning.

Bond markets are under pressure generally, with Treasury yields backing up 1.4bps, although still unable to break the recent highs of 1.15%, Gilts are also softer with yields higher by 1.2bps while bunds and OATs are little changed. BTP’s, however, have fallen ¼ point with yields higher by 2.5bps, which means that spread has risen by the same amount.  Keep an eye on this.

Oil (WTI +1.3%) and gold (+0.5%) are both firmer this morning while the dollar is broadly under pressure.  However, the magnitude of that weakness is fairly minimal, with AUD (+0.35%) the biggest gainer in the G10 on the back of firmer commodity prices, while SEK (-0.35%) is the laggard on what appears to be position unwinding.  The euro (-0.15%) is definitely not following a classic risk-on pattern here, with some reason to believe traders are beginning to take the YSC into account.  In the EMG space, the moves are also limited, with TRY (+0.4%) and BRL (+0.25%) the leading gainers while CE4 currencies (CZK and PLN both -0.1%) are the laggards.  But overall, the risk theme does not appear to be having an impact in FX.

Once again there is no data released today and we are still in the quiet period, so no Fedspeak.  And we don’t even have Yellen to testify, so the FX market is going to be paying attention to equity movements and the bond market, probably in that order.  If risk continues to be acquired, I expect the dollar will have difficulty gaining any traction, but if we start to see a reversal, don’t be surprised to see some of the massive dollar short positions unwound.

Good luck and stay safe
Adf

Blue Wave at Last

Psephologists have now decided
The run-off election provided
A blue wave at last
So laws can be passed
Republicans view as misguided

The market responded by sellin’
The 10-year, with traders foretellin’
Inflation to come
As Powell stays mum
While financing Treasury’s Yellen

While the election results from Georgia are not yet final, the indications at this time are that the Democratic party won one of the seats with the second one still too close to call.  However, the market has already made its decision, that both seats flipped to the Democrats and that the Senate will now be split 50:50, which means that the Vice President will be able to cast the deciding vote.  The clear implication is that, while hardly a mandate, the Democrats will control both the executive and legislative branches and be able to implement a great deal of their agenda.  In other words, the blue wave high tide has finally crested.

The initial reaction to this news has been seen in the sell-off of the 10-year Treasury, where the yield has risen to 1.02% as I type, its first foray above 1.00% since March 19th, during the first days of the Covid-19 market panic.  The reflation trade is back in vogue, with expectations now that the new administration will be aggressively adding fiscal stimulus, thus increasing Treasury issuance significantly and ultimately steepening the yield curve as demand for long-dated Treasuries will not be able to keep pace with the new supply.  However, given the already record levels of debt outstanding, the government simply cannot afford for interest rates to rise too far, as if they do, interest payments will soak up an ever-increasing proportion of available revenues.  It is for this reason that I continue to believe the Fed will increase their current activity, and whether tacitly, by expanding QE and extending the maturity of purchases, or explicitly, by setting a yield target, implement Yield Curve Control (YCC).

At the same time, the Fed has made it abundantly clear that higher inflation is of no concern to the committee.  The latest proof comes from Chicago Fed President Charles Evans, who explained to us yesterday, “Frankly, if we got 3% inflation, that would not be so bad.  It is very difficult to imagine out of control inflation, even with the large debt that fiscal authorities have been running up.”   Perhaps, as a Regional Fed President, he simply lacks imagination.  After all, just yesterday, almost at the same time he was recounting his views, the ISM Prices Paid index printed at 77.6, well above expectations and at a level seen only twice, briefly, in the past decade.  There is a strong correlation between this index and PPI, so the idea that inflation pressures are building is hardly unimaginable.

Which brings us back to the prospects for the dollar, as well as other markets.  While yields have climbed today, the prospect of inflation rising more rapidly and real rates falling further into negative territory still informs my view that the dollar has further to decline.  This will become more obvious when the Fed steps in to prevent the rise in nominal yields, which I am confident will occur sooner rather than later.  Again, while I don’t anticipate a dollar collapse, as other central banks will fight to prevent such an outcome, further dollar weakness is in the cards.

Speaking of other central banks fighting the dollar’s weakness, last night the PBOC started to do just that by establishing the CNY fix at a weaker renminbi rate than anticipated.  Since August 1st, CNY has appreciated by nearly 8% vs. the dollar, which for an economy that remains heavily reliant on exporting for GDP growth, is a growing problem.  As the PBOC makes no bones about directing the value of the currency, you can expect that they will be actively managing the renminbi’s value going forward in an effort to prevent too much further strength.  But, as long as both nominal and real yields remain positive in China, that will attract significant capital flows and continue to pressure the renminbi higher.

So, what has all this news done to other markets?  Well, most of Europe is ecstatic at the election outcome, at least that seems to be the case based on the rallies seen in equity markets there.  The FTSE 100 (+2.3%) is leading the way, but we are seeing strong gains in the DAX (+0.9%) and CAC (+0.8%) as well, despite the fact that the PMI Services data disappointed across the board.  The story in Asia was more mixed with the Nikkei (-0.4%) and Australia (-1.1%) underwhelmed by the outcome, although the Hang Seng (+0.2%) and Shanghai (+0.6%) both wound up in the green.  As to US futures, as I type, they are a mixed bag, with DOW futures higher by 0.2%, SPU’s lower by 0.4% while NASDAQ futures are down 2.0%.  The latter’s decline are a response to the election results as concerns grow that Big Tech will now be in the crosshairs of Congress for more regulation if not outright dismemberment.

While we have already discussed the Treasury market, European government bonds are mostly softer today as well, with yields rising as much as 4bps in the UK, although German bunds are unchanged on the session.

Another inflationary impulse comes from oil, where yesterday the Saudis surprised the market by unilaterally cutting production by 1 million barrels/day helping to take WTI above $50/bbl for the first time since late February.  If this rally continues, look for gasoline prices to creep higher, one of the key sentiment indicators regarding the perception of inflation.

And finally, the dollar remains broadly under pressure this morning, with NOK (+0.75%) the leading gainer in the G10 on the back of the oil rally, although both AUD (+0.6%) and NZD (+0.65%) are also having a good day as both commodity prices gain and they serve as a proxy for Asian growth.  Meanwhile, the euro (+0.35%) is trading at new highs for the move and back to levels not seen since April 2018.

Emerging market currencies are universally higher this morning, led by PLN (+0.85%), MXN (+0.8%) and HUF (+0.8%).  Those stories are easy to see, with oil helping the peso, while the CE4 currencies are tracking the euro’s strength.  Asian currencies, while all firmer, did not show nearly the enthusiasm, with gains between 0.1% and 0.2%, but of course, the election results were not fully known during their session.

On the data front, this morning brings ADP Employment (exp 75K) as well as Factory Orders (0.7%) and the PMI Services index (55.2).  Then, this afternoon, we see the FOMC Minutes of the December meeting, one where they disappointed many folks by not easing further. The first thing to note is that after yesterday’s ISM data, the ADP forecast increased from 50K.  Clearly, the manufacturing sector remains in better shape than expected.  At the same time, the Minutes ought to be interesting as perhaps we will learn more about attitudes regarding any prospects for what could change policy.  Of course, given the world was a different place then, and as Evans explained, inflation is of no concern, the real question from the Minutes will be what will the Fed do next to ease further.

As to the dollar, it is hard to see a short-term path in any direction other than lower, but I continue to expect the decline to be slow and orderly.

Good luck and stay safe
Adf

No Antidote

In Georgia, today’s runoff vote
For Senate is no antidote
To nationwide fears
The quartet of years
To come, more unease, will promote

Investors expressed their dismay
By selling stocks all yesterday
As well, though, they sold
The buck and bought gold
Uncertainty’s with us to stay

Markets certainly got off to an inauspicious start yesterday as a number of concerns regarding upcoming events, as well as the possibility that some markets are overextended, combined to induce a bit of risk reduction.  Clearly, the top story is today’s runoff election in Georgia, where both US Senate seats are up for grabs.  The Republicans currently hold a 50-48 majority, but if both seats are won by the Democratic candidates, the resulting 50-50 tie will effectively give the Democrats control of the Senate as any tie votes will be broken by the Vice-President.  In that event, the Democrats should be able to institute their platform which, ostensibly, includes infrastructure spending, the Green New Deal, or parts thereof, and more substantial stimulus to address the impact of the coronavirus.

This blue wave redux has been a key topic in markets of late.  You may recall that heading into the election in November, when the polls were calling for the original blue wave, the market anticipated a huge amount of fiscal stimulus driving significantly larger Federal budget deficits.  The ensuing Treasury bond issuance required to fund all this spending was expected to result in a much steeper yield curve, a continuing rally in the stock market as the economy recovered (and this was before the vaccine) and a declining dollar.  As the runoff election approached, markets started to replay that scenario which has, until yesterday, led to successive new all-time high closes in equity indices as well as a steeper Treasury yield curve.  As well, the dollar has remained under pressure, as that remains one of the strongest conviction trades of 2021.

But yesterday, and so far this morning, we are seeing a potential change of heart, or perhaps just a note of caution.  Because if the Republicans retain one of the two seats, that will put paid to the entire blue wave hypothesis.

Of course, there is another possibility that is driving investor caution, and that is the idea that markets, especially equity markets, remain extremely frothy at current levels.  Certainly, on a historical basis, valuation indicators like P/E or Shiller’s CAPE, or Price/Book or even Total Market Cap/GDP are at historically high extremes.  Is it possible that the market has already priced in every conceivable positive event to come?  There are those who would make that argument, and if they are correct, then the required catalyst for a correction of some sorts is likely not that large.  For instance, if the Republicans win even one seat, the entire stimulus bandwagon may never get going, let alone any of the more widescale projects.  And that could well be enough to force a rethinking of the endless stimulus theory with a resultant revaluation of investment risks.

One of the things that always bothered me about the blue wave hypothesis was the idea that the Treasury yield curve would steepen, and the dollar would decline.  Historically, a steeper yield curve has indicated a strengthening US economy which has drawn investment and strengthened the dollar.  I don’t believe that relationship will change, however, a weaker dollar does make sense if you consider how the Fed is likely to respond to rising Treasury yields; namely with Yield Curve Control (YCC).  The US government cannot afford for interest rates to rise substantially, especially as the amount of debt issued continues to grow rapidly.  In fact, the only way it can continue to pay interest on the growing pile of debt is to make sure that interest rates remain at historically low levels.  The implication is that if the Treasury continues to flood the market with issuance, the Fed will be required to buy all of it, and then some, in order to prevent yields from rising.  And whether it is explicit, or implicit, that YCC is going to result in increasingly negative real yields in the US (as inflation is almost certainly going higher).  Now, if you wanted a catalyst to drive the dollar lower, increasing negative real yields is a perfect solution.  While that may not be such a benefit for investors and savers, it will help the Fed retain the upper hand in the global policy ease race, and with it, help undermine the value of the dollar.  It is, in fact, the basis for my views this year.  All that from the Georgia run-off elections!  Who would have thunk?

As to markets this morning, yesterday’s weakness remains fairly widespread in the equity space, as all European bourses are lower (DAX -0.4%, CAC -0.5%, FTSE 100 -0.1%) after a mixed Asian session (Nikkei -0.4%, Hang Seng +0.6%, Shanghai +0.7%).  In fact, Shanghai reached its highest level since August 2015, the previous bubble we saw there.  US futures, meanwhile, are little changed at this hour as traders await the first indications from the Georgia elections.

Bond markets are broadly lower this morning, with Treasury yields higher by 1.3bps and most European bonds showing similar rises in their yields.  On the one hand this is unusual, as bonds generally benefit from a risk off mood.  On the other hand, if I am correct about the move toward negative real yields, bonds will not be a favored investment either and could well underperform going forward, at least until the central banks increase their purchases.

Another beneficiary of negative real yields in the US is gold, which rallied sharply yesterday, more than 2%, and is up a further 0.3% this morning, back at $1950/oz.  Oil, meanwhile, is starting to move higher as well, up 1.8%, as some optimism over the outcome of the OPEC+ meeting is adding to the broad commodity rally.

And finally, the dollar is generally weaker this morning, down against all its G10 counterparts and many of its EMG counterparts as well.  In the G10, SEK (+0.6%) is the leader, which appears to simply be an example of its higher beta relative to the euro or pound vs. the dollar. But we are also seeing the commodity bloc perform well (AUD +0.5%, CAD +0.3%, NOK +0.3%) alongside their main exports.  However, this is clearly a dollar weakness story as the yen (+0.25%) is rallying alongside the rest of the bloc.

Interestingly, in the EMG group, ZAR (-1.35%) is the worst performer, followed by RUB (-0.6%), neither of which makes sense based on the G10 performance as well as that of commodities.  However, it is important to remember that short dollar is one of the most overindulged positions in markets, and the carry trade has been a favorite with both these currencies benefitting from that view.  This looks like a bit of position unwinding more than anything else.  On the positive side in this bloc, the CE4 remain solid and are leading the way, while LATAM currencies are little changed on the open.

On the data front, this week brings a lot of new information culminating in the payroll report on Friday.

Today ISM Manufacturing 56.7
ISM Prices Paid 65.0
Wednesday ADP Employment 50K
Factory Orders 0.7%
FOMC Minutes
Thursday Initial Claims 803K
Continuing Claims 5.1M
Trade Balance -$67.3B
ISM Services 54.5
Friday Nonfarm Payrolls 50K
Private Payrolls 50K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

Last Thursday saw a stronger than expected Chicago PMI and yesterday’s PMI data was strong as well, so the economy remains a bit enigmatic, with manufacturing still robust, but services in the dumps.  The payroll expectations are hardly inspiring, and with lockdowns growing in the States, as well as worldwide, it doesn’t bode well for Q1 at least, in terms of GDP growth.  We also hear from seven Fed speakers this week, which could well be interesting if anyone is set to change their tune regarding how long easy money will remain the norm.  However, I doubt that will happen.

The dollar remains on its back foot here, and I see no reason for it to rebound in the short run absent a change in the underlying framework.  By that I mean, something that will imply real yields in the US are set to rise.  Alas, I don’t see that happening in the near future.

Good luck and stay safe
Adf

Signs of Dissension

In China they claim that firms grew
Their profits and gross revenue
Encouraged by this
The bulls added risk
While bears had to rethink their view

Quite frankly, it has been a fairly dull session overnight with virtually no data and only a handful of comments.  Risk appetite is in the ascension after the Chinese reported, Saturday night, that Industrial Profits rose 19.1% Y/Y.  What’s truly remarkable about that statistic, and perhaps what makes it difficult to accept, is that throughout most of 2019, those numbers were negative.  In other words, prior to the outbreak of Covid-19, Chinese firms were struggling mightily to make money.  But since the very sharp dip in March, the rebound there, at least in this statistic, has been substantial.  While it is certainly possible that organic growth is the reason for this sharp rebound, it seems far more likely that PBOC support has been a key factor.  Remember, while they don’t get as much press as the Fed or ECB, they are extremely involved in the economy as well as financial markets.  After all, there is no semblance of independence from the government.

According to those in the know
The ECB’s starting to show
Some signs of dissension
Amid apprehension
The rate of inflation’s too low

In one camp the PIGS all believe
More money they ought to receive
But further up north
The hawks have put forth
The view PEPP should end New Year’s Eve

Meanwhile, the other story that is building is the growing split in the ECB between the hawks and doves regarding how to react to the evolving situation.  The breakdown is exactly as expected, with Italian, Spanish and Portuguese members calling for more support, via an expansion of the PEPP by December, latest, in order to assure those economies still suffering the aftereffects of the Covid shutdowns, that the ECB will prevent borrowing costs from rising.  Meanwhile, the hawkish set, led by Yves Mersch, the Luxembourgish ECB governor, sees the glass half full and has explained there is no need for further action as the economy looks much better.  Naturally, German, Dutch and Austrian members are on board with the latter view.  Madame Lagarde, the consensus builder, certainly has her work cut out to get policy agreement by the next meeting at the end of October.

Adding to the difficulty for the ECB is the apparent strength of the second wave of the virus that is truly sweeping the Continent.  While France has been the worst hit, with more than 11,000 new cases reported yesterday, the Netherlands, Belgium, Italy and Germany are all seeing caseloads as high, or higher, than the initial wave back in March.  European governments are reluctant to force another shutdown as the economic consequences are too severe, but they feel the need to do something that will demonstrate they are in control of the situation.  Look for more rules, but no mandatory shutdowns.

And remarkably, those are the only economically focused stories of the session.  The ongoing US presidential campaigns, especially now that the first debate is nearly upon us, has captured the bulk of the US press’s attention, although the angst over the Supreme Court nomination of Judge Amy Coney Barrett has probably been the cause of more spilled digital ink in the past several days.

So, a turn toward markets shows that Asian markets generally performed well (Nikkei +1.3%, Hang Seng +1.0%) although interestingly, despite the Chinese profits data, Shanghai actually fell -0.1%.  Europe, on the other hand, is uniformly green, led by the DAX (+2.7%) and CAC (+2.0%), with the FTSE 100 higher by a mere 1.5%.  US futures have taken their cues from all this and are currently pointing to openings nearly 1.5% higher than Friday’s closing levels.

Bond markets continue to offer little in the way of price signals as central bank activity continues to be the dominant force.  I find it laughable that Fed members are explaining they don’t want to increase QE because they don’t want to have an impact on the bond market.  Really?  Between the Fed and the ECB, the one thing in which both have been successful is preventing virtually any movement, up or down, in yields.  This morning sees the risk-on characteristic of a rise in Treasury and Bund yields, but by just 1.5bps each, and both remain well within their recent trading ranges.  Yield curve control is here in all but name.

As to the dollar, it is softer vs. its G10 counterparts with the pound (+1.25%) rising sharply in the past few minutes as the tone leading up to the restart of Brexit negotiations tomorrow has suddenly become quite conciliatory on both sides.  But we have also seen solid gains in SEK (+0.7%), NOK (+0.6%) and AUD (+0.5%).  The Stocky story has to do with the fact that the Riksbank did not receive any bids for credit by the banking community, implying the situation in the economy is improving.  As to NOK and AUD, a reversal in oil and commodity prices has been seen as a positive in both these currencies.

In the emerging markets, the picture is a bit more mixed with ZAR (+0.3%) as the leading gainer, although given the relative movement in the G10 space, one would have expected something more exciting.  On the downside, TRY (-1.65%) and RUB (-0.85%) are outliers as the declaration of war between Armenia (Russian-backed) and Azerbaijan (Turkish-backed), has raised further concerns about both nations’ financial capabilities to wage a hot war at this time.

On the data front, while the week has started off slowly, we have a lot to absorb culminating in Friday’s NFP numbers.

Tuesday Case Shiller Home Prices 3.60%
Consumer Confidence 90.0
Wednesday ADP Employment 630K
Q2 GDP -31.7%
Chicago PMI 52.0
Thursday Initial Claims 850K
Continuing Claims 12.25M
Personal Income -2.5%
Personal Spending 0.8%
Core PCE 0.3% (1.4% Y/Y)
Construction Spending 0.7%
ISM Manufacturing 56.3
ISM Prices Paid 59.0
Friday Non Farm Payrolls 850K
Private Payrolls 850K
Manufacturing Payrolls 38K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Michigan Sentiment 78.9
Factory Orders 1.0%

Source: Bloomberg

On top of the data, we have thirteen Fed speeches by eight different Fed speakers, although the Chairman is mute this week.  It seems unlikely that we will get a mixed message from this group, but it is not impossible.  After all, we have both the most hawkish (Mester today) and the most dovish (Kashkari on Wednesday) due, so the chance for some disagreement there.  As to the data, it would appear that the payroll data will be most important, but do not ignore the PCE data.  Remember, both PPI and CPI have been surprising on the high side the past two months, so a surprise here might get some tongues wagging, although I wouldn’t expect a policy change, that’s for sure.

Net, with a positive risk backdrop, it is no surprise to see the dollar under pressure.  However, I expect that we are more likely to see a modest reversal than a large extension of the move unless stocks can go up sharply from their already elevated levels.

Good luck and stay safe
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Dreams All Come True

The Minutes explained that the Fed
Was actively looking ahead
Twixt yield curve control
And guidance, their goal
Might not be achieved, so they said

This morning, though, payrolls are due
And traders, expressing a view
Continue to buy
Risk assets on high
Here’s hoping their dreams all come true!

In the end, it can be no surprise that the Fed spent the bulk of their time in June discussing what to do next. After all, they had to be exhausted from implementing the nine programs already in place and it is certainly reasonable for them to see just how effective these programs have been before taking the next step. Arguably, the best news from the Minutes was that there was virtually no discussion about negative interest rates. NIRP continues to be a remarkable drag on the economies of those countries currently caught in its grasp. We can only hope it never appears on our shores.

Instead, the two policies that got all the attention were forward guidance and yield curve control (YCC). Of course, the former is already part of the active toolkit, but the discussion focused on whether to add an outcome-based aspect to their statements, rather than the more vague, ‘as long as is necessary to achieve our goals of stable prices and full employment.’ The discussion centered on adding a contingency, such as; until inflation reaches a certain level, or Unemployment falls to a certain level; or a time-based contingency such as; rates will remain low until 2023. Some would argue they already have that time-based contingency in place, (through 2022), but perhaps they were leading up to the idea it will be longer than that.

The YCC discussion focused on research done by their staff on the three most well-known instances in recent history; the Fed itself from 1942-1951, where they capped all rates, the BOJ, which has maintained 10-year JGB yields at 0.0% +/- 0.20%, and the RBA, which starting this past March has maintained 3-year Australian yields at 0.25%. As I mentioned last week in “A New Paradigm” however, the Fed is essentially already controlling the yield curve, at least the front end, where movement out to the 5-year maturities has been de minimis for months. Arguably, if they are going to do something here, it will need to be in the 10-year or longer space, and the tone of the Minutes demonstrated some discomfort with that idea.

In the end, my read of the Minutes is that when the FOMC meets next, on July 29, we are going to get a more formalized forward guidance with a contingency added. My guess is it will be an Unemployment rate contingency, not a time contingency, but I expect that we will learn more from the next set of Fed speakers.

Turning to today, as the market awaits the latest payroll report, risk assets continue to be on fire. The destruction in so many areas of the economy, both in the US and around the world, is essentially being completely ignored by investors as they continue to add risk to their portfolios amid abundant central bank provided liquidity. Here are the latest median forecasts as compiled by Bloomberg for today’s data:

Nonfarm Payrolls 3.06M
Private Payrolls 3.0M
Manufacturing Payrolls 438K
Unemployment Rate 12.5%
Average Hourly Earnings -0.7% (5.3% Y/Y)
Average Weekly Hours 34.5
Participation Rate 61.2%
Initial Claims 1.25M
Continuing Claims 19.0M
Trade Balance -$53.2B
Factory Orders 8.7%
Durable Goods 15.8%
-ex Transport 6.5%

Because of the Federal (although not bank) holiday tomorrow, the report is being released this morning. It will be interesting to see if the market responds to the more timely Initial Claims data rather than the NFP report if they offer different messages. Remember, too, that last month’s Unemployment rate has been under much scrutiny because of the misclassification of a large subset of workers which ultimately painted a better picture than it might otherwise have done. Will the BLS be able to correct for this, and more importantly, if they do, how will the market interpret any changes. This is one reason why the Initial and Continuing Claims data may be more important anyway.

But leading up to the release, it is full speed ahead to buy equities as yesterday’s mixed US session was followed by strength throughout Asia (Nikkei +0.1%, Hang Seng +2.85%, Shanghai +2.1%) and in Europe (DAX +1.6%, CAC +1.3%, FTSE 100 +0.6%). US futures are also higher, between 0.4%-0.8%, to complete the virtuous circle. Interestingly, once again bond yields are not trading true to form on this risk-on day, as yields in the US are flat while throughout Europe, bond yields are declining.

But bonds are the outlier here as the commodity space is seeing strength in oil and metals markets and the dollar is under almost universal pressure. For example, in the G10, NZD is the leading gainer, up 0.6%, as its status as a high beta currency has fostered buying interest from the speculative crowd betting on the recovery. But we are also seeing NOK and SEK (both +0.5%) performing well while the euro (+0.3%) and the pound (+0.3%) are just behind them. The UK story seems to be about the great reopening that is due to occur starting Saturday, when pubs and restaurants as well as hotels are to be allowed to reopen their doors to customers. The fear, of course, is that this will foster a second wave of infections. But there is no doubt there is a significant amount of pent up demand for a drink at the local pub.

In the EMG bloc, the ruble is today’s winner, rising 1.2% on the back of oil’s continued rebound. It is interesting, though, as there is a story that Saudi Arabia is having a fight with some other OPEC members, and is close to relaunching a full-scale price war again. It has been the Saudis who have done the lion’s share of production cutting, so if they turn on the taps, oil has a long way to fall. Elsewhere in the space, INR (+0.8%) and ZAR (+0.75%) are having solid days on the back of that commodity strength and recovery hopes. While the bulk of the space is higher, IDR has had a rough session, in fact a rough week, as it has fallen another 0.65% overnight which takes its loss in the past week near 2.0%. Infection rates continue to climb in the country and investors are becoming uncomfortable as equity sales are growing as well.

So, this morning will be a tale of the tape. All eyes will be on the data at 8:30 with the odds stacked for a strong risk session regardless of the outcome. If the data shows the recovery is clearly strengthening, then buying stocks makes sense. On the other hand, if the data is disappointing, and points to a reversal of the early recovery, the working assumption is the Fed will come to the rescue quite quickly, so buying stocks makes sense. In this worldview, the dollar is not seen as critical, so further dollar weakness could well be in our future.

Good luck and stay safe
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