Tag Archives: #Yellen

Before Omicron

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There once was a narrative told
Explaining the Fed still controlled
The market’s reaction
Preventing contraction
Thus, making sure stocks ne’er got sold

But that was before Omicron
Evolved and put more pressure on
The future success
Of Fed’ral largesse
With no real conclusion foregone

So, later this morning we’ll hear,
When Janet and Jay both appear,
In front of the Senate
If they’ve still the tenet
That all will be well by next year

Perhaps all is not right with the world.  At least that would be a conclusion easily drawn based on market activity this morning.  Once again, risk is being shed rapidly and across the board.  Not only that, but the market is completely rethinking the idea of tighter monetary policy by the Fed with the growing conclusion that it is just not going to happen, at least not on the timeline that had been assumed a few short days ago.

It seems that the Omicron variant of Covid is proving to be a bigger deal in investor’s eyes than had been originally assumed.  When this variant was first identified by South African scientists, the initial belief was it was more virulent but not as acute as the Delta variant.  So, while it was spreading quite rapidly, those who were infected displayed milder symptoms than previous variants.  (If you think about the biology of this, that makes perfect sense.  After all, every organism’s biologic goal is to continue to reproduce as much as possible.  If a virus is so severe that its host dies, then it cannot reproduce very effectively.  Thus, a more virulent, less severe strain is far more likely to remain in the world than a less virulent, more deadly strain, which by killing its hosts will die off as well.)

In the meantime, financial markets have been trying to determine just what type of impact this new strain is going to have on economies and whether it will induce another series of lockdowns slowing economic activity, or if it will be handled in a different manner.  And so far, there is no clear conclusion as evidenced by the fact that we saw a massive sell-off in risk assets Friday, a major rebound yesterday and another sell-off this morning.  If pressed, I would expect lockdowns to come back into vogue as despite questions over their overall efficacy, their imposition allows government officials to highlight they are ‘doing something’ to prevent the spread.  Additional bad news came from the CEO of Moderna, one of the vaccine manufacturers, when he indicated that the nature of this variant would likely evade the vaccines’ defense.

So, story number one today is Omicron and how this new Covid variant is going to impact the global economy.  Ironically, central bankers around the world must be secretly thrilled by this situation as the focus there takes the spotlight off their problem, rapidly rising inflation.

For instance, after yesterday’s higher than expected CPI prints in Spain and Germany, one cannot be surprised that the Eurozone’s CPI printed this morning at 4.9%, the highest level since the Eurozone was born in 1997, and far higher than any of the 40 economist forecasts published.  Madame Lagarde wasted no time explaining that this was all temporary and that by the middle of next year inflation would be back to its pre-pandemic levels, but it seems fewer and fewer people are willing to believe that story.  Do not mistake the run to the relative safety of sovereign bonds as a vote of confidence in the central bank community.  Rather that is simply seen as a less risky place to park funds than the equity market, which by virtually every measure, remains significantly overvalued.

This leads to the third major story of the day, the upcoming testimony by Chairman Powell and Treasury Secretary Yellen in front of the Senate Banking Committee.  The pre-released opening comments focus on Omicron and how it can be a risk for both growth and inflation thus once again trying to divert attention from Fed policies as a problem by blaming exogenous events beyond their control.  Of course, this story will resolve itself starting at 10:00, so we will all listen in then.

Ok, with all that as prelude, a quick tour of markets shows just how much risk is in disfavor this morning.  Overnight in Asia we saw broad weakness (Nikkei -1.6%, Hang Seng -1.6%) although once again Shanghai was flat.  Europe is completely in the red (DAX -1.45%, CAC -1.25%, FTSE 100 -1.0%) and US futures are also pointing lower (DOW -1.2%, SPX -1.0%, NASDAQ -0.5%).

Meanwhile, bond markets are ripping higher with Treasuries (-5.1bps) leading the way as yields fall back to levels last seen in early September.  In Europe, Bunds (-2.1bps), OATs (-2.2bps) and Gilts (-4.0bps) are all seeing demand pick up with the rest of the Continent all looking at lower yields despite rising inflation.  Fear is clearly a powerful motivator.  Even in Asia we saw JGB’s (-1.9bps) rally as did Australian and New Zealand paper.

Commodity markets are having quite a day with some really mixed outcomes.  Oil (-2.5%) is back in the red after yesterday’s early morning rebound faded during the day, and although oil did close higher, it was well of the early highs.  NatGas (-5.0%) is falling sharply, which at this time of year is typically weather related.  On the other hand, gold (+0.5%) is bouncing from yesterday and industrial metals (Cu +1.4%, Al +1.6%, Sn +2.7%) are in clear demand.  It seems odd that on a risk-off day, these metals would rally, but there you have it.

Finally, the dollar can only be described as mixed this morning, with commodity currencies under pressure (NOK -0.4%, CAD -0.25%) while financial currencies (EUR +0.5%, CHF +0.5%, JPY +0
4%) are benefitting on receding expectations for a tighter Fed.  PS, I’m sure the risk off scenario is not hurting the yen or Swiss franc either.

Emerging market currencies are demonstrating a broader based strength with TRY (-1.6%) really the only major loser as further turmoil engulfs the central bank there and expectations for lower interest rates and higher inflation drive locals to get rid of as much lira as possible.  Otherwise, PLN (+0.8%) is leading the way higher as expectations for the central bank to raise rates grow with talk now the rate hike will be greater than 50 basis points.  But MYR (+0.8%) and CZK (+0.75%) are also showing strength with the ringgit simply rebounding after a 10-day down move as bargain hunters stepped in, while the koruna has benefitted from hawkish comments from the central bank governor.  It appears that most EMG central banks are taking the inflation situation quite seriously and I would look for further rate hikes throughout the space.

Aside from the Powell/Yellen testimony, this morning brings Case Shiller House Prices (exp 19.3%), Chicago PMI (67.0) and Consumer Confidence (111.0).  As well, two other Fed speakers, Williams and Clarida, will be on the tape, but it is hard to believe they will get much notice with Powell front and center.

The dollar appears to be back following the interest rate story, which means that if expectations of Fed tightening dissipate, the dollar will likely fade as well, at least versus the financial currencies.  Commodities have a life of their own and will continue to dominate those currencies beholden to them.  The tension between potential slower growth and rising inflation has not been solved, and while my view is the Fed will allow inflation to burn still hotter, keep in mind that if they do act to tighten policy, the dollar should find immediate support.

Good luck and stay safe
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Ill-Starred

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The latest from Treasury’s Yellen
Is really not all that compellin’
The problem, she said
Is Covid’s widespread
So, prices just won’t stop their swellin’

This morning, then, Madame Lagarde
Repeated her latest canard
If we were to tighten
Too early, we’d heighten
The risk of an outcome, ill-starred

As we begin a new week the only thing that has changed is the date, at least with respect to the official narrative regarding inflation and the economy.  Once again, this weekend, Treasury Secretary Yellen complained explained that Covid-19 is the reason inflation is running so high, and that once the pandemic is under control, prices will slow their ascent.  That seems to ignore the Fed’s balance sheet expansion of $5 trillion since last year, as well as the $5 trillion in special fiscal assistance that has been enacted by the government, the last $1.9 trillion under her guidance.  And of course, she is cheerleading the next $1.75 trillion in the Administration’s plans.  Yet she continues to claim that when Covid recedes, all will be well again.

At the same time, ECB President Christine Lagarde continues along the same lines, pooh-poohing the idea that the ECB should consider tightening policy because the current bout of inflation is only temporary (wisely, she has stopped using the term transitory at this point) and were they to act now, by the time their policy change had any effect on the economy, inflation would already be slowing down on its own.  So, you can be sure that the ECB is not about to alter its policy either anytime soon.  In fact, when the PEPP expires in March next year, you can be certain that the APP, the original Asset Purchase Plan (QE) will be expanded and extended to keep the cocaine flowing into the Eurozone economy’s bloodstream.

Will this process change at any point soon?  The odds remain extremely low in either the US or Europe given the evolution of the membership of both policy boards.  In the US, it appears the odds of a Chairwoman Lael Brainerd grow each day, and with that, the odds of easier monetary policy for an even longer time.  A telling blurb about her views recounts the time when then Chair Yellen wanted to start to raise rates in 2015 and Brainerd argued forcefully against the idea.  History shows that the Fed missed a key opportunity at that time to more fully normalize policy, leading directly to the lack of effective tools they currently possess.  While Chairman Powell has certainly been no hawk, relative to Ms Brainerd, his talons look quite sharp.

At the same time, the news that Bundesbank president Jens Weidmann is stepping down has resulted in the most forceful counterbalance to the large dovish wing in the ECB leaving the governing council.  While the next Buba president is sure to be more hawkish than most ECB members, he will not have the gravitas nor sway that Weidmann holds, and therefore, will be less able to push against the doves.

While smaller economies around the world continue to respond to rapidly rising inflation (just Thursday, Banxico raised the base rate in Mexico another 0.25% to 5.00%) it is abundantly clear that neither the Fed nor ECB is anywhere near that path.  Yes, the Fed has started to marginally slow down balance sheet expansion, but that is not tightening policy under any definition.  It is unclear what type of shock will be necessary to force these two central banks to rethink their current plans, but if history is any guide, central banks tend to overstay their welcome when it comes to easing monetary policy.  You can have too much of a good thing and I fear that is what we are all going to experience at some point in the not too distant future.

In the meantime, however, nothing seems to stop the march higher in equity markets and today is no exception.  Last night in Asia, the Nikkei (+0.6%) and Hang Seng (+0.25%) both moved higher although Shanghai (-0.2%) continues to be weighed down by the property sector with Evergrande as well as several other developers barely able to continue as going concerns.  Europe is generally firmer as well led by the CAC (+0.4%) and DAX (+0.1%) although, here too, there is a laggard in the form of the FTSE 100 (-0.2%) after housing prices slipped and seemed to portend a slowing in the economy there.  US futures are currently about 0.2% higher on the day.

In the bond market, which has been remarkably volatile lately, this morning is showing a respite, with Treasury yields (-0.3bps) nearly unchanged and similar modest yield declines throughout Europe (bunds flat, OATs -0.5bps, Gilts -0.9bps).  At this stage, the bond bulls and bears are fighting to a draw and waiting the next key signal.  Certainly, inflation would have you believe that yields should rise, but between ongoing QE and concerns over a slowing economy, the bond bulls are still in the driver’s seat.

In the commodity markets, oil is continuing last week’s sell-off, down 1.5% this morning with WTI back below $80/bbl. NatGas (-0.9%), too is falling, at least in the US, but not in Europe, where Gazprom, which had increased flows for a few days, seems to have cut back yet again.  I fear it is going to be a long, cold winter on the continent.  In the metal’s markets, gold (-0.1%) has edged lower this morning although has been performing quiet well over the past two weeks having rallied more than 6%.  But all the base metals (Cu -0.3%, al -0.7%, Sn -0.8%) are under pressure, hardly a sign of robust growth on the horizon.

Overall, the dollar is under modest pressure this morning, although recall, it has been quite firm for the past several weeks.  In the G10, AUD (+0.45%) and NZD (+0.4%) are the leading gainers as investors are sensing an opportunity in recently rising bond yields there.  Interestingly, NOK (+0.35%) is also higher despite oil’s decline, although this appears to be more of a technical correction than a trend change.  In the EMG bloc, ZAR (+0.9%) and RUB (+0.7%) are the leading gainers, both on the strength of expectations for further policy tightening by their central banks.  On the downside, PHP (-0.65%) is the key laggard as importers were seen selling dollars to pay for things like oil and gas.

Data this week is led by Retail Sales and comes as follows:

Today Empire Manufacturing 22.0
Tuesday Retail Sales 1.3%
-ex Autos 1.0%
IP 0.8%
Capacity Utilization 75.9%
Wednesday Housing Starts 1580K
Building Permits 1630K
Thursday Initial Claims 260K
Continuing Claims 2123K
Philly Fed 24.0
Leading Indicators 0.8%

Source: Bloomberg

In addition, we have ten Fed speakers on the calendar across fifteen different speaking engagements.  Be prepared for at least a little movement from that cacophony.

For now, the medium-term trend remains for dollar strength, despite today’s price action, as ongoing high inflation readings continue to drive the idea that the Fed will actually tighten policy at some point.  While that remains to be seen, it is the current market view, and I would not stand in its way.

Good luck and stay safe
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Prices Will Grow

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As markets await CPI
It’s funny to watch the Fed try
Explaining inflation
Will lack the duration
To send expectations sky-high

But even their own surveys show
That most people already know
Inflation is here
And well past next year
The level of prices will grow

Each month the Federal Reserve Bank of New York publishes the results of a survey of consumer expectations on inflation.  Yesterday, they published the September results and, lo and behold, the data showed that 1-year inflation expectations rose to 5.31%, by far the highest point since the survey began in 2013.  The 3-year data rose to its highest ever level of 4.19%, also well above the Fed’s 2.0% target.  And yet somehow, the authors of the report explained that inflation expectations remain well anchored.  Their claim is that if you look at the 5-year expectations, they remain near the levels seen before the pandemic, indicating that there should be no concern.  I don’t know about you, but 3 years of inflation running above 4.0% seems a lot longer than transitory.

Of course, it’s not just the analysts at the NY Fed who are unwilling to admit to the increasingly obvious situation, we continue to hear the same from other officials.  For instance, Treasury Secretary Janet Yellen, in a televised interview yesterday remarked, “I believe it’s [inflation] transitory, but I don’t mean to suggest these pressures will disappear in the next month or two.”  She then raised the specter of shortages by commenting, “There’s no reason for consumers to panic over the absence of goods they’re going to want to acquire at Christmas.”  Now, don’t you feel better?

In fairness, however, there are several Fed members who have finally admitted that the transitory emperor has no clothes.  Atlanta Fed President Raphael Bostic explained yesterday, “It is becoming increasingly clear that the feature of this episode that has animated price pressures – mainly the intense and widespread supply-chain disruptions – will not be brief.  By this definition, then, the forces are not transitory.”  As well, we heard from St Louis Fed President James Bullard, “I have to put some probability on a scenario where inflation stays high or even goes higher.”

At this point, it’s fair to ask, which is it?  Clearly there is a split at the Fed with some regional presidents recognizing that inflation has risen sharply and has all the appearances of being persistent, while Fed governors seem more likely to lean toward the transitory fable.  Perhaps what explains this split is the regional presidents have a far different constituency than do the Fed governors.  The Fed presidents are trying to address the issues extant in their respective geographies, so rising inflation matters to them.  Meanwhile, the governors, despite the claim that the Fed is apolitical, serve their masters in Congress and the White House, who believe they need to continue QE and ZIRP forever to continue spending money in unconscionable sums while not suffering from the slings and arrows of the bond market vigilantes.  But remember this too, every Fed governor votes at every meeting while only a handful of regional presidents vote (granted, Bostic is one of those right now.)  I fear we will continue to hear transitory for a while yet.

All this is a prelude to two key pieces of information today, this morning’s CPI release (exp 5.3% headline, 4.0% core) and the FOMC Minutes from the September meeting to be released at 2:00pm.  The one thing that has been very clear lately is that interest rate markets are beginning to buy into the persistence of inflation.  While Treasury yields have edged lower by 1.6bps this morning, in the past 3 weeks, those yields have risen 26 basis points.  And this is a global phenomenon with Bund yields, for instance, having risen 20 basis points over the same period despite a 4.1bp decline today.  Investors are starting to pressure the central bank community with respect to interest rates, driving them higher as fears of rising inflation abound worldwide.  While some, central banks have recognized the reality on the ground (Norway, New Zealand, numerous EMG nations) and others have paid lip service to the idea of raising rates (the UK, Canada), the two biggest players, the Fed and ECB, will not even discuss raising rates, although the Fed continues to tease us with talk of tapering.

However, I will ask again, do you believe the Fed will taper (tighten) policy if GDP growth is more clearly abating?  My view remains that they may actually start to taper, but that it will be a short-lived process as weak GDP growth will dissuade them from doing anything to worsen that side of the ledger.  While eventually, weaker GDP growth will result in demand destruction and reduced price pressures, that is likely to take a very long time.  Hence, the idea of stagflation remains very viable going forward.

Now it’s time to look at markets.  Equities have had a mixed session thus far with Asia (Nikkei -0.3%, Hang Seng -1.4%, Shanghai +0.4%) seeing both gainers and losers and Europe (DAX +0.7%, CAC +0.25%, FTSE 100 -0.1%) seeing similar mixed price action.  UK data showed August GDP was a tick lower than forecast and is clearly slowing from its previous pace, arguably weighing on the FTSE.  As to US futures, they are edging higher ahead of the data with gains in the 0.1%-0.3% range after yesterday’s modest declines.

We’ve already discussed bonds so a look at commodities shows that oil (-0.6%) is retreating for the moment as is NatGas (-1.5%), while we are seeing strength in gold (+0.7%) and copper (+1.7%).  In fact, the entire metals complex is stronger today as apparently, weaker energy prices are good for industrial activities.

As to the dollar, it is under some modest pressure today across the board.  In the G10, SEK (+0.35%) and CHF (+0.35%) lead the way with JPY (0.0%) the laggard.  However, there are no specific stories that seem to be driving things, rather this is a broad-based dollar correction from recent strength.  The same situation holds in the EMG bloc with ZAR (+0.75%) the leader followed by much lesser movement of KRW (+0.4%), CZK (+0.35%) and PLN (+0.35%).  The won has responded to comments from the central bank that it is closely watching the exchange rate and will not be afraid to step in if it becomes destabilized.  That is a euphemism for much weaker, as the currency had fallen nearly 9% in the previous four months.  As to the others, recent weakness seems to merely being consolidated with nothing new driving price action.

While the Fed may not care much about CPI, the rest of us do care.  And really, so do they, but it doesn’t tell their story very well.  At any rate, while it is entirely reasonable that we see a continued flatlining of price rises, the risks remain to the upside as at some point, housing inflation is going to show up in the data.  And that, my friends, is going to be significant and persistent!  Ahead of the number, don’t look for much.  If we see a high print, expect the dollar to regain this morning’s losses, though, as the market will become that much surer the taper is on its way.

Good luck and stay safe
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No Yang, Only Yin

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According to every newspaper

The Fed’s getting ready to taper

With late Twenty-two

The popular view

Of when, QE, they will escape(r)

But what if, before they begin

To taper, to Powell’s chagrin

The bond market tanks

As traders and banks

Believe there’s no yang, only yin

The Fed begins its two-day meeting this morning and the outcome remains the primary topic of conversation within every financial market.  The growing consensus is that there will be some discussion in the meeting of when the Fed should begin to reduce their QE purchases as well as what form that should take.  Given the extraordinary heat in the housing market, there have been numerous calls for the Fed to stop buying mortgage-backed securities first as that market hardly needs any more support.  In the end, however, the details of how they choose to adjust policy matters less than the fact that they are choosing to do so at all.

As pointed out yesterday, the bond market’s rally thus far in Q2 appears to be far more related to the lack of new Treasury supply than increasing demand and declining concerns over future inflation.  If that view is correct, then discussing the timing of tapering QE will seem quite premature.  It is true Treasury Secretary Yellen said that higher interest rates would be a good thing, but it seems highly likely she was not thinking of 10-year yields at 3.0% or more, rather somewhere just south of 2.0%.  In other words, a modest increase from current levels.  History, however, shows that markets rarely correct in a modest manner, rather they tend to move to extremes before retracing to a new equilibrium.  Thus, even if 2.0% is a new equilibrium (and I don’t believe that will be the case) do not be surprised to see yields significantly higher first.

In this view, the impact on markets worldwide is likely to be significant.  It seems unlikely that equity markets anywhere will respond positively to higher interest rates at all, let alone sharply higher rates.  As well, bond markets will, by definition, have been falling rapidly with much higher yields, not just in the US but elsewhere as well.  As to the dollar, it would seem that it will also be a big beneficiary of higher US yields, arguably with USDJPY the most impacted.  A quick look at recent correlations between different currencies and US 10-year yields shows the yen is the only major currency that has a significant correlation to yields (0.46).  But I would not discount the idea that the dollar will rally versus pretty much the rest of the G10 as well as the EMG bloc in a situation where dollar yields are rising sharply.  Consider that in this situation, we will likely be looking at a classic risk-off scenario when the dollar tends to perform best.

Of course, there are many in the camp who believe that the central banking community will remain in control of markets and that inflation is transitory thus allowing them to adjust policy at their preferred pace.  It is this scenario that Ms Yellen clearly is expecting, or at least describing in her desire for higher yields.

And this is the crux of the market’s future decisions; will central banks be able to slowly reduce monetary accommodation as economies around the world slowly return to pre-pandemic levels of activity, or will the dramatic increase in government debt issuance force central banks to maintain their QE programs in order to prevent the economic chaos that could result from sharply higher interest rates?  While my money is on the latter, it remains too soon to determine which broad outcome will occur.  It is also not clear to me that tomorrow’s FOMC announcement is going to be that big a deal in the long run, as it seems doubtful there will be any actual policy changes, even if they begin to discuss how they might do so in the future.  Remember, talk is cheap, even central bank forward guidance!

Markets remain in a holding pattern ahead of tomorrow’s FOMC statement and Powell’s press conference, although there have been some idiosyncratic moves overnight.  For instance, while Japanese equity markets continue to rally (Nikkei +1.0%) on the back of optimism regarding the Olympics and the idea that Covid inspired lockdowns will be ending soon, the same was not true in China where the Hang Seng (-0.7%) and Shanghai (-0.9%) markets both suffered after the PBOC failed to inject any additional liquidity into the money markets there.  With quarter-end approaching, demand for funds by financial institutions is rising and the fact that the PBOC continues to be somewhat parsimonious has been a key support for the renminbi, but not really helped the equity markets there.  Remember, China is quite concerned over what had been a growing housing bubble, and this is designed to help restrict the growth of that situation.

European equity markets are somewhat mixed this morning as the major indices have performed well (DAX +0.5%, CAC +0.4%, FTSE 100 +0.3%) but both Italy (-0.2%) and Spain (-0.5%) are lagging on the day.  The data of note has been CPI which showed that Germany (+2.5%) continues to feel the most inflationary pressure, while both France (+1.8%) and Italy (+1.2%) remain unable to find much inflationary impulse at all.  This is certainly a far cry from the situation here in the US and speaks to the idea that the ECB is not likely to begin tapering anytime soon.  In fact, it would not be surprising if they wind up either extending PEPP or expanding the original QE known as APP.  US futures, meanwhile, are little changed at this hour after yesterday’s mixed session.

Global bond markets are on hold this morning with none of the major nations seeing movement of even 1 basis point, despite yesterday’s Treasury sell-off raising 10-year yields by nearly 6 bps.  That movement has been described as technical in nature given the complete lack of new information seen.

On the commodity front, oil (WTI +0.8%) continues to power higher driving the entire energy complex in that direction but the rest of the space has seen quite a different outcome.  Precious metals (Au -0.2%, Ag -0.8%) continue their recent weak performance while industrial metals (Cu -3.5%, Al -1.3%, Sn -2.1%) have been absolutely crushed.  Agricultural products are mostly softer on the weather story, although soybeans is bucking that trend with a modest gain on the day.

As to the FX market, the dollar is mixed in both G10 and EMG blocs.  In the G10, AUD (-0.2%) has suffered on the back of dovish RBA Minutes released last night as they indicated it was premature to discuss tapering.  CAD (-0.3%) appears to be suffering on the back of the base metals decline and the pound (-0.25%) is on its back foot after slightly disappointing employment data.  Interestingly, NOK is unchanged on the day despite oil’s rally and CHF’s 0.1% gain, which leads the pack appears to be technical in nature.

In the EMG bloc, TRY (-1.3%) is suffering after the US-Turkey meeting at the G7 meetings was less fruitful than hoped with no breakthroughs achieved.  HUF (-0.7%) is declining after conflicting statements from a central bank member regarding a short-term liquidity facility has traders uncertain if policy accommodation is going to be ended soon or not.  Remember, uncertainty breeds contempt in markets.  Away from those two, however, the rest of the block saw very small movements with no significant stories.

On the data front, we get two important pieces this morning; Retail sales (exp -0.7%, +0.4% ex autos) and PPI (6.2%, 4.8% ex food & energy).  In addition, at 8:30 we see Empire Manufacturing (22.7) and then later we see IP (0.7%) and Capacity Utilization (75.1%).  Retail Sales is likely to dominate the discussion unless PPI is really high, above 7.0%.  But in the end, markets continue to wait for tomorrow’s FOMC, so large movement still seems unlikely today.  That said, if we do see Treasury yields creeping higher, I expect the dollar to perform pretty well.

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

Adf

A ZIRP Doctrinaire

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The lady who once ran the Fed

And, Treasury, now runs instead

Explained higher rates

Right here in the States

Are something that she wouldn’t dread

But when she was Fed Reserve chair

And she had a chance to forswear

That rates should stay low

Her answer was, no

As she was a ZIRP doctrinaire

“If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view.  We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade.  We want them to go back to a normal interest rate environment, and if this helps a little bit to alleviate things then that’s not a bad thing, that’s a good thing.”  So said Treasury Secretary Janet Yellen in a Bloomberg News interview as she was returning from the G7 FinMin meeting in London.

What are we to make of these comments?  Arguably, the first thing to note is that the myth of Fed independence is not merely shattered, but rather that the Treasury now explicitly runs both fiscal and monetary policy.  Can Chairman Powell resist a call for higher rates from his boss?  And yet this is diametrically opposed to everything we have heard from the majority of the FOMC lately, namely until “substantial further progress” is made toward achieving their key goal of maximum employment, policy is going to remain as is.  In other words, they are going to continue to buy $120 billion per month of Treasury and mortgage backed paper.  However, QE’s entire raison d’etre is to keep rates lower.  Does this mean tapering is going to begin soon?  Will they be talking about it at next week’s FOMC meeting?  Again, based on all we had heard up through the beginning of the quiet period, there was only a small minority of FOMC members who were keen to slow down the purchases.  Is Yellen a majority of one by herself?

The other thing that seems odd about this is that elsewhere in the interview she strongly backed the need for the proposed $4 trillion of additional government spending, which is going to largely be funded by issuing yet more Treasury debt.  I fail to understand the benefit, for the Treasury (or taxpayers) of spending more on debt service due to higher interest rates.  Or perhaps, Yellen was simply saying she thought spreads over Treasuries should rise, so others paid more, but the US still paid the least amount possible.  Somehow, though, I don’t believe the latter sentiment is what she meant.  (A cynic might assume she was short Treasuries in her PA after Friday’s data and was simply looking for a quick profit.  But, of course, no government official would ever seek to gain personally from their official role…right?)

Regardless of her motivation, the market took it to heart and 10-year Treasury yields have backed up 2.5 bps this morning, although that is after Friday’s very strong rally (yields fell more than 7 basis points) on the back of the weaker than expected NFP report convinced the market that tapering was now put off for much longer.

Which brings us to Friday’s data.  Once again, the NFP report missed the mark, with a gain of 559K, well below the 675K expected.  Interestingly, despite last month’s even bigger miss, revisions were miniscule, just 27K higher.  So, at least according to the BLS, job growth is not nearly as fast as previously expected/hoped.  What makes this so interesting was last week’s ADP data showed nearly 1 million new jobs were taken.  It appears that Covid has had a significant impact on econometric models as well as the economy writ large.  Of course, the stock market took this goldilocks scenario as quite bullish and we saw equity markets rally nicely on Friday.

In sum, Yellen’s comments seem a bit out of step with everything we had previously understood.  There is, though, one other possibility.  Perhaps Ms Yellen understands that inflation is not going to be transitory and that the Fed may well find itself forced to raise rates to address this situation.  If this is the case, then the fact that the Treasury Secretary has already explained she thinks higher rates would be “a good thing,” it leaves the Fed the leeway needed to address the coming inflationary wave.  One thing is certain, the inflation discussion is going to be with us for quite a while yet.

Market activity overnight has been fairly dull despite the Yellen comments, with equity markets mixed in Asia (Nikkei +0.3%, Hang Seng -0.45%, Shanghai +0.2%) although European markets have started to climb after a very slow start (DAX +0.2%, CAC +0.3%, FTSE 100 +0.3%).  US futures are mixed to slightly lower as NASDAQ futures (-0.35%) feel the force of potentially higher interest rates, while the other two indices are little changed.  (Remember, tech/growth stocks are akin to having extremely long bond duration, so higher interest rates tend to push these stocks lower.)

As mentioned, Yellen’s comments have led to Treasuries falling, and we have seen the same behavior in Europe with sovereigns there looking at yields higher by between 1.5 and 2.0 bps at this hour.  Higher interest rates have also had a negative impact on commodity prices with oil (-0.4%), gold (-0.25%), copper (-1.0%) and aluminum (-1.0%) all under pressure.  The one exception in the commodity space is foodstuff where the grains are all higher by at least 1.5% this morning.

Finally, the currency market is mixed although arguably leaning toward slight dollar weakness.  In the G10, the most notable mover is NOK (+0.5%) which is gaining despite oil’s weakness on the assumption that it will be the first G10 country to actually raise interest rates, with Q4 this year now targeted.  But away from that, the other 9 currencies are within 0.2% of Friday’s close with no stories of note.  In the emerging markets, MXN (+0.85%) is the runaway leader after yesterday’s elections handed AMLO a loss of his supermajority in the Mexican congress.  It seems investors are glad to see a check on his populist agenda of spending.  Beyond that, we see TRY (+0.5%) benefitting from hopes that President Biden’s meeting with Turkish President Erdogan will result in reduced tensions between the two countries.  And lastly, KRW (+0.3%) continues to see investment inflows drive the currency higher.

On the data front, there was nothing of note overnight, but this week has some important activities, namely US CPI and the ECB meeting.

Tuesday NFIB Small Biz Optimism 100.9
Trade Balance -$68.5B
JOLTS Job Openings 8.3M
Thursday ECB Meeting
CPI 0.4% (4.7% Y/Y)
-ex food & energy 0.4% (3.4% Y/Y)
Initial Claims 370K
Continuing Claims 3.7M
Friday Michigan Sentiment 84.2

Source: Bloomberg

Clearly, all eyes will be on CPI later this week as while widely expected to be rising again due to base effects, it is important to remember that it has risen far faster than even those expectations.  While the Fed remains quiet, the ECB is likely to reiterate that it is going to be keeping a ‘stepped up pace’ of asset purchases.  Although there is a great deal of belief in the dollar weakness story, I assure you, the ECB is not interested in the euro rallying much further.  Just like the Chinese, it appears most countries have had enough of a weak dollar.  Until the next cues, however, it seems unlikely that there will be large movement in the FX market.

Good luck and stay safe

Adf

Rates May Have to Rise

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Said Janet, “rates may have to rise”
Which really should be no surprise
The money we’ve spent
Has markets hell bent
On constantly making new highs

But right after this bit of diction
The market ran into some friction
So quick as a wink
She had a rethink
And said “this is not a prediction”

Just kidding!  What was amply demonstrated yesterday is that the Fed, and by extension the US government, has completely lost control of the narrative.  The ongoing financialization of the US economy has resulted in the single most powerful force being the stock market.  Policymakers are now in the position of doing whatever it takes, to steal a phrase, to prevent a decline of any severity.  This includes actual policy decisions as well as comments about potential future decisions.

A brief recap of yesterday’s events shows that Treasury Secretary Yellen, at a virtual event on the economy said, “rates may have to rise to stop the economy from overheating.”  Now, on its surface, this doesn’t seem like an outrageous statement as it hews directly to macroeconomic theory and is widely accepted as a reasonable idea. However, Janet Yellen is no longer a paid consultant for BlackRock, but US Treasury Secretary.  And the only market fundamental that matters currently is the idea that the Fed is not going to raise interest rates for at least another two years.  Thus, when a senior administration financial official (has a Freudian slip and) talks about rates needing to rise, investors take notice.

So, in a scene we have observed numerous times in the past, immediately after the comments equity markets started to sell off even more sharply than their early declines and the market discussion started to turn to when rates may be raised.  But a declining stock market is unacceptable, so in a later WSJ interview, Yellen recanted clarified those remarks explaining that she was neither predicting nor recommending rate hikes.  It was merely an observation.

However, what was made clear was just how few degrees of freedom the Fed has to implement the policy they see fit.  It is for this reason that every time an official explains the Fed ‘has the tools’ necessary to fight inflation should it arise, there is a great deal of eye-rolling.  The first tool in fighting inflation is raising interest rates, and that will not go down well in the equity world, regardless of the level of inflation.  And what we know is that the Fed clearly doesn’t have the stomach to watch stocks decline by 10% or 20%, let alone more, in the wake of their policy decisions to raise interest rates.  We know this because in Q4 2018, when they were attempting to normalize policy, raising rates and shrinking the balance sheet simultaneously, the stock market fell 20% and was starting to gain serious downside momentum.  This begat the Powell Shift on Boxing Day, which saw the Fed stop tightening and stocks stop falling.

It is with this in mind that we view the comments of other Fed speakers.  Most are hewing to the party line, with NY’s Williams and SF’s Daly both right on script explaining that while growth will be strong this year, there is still a great deal of slack in the economy and supportive (read easy) monetary policy is still critical in achieving their goals.  It is also why Dallas Fed president Kaplan is roundly ignored when he explains that tapering purchases later this year may be sensible given the strength of the economy.  But Kaplan isn’t a voter nor will he be one until 2023, so no matter how passionate his pleas are in the FOMC meeting room, it will never be known as he cannot even dissent on a policy choice.

In summary, yesterday’s Yellen comments and corrections simply reinforce the idea that the Fed is not going to raise rates for at least another two years and that tapering of asset purchases is not on Powell’s mind, nor that of most of his FOMC colleagues.  So…party on!

And that is exactly what we are seeing today in markets.  While the Hang Seng had a poor showing (-0.5%) which followed yesterday’s tech heavy selloff in the US, Europe, which of course lacks any tech sector to speak of, is sharply higher this morning (DAX +1.35%, CAC +0.9%, FTSE 100 +1.1%) as a combination of Services PMI data strength and optimism about the ending of lockdowns has investors expecting superior profit growth going forward.  US futures are also pointing higher (DOW +0.3%, SPX +0.4%, NASDAQ +0.5%) as confirmation that rates will remain low added to rising growth forecasts continue to underpin the equity case.  As an example of the growth optimism, the Atlanta Fed’s GDPNow forecast tool has risen to 13.567% as of yesterday, up from just 7.869% a week earlier!  Now, as more data is released, that will fluctuate, but if that data continues to be as strong as recent outcomes, do not be surprised to see Q2 GDP forecasts move a lot higher everywhere.

Turning to the bond markets, Treasury yields this morning are higher by 1.3 basis points, although that is after having slipped 3 bps on Monday and ultimately remaining unchanged yesterday.  But in this risk-on meme, bonds do lose their appeal.  European sovereigns are also generally lower with Bunds (+1.9bps), OATs (+2.3bps) and Gilts (+3.0bps), all seeing sellers converting their haven money into stock purchases.

Risk appetite in commodities remains robust this morning as oil prices continue to escalate (+1.1%) and are pushing back near their recent highs above $67/bbl.  While precious metals continue to lack traction, the base metal space is back in high gear this morning (Cu +0.5%, Al +0.65%, Sn +1.1%).  Agriculturals?  Wheat +0.3%, Soybeans +1.0%, Corn +0.85%.  It’s a good thing the price of what we eat has nothing to do with inflation!  As an example, Corn is currently $7.50/bushel, a price which has only been exceeded once in the data set going back to 1912, when it touched $8.00 in July 2012.  And looking at the chart, there is no indication that it is running out of steam.

Finally, the dollar has evolved from a mixed session to one where it is now largely under pressure.  This fits with the risk-on theme so should be no surprise.  NZD (+0.65%) leads the way higher but the commodity bloc is all firmer (AUD +0.4%, NOK +0.35%, CAD +0.3%) on the back of the commodity rally.  The rest of the G10, though, is little changed overall.  In the EMG space, PLN (-0.4%) is the outlier, falling ahead of the central bank’s rate announcement, although there is no expectation for a rate move, there is concern over a change in the dovish tone.  As well, the Swiss franc mortgage issue continues to weigh on the nation as a decision is due to be released next week and could result in significant bank losses and concerns over the financial system there.  But away from the zloty, there are a handful of currencies that are ever so slightly weaker, and the gainers are unimpressive as well (ZAR +0.35%, RUB +0.2%), both of which are commodity driven.

Two data points this morning show ADP Employment (exp 850K) and ISM Services (64.1) with more attention to be paid to the former than the latter.  We also have three more Fed speakers, Evans, Rosengren and Mester, with the previously hawkish Mester being the one most likely to discuss things like tapering being appropriate.  But in the end, there remains a very clear majority on the FOMC that there is no reason to change policy for a long time to come.

It is difficult to develop a new narrative on the dollar at this stage.  Rising Treasury yields on the back of rising inflation expectations are likely to offer short term support for the buck but can undermine it over time.  For today, however, it seems that the traditional risk-on theme is pushing back on its modest gains from yesterday.

Good luck and stay safe
Adf

The Seeds of Inflation

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Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory

But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone

Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation.  It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip.  The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives.  But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed.  (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)

For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%.  While both those results were exactly as forecast, the trend for both remains sharply higher.  The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation?  After all, it is not as though the data comes with a disclaimer.  Ultimately, a decision is going to have to be made that rising prices are becoming a problem.  Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.

For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession.  The June data will be the first test as that monthly CPI print last year was a robust 0.5%.  Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities.  But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand.  In fact, it is this uncertainty that is the primary rationale for corporate hedging.  There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results.  FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.

This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing.  Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%.  Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector.  In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday.  The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency.  Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.

Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds.  So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged.  Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets.  Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.

Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%).  The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs.  Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.

It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher.  Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today.  Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength.  There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.

As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.

Today ISM Manufacturing 65.0
ISM Prices Paid 86.1
Construction Spending 1.7%
Tuesday Trade Balance -$74.3B
Factory Orders 1.3%
-ex transport 1.8%
Wednesday ADP Employment 875K
ISM Services 64.1
Thursday Initial Claims 540K
Continuing Claims 3.62M
Nonfarm Productivity 4..2%
Unit Labor Costs -1.0%
Friday Nonfarm Payrolls 978K
Private Payrolls 900K
Manufacturing Payrolls 60K
Unemployment Rate 5.7%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%
Consumer Credit $20.0B

Source: Bloomberg

As well, we hear from five Fed speakers, including Chairman Powell this afternoon.  Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.

Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future.  Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact.  Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar.  We shall see.  As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast.  While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.

Good luck and stay safe
Adf

No line in the Sand

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The story from Janet and Jay
Continues to point to a day
In two years, nay three
That both can foresee
A rate hike could be on the way

Until then, while growth should expand
No policy changes are planned
If prices should rise
Though, we’ll recognize
There’s simply no line in the sand

With a dearth of new news overnight, the market appears to be consolidating at current levels awaiting the next big thing.  With that in mind, market participants continue to parse the words of the numerous central bank and financial officials who have been speaking lately.  Atop this list sits the second day of testimony by Fed Chair Powell and Treasury Secretary Yellen, who yesterday were in front of the Senate Banking Committee.  While several senators tried to get a clearer picture of potential future activities from both Powell and Yellen, they have become quite practiced at not saying anything of note in these settings.

Perhaps the most interesting thing to be learned was, when Yellen was being questioned about her change of heart on the growth of the Federal debt load (in 2017 she publicly worried over a debt/GDP ratio of 75% vs. today’s level of 127%), she repeated her new belief that the Federal government has room to borrow trillions of more dollars to fund their wish list.  “My views on the amount of fiscal space that the United States [has], I would say, have changed somewhat since 2017.  Interest payments on that debt relative to GDP have not gone up at all, and so I think that’s a more meaningful metric of the burden of the debt on society and on the federal finances.” She explained.  It is remarkable what a change of venue will do to one’s opinions.  Now that she is Treasury Secretary, and wants to spend more money, it appears much easier for her to justify the new borrowing required.

At the same time, Chair Powell explained that the rise in bond yields was of no concern and that it represented a vote of confidence in the growth of the economy.  We heard this, too, from Atlanta Fed President Bostic yesterday, and this is clearly the new mantra.  So, while 10-year yields have backed off their recent highs by a few basis points, be prepared for further movement higher as positive data gets released.  The bond market has a history of testing the Fed in times like this, and remember, history also shows that when the 2yr-10-yr spread starts to steepen, it doesn’t stop until it reaches 250-275 basis points, which is more than one full percent higher than its current level.  I expect to see that test sometime this summer, as inflation rises.  Beware the impact on risk assets in that scenario.

But other than that, and of course the fact that the Ever Given remains wedged side-to-side in the Suez Canal, there is very little happening in markets today. (Apparently, the economic cost to the global economy of this incident is $400 million per HOUR!  And consider what it is doing to the concept of just-in-time delivery for supply chains.  We have not yet felt the full impact of this event.)

A quick tour of markets shows that Asian equity markets were mixed, with the Nikkei (+1.1%), by far the best performer, while the Hang Seng (0.0%) and Shanghai (-0.1%) essentially tread water.  European markets are mostly red, but the movement has been minimal.  The DAX (-0.2%), CAC (-0.2%) and FTSE 100 (-0.3%) are perfectly representative of pretty much the entire European equity space.  Meanwhile, US futures are edging higher (NASDAQ +0.4%, SPX +0.25%, DOW +0.2%) after yesterday’s late day sell-off.  Anecdotally, one of the things I have noticed lately is that the US equity markets tend to close nearer their trading lows than highs, which is a far cry from their behavior up through January, where late day price action almost always pushed prices higher.  The other thing that is changing is that the huge retail push into single stock options has been fading lately.  Perhaps it’s not as easy to make money in the stock market as it was claimed several weeks ago.

As to the bond market, we continue to see modest strength in the European sovereign market, where the ECB’s impact is clear to all.  This morning, in contrast to Treasury yields edging slightly higher (+0.5bps), we are looking at yield declines of between 1.3bps (OATs) and 2.5bps (Gilts) with Bunds in between.  There is no question that the ECB’s purchase numbers this week will be close to last week’s rather than near their longer-term average.  As an aside, we heard from BOE chief economist Haldane this morning and he explained that the UK economy could be set for a “rip roaring” move higher in Q2 given the amount of savings available to spend as long as the vaccine roll-out continues apace.

On the commodity front, despite the ongoing disruption in the Suez, oil prices have slipped back by 1.3%, although continue to hold above the psychologically important $60/bbl level.  As to metals prices, they have drifted down as well, along with most agricultural products.  Again, the movements here are not substantial and are indicative of modest position adjustments rather than a new trend of any sort.

Lastly, turning to the dollar, it too has had a mixed session, with both gains and losses across the spectrum.  In the G10, AUD (+0.4%) is the leader, followed by the GBP (+0.3%) and then lesser gains amongst most of the rest.  Meanwhile, JPY (-0.35%) has been the laggard in the group.  Aussie was the beneficiary of short covering as well as exporter interest taking advantage of its recent declines, while the pound seems to have been responding to the Haldane comments of potential strong growth.  As to the yen, while there are some concerns the BOJ may cut back on its JGB purchases, it appears the yen was a victim of some importer selling ahead of the Fiscal year end next week.

EMG currencies are also mixed, with gainers led by RUB (+1.0%), ZAR (+0.7%) and MXN (+0.45%) while the laggards have a distinctly Asian flavor (THB -0.35%, MYR -0.35%, TWD -0.3%).  The ruble appears to be benefitting from a trading bounce after a 3-day losing streak, while the rand is gaining ahead of a central bank meeting today, although expectations are for no policy change given the still low inflation readings in the country.  On the downside, the Bank of Thailand left policy on hold, as expected, but forecast a narrowing of the current account surplus, thus weakening the baht.  Meanwhile, both the ringgit and the Taiwan dollar are suffering from concerns over continued USD strength in combination with some technical moves.  Overall, the bloc remains beholden to the dollar, so should the buck start to gain vs. the G10, look for these currencies to suffer more acutely.

As it is Thursday, we start the day with Initial Claims (exp 730K) and Continuing Claims (4.0M), but also see a Q4 GDP revision (4.1%, unchanged) along with some of the ancillary GDP readings that tend to be ignored.  In addition, we hear from five more Fed speakers, but it is hard to believe that any of them is going to have something truly new to tell us.  We already know they are not going to raise rates until 2023 at the earliest and that they are comfortable with higher inflation and higher bond yields.  What else is there?

With all this in mind, I keep coming back to the Treasury market as the single key driver of markets overall.  If yields resume their rising trend, look for the dollar to rally and equities to fade.  If yields edge back lower, there is room for modest dollar weakness.

Good luck and stay safe
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Will Not Be Deterred

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There once was a really big boat
Designed, lots of cargo, to tote
But winds from the west
Made it come to rest
Widthwise in the Suez, not float

A mammoth cargo ship, the Ever Given has run aground in the Suez Canal while it was fully laden and heading northbound toward the Mediterranean Sea.  The problem is that, at over 400 meters in length, it is blocking the entire waterway in both directions.  The resulting traffic jam has affected more than 100 ships in both directions and could take several days to unclog.  As a point of interest, roughly 12% of global trade passes through the Suez each year, including 1 million barrels of oil per day and 8% of LNG shipments.  The market impact was seen immediately in oil prices which jumped more than 3%, although remain just below $60/bbl after the dramatic sell-off seen in crude during the past week.  Canal authorities are working feverishly to refloat the ship, but given its massive weight, 224,000 tons, they don’t have tugboats large enough to do the job on site.  While larger tugs are making their way to the grounding, things will be messy for a while.  Do not be surprised if oil prices continue to climb in the short run.

The ECB picked up the pace
Of purchases as they embrace
The call to do more
Or else, answer for
The failure in Europe’s workplace

Meanwhile, from the House what we heard
Was Powell will not be deterred
From keeping rates low
If prices do grow
While Janet, on taxes, deferred.

Looking beyond the ship’s bow to the rest of the world, the two key stories so far this week have been the data from the ECB about increased QE purchases, as well as the joint testimony at the House of Representatives by Powell and Yellen.  Regarding the ECB, they announced they had purchased €21 billion in bonds last week, up 50% from the previous weekly pace of €14 billion, and exactly what one would expect given Madame Lagarde’s promise of an increased pace of buying.  Unfortunately for the ECB, European sovereign bond yields rose between 10-15 basis points while they were increasing purchases, as they followed US Treasury yields higher.  The problem for the ECB is that if Treasury yields do continue to rally (and while unchanged this morning, they have fallen back by 13 basis points since Friday’s peak), it is entirely realistic that European bonds will see the same price action regardless of the ECB’s stepped up purchases.  Of course, that is the last thing the ECB wants to see in their efforts to stimulate both growth and inflation.  Essentially, what this tells us is that the ECB does not really have the ability to guide the market in a direction opposite the global macro factors.  Perhaps, whatever it takes is no longer enough!

As to the dynamic duo’s testimony, there was really nothing surprising to be learned.  Powell continues to explain that while things are looking better, the Fed’s focus is on the employment situation and they won’t stop supporting the economy until all the lost jobs are regained.  As to inflation, he pooh-poohed the idea that a short-term burst in prices will have any impact on either inflation expectations or actual longer-term inflation outcomes.  In other words, he has been completely consistent with the FOMC statement and press conference.  As to the diminutive one, she promised that more spending was coming, but that it would be necessary to raise taxes on some people as well as the corporate tax rate.  The working assumption seems to be that corporate taxes are due to head to 28%, from the current 21% level, in the next big piece of legislation.  After that, they both had to defend their positions from rank political comments by Congressfolk trying to burnish their own credentials.

And in truth, those are the stories that are top of the list today, showing just how dull things are in the markets.  However, with that in mind, following yesterday’s late day sell-off in US equities, Asian equities were pretty much lower across the board (Nikkei -2.0%, Hang Seng -2.0%, Shanghai -1.3%) and Europe is entirely in the red as well, albeit not nearly as severely (DAX -0.6%, CAC -0.3%, FTSE 100 -0.3%).  And all this equity price action is despite the fact that PMI data from Japan and Europe was far better than expected, with, for example German Mfg PMI posting a 66.6 reading and Eurozone Mfg posting at 62.4.  Services remains much weaker, but in all cases, the outcomes were better than forecast, although still just below the 50.0 level.  It seems that there is more to the current level of fear than the data.  As to the US, futures here are higher led by the NASDAQ (+0.7%) with the other two major indices up by a more modest 0.3%.

In the bond market, Treasuries are seeing a bit of selling pressure as NY walks in, although the 10-year yield is only higher by 0.5bps.  Meanwhile, in Europe, there is a very modest bond rally (Bunds -1.3bps, OATs -1.4bps, Gilts -0.7bps) which is consistent with the modest risk off theme in equity markets there.  Price action in Asian bond markets, though, has been a bit more frantic with NZD bonds soaring (yields -15.7bps) as investors continue to respond to the government’s efforts to rein in housing prices, thus slowing inflation pressures.  This helped Aussie bonds as well, although yields there only fell 8 basis points.  The one truism is that bond market activity is far more interesting than equity market activity right now.

In the commodity markets, aside from oil’s rally on the supply disruption caused by the ship, price action has been far less significant.  Metals prices are very modestly higher (CU +0.35%, AL +2.1%, AU +0.2%) while the agricultural space is mixed, with a range of gainers and losers.

And finally, in the FX markets, the dollar is broadly stronger this morning, although not universally so.  In the G10, only NOK (+0.6%) and CAD (+0.1%) are firmer with the former clearly responding to higher oil prices, but also to a growing belief that the Norgesbank will be the first G10 bank to raise interest rates.  Meanwhile, the BOC, yesterday, explained that they were immediately stopping the expansion of their balance sheet, halting all programs, so also moving toward a tightening bias.  However, the rest of the bloc is softer, albeit by fairly modest amounts led by GBP (-0.3%) which posted lower than expected inflation readings.

Emerging market currencies are split in their behavior with ZAR (+0.9%), MXN (+0.7%) and RUB (+0.4%) all benefitting from the rising commodity price story while virtually every other currency in both APAC and the CE4 are softer on the decline in risk sentiment.  The one thing that is abundantly clear is that the EMG currencies are following the big risk meme.

Turning to this morning’s data releases, we see Durable Goods (exp 0.5%, 0.5% ex transport) and the preliminary PMI data (Mfg 59.5, Services 60.1).  Yesterday’s New Home Sales data disappointed at just 775K but was chalked up to a lack of supply.  It seems the supply of available housing is at generational lows these days, while prices rise sharply on the back of a doubling of lumber costs.  We also hear from Powell and Yellen again, this time at 10:00am in the Senate, but there is no reason to believe that anything different will be said.  In addition, four more Fed speakers will be heard, although the message continues to be consistent and clear, rates are not going to rise until 2023 earliest, no matter what happens.

For now, the dollar is benefitting from the market’s risk aversion, however, if Treasury yields fall further, I expect that the dollar will lose its luster and equities will find their footing.  On the other hand, if this is the temporary lull before the next lurch higher in yields, look for the dollar to continue to rally.

Good luck and stay safe
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