Rates May Have to Rise

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

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

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
Adf

Will Not Be Deterred

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
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

Flames of Concern

In Turkey, the president canned
The central bank chief, and has fanned
The flames of concern
As traders now spurn
The lira in lieu of the rand

The top FX story this morning clearly revolves around the abrupt firing of the Turkish central bank’s governor, Naci Agbal, after he had the audacity to raise rates a surprising 2.0% last week in his effort to combat rising inflation.  The market had applauded the rate move and TRY had risen sharply, more than 4%, in the aftermath.  Unfortunately for him, Turkish president Erdogan is strongly of the opinion that rising inflation is caused by higher interest rates and is adamantly against the idea of raising rates.  (It appears that Erdogan is an MMTer at heart).  Arguably this is because it costs his government more to borrow for his spending plans, but whatever the rationale, this is at least the second central bank governor he has fired after a rate hike.  It cannot be a surprise that the lira has fallen dramatically in markets this morning and is down more than 10% as I type.  I highlight this to remind readers that abrupt and very large movements remain quite feasible in the FX markets.

Meanwhile, it’s the Treasury bond
About which most markets respond
Two camps have emerged
Where one side has urged
A cap, while the other side’s yawned

But really, the story that matters the most in markets right now continues to be the future price action in US Treasury markets.  The battle lines have been drawn with the inflationistas convinced that the combination of massive money printing by the Fed (M2 +25.8% Y/Y as of January 31) combined with the recently passed $1.9 trillion Covid bill is going to lead to significant price rises and much higher yields in the bond market.  In this camp, many expect the Fed to be forced to cap yields, either tacitly, by extending the maturity of QE purchases, or explicitly by telling us so, thus driving real yields lower and the dollar down as well.

In the other camp are the deflationists, a shrinking group, who nevertheless believe that the underlying drivers of declining inflation over the past 40 years; namely globalization, technology and demographics, remain firmly in place and will reassert themselves in the medium term.  This camp will also point to the fact that the ratio of interest payments to GDP, a key metric determining the affordability of government debt loads, continues to decline in the US and so a short-term rise in Treasury yields is no cause for concern.   Arguably, Treasury Secretary Yellen lives in this camp as she has consistently expressed her belief that the risks to the economy now are not doing enough to support growth and has been completely unconcerned with the rapid growth of Treasury debt to fund the serial government programs that have been enacted.  In this telling, the current price action in bonds is temporary and will soon be corrected as it becomes clear inflation is not a significant problem.

Ultimately, what this means is that the rest of us are beholden to the outcome of this situation and need to remain vigilant for clues as to how the situation will evolve.  Perhaps this week we will get some clues, if not from the data, then from the twenty-two different Fed speeches that are on the calendar.  Almost every FOMC member will be regaling us with their views following last week’s FOMC meeting.  In fact, the first, Richmond Fed president Barkin, has already spoken overnight and dismissed concerns over rising yields as an issue, rather explaining they were a vote of confidence in the economy and no problem at all.  We shall see!

Ok, on to markets, where the overriding theme is… there is no theme.   Equity markets were mixed overnight (Nikkei -2.1%, Hang Seng -0.4%, Shanghai +1.1%) and European bourses are showing a similar spread (DAX +0.25%, CAC -0.25%, FTSE 100 0.0%). US futures?  Same thing here with NASDAQ up 0.8% while DOW futures are slightly softer, -0.1% and SPUs are +0.1%.

Bond markets, however, are rallying somewhat after last week’s gyrations with the 10-year Treasury yield down 4.6bps and back below 1.70%.  The yield declines in Europe are far more muted (Bunds -1.5bps, OATs -1.0bps, Gilts -1.5bps) although we did see JGB’s (-2.9bps) rally last night.  If pressed, I would say that investors, given the lack of theme are taking advantage of the recent rise in yields to earn a bit more.

In the commodity space, earlier price action saw much deeper declines, but as New York is walking in, oil (-0.2%) is just marginally lower; gold (-0.4%) has retraced some early losses and the base metals are mixed at this time with copper (+0.6%) higher while aluminum (-0.2%) is lagging.

Finally, looking at the dollar, aside from TRY’s collapse, the rest of the EMG space is far less dramatic with MXN (-0.75%) the laggard on a combination of weaker oil and the ongoing border crisis being seen as a negative for the economy there.  On the positive side, the gains are de minimis (PLN +0.3%, KRW +0.25%, PLN +0.2%) with CE4 currencies tracking the euros modest gains and Korea benefitting from comments about a faster than previously expected recovery.

G10 currencies, which had been mixed earlier, have started to gain a bit, led by CHF (+0.3%) and SEK (+0.3%) although the rest of the bunch have seen much smaller movement overall.  The interesting CHF story was that the SNB executed $118 billion of FX intervention last year, which may come under further scrutiny by the US Treasury given the fact that Switzerland was named a currency manipulator last year.  In the end, though, given the remarkably small size of the Swiss economy, it is hard to believe that there has been any real impact on the US economy by their actions.  The SNB meets this week and will almost certainly defend their activities as a requirement to prevent further strength in the currency which could drive a significant deflationary spiral, at least so they believe.

On the data front, there is a good deal coming up as follows:

Today Existing Home Sales 6.49M
Tuesday Current Account Balance -$188.3B
New Home Sales 873K
Wednesday Durable Goods 0.7%
-ex transport 0.6%
PMI Manufacturing (prelim) 59.5
Thursday Initial Claims 730K
Continuing Claims 4.0M
GDP Q4 4.1%
Friday Personal Income -7.2%
Personal Spending -0.8%
Core PCE Deflator 1.5%
Michigan Sentiment 83.6

Source: Bloomberg

In truth, the Friday data seems the most important, as the Personal Spending and PCE are keys being watched most closely.  We all know that the housing market is hot, and that PMI is likely to be strong as the economy reopens.  But what will happen with the Fed’s key measure of inflation?

And then, amidst all the Fed speak, we have Chair Powell in two joint appearances with Treasury Secretary Yellen, first before the House tomorrow and then the Senate on Wednesday, but given the sheer breadth of commentary we are going to hear, it will be important to see if a theme regarding the bond market’s recent declines with ensuing yield increases becomes a key topic.  Certainly, market participants are highly focused on the subject.

So, adding it all up, we have a decent amount of data and a lot of Fed speakers coming our way.  As I strongly believe the dollar’s direction will be driven by the bond market for the near-term, at least, listen carefully to those comments.  Powell actually starts the commentary this morning at 9:00.  The more unconcerned the Fed speakers are with rising yields, the more likely, in my estimation, the dollar is to rise.

Good luck and stay safe
Adf

Hubris

Said Janet, the risk remains “small”
Inflation could come to the ball
But if that’s the case
The tools are in place
To stop it with one conference call

hu∙bris
/ (h)yoobrəs/
noun: excessive pride or self-confidence

Is there a risk of inflation?  I think there’s a small risk and I think it’s manageable.”  So said Treasury Secretary Janet Yellen Sunday morning on the talk show circuit.  “I don’t think it’s a significant risk, and if it materializes, we’ll certainly monitor for it, but we have the tools to address it.”  (Left unasked, and unanswered, do they have the gumption to use those tools if necessary?)

Let me take you back to a time when the world was a simpler place; the economy was booming, house prices were rising, and making money was as easy as buying a home with 100% borrowed money (while lying on your mortgage application to get approved), holding it for a few months and flipping it for a profit. This was before the GFC, before QE, before ZIRP and NIRP and PEPP and every acronym we have grown accustomed to hearing.  In fact, this was before Bitcoin.

In May 2007, Federal Reserve Chairman Ben Bernanke, responding to a reporter’s question regarding the first inklings of a problem in the sector told us,  “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the sub-prime sector on the broader housing market will likely be limited.”  Ten months later, as these troubles had not yet disappeared, and in fact appeared to be growing, Bennie the Beard uttered his most infamous words, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.

Notice anything similar about these situations?  A brewing crisis in the economy was analyzed and seen as insignificant relative to the Fed’s goals and, more importantly, inimical to the Fed’s desired outcomes.  As such, it is easily dismissed by those in charge.  Granted, Janet is no longer Fed chair, but we have heard exactly the same story from Chairman Jay and can look forward to hearing it again on Wednesday.

Of course, Bernanke could not have been more wrong in his assessment of the sub-prime situation, which was allowed to fester until such time as it broke financial markets causing a massive upheaval, tremendous capital losses and economic damage and ultimately resulted in a series of policies that have served to undermine the essence of capital markets; creative destruction.  While hindsight is always 20/20, it does not detract from the reality that, as the proverb goes, an ounce of prevention is worth a pound of cure.

But right now, the message is clear, there is no need to be concerned over transient inflation readings that are likely to appear in the next few months.  Besides, the Fed is targeting average inflation over time, so a few months of above target inflation are actually welcome.  And rising bond yields are a good thing as they demonstrate confidence in the economy.  Maybe Janet and Jay are right, and everything is just ducky, but based on the Fed’s track record, a lot of ‘smart’ money is betting they are not.  Personally, especially based on my observations of what things cost when I buy them, I’m with the smart money, not the Fed.  But for now, inflation has been dismissed as a concern and the combination of fiscal and monetary stimulus are moving full speed ahead.

Will this ultimately result in a substantial correction in risk appetite?  If Yellen’s and Powell’s view on inflation is wrong, and it does return with more staying power than currently anticipated, it will require a major decision; whether to address inflation at the expense of slowing economic growth, or letting the economy and prices run hotter for longer with the likelihood of much longer term damage.  At this stage, it seems pretty clear they will opt for the latter, which is the greatest argument for a weakening dollar, but perhaps not so much vs. other fiat currencies, instead vs. all commodities.  As to general risk appetite, I suspect it would be significantly harmed by high inflation.

However, inflation remains a future concern, not one for today, and so markets remain enamored of the current themes; namely expectations for a significant economic rebound on the back of fiscal stimulus leading to higher equity prices, higher commodity prices and higher bond yields.  That still feels like an unlikely trio of outcomes, but so be it.

This morning, we are seeing risk acquisition with only Shanghai (-1.0%) falling of all major indices overnight as Tencent continues to come under pressure after the government crackdown on its financial services business.  But the Nikkei (+0.2%) and Hang Seng (+0.3%) both managed modest gains and we have seen similar rises throughout Europe (DAX +0.2%, CAC +0.3%, FTSE 100 +0.3%) despite the fact that the ruling CDU party in Germany got clobbered in weekend elections in two states.  US futures are also pointing higher by similar amounts across the board.

Bond markets, interestingly, have actually rallied very modestly with Treasury yields lower by 1.2 basis points, and similar yield declines in both Bunds and OATs.  That said, remember that the 10-year did see yields climb 8 basis points on Friday amid a broad-based bond sell-off around the world.  In other words, this feels more like consolidation than a trend change.

Commodity markets have also generally edged higher, with oil (+0.35%), gold (+0.1%) and Aluminum (+1.0%) showing that the reflation trade is still in play.

Given the modesty of movement across markets, it seems only right that the dollar is mixed this morning, with a variety of gainers and laggards, although only a few with significant movement.  In the G10 this morning, SEK (-0.7%) is the worst performer as CPI was released at a lower than expected 1.5% Y/Y vs 1.8% expected.  This has renewed speculation that the Riksbank may be forced to cut rates back below zero again, something they clearly do not want to do.  But beyond this, price action has been +/- 0.2% basically, which is indicative of no real news.

In EMG currencies, it is also a mixed picture with ZAR (+0.7%) the biggest gainer on what appear to be carry trade inflows, with TRY (+0.6%) next in line as traders anticipate a rate hike by the central bank later this week.  Most of LATAM is not yet open after this weekend’s change in the clocks, but the MXN (+0.3%) is a bit firmer as I type.  On the downside, there is a group led by KRW (-0.3%) and HUF (-0.25%), showing both the breadth and depth (or lack thereof) of movement.  In other words, movement of this nature is generally not a sign of new news.

On the data front, all eyes are on the FOMC meeting on Wednesday, but we do get a few other releases this week as follows:

Today Empire Manufacturing 14.5
Tuesday Retail Sales -0.5%
-ex autos 0.1%
IP 0.4%
Capacity Utilization 75.5%
Wednesday Housing Starts 1555K
Building Permits 1750K
FOMC Decision 0.00% – 0.25%
Thursday Initial Claims 700K
Continuing Claims 4.07M
Philly Fed 24.0
Leading Indicators 0.3%

Source: Bloomberg

While Retail Sales will garner some interest, the reality is that the market is almost entirely focused on the FOMC and how it will respond to, or whether it will even mention, the situation in the bond market.  Certainly, a strong Retail Sales report could encourage an even more significant selloff in bonds, which, while seemingly embraced by the Fed, cannot be seen as good news for the Treasury.  After all, they are the ones who have to pay all that interest. (Arguably, we are the ones who pay it, but that is an entirely different conversation.)

As to the dollar, while it has wandered aimlessly for the past few sessions, I get the sneaking suspicion that it is headed for another test of its recent highs as I believe bond yields remain the key market driver, and that move is not nearly over.

Good luck and stay safe
Adf

Misled

Said Janet, do not be misled
Strong growth is no sub for widespread
Support from the bill
In Congress which will
Insure budget’s stay in the red
Insure higher yields lay ahead
Insure every table has bread

Treasury Secretary Janet Yellen, who polished her dovish bona fides as Fed Chair from 2013 to 2017, has taken her act to the executive branch and is vociferously trying to make the case that recent positive data is of no concern at this time and that the $1.9 trillion package that is slowly wending its way through Congress remains critical for the economy.  “It’s very important to have a big package that addresses the pain this has caused.  The price of doing too little is much larger than the price of doing something big,” was her exact quote in an interview yesterday.  I wonder, is ‘going big’ the new zeitgeist, replacing YOLO?  After all, not only has Ms Yellen been harping on this theme, which has been taken up by others in government, but there is even a weekly TV Show with that name that opens the door to some of the more remarkable, if ridiculous, things people are willing to do to get on TV.

But go big it is, with no indication that the current administration is concerned about potential longer term negative fiscal outcomes.  The pendulum has swung from the Supply Side rationale for fiscal stimulus (cutting taxes to drive incentives) to the MMT rationale for fiscal stimulus (as long as we borrow in our native currency, we can always repay any amount).  History will almost certainly show that this side of the pendulum is no less damaging than the other side, but given that politics is a short-term phenomenon, only concerned with the time until the next election, we are virtually guaranteed to continue down this road to perdition.

Thus far, the results have been relatively benign, first off because the bill has not yet been made into law, although markets clearly assume it will be, and secondly because the depths of the government induced recession from which we are emerging were truly historic, so it takes some time to go from collapse to explosive growth.  The gravest concern for some (this author included) is that we are going to see significant price inflation in the real economy, not just in asset prices, and in the end, the economy will simply suffer from different problems.  But then, isn’t that what elections are really about?  When administrations change it is a cry to address different issues, not improve the overall situation.

So, with that in mind on this Friday, let’s take a tour of the markets.  Today is one of the few sessions so far this year where the major themes entering 2021 are actually playing out according to plan.  As such, we are seeing continued support in the equity space, with yesterday’s modest sell-off being reversed in most markets.  We are seeing bond markets continue to come under pressure with yields rising on the reflation narrative, and we are watching the dollar decline, albeit still firmly in the middle of the trading range it has traced out this year.

In the equity space, while the Nikkei (-0.7%) was under modest pressure, we saw small gains in the Hang Seng (+0.2%) and Shanghai (+0.5%).  Also noteworthy was the Sydney /ASX 200 (-1.3%) which fell after a widely followed analyst Down Under increased his forecast for interest rates by nearly 50 basis points by year end.  Not surprisingly, this helped AUD (+1.0%) which is the best performing currency today.  As to Europe, the gains are more broad-based with both the CAC and DAX rising by 0.5% although the FTSE 100 is basically flat on the day.  Here, too, there was data that helped drive the market narrative with UK Retail Sales disastrous in January (-8.2%, -8.8% ex fuel) weighing on the FTSE despite stronger than expected preliminary PMI data from the UK (Composite PMI rising to 49.8, up more than 8 points from last month).  Meanwhile, German PPI data jumped sharply (+1.4% in Jan), its largest rise since 2008.  I find it quite interesting that we saw a similarly large rise in the US earlier this week.  It appears that inflationary pressures are starting to bubble up, at least in some economies.  French and Italian CPI data remain mired well below 1.0%, a sign that neither economy is poised to rebound sharply quite yet.  As to US futures, they are all green, but with gains on the order of 0.2%-0.3%, so hardly earth-shattering.

Bond markets, however, continue to sell off around most of the world which is feeding a key conundrum.  One of the rationales for the never-ending stock market rally is the low yield environment, but if bond yields keep rising, that pillar may well be pulled out with serious consequences to the bull case.  But in true reflationary style, Treasury yields have backed up 1 basis point and we are seeing larger yield gains in Europe (Bunds +1.7bps, OATs +1.2bps, Gilts +2.1bps).  In fact, the only bonds in Europe rallying today are Super Mario bonds Italian BTPs (-1.5bps) as the market continues to give Draghi the benefit of the doubt with respect to his ability to save Italy’s economy.

In the commodity space, oil has ceded some of its recent gains with WTI (-2.25%) back below $60/bbl, although still higher by 22% this year.  Precious metals are slightly softer and base metals are mixed with Copper (+1.9%) the true outperformer.

Finally, in the FX market, the dollar is under pressure against the entire G10 space and much of the emerging market space.  In G10, we already discussed Aussie, which has helped drag NZD (+0.7%) higher in its wake.  But the rest of the bloc is seeing solid gains of the 0.3%-0.4% variety with the pound (+0.15%) the laggard after that Retail Sales data.  However, the pound did trade above 1.40 briefly this morning for the first time since April 2018, nearly three years ago.

In the Emerging markets, CNY (+0.5%) has been the biggest gainer with CLP (+0.4%) right behind on the strong copper showing.  However, the CE4 have all tracked the euro higher and are performing well today.  On the downside, BRL (-0.6%), ZAR (-0.5%) and MXN (-0.4%) are the laggards, with the real suffering after cryptic comments from President Bolsonaro regarding fuel price rises by Petrobras and potential government action there.  Meanwhile, the peso has been under pressure of late after Banxico’s 25bp rate cut last week, and growing talk that there could be others if inflation remains quiescent.  And lastly, South Africa suffered almost $1 billion of outflows from the local bond market there, with ensuing pressure on the rand.

On the data front this morning we get Existing Home Sales (exp 6.6M) and the preliminary US PMI data (58.8 Mfg, 58.0 Composite), although as we already learned, strong US data is irrelevant in the fiscal decision process right now.  Two more Fed speakers, Barkin and Rosengren, are on the docket for today, but again, until we hear of a change from Chairman Powell, it is unlikely that the other Fed speakers are going to have much impact.

Summing things up, right now, the reflation trade, as imagined on January 1st, is playing out.  Quite frankly, the dollar is simply trading in a new range (1.1950/1.2150) and until the euro can make new highs, above 1.2350, I would not get too excited.  The one thing that is very true is that market liquidity is shallower than it has been in the past which explains the choppiness of trading, but also should inform hedging expectations.

Good luck, good weekend and stay safe
Adf

De Minimis Sellin’

There once was a Fed Chair named Yellen
Whose term saw di minimis sellin’
Of bonds or of stocks
As from her soapbox
She promised a balance sheet swellin’

But now she’s the Treasury Sec
And her goal’s to get a blank check
For spending, not saving
Though that might be paving
The way to a financial wreck

Investors continue to add to their risk portfolios this morning amid the never-ending hopes for yet more fiscal stimulus from the US.  This can be seen most clearly from the combination of rising stock prices and rising bond yields.  In classic risk-on fashion, the ongoing speculative mania continues to drive equity markets higher around the world.  Asia is uniformly green, with the Nikkei (+2.1%) leading the way but strength in Shanghai (+1.0%) and Hong Kong (+0.1%).  The concern for the latter has to do with the upcoming Lunar New Year holiday and the fact that the link between the mainland and Hong Kong stock markets will be turned off during that period, thus reducing inflows. Meanwhile, Europe is also firmer across the board with Italy’s FTSE MIB (+1.4%) the leader as investors gain confidence that Super Mario Draghi will be as “successful” a PM as he was an ECB President.  But the FTSE 100 (+0.95%), CAC (+0.6%) and DAX (+0.3%) are all firmer with the DAX lagging on the back of weaker than expected IP data (0.0%, exp +0.3%) indicating that the ongoing lockdowns in Germany, which are slated to continue for another 6 to 8 weeks, are taking a toll.  And don’t worry, US futures are all green too, higher by roughly 0.4% each.

The second piece of this puzzle is the bond market, which is behaving exactly as expected in a risk-on session by selling off nicely.  In fact, Treasury yields have touched new highs for the move with the 10-year at 1.19% (+2.9bps) while 30-year bonds have just traded to 2.00% for the first time since Feb 19 of last year, right as the Covid crisis was beginning.  But this is not an isolated US feature, we are seeing higher yields throughout Europe, Italy excepted, as Bunds (+2.6bps), OATs (+2.5bps) and Gilts (+3.3bps) are all under pressure today.  Why, you may ask, are European bond markets selling off if the story is US stimulus?  Because it’s one big global trade, and if the $1.9 trillion stimulus package gets passed, the idea is a faster US recovery will support European and Asian companies that sell into the US.

Of course, politics being what it is, even control of the House and Senate doesn’t mean that passing a bill this large is easy.  And this is where Ms Yellen comes in, she needs to forcefully make the case passage is critical for the nation’s economy.  The problem is that the recent data trend, which has been generally better than expected (excluding Friday’s jobs data) points to the fact that perhaps not so much stimulus is needed.  So, on the Sunday morning talk shows she was emphatic in her comments that it is critical, and that erring by spending too much is a significantly better mistake than spending too little.  Interestingly, even some left-leaning economists don’t back that view.  Notably, Larry Summers, former director of the National Economic Council for President Obama, and Olivier Blanchard, former chief economist at the IMF, have highlighted the risks to this package on two fronts; first, it could result in inflation and second, it may prevent the passage of other legislation focused on infrastructure and green investment deemed more important.

Now, the one thing we know about Congress is that virtually none of the members of either the House or Senate have any understanding of economics or finance.  As such, they take their cues from their financial backers staffers and the pronouncements of eminent economists from their side of the aisle.  And this is what makes the Summers and Blanchard comments noteworthy, they are both clearly left of center and both are arguing for less Covid stimulus. Janet has her work cut out for her to get what she wants.  Ironically, the fact that this package may not be passed until March is probably a positive for stocks, after all, that means another 4-6 weeks of stimulus hopes!

A quick look at commodity prices shows that virtually every commodity price is higher this morning led by oil (+1.3%), but with strength in precious metals (gold +0.4%, silver +1.0%) and agriculturals (wheat +0.7%, corn +0.6%).  Again, this is a risk-on market.

The one piece of the relation trade narrative that continues to fail, however, is the weak dollar story.  For now, before inflation data starts to rise sharply and real yields tumble, rising US rates are leading to a rising US dollar.  So, this morning the pound (-0.4%) is the laggard, but the weakness is across the board.  Even NOK (-0.1% and CAD (-0.15%) are softer despite the ongoing oil price rally.  In fact, the entire commodity bloc is suffering despite firmer commodity prices.  This is true in emerging markets as well which is led lower by ZAR (-1.0%) and both BRL (-0.7%) and MXN (-0.7%) today.  The rand story continues to be virus related as the vaccine rollout stalls given the realization that the new strain of virus is not responding well to the AstraZeneca vaccines they have.  In fact, the vaccine story is part of the LATAM problems, but of greater consequence is the fact that as US yields rise, the carry trade is becoming less attractive, and both these currencies are beneficiaries of carry.  On the plus side in EMG, KRW (+0.35%) is the best performing currency around after virus restrictions were eased somewhat amid declining infection statistics.

Speaking of statistics, it is a very quiet week on the data front, with CPI the marquis number on Wednesday.

Tuesday NFIB Small Biz Optimism 97.5
JOLTs Job Openings 6.4M
Wednesday CPI 0.3% (1.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Thursday Initial Claims 760K
Continuing Claims 4.41M
Friday Michigan Sentiment 80.9

Source: Bloomberg

Regarding the CPI data, it has printed higher than the survey in all but one month since June and given the ongoing inflationary pressures of higher commodity prices and supply chain issues, my sense is we will see that again.  On the speaking front, just three Fed speakers this week, Mester today, Bullard tomorrow and then Chairman Powell speaks Wednesday afternoon.  This makes Wednesday the day to watch.  Until then, I expect the market will focus on stimulus matters and equity prices.  If US yields continue to rise I suspect the dollar will test resistance again, with the key level in the euro at 1.1910.  Once again, nothing has changed my medium-term view about dollar weakness, and last week did see a halving of the long euro positions in the CFTC data, but for now, I feel like the dollar still has the upper hand.

Good luck and stay safe
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Money’s Still Free

There once was a time, long ago
When traders all just had to know
If payrolls were strong
So they could go long
If not, they would sell with the flow

But these days, with ZIRP and QE
Attention’s not on NFP
Instead it’s the pace
Of central bank grace
And making sure money’s still free

One of the biggest changes in the market environment since the onset of the global pandemic has been the change in what markets find important.  This is not the first time market focus has changed, nor will it be the last, but a change has definitely occurred.  Consider, for a moment, why the market focuses so intently on certain data points.  Essentially, traders and investors are looking for the information that best describes the policy focus of the time, and therefore, changes in that information are sufficient to change opinions, at least in the short term, about markets.  And remember, that policy focus can come from one of two places, either the Fed or the Administration.

A step back in time shows that in the early 1980’s, when Paul Volcker was Fed Chair, the number that mattered the most was the M2 money supply which was reported on Thursday afternoons.  In fact, the market impact grew so large that they had to change the release time from 3:50 pm to 4:10 pm, after the stock market closed, to reduce market volatility. Trading desks would have betting pools on the number and there were a group of economists, Fed watchers, whose entire job was to observe Fed monetary activity in the markets and make estimates of this number.  At the time, the Fed would not explicitly publish their target Fed Funds rate, they would add and remove liquidity from the money markets in order to achieve it.  And, in fact, you never heard comments from FOMC members which is why Fed Chairs are now compelled to testify to Congress twice a year.

But as time passed and the economy recovered from the recession of 1980-81, the Reagan Administration became highly focused on the US Trade Balance, (especially the deficit with Japan) which became THE number right up through the early 90’s.  Once again, betting pools were common on trading desks and futures markets would move sharply in the wake of the 8:30am release.

At some point there, while Alan Greenspan was still Fed Chair, but there was a new administration, the market turned its attention away from trade and started to focus on domestic indicators, with payrolls claiming the mantle of the best indicator of economic activity.  This suited the Fed, given its mandate included employment, and it suited the Clinton Administration, given they were keen to show how well the economy was doing in order to distract the populace from various scandals.

With the change in Fed Chair from Greenspan to Ben Bernanke, the Fed suddenly became a very different source of market information.  No longer did economists need to read tea leaves, but instead the Fed told us explicitly what they were doing and where rates were set.  Thus, during the GFC, Bernanke was on the tape constantly trying to guide markets to his preferred place.  And that place was full employment, so payrolls still mattered a great deal.  Of course, the market still cared about other things, like the level of interest rates, but still, NFP was seen as the single best indicator available.  Remember, during Bernanke’s leadership, the Fed initiated the QE that began the expansion of its balance sheet and changed the way the Fed worked, seemingly forever.  No longer would the Fed adjust the reserve balances in the system, instead, they would simply post an interest rate and if supply or demand didn’t suffice to achieve that rate, they would step into the markets and smooth things out.

Payrolls were still the focus through Chair Yellen’s term, especially since her background is as a labor economist, so the employment half of the mandate was far more important to her than the inflation half, and so, if anything, NFP took on greater importance.

Jay Powell’s turn at the Fed started amid a period where the economy was getting significant fiscal support and interest rates were trying to be normalized.  In fact, the Unemployment Rate had fallen to its lowest level in more than 50 years and seemed quite stable there, so Powell seemed to have an easy job, just don’t screw things up.  Alas, his efforts to continue normalizing interest rates (aka tightening policy) resulted in a sharp equity market correction in December 2018.  The President was none too pleased with that outcome, as the Trump administration was highly focused on the stock market as a barometer of its performance.  Thus, once again, the Fed stepped in to stabilize markets, and turned from tightening policy to easing in the Powell Pivot.  And perhaps that is the real message here, the most important data point to both the Fed and every administration is not payrolls or unemployment or inflation.  It is the S&P500.

But Covid’s shock to the market was unlike anything seen in a century, at least, and arguably, given the interconnectivity of the global economy compared to the last pandemic in 1918-20, ever.  So, the first NFP data points were shocking, but the market quickly grew accustomed to numbers that would have been unthinkable just months prior.  Instead, the numbers that mattered were the infection count, and the mortality rate.  And arguably, those are still the numbers that matter, along with the vaccination rate and the stimulus size.  All of these have been the market’s primary focus since March last year, and until the idea of the government lockdown fades, are likely to continue to be the keys for market behavior.

Which brings us back to this morning, when the payroll report is to be published.  Does it really have that much impact any longer?  Or has its usefulness as an indicator faded?  Well, it seems apparent that market participants are far more intent on hearing from Fed speakers and trying to discern when monetary accommodation is going to be reduced (never) than on the jobs number.  In fact, given virtually every major central bank has explained that rates will remain at current levels for the next 3 to 4 years, at least, the only thing the data can tell us is if that will last longer than currently expected.

Ok, ahead of payrolls we have seen a general embrasure of risk, with equity markets strong, following yesterday’s US rally.  The Nikkei (+1.5%) and Hang Seng (+0.6%) both performed well although shanghai (-0.2%) slipped slightly.  In Europe, the CAC (+1.1%) leads the way followed by the DAX (+0.3%) after weak Factory order numbers (-1.9%) and the FTSE 100 (+0.1%).  US futures are currently trading higher by about 0.5% to round things out.

Bond markets are behaving as you would expect in a risk on session, with 10-year Treasuries printing at a new high yield for the move, 1.16%, up 2.1bps.  In Europe, the bond selling is greater with Bunds (+2.5bps) and Gilts (+5.3bps) getting tossed in favor of stocks.  Commodities are still in vogue, with oil (+1.0%) and gold (+0.4%) firm alongside all the base metals and agriculturals.

Finally, the dollar, is acting a bit more like expected, softening a bit while risk is being acquired.  The dollar’s recent rally alongside the equity rally seemed unusual compared to recent history, but today, things look more normal.  S,o NOK (+0.4%) and CAD (+0.3%) lead the G10 charge while JPY (-0.15%) is today’s laggard.  Clearly these stories are commodities and risk preference.  In the EMG space, APAC currencies were under a bit of pressure overnight, led by KRW (-0.4%) and MYR (-0.25%), but this morning we are seeing strength in TRY (+1.0%), RUB (+0.8%) and MXN (+0.4%) to lead the way.  The CE4 are also performing relatively well alongside modest strength in the euro (+0.2%).

Now the data:

Nonfarm Payrolls 105K
Private Payrolls 163K
Manufacturing Payrolls 30K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B

Source: Bloomberg

Which brings us back to the question, does it really matter?  And the answer is, not to the stock market, and therefore not really to the Fed.  However, a strong number here could well hit the bond market pretty hard as well as support the dollar more fully.  We shall see.  FWIW, I don’t believe the dollar’s correction is over, and another 1%-2% is entirely viable in the short-run.

Good luck, good weekend and stay safe
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