ポリシー

Dear client, There will be no weekly bulletin next week. Instead, I will be hosting a webcast, with my colleague, Matt Gertken, titled “Currencies And Geopolitics: A Discussion.” I hope you will tune in so that we can have an interactive session. Also, we will be revamping the traditional backsections that FX has been publishing and will send a mockup in the coming weeks. Feedback on the new format will be greatly appreciated. Finally, I hosted a webcast this week with Japanese clients titled “A Guide To Currency Management For Japanese Corporates.” For those who are interested but were unable to attend, I encourage you to consult your sales representative for a replay. Kind regards, Chester Highlights The Fed will taper asset purchases this year, but it could be a non-event for the US dollar. The reason is that the Fed is lagging other G10 central banks in tapering asset purchases. Many will end QE even before the Fed begins tapering. The two big exceptions are the ECB and the BoJ. But while dovish monetary policy is well priced into both the interest rate curve and their currencies, upside surprises are not. Most global central banks will remain data dependent. So the key to gauging the move in currencies is to observe (and forecast) economic data. On that front, the current evidence is that US growth is robust, but is losing momentum to other developed markets. Volatility in currencies will be on the rise. We went long CHF/NZD on this basis last week and maintain long yen positions. But our bias is that any rally in the DXY will fizzle out at the 94-95 level. Feature This week was a busy one for central bankers. We kicked off with the Riksbank on Tuesday, the Bank of Japan and the Federal Reserve on Wednesday, and concluded with the Swiss National Bank, the Bank of England, and the Norges bank on Thursday. The highlight was the Fed, but the general message from most central banks is that less monetary accommodation will be forthcoming, as economic activity picks up. Most central bankers also admitted that inflation was proving a bit more sticky than initially anticipated. The key question therefore for currency strategists is whether the Federal Reserve will be more or less orthodox with monetary policy, compared to other developed market central banks, and what that means for the dollar. Our bias is that while the Fed was slightly more hawkish this week, it will continue to lag other G10 central banks in curtailing monetary accommodation. The Message From The FOMC Chart I-1The Market Has Priced Fed Hawkishness The key development from the Fed meeting this week was an upgrade to the dot plot. Half of the committee now expects at least one interest rate hike in 2022, with perhaps 7-8 hikes by the end of 2024. This is a more aggressive path of interest rate increases compared to the June FOMC meeting. The Fed also suggested tapering could begin at the next policy meeting and end towards the middle of next year, in time for rate increases. The immediate market response to the FOMC meeting did certainly suggest a hawkish undertone. The two-year US Treasury yield rose by 4 bps, which boosted the DXY index from a low of 93 to a high of 93.5 (intraday). Stocks rose and the 10-year Treasury yield edged mildly lower. The 30/2-year Treasury slope flattened by almost 10 bps. In our view, this was a rather muted response. For one, most of these moves are fading as we go to press. More importantly, going into the meeting, the market was already priced for a liftoff in 2022. This will suggest that the market was well positioned for Fed tapering at a minimum, and possibly an upgrade to the dots (Chart I-1). The Message From Other Central Banks While the Fed is still considering tapering asset purchases (and would very likely do so) by year-end, other central banks are well ahead in exiting emergency monetary settings. Just this week: The Norges bank hiked interest rates by 25 bps. We are particularly bullish on the krone, as highlighted in our Norwegian Method report; The Riskbank will end asset purchases this year. Its balance sheet is slated to be flat for 2022. It also closed all lending facilities launched during the pandemic. The offer for USD loans via the Fed’s swap facility will expire this month; The Bank of England kept monetary policy unchanged, but has already purchased £852bn of its £895bn target for government and corporate bonds. In fact, two of its members voted this week to reduce this target by £35bn, which would have effectively ended QE on a majority vote; The Swiss National Bank said in its introductory statement that it is fighting against an expensive franc, but modestly upgraded its inflation forecasts for 2022; The sole dovish central bank (aside from the SNB) was the Bank of Japan, but with elections on the horizon, and the possibility (or not) of a big fiscal package, their policy stance made sense.  Chart I-2Central Bank Holdings Of Government Bonds Elsewhere, the Bank of Canada has already cut its asset purchases in half, the Reserve Bank of New Zealand has ended QE, and the Reserve Bank of Australia has already been tapering asset purchases. In a nutshell, a Fed tapering at this point is well behind the actions of other G10 central banks. This is one key reason why the DXY index has failed to punch above the 94-95 level, and is relapsing as we go to press. From a bird’s eye view, many G10 central banks already have bloated balance sheets and a strong incentive to curtail asset purchases as growth recovers. Within the G10, the US central bank has the smallest holdings of outstanding bonds (Chart I-2). This not only means that, ceteris paribus, the incentive to taper asset purchases is bigger for other central banks, but the scope for the Federal Reserve to ease monetary policy is quite substantial should another shock occur. This might explain why there is unease among other central bankers, to exit emergency settings. Admittedly, this week, traditionally dovish central banks such as the Bank of Japan and the Swiss National Bank kept policy on hold and telegraphed a message that they will keep doing so for the foreseeable future. With a slightly more hawkish Federal Reserve, this should be a negative for these currencies. The same will apply to the ECB (Chart I-3). However, it is important to note that relatively dovish policy settings are well priced into both interest rate curves and their currencies, while upside surprises are not. The market does not expect any interest rate increases in the euro area or Japan before 2024, while it is priced for an aggressive pace of Fed rate hikes (Chart I-4). The starting point for any currency investor is an extremely dovish ECB and BoJ, relative to the Fed. Chart I-3A Pickup In US Yields Has Boosted The Dollar Chart I-4Markets Expect A More Aggressive Fed What Could Change? Global central banks are clearly focused on two goals – the outlook for growth and what that means for their maximum employment objective, and the long-run rate of inflation. These two objectives are interlinked. On the growth front, central bankers are justifiably admitting that the outlook remains clouded due to the Delta variant of COVID-19 and supply disruptions that are muddling the manufacturing outlook. However, it is important to remember that this is a global phenomenon. On a relative basis, there has been a growth rotation from the US to other economies that has historically supported the performance of DM currencies (Chart I-5). The primary reason is that many economies outside the US were in various forms of a lockdown over the last several months. As these economies reopen, so will economic activity. Chart I-5ARelative Growth And Currencies Chart I-5BRelative Growth And Currencies On the inflation front, the most acute problem has been tied to supply bottlenecks and this is not a US-centric problem. Inflation in the euro area, Sweden, the UK, Canada, or New Zealand are all above central bank targets (Table I-1). While all these central banks view the current overshoot as temporary, most have already pared back emergency monetary settings, as we highlighted above. Table I-1Inflation In The G10 The key takeaway is that most central banks view inflation risks as symmetric, while the Fed has telegraphed it is willing to tolerate an inflation overshoot following downturns (Chart I-6). During the Fed’s last two meetings, it has been clear that there is a limit to how much of an overshoot they will tolerate. However, it still suggests that the Fed remains well behind the inflation curve, with one of the most negative 2-year rates in the G10 (Chart I-7). Chart I-6The Fed And Inflation Overshoots Chart I-7Real Yields In The US Are Very Low In a nutshell, if our bias turns out to be correct that growth does recover more earnestly outside the US, and other central banks remain more orthodox than the Fed, this will be a headwind for a stronger US dollar. A Final Note On Canada Canada re-elected a Liberal minority government on September 20. Prime Minister Justin Trudeau’s bet on a majority government, given an astute handling of the pandemic, and massive fiscal stimulus, failed. The implication is a continuation of the status quo in Canada. The good news is that the status quo is actually bullish for the loonie. As we highlighted in our recent report, minority governments tend to be positive for the loonie, while majority governments generally nudge the CAD lower post election (Chart I-8). The rationale is that fiscal policy is slated to stay easy, but not overly so, providing gentle room for the BoC to hike interest rates. Easy fiscal but tighter monetary policy is usually bullish for a currency. Chart I-8Historically, The CAD Likes A Minority Government Given our view on the US dollar, we expect the CAD/USD to punch above the recent 82-cent high, towards 85 and eventually 90 cents. While this view might take time to play out, both rising relative interest rates in Canada (our base case) and high oil prices will be the key catalysts. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Forecast Summary Strategtic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Closed Trades

Highlights Global Inflation: Most central banks, led by the Fed, have stuck to the narrative that surging inflation is a temporary phenomenon that will not require an aggressive monetary policy response. However, global supply chain disruptions are lasting for much longer than originally expected, while faster realized global inflation is feeding through into higher longer-term consumer inflation expectations, most notably in the US. This raises the risk that the 2021 inflation pickup will prove to be longer lasting, leading to higher global bond yields. Real Bond Yields: Global bond markets have made a collective bet on the “transitory” inflation narrative by driving yields on government bonds, and even the riskier parts of the corporate credit universe like US and European high-yield, below actual inflation. Markets will have to reprice those negative real bond yields higher if inflation proves to be more persistent than expected - particularly with central banks likely to respond with faster tapering and, in some cases, eventual rate hikes. Feature The month of September has often not been kind to financial markets and September 2021 is already providing many reasons for investors to be nervous. Slowing global growth momentum, uncertainty over the Delta variant, yet another US Debt Ceiling debate in D.C. and worries about excessive Chinese corporate leverage and contagion risks from the looming Evergrande default are all valid reasons for market participants to become more risk averse. On top of that, the monetary policy backdrop is threatening to become less overwhelmingly supportive for markets with the Fed set to begin tapering its asset purchases. Chart of the WeekInflation Expected To Slow But Remain Above Bond Yields One other source of angst that markets seem less concerned about is inflation. Markets have generally come around to the view of most major central banks, led by the Fed, that the surge in inflation seen this year has been all pandemic related - base effect comparisons to 2020 and temporary supply chain squeezes – and will not last into 2022. Yet we have seen very strong realized global inflation readings in the August data, beyond the point of maximum base effect comparisons versus a year ago, while supply squeezes and soaring shipping costs are showing no signs of slowing as we approach the fourth quarter. Global bond markets have made a collective bet that current high rates of inflation will prove to be temporary. Developed market bond yields are all trading well below actual inflation, as are riskier fixed income asset classes like US and European high-yield (Chart of the Week). While consensus expectations are calling for some rise in government bond yields in 2022, yields are expected to remain below inflation. Those persistent negative real yield expectations remain the biggest source of vulnerability for global bond markets. If inflation turns out to be “less transitory” than expected, nominal bond yields will need to move higher to reprice both real yields and the risk of more hawkish central bank responses to sustained high inflation. A Persistent Inflation Threat From Supply Chain Disruptions Chart 2A Broad-Based Surge In Global Inflation Our base-case view remains that global inflation will slow in 2022, but not by enough to prevent the major developed market central banks from tapering asset purchases. We expect the Fed to begin buying fewer bonds in January. Central banks that have already begun to slow the pace of quantitative easing (QE) like the Bank of Canada and Bank of England will likely continue to taper as fast, if not even faster, than the Fed. Even the ECB will likely not roll the full amount of the expiring Pandemic Emergency Purchase Program (PEPP) into the existing pre-COVID asset purchase programs, resulting in a mild form of tapering next year. Our view on global inflation has been predicated on an expected shift away from more externally-driven inflation towards more sustainable domestic price pressures stemming from tightening labor markets and the closing of pandemic output gaps (Chart 2). So the mix of inflation in most developed market countries will be more “core” and less “non-core” inflation driven by higher commodity prices and global supply chain disruptions. Yet there is little sign that those non-core inflation pressures are slowing, particular in price gauges most exposed to supply chains like producer price indices (PPI). US PPI inflation climbed to 15-year high of 8.3% on a year-over-year basis in August, while annual growth in the euro area PPI hit 12.1% in July – the fastest pace in the 30-year history of that data series (Chart 3). Surging PPI inflation reflects global price pressures, with import prices expanding at double-digit rates in both the US and Europe. Some of that more externally driven price pressure stems from commodity markets. While the prices for some notable commodities like lumber and iron ore have seen significant retracements from pandemic-era highs over the past several months, more economically sensitive commodities like aluminum and natural gas have all seen very strong price increases (Chart 4). Copper and oil prices are also holding firm, although both are off 2021 highs. Chart 3No Sign Of Slowing Global Inflation At The Producer Level The price momentum of overall commodity price indices like the CRB Raw Industrials has clearly rolled over, but has held up much better than would be expected given signs of slowing global growth. Chart 4Commodity Markets Still More Inflationary Than Disinflationary The current depressed level of the China credit impulse, and the flat year-over-year change of the global PMI, would typically be associated with flat commodity prices rather than the current 34% annual growth rate (Chart 5). A lack of sustained upward pressure on the US dollar is likely helping keep commodity prices, which are priced in dollars, more elevated than expected. Even more important, however, are the low inventories for many commodities relative to firm demand (which largely explains the current surge in aluminum and natural gas prices). This mirrors a broader global economic trend towards companies running lower inventories relative to sales, which has been exacerbated by the economic uncertainties of the COVID-19 pandemic. The US overall business inventory-to-sales ratio is now at the lowest level in the history of the series (Chart 6). Chart 5Commodity Price Inflation Peaking, But Not Slowing Much Chart 6Supply Squeezes Are Likely To Persist Before the pandemic, firms have gotten away with running very lean inventories because of globalized supply chains that allow firms to maintain the minimum amount of inventory to meet demand. Yet “just-in-time” inventory management only works when suppliers can deliver raw materials or finished goods in a timely fashion at low cost. The pandemic has blown up that model, making it much harder to deliver products and materials from critical countries like China. Global shipping costs have exploded higher and are showing no signs of slowing (bottom panel), while supplier delivery times remain well above historical averages according to measures like the US ISM index. Those higher costs are feeding through into overall inflation measures, particularly for the components most exposed to supply chain disruption. In Chart 7, we show a breakdown of the overall CPI inflation data for the US, euro area, UK and Canada. The groupings shown in the chart are based on an analysis done by the Bank of Canada back in August to measure pandemic impacts on Canadian inflation.1 The top panel of the chart shows the contribution to overall inflation for elements most exposed to supply constraints (like autos and durable goods). The second panel of the chart shows the contribution from sectors more exposed to increased demand as economies reopen from pandemic restrictions, like dining at restaurants and travel. The remaining panels of the chart show the contributions from energy prices and all other components not covered in the top three panels. Chart 7Fed's Transitory Narrative At Risk From Lingering Supply Chain Disruption Chart 8High US Inflation May Not Prove To Be So Transitory The conclusion from our chart is that supply disruptions have added more to US and Canadian inflation so far in 2021, while reopening demand has been more meaningful for UK and US inflation. The pickup in euro area inflation has been mostly an energy price story, although reopening demand has started to contribute to the rising trend of overall inflation. The implication from this analysis is that persistent supply chain disruptions could become a bigger issue for future inflation – and monetary policy decisions – in the US and Canada. The acceleration of US realized inflation in 2021 has already begun to broaden out from the most volatile components, according to measures like the Dallas Fed Trimmed Mean PCE (Chart 8). Faster inflation is also feeding through into higher US consumer inflation expectations according to surveys from the New York Fed and the University of Michigan. Those increases are not deemed to be temporary, with longer-term inflation expectations now moving higher. The New York Fed’s survey shows that inflation is expected to be 4% over the next three years, two full percentage points above the Fed’s target, which must be ringing some alarm bells on the FOMC. Chart 9European Consumers Are Waking Up To Higher Inflation Consumer inflation expectations are also starting to perk up outside the US. The YouGov/Citigroup survey shows an expectation of UK inflation over the next 5-10 years of 3.5%, while the Bank of England/Kantar survey is at 3% over the next five years (Chart 9, top panel). Both are above the Bank of England’s 2% inflation target. The European Commission confidence surveys have shown a sharp increase in the net share of respondents expecting higher inflation in the coming months (bottom panel), while the Bundesbank’s August consumer survey shows that Germans now expect 3.5% inflation over the next 12 months, up from 2% back in March. Bottom Line: Supply chain disruptions are lasting for much longer than originally expected, while faster realized global inflation is feeding through into higher longer-term consumer inflation expectations, most notably in the US. This raises the risk that the 2021 inflation pickup will last much longer than expected and force a bond-bearish repricing of future interest rate expectations. Negative Real Yields – The Achilles Heel For Bond Markets It is clear that supply chain disruptions are having a more lasting effect on global inflation than investors, and policymakers, expected earlier this year. Yet while both market-based and survey-based measures of inflation expectations are moving higher, interest rate markets are still pricing in a very dovish future path for policy rates of the major developed market central banks. For example, our 24-month discounters, which measure the change in interest rates over the next two years discounted in overnight index swap (OIS) curves, show that only 71bps, 61bps and 13bps of rate hikes are expected in the US, UK and euro area, respectively, by September 2023 (Chart 10). This continues a trend that we have highlighted in recent reports – the persistence of negative real interest rate expectations in the developed markets that is also keeping real bond yields in sub-0% territory. In the US, the OIS forward curve shows that the first Fed rate hike is expected in early 2023 with a very slow pace of rate increases over the following 2-3 years (Chart 11). The funds rate is expected to level off at 1.75% and stay there through 2030. At the same time, the CPI swap forward curve has inflation falling steadily over the next couple of years, but leveling off around 2.35% for the rest of the upcoming decade. Combining those two forward projections comes up with an implied path for the real fed funds rate that is persistently negative for the next ten years, “settling” at -0.6% by the end of the decade. Chart 10Bond Markets Exposed To More Hawkish Central Banks Chart 11US Real Yields Priced For Extended Fed Dovishness An even more deeply negative real rate path is discounted in the euro area forward curves. The ECB is expected to begin lifting rates in 2023, eventually moving out of negative (nominal) territory in 2026 before climbing to +0.5% by 2030 (Chart 12). Euro area CPI swaps are priced for a fall in inflation back below 2% over the next two years, eventually stabilizing at 1.75% over the latter half of the next decade. The real ECB policy rate is therefore expected to settle at -1.25% by 2030. In the UK, markets are discounting much of what has been seen in the years since the 2008 financial crisis – a Bank of England that does very little with interest rates. The central bank is expected to begin lifting rates in 2023, but only a handful of rate hikes are expected in the following years with Bank Rate only climbing to 1% and settling there for most of the upcoming decade. The UK CPI swap curve is discounting relatively high inflation over the next decade, settling at 3.6% in 2030. Thus, the market is discounting a long-run real Bank of England policy rate of -2.6%. This pricing of negative real policy rates so far into the future goes a long way to explain why longer-term real government bond yields have also been consistently negative in the US, Germany, UK and elsewhere in the developed markets. That can be seen in Charts 11, 12 and 13, where we have added the 10-year inflation-linked (real) bond yield for US TIPS, French OATis and UK index-linked Gilts. In all three cases, the 10-year real yield has “gravitated” towards the realized path of the real policy rate – the nominal rate minus headline CPI inflation – over the past two decades. Chart 12Negative Real Rates Forever In Europe? Chart 13BoE Not Expected To Do Much Over The Next Decade Chart 14Nominal Yields Will Move Higher If Negative Real Yields Persist Persistent low government bond yields, both in nominal and inflation-adjusted terms, have resulted in lower yields across the global fixed income markets as investors have been forced to take on more risk to find acceptable yields. This has resulted in a situation where nominal yields on riskier assets like US high-yield corporate bonds and Italian government debt are trading below prevailing headline inflation rates in the US and Europe (Chart 14). Bond investors would likely only be comfortable accepting such negative real yields on the riskier parts of the fixed income universe if a) inflation was expected to decline, and/or b) real yields on risk-free government bonds were expected to stay negative for longer as central banks stay dovish. In either case, the “bet” made by investors is that the inflation surge seen this year will indeed prove to be transitory, as central banks are forecasting. If that benign outlook proves to be incorrect and inflation stays resilient for longer – potentially because of the risk of lingering supply chain disruptions described earlier in this report - nominal bond yields will have to reprice higher to account for faster realized inflation (and, most likely, rising inflation expectations). This process will start in government bond markets, as global central banks will be forced to respond to stubbornly high inflation by turning more hawkish, first with faster tapering of QE bond buying and, later, with interest rate hikes. We continue to see persistent negative real yields as the biggest source of risk in developed economy bond markets over the next couple of years. Those yields discount a benign path for both inflation and future monetary policy that is looking increasingly less likely – especially with tightening labor markets and rising consumer inflation expectations already forcing central banks, led by the Fed, to move incrementally towards less accommodative policy settings. Bottom Line: Global bond markets have made a collective bet on the “transitory” inflation narrative by driving yields on government bonds, and even the riskier parts of the corporate credit universe like US and European high-yield, below actual inflation. Markets will have to reprice those negative real bond yields higher if inflation proves to be more persistent than expected - particularly with central banks likely to respond with faster tapering and, in some cases, eventual rate hikes. Stay below-benchmark on overall global duration exposure in fixed income portfolios.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 We have attempted to match the groupings shown in the Bank of Canada analysis as much as possible for the other countries, although there are some minor differences based on how each country’s consumer price index sub-indices are defined. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns