Steady On The Policy Front For Now

Steady on the policy front for now

Fed Chair Powell on Wednesday maintained both patience and dovish narrative, despite the blockbuster US CPI and PPI reports for June. 

US 7s to 30s slid more than 6bp, reversing the post-CPI/bond supply selloff. Powell noted that reaching "substantial further progress" is still a ways off and that the FOMC will continue the bond-buying debate in the coming meetings.

Photo by Michelle Spollen on Unsplash

Into and through most of the Q&A yesterday, even 30y maintained a 1bp range. Closer to the conclusion of his testimony, buyers took 7s to 30s down another basis point. 

Powell stressed that the economy is not experiencing "genuine" inflation, which Powell explained, is extended periods of price increases year after year.

The dovish intimations were sufficient enough to propel the S&P 500 Index to an all-time intraday high.

Still, Powell also hinted that taper discussion would be forthcoming at the September meeting, but reiterated any decision would be announced "well in advance"; inflation has been "higher than expected and hoped for," but "we very much think that the price increases (for used cars, etc)are temporary … and prices will begin to decline at some point." 

Markets are shrugging off high and rising CPI inflation, with upside surprises to both US and UK CPI data this week not impacting their respective rates markets. So far, Chair Powell has been convincing enough to convey the idea that inflation is transitory. Still, the details of the US CPI release suggest inflation is getting clingy more tenacious. 

Two things can happen from here on out. Either investors accept the transitory arguments, or the hawkish camp on the FOMC could re-assert itself more deliberately at the July 28 meeting. 

The reflation trade could return if a behind-the-curve Fed drives steeper curves. But the risk is that it wouldn’t be back for long, with flatter nominal curves and higher real yields undercutting reflation trades and boosting the USD. 

Forex

In currency news, all eyes and ears were trained on the Bank of Canada, where the action in USDCAD suggests systematic trading machines jumped on the first Bank of Canada headline about slack in the labor market. Still, hawkish expectations were not met, as inflation is still passing -- as opposed to the real worry expressed by the RBNZ earlier Tuesday. USDCAD reversed all the selloff and is back to the same level as yesterday's Asia open +1.2500  

Bank of Canada Governor Tiff Macklem suggested that there are three reasons behind the view that inflation is fleeting: 

1. Semiconductor chips and gasoline prices are a result of the pandemic and thus temporary. 
2. Economic slack is putting downward pressure on inflation. 
3. Inflation surveys show expectations are stable. 

Meanwhile, fissures in the central bank unity on the persistence of inflation offer scope for further downside in AUDNZD and EURGBP. The RBNZ is turning more hawkish, and the growing possibility of a BoE pivot Aug. 5 meeting.

Gold

Gold jumped after Fed Chair Powell's reassurance on accommodative monetary policy. Dovish signals from the ECB and the PBoC earlier were good news for the stimulus trade, and that's positive for the yellow metal. XAUUSD sliced through decent resistance like a hot knife through butter. After breaking above $1820, it is now hovering the 20-day at $1826/27. Real yield is still a driver, and momentum is moving higher given the positive CPI.