This was out yesterday but I need to highlight it in case you missed it. German PPI in January rose .7% m/o/m, well above the estimate of up .3% and brings the y/o/y gain to 2.4% from 1% in December. This is the fastest pace of gain since March 2012 and yes energy is the main culprit but PPI ex energy was still up a sharp .6% m/o/m and 1.8% y/o/y. What is also noteworthy is the rapidity of the rise. I’ve included a chart that reflects the 2008 spike in energy prices, the plunge to follow and the V bottom thereafter. Taking out this unusual time period you can see this recent move vs other contexts. This follows a string of inflation stats out of Germany that show a similar spike so there wasn’t much market reaction but I repeat my belief that is will be kettle that will only further boil between Germany and the ECB this year.
Today we saw the final read on French consumer inflation and it rose 1.6% y/o/y (EU harmonized) as expected and that is double the level as seen in December and the quickest pace of gain also since 2012. Energy prices of course had the most profound impact. On a m/o/m basis though prices cooled by .3% after a .3% rise in the prior month but that’s because of seasonal drops in clothing and shoes post holiday. We are seeing another day of selling in French bonds but we of course know that’s in response to Marie Le Pen worries. The 10 yr French oat yield is up 3.5 pbs to 1.10% and up 8 bps in just the past 3 days. As the German 10 yr yield is up by the same amount today, the spread between the two is holding at 77 bps, the most since 2012.
Also putting upward pressure on European sovereign bond yields was the better than expected Eurozone manufacturing and services composite index which is at its best level since April 2011. It came in at 56 vs the estimate of 54.4. Most of the upside was seen in services as this component was up almost 2 pts led by France. Manufacturing rose .3 pts m/o/m and that was driven by Germany as French manufacturing fell. Markit said “job creation was the best seen for 9 ½ years, order book growth picked up and business optimism moved higher, all boding well for the recovery to maintain strong momentum in coming months.” For Mario Draghi’s focus, “Inflationary pressures meanwhile continued to intensify.” Input costs rose at the fastest pace since May 2011, “with rates accelerating in both services and manufacturing.” Higher global commodity prices, the weak euro and “suppliers regaining some pricing power amid stronger demand.” Mario Draghi, be careful what you wish for because the European bond market is a trainwreck waiting to happen. Eurozone growth in Q1 may peak above 2% annualized.
US Treasury yields are getting lifted by the weakness in European bond prices and we are now hearing from another Fed President who happens to vote, Mr. Kashkari, who said shrinking the balance sheet may start at “some point in probably the not too distant future.” This theme is getting more and more play and it was highlighted at last week’s testimony from Yellen where a few Congressman wanted answers on when this process was going to begin. Because Fed members seem to think this process won’t be a big deal, I’m beginning to believe this could be a 2017 event rather than one in 2018. I happen to think it would be a huge deal as it’s a reverse QE and we know how excited everyone got when QE was on. Multiple compression anyone?
Kashkari also said he’s got his eyes open for potential bubbles as he said “financial stability” was their 3rd mandate. I wish I can show him my equity valuation charts and explain to him that the global bond bubble is the biggest one ever. I don’t know him so that won’t be happening.
Patrick Harker, another voting member, is repeating today that a March rate hike is on the table.
In England, the BoE’s Ian McCafferty who is a hawkish leaning member said “we are closer to those limits of tolerance than we were six months ago” in reference to the rising rate of inflation. He sounds like he’s ready to vote for a hike. Mark Carney is speaking too and not committing to anything right now but did acknowledge that a “smooth Brexit process could mean higher path for rates.” With all due respect to Mr. Carney, he is kind of screwed because he’s afraid to hike until he gets clarity on Brexit which may not happen for a few years at the same time the plunge in the pound is threatening his SOLE mandate called price stability. The 10 yr gilt yield is higher by 4 bps to 1.27% and the pound is lower.
Markit’s February US manufacturing and services composite index fell to 54.3 from 55.8 in January. This index is now back below the pre election October level of 54.9 with manufacturing slightly above and services now below. Manufacturing dipped by .7 pts to 54.3 while services were down by 1.7 pts to 53.9. The post election enthusiasm has cooled a bit. Markit said the “latest survey data indicated that business optimism moderated among US private sector firms in February, driven by weaker confidence across the service economy. Measured overall, survey respondents were the least upbeat about the growth outlook since September 2016.” With services, new orders fell to a 5 month low as “some service providers commented on a greater degree of caution in terms of client spending.” Job growth also slowed to a 3 month low. With manufacturing, “softer output and new order growth were the main factors” for the m/o/m drop. Prices paid rose at the fastest clip since September 2014 due to the rise in “a range of raw materials.” Prices received though fell to a 3 month low “suggesting a continued squeeze on operating margins.”
Bottom line, the post election ebullience is now calming down. It’s time for the rubber to meet the road in terms of seeing what new economic policies are to come.