First, CPI data’s released
Which ought to show prices increased
Then Janet and friends
Make further amends
With twenty-five bps at the least
Ugh! How many days in a row do I need to describe market activity as dull? Once again there has been minimal movement overnight across most markets, although at least today brings two events which might have some real impact. First thing this morning we see November CPI data released with expectations at 0.4% (2.2% Y/Y) for the headline number and 0.2% (1.8% Y/Y) for the ex food & energy print. While these numbers are lower than they were back in February, when there was much discussion of how the Fed may be forced to respond more forcefully to incipient inflation, looking back over the past two years, the trend higher remains quite clear and old concerns over deflation are a distant memory. Given yesterday’s higher than expected PPI print, I would argue that a small portion of the market is even looking for a high-side surprise.
One thing I do know is that the big picture narrative continues to downplay any significant inflationary pressures in the US, or at least assumes that the market has already priced those in. Investor surveys consistently show that higher inflation is a very low priority for most fund managers although it is likely one of the biggest risks that exists to the current ‘goldilocks’ scenario. Consider this, if measured US inflation starts to climb more rapidly than currently expected, Jay Powell may find himself pushed into a far more aggressive reduction of policy accommodation than currently forecast. Remember, too, that the futures market is currently pricing just 40bps of rate hikes next year. What if that number turns into 125bps or 150bps due to rising inflation? I assure you that will have a significant negative impact on financial asset prices! And while I am not trying to forecast an outlier event, neither is it is inconceivable.
This brings us to the other event today, the FOMC statement and following press conference. The market has fully priced in a 25bp rate hike for today and given the last rhetoric we had from any Fed speakers, that is in line with their thoughts as well. Certainly there has been no data released in the interim that would change that view. So all eyes will be on the new dot plot as a means to anticipating the Fed’s view of the future of interest rates. The current median forecast for Fed Funds at the end of 2020 is 2.875%, which as a terminal rate would be historically low. Given that after today’s move, Fed Funds will be at 1.50%, it means there is not very much movement left ahead. This is one of the reasons that forecasts are for the dollar to decline next year and beyond. After all, both the ECB and BOJ currently have much lower rates and therefore, theoretically, far more room to raise them. In fact, there is growing talk that the ECB, when they meet tomorrow, may signal a shorter timeline between the end of QE and the first rate hikes. My point is, as expectations gel around the idea that the Fed won’t be doing much more, relative monetary policy tightness would turn to favor other currencies.
But…all this presumes that the dot plot is an accurate representation of the future. What happens if measured inflation in the US begins to pick up more rapidly? It is very easy to envision that the dot plot will be adjusted higher quite quickly in the event that we see faster inflation. This is especially true if the Average Hourly Earnings data starts to climb at a quicker pace (wages, as per the Atlanta Fed are already rising at 3.4%). In the long history of Fed Funds, 2.875% is far closer to the lows than the highs. There is no reason that Fed Funds cannot move back toward 4% or 5% if inflation persists alongside GDP growth. All I’m saying is that it is quite shortsighted to consider Fed Funds at 3.0% as ‘high’. In fact it is quite low! So do not be fooled into thinking that the ECB or BOJ have more room to raise rates than does the Fed, it is simply not true. And that is a key underlying feature of the current narrative.
Well, we shall see later today how the next step progresses, but arguably, come March, the inflation story will be far better defined. In the meantime, the overnight markets have done virtually nothing, with only one currency moving more than 0.25%, the Brazilian real. The story there has been the setting of the date in January for the corruption trial of former President, Lula da Silva, which will likely prevent him for running for President again. He is seen as the least market friendly potential candidate, and so removing him from the equation was a distinct positive for the currency. This is doubly true as the economic story there continues to improve and they seem to be making some headway on their pension reforms. But away from that, both G10 and EMG currencies have traded in tight ranges with limited news.
Once the Fed is out of the way, we hear from the BOE and ECB tomorrow, with the latter offering an opportunity for some surprises, and then I would argue that there will be very little to discuss until the new year. As such, after tomorrow’s note, there will be no poetry until January 3, 2018, when the market is back closer to full strength.