Said Jay, we’ve “a long way to go”
Ere driving inflation too low
Employment’s still tight
But we’ll get it right
Or not… it’s too early to know

His colleagues, though, aren’t in sync
As some of them seemingly think
They’ve tightened enough
And now would rebuff
The call for more Kool-Aid to drink

Lots to touch on this morning between Powell’s testimony yesterday along with other Fed speakers and then a raft of central bank meetings with rate hikes across the board.

 

Starting with the Fed, Powell tried to be very clear that his expectation, and that of the bulk of the FOMC, is interest rates have further to rise.  While they chose to skip a hike last week, they are under no illusion that they have beaten inflation.  Instead, Powell was very clear in his comments that they “have a long way to go” before they have finished the job with inflation.  Of course, yesterday I laid out a theme of why their medicine for inflation is not likely to be that effective, but that is not a conversation that Powell, or any FOMC member, is likely to entertain.

 

However, despite Powell’s insistence that there are likely two more 25bp rate hikes in the offing, we are finally beginning to hear some dissent from the rest of the committee.  Yesterday both Raphael Bostic from Atlanta and Austin Goolsbee from Chicago were clear that a pause at the current level made the most sense and they would support that outcome.  While Governor Christopher Waller remains on board with further rate hikes, Bostic is not a voter (Goolsbee is) so I expect that the July meeting will have a lot of discussion.

 

Interestingly, the market reaction was different in different markets, with the equity markets hearing Powell and accepting his words at face value thus selling off, while the FX market seems more suspect, with the dollar failing to gain after his comments.  In fact, the euro has traded back above 1.10 this morning for the first time in more than a month.  As to the Treasury market, yields are pushing higher again, with 10yr yields up by 1.5bps this morning, but the real movement has been in the 2yr which has seen the curve inversion push back to -99bps.  Bond investors seem to believe Powell.

In Europe, though, things ain’t the same
As central banks still try to blame
Their failure to slow
Inflation and grow
On Russia, a pitiful claim

In the meantime, three central banks met today in Europe and all three hiked rates, with two, Norway and the UK, hiking by 50bps and Switzerland hiking just 25bps.  The 50bp hikes were more than expected and indicative of the fact that both nations, and in truth the entire continent, remain far behind the curve in their respective inflation fights.  Alas, for these nations, too, I fear they are not using the best tool to address the issue as all were guilty of excessive fiscal stimulus and all face worse demographic trends than the US, so are unlikely to get the desired response from rate hikes. 

 

It should be no surprise that both the pound and krone have rallied sharply on the day, with NOK higher by 1.3% and the best performing currency in the world, as investors and traders are concluding that these central banks are going to keep at it until such time as inflation finally does slow down.  The pound reacted immediately, with a quick 0.5% pop, although it is since retraced those gains and is only slightly higher on the day now. 

 

What should we make of all this central bank activity?  While there are a growing number of analysts and economists who continue to believe that inflation is due to decline sharply over the summer, apparently none of them work in any central bank.  The relative amount of tightness from one bank to another may vary slightly, but other than the BOJ, which is completely uninterested in adjusting its policy anytime soon, it is very easy to believe that interest rates have higher to go from here.  Plan accordingly.

 

So, what have these comments and actions wrought in markets?  Well, my entire equity market screen is red this morning with Japan and China both sharply lower as well as every major index in Europe falling by at least -1.0%.  US futures are also in the red after a weak session yesterday, and it is very easy to believe that we are due a correction, if nothing else, given the remarkable run up we have seen lately.

 

Bond yields, as mentioned above, are generally higher, although 10yr Gilts are bucking the trend, falling 3bps in the wake of the BOE action as investors are hopeful they are truly going to be able to halt the inflationary spiral.  As with most other things, JGB’s are not following suit and in fact, with the 10yr yield back down to 0.367%, virtually all discussion of the end of YCC has vanished.  Ueda-san is one lucky guy.

 

On the other hand, oil (-2.1%) is under pressure this morning as the idea of higher interest rates slowing economic growth continues to pervade the market.  Perhaps more surprisingly, both copper and aluminum have rallied a bit and are holding onto their gains in the face of higher rates.  Ultimately, copper especially, is a resource that is in short supply for all the grandiose electrification plans that are bandied about by politicians worldwide, and so I expect, just like oil, there is a structural deficit and it should trade higher.  I am simply surprised it is doing so in the current environment.

 

Finally, the dollar is mixed this morning, as after the NOK, the rest of the G10 is +/- 0.2% from yesterday’s closing levels, hardly enough to discuss.  In the emerging markets, the biggest mover is TRY (-2.3%) after the central bank disappointed by only raising rates from 8.50% to 15.0%!  With a new central bank chief, the market was expecting a move to 20.0%, which would still be far below the current level of CPI there, which at last reading was 39.6%.  But away from that, the dollar is mixed with no outliers in either direction.

 

Today we do get a lot of data as follows: Chicago Fed National Activity Index (exp -0.10); Initial Claims (259K); Continuing Claims (1785K); Existing Home Sales (4.25M); Leading Indicators (-0.8%) and KC Fed Manufacturing Index (-5).  Chair Powell also speaks to the Senate Banking Committee today, but I doubt much new will come from that.  Look at the Initial Claims data, which is the best real time indicator of the employment situation as any jump there will likely get tongues wagging about the end of the Fed rate hikes.

 

Right now, investors are a bit nervous about just how hawkish the Fed is going to ultimately be, so my take is we will see caution, meaning profit taking and a modest correction in risk assets, until such time as participants are all convinced that the pivot is coming.  The fact that a pivot means the economy is distressed does not seem to matter right now. As to the dollar, it will have a hard time as long as traders question the Fed’s conviction while other central banks raise rates.  So, while the yen and renminbi should be the worst performers, the G10 is likely to outperform the buck for now.

 

Good luck

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