The CPI data made clear
That markets no longer have fear
But Jay and his team
Will still push the theme
That cuts in Fed funds just ain’t near

As such markets have been persuaded
It’s time for the Fed to be faded
The bulls are on top
And they just won’t stop
Til new record highs have been traded

By now, you are all well aware that yesterday’s CPI data came in a bit softer than the forecasts with the headline printing at 3.2% Y/Y while the core printed at 4.0% Y/Y.  Both of these were 0.1% lower which doesn’t seem to be that big a difference.  But the bulls are stampeding on the idea that if you look at the recent trend, the annualized rate for the past 6 months is lower still (3.0% and 3.1% respectively) and the implication is that inflation is dead and the Fed has achieved the impossible, reducing inflation without causing a recession.  And maybe they have, but boy, that is a lot to take away from a single data point that printed a smidge lower than expectations.

Two weeks ago, in the wake of the last FOMC meeting, I wrote (Bulls’ Fondest Dreams) that the Fed changed their tune and despite all the pushback we have received from Fed speakers in the interim, they definitely saw the end of the hiking path coming into view.  Yesterday’s data seemed to confirm this view, at least in the markets’ eyes.  As such, we saw a massive rally in both stocks and bonds, with 10-year yields falling 20 basis points at one point in the day before closing lower by about 17bps.  They are 2bps higher this morning on the bounce.  Interestingly, European sovereign yields also fell quite sharply despite the lack of local news as the price action once again proved that the 10yr Treasury yield is the only bond price that really matters in the world.

So, to me the question is now, is this view correct?  Has the Fed actually threaded the needle and successfully reduced inflationary pressures without causing a meaningful economic slowdown?  If so, Chairman Powell will rightly be hailed as a brilliant central banker, even if there was some luck involved.  How can we know, and more importantly, when will we be certain this is the case?

I think it is important to try to separate the markets and the economy as the two are really quite different.  The economy is where we all live.  From an individual perspective, I would contend it is a combination of one’s employment situation(and whether there is concern over losing one’s job or finding a new one), the true cost of living, meaning the ability to afford the mortgage/rent as well as put food on the table, and then to see if there is any additional money left to either save or spend on desires rather than necessities.  It seems abundantly clear that from this perspective, there is a large segment of the population that doesn’t feel great about things.  This was made clear in an FT survey that showed just 14% of those surveyed thought things had gotten better economically under the Biden Administration’s policies.

However, if this poet has learned nothing else in his time trading in, and observing, financial markets, it is that policymakers do not care one whit about those issues.  Despite periodic attempts to seem down-to-earth, the reality is they all exist within a policy bubble with no concerns about the rent or their next meal.  In this bubble exist only numbers like yesterday’s CPI or today’s Retail Sales (exp -0.3% headline, 0.0% ex autos).  GDP, to them, is not a measure of people’s confidence or belief in the state of the current world, it is a policy variable that they are trying to manage or manipulate so they can make positive pronouncements.

There is obviously quite a gulf between those two views of the world and the markets are the connection, trying to interpret the reality on the ground through the lens of the data.  Well, the policymakers must be thrilled today because the extraordinary bullishness that is now evident across all risk markets, in their minds, means that their jobs are secure.  When things are going well, reelection/reappointment are the expected outcomes.  However, that FT survey was clearly a warning shot across the bow of their Good Ship Lollipop that everything was going to be great going forward.

So, what’s it going to be?  As I wrote after the FOMC meeting, I believe the market is prepped to rally through the rest of the year.  After yesterday’s data, that seems even clearer.  But do not forget that one of the key rationales for the Fed’s change of heart was that the market was doing the Fed’s work for them, tightening policy by raising rates and watching risk assets drift lower, thus tightening financial conditions.  Let me tell you, financial conditions loosened a lot yesterday, and if this rally continues, you can be certain that Powell and friends will grow more concerned about a rebound in inflation.  The market has completely removed any probability of a December rate hike, or any further rate hikes by the Fed as of yesterday with the first cut now priced for May 2024.  At this stage, it seems probable that the October PCE data will be on the soft side so much will depend on the next NFP and CPI readings, both of which are released before the next FOMC meeting.

And there is one more thing that must be remembered when it comes to the bond market.  The US is still going to issue an enormous amount of debt going forward between refinancing ($8.3 trillion though 2024) the current debt and the new $2 trillion budget deficit that needs to be funded for next year.  Can bonds continue to rally in the face of that much supply?  Maybe they can, but it would seem to require a reengagement of foreign buyers rather than relying entirely on domestic savers.  Either that or the Fed will need to end QT and possibly even restart QE.  In the latter case, inflation would almost certainly become a major issue again.  The point is, while everyone is feeling great this morning, there are still numerous perils to be navigated in order to maintain economic growth with a low inflation regime.  I hope Jay and all the central bankers are up to the task, but a little skepticism seems in order.

Ok, the overnight session can be summed up in one word: BUY!  Equity markets everywhere rallied with strong gains in Asia (Hang Seng +3.9%) and Europe, after rallying yesterday, continuing higher by nearly 1% this morning.  US futures are also all green this morning, generally +0.5% at this hour (7:30).

Bond markets have mostly held onto yesterday’s impressive gains with some trading activity, but movements all within a basis point or two from yesterday’s close.  The exception was Asian government bond markets, where prices rallied sharply, and yields tumbled there as well, following the US lead.

Metals prices are ripping higher again this morning, with gold, silver, and copper all up nicely after strong gains yesterday.  The outlier here is oil, which is a touch lower (-0.4%) this morning after a very lackluster session yesterday.  Now, in fairness, it has been creeping higher for the past several sessions, but compared to other markets, oil is remarkably quiet right now.

Finally, the dollar got smoked yesterday, with the euro rallying 1.5% and similar moves across the other European currencies.  Meanwhile, AUD rallied more than 2% yesterday as the combination of rocketing metals prices and a broadly weaker dollar were just the ticket for the currency.  In the EMG bloc, ZAR (+3.0%) and MXN (+1.5%) were the big winners yesterday although, interestingly, most of the APAC currencies had much more muted runs, on the order of 0.5%-1.0% gains.  This morning, price activity is much more subdued as FX traders are trying to get their bearings again.  It was, however, a 3-sigma day, a rare occurrence.

On the data front, as well as Retail Sales, we also see PPI (exp 2.2% headline, 2.7% ex food & energy) and the Empire Manufacturing Survey (-2.8) along with EIA oil information where inventory builds are forecast.  There is only one Fed speaker, vice chairman of supervision Michael Barr, and I don’t expect he will be able to sway any views today.

For now, the die is cast, and the bulls are in the ascendancy.  We will need to see some very big changes in the data trajectory for the current momentum to stall, and quite frankly, I don’t see what that will be for now.  So, go with the flow here, higher stocks, lower yields and a softer dollar seem to be the trend for now.  There will be some trading back and forth, but you can’t fight City Hall.

Good luck

Adf