For months the Fed had been mendacious
In calling inflation fugacious
But that view’s expired
And Jay has retired
The word that had been so fallacious
So, later this morning we’ll see
The reason that transitory
Is out on its ear
As it will be clear
Inflation’s not hyperbole
Chairman Powell must be chomping at the bit this morning as he awaits, along with the rest of us, the release of the November CPI data. For us, it will be the latest data point to which the inflationistas will point and say, ‘see? I told you so.’ But, given the timing of the release, just days before the FOMC is scheduled to meet and therefore during the Fed’s self-imposed quiet period, whether the print is higher than the expected (0.7% M/M, 6.8% Y/Y) number or lower, no Fed speaker will be able to try to shape the discussion. Instead, they will be left to the mercy of the punditry and the markets, something with which they have never been comfortable, at least not since Paul Volcker retired from the Fed.
Of course, they are not completely without capabilities as you can be sure the WSJ is going to run an article later this morning by Nick Timiraos, the current Fed Whisperer, which will be designed to explain the Chairman’s views without attribution. However, given the recent history of the median forecast, which have consistently underestimated the rise in CPI (and PCE for that matter), it seems likely the official narrative will fall further behind the curve. Speaking of the curve, looking at the Fed funds futures markets, expectations are for the first rate hike to come in either May or June of next year, which means if the Fed truly wants to finish QE before raising rates, current expectations for a doubling of the speed of tapering may be underestimating the pace.
We have also heard recently from former Fed officials, who clearly remain in contact with the current group, and virtually every one of these has forecast that the dot plot will show a median of two rate hikes next year with a chance of three and then another four in 2023 with the eventual neutral rate still anchored at 2.50%. And yet, this quasi-official view remains at odds with all the other information we have regarding inflation expectations. For instance, later today we see the University of Michigan stack of data which last month showed 1-year inflation expectations at 4.9% and the 5-10-year figure at 3.0%. Since the Fed is one of the greatest champions of the inflation expectations theory (i.e. inflation can be self-fulfilling, so higher expectations lead to higher actual inflation), it would seem that if the dot plot does indicate long-term rates ought be centered around 2.50%, the Fed believes the neutral rate is negative in real terms. Either that, or they are willing to dismiss data that doesn’t suit the narrative. However, it is more difficult to understand how they are willing to dismiss the data they themselves compile, like the NY Fed’s Consumer Expectations survey which indicates 1-year inflation is expected at 5.7% and 3-year at 4.2%.
Ultimately, there is nothing that we have seen of late that indicates either inflation or inflation expectations are peaking. In addition, inflation continues to be a major topic on Capitol Hill, so for now, it seems clear the Fed will continue to preen its hawkish feathers. This speaks to the dollar resuming its upward trend and calls into question the ability of the equity markets to maintain their euphoria. In fact, a reversal in equity markets will pose a very real conundrum for the Fed as to how to behave going forward; fight inflation or save the stock market. You already know my view is they will opt for the latter.
Anyway, with all eyes set to be on the tape at 8:30, here’s what we have seen overnight. After a late sell-off in the US, equity markets in Asia (Nikkei-1.0%, Hang Seng -1.1%, Shanghai -0.2%) all suffered although European bourses have managed to recoup early weakness and are essentially unchanged across the board as I type. The only data of note has come from the UK, where October GDP rose a less than expected 0.1% pouring some more cold water on the BOE rate hike thesis for next week. US futures, however, are trading higher at this hour, with all three major indices looking at gains of 0.3% or so.
The bond market is under modest pressure this morning, with yields edging higher in the US (+1.4bps) as well as Europe (Bunds +2.4bps, OATs +1.9bps, Gilts +2.8bps) as investors around the world continue to prepare for a higher interest rate environment. Remember, just because the G10 central banks have been slow to tighten policy doesn’t mean that is true everywhere in the world. For instance, Brazil just hiked rates by 150 bps to 9.25% and strongly hinted they would be raising them another 150bps in February given inflation there just printed at 10.74% this morning. Mexico, too, has been steadily raising rates with another 25bps expected next week, and throughout Eastern Europe that has been the norm. The point is that bond markets have every chance of remaining under pressure as long as inflation runs rampant. In fact, that is exactly what should happen.
In the commodity world, early weakness in the oil price has been reversed with WTI (+1.1%) now firmly higher on the day. NatGas (+1.3%) is also firmer although we are seeing much less movement from the metals and agricultural spaces with virtually all of these products withing 0.1% or so of yesterday’s closing levels.
As to the dollar, it is broadly firmer again this morning, albeit not by very much. NZD (-0.25%) and JPY (-0.25%) are the laggards in the G10, although one is hard-pressed to come up with a rationale other than position adjustments ahead of the data release this morning. In fact, that is true with all the G10 currencies, with movements other than those two of less than 0.2%.
The same cannot be said for the EMG space, where TRY (-1.05%) continues to slide as the combination of rampant inflation and a leadership that is seeking to cut interest rates as a means to fight it is likely to undermine the lira for the foreseeable future. Thus far, TRY has not quite reached 14.00 to the dollar, up from 9.00 in mid-October. But there is nothing to prevent USDTRY from trading up to 20 or higher as long as this policy mix continues. Elsewhere, KRW (-0.6%) fell on the news that Covid infections grew at their fastest pace in a year and concerns over potential government actions to slow its spread. Otherwise, weakness in PLN (-0.4%), INR (-0.35%) and CLP (-0.3%), for instance, all seem to revolve around expectations for tighter US monetary policy rather than local weakness.
In addition to the headline CPI discussed above, expectations are for core (+0.5% M/M, +4.9% Y/Y) and Michigan Sentiment is expected at 68.0. Until the data is released, there should be very little in the way of movement. Afterwards, though, I would look for the dollar to rally on higher than expected data and vice versa. We shall see.
Good luck, good weekend and stay safe