Tag Archives: #tightmoney

Firmly On Hold

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For now the Fed’s firmly on hold
While Powell made statements quite bold
It’s time to assess
How great is the mess
Created by stories we’ve told

This morning then, Christine is live
With certainty that twenty-five
Is how much she’ll hike
As she tries to spike
Inflation while growth she’ll still drive

To virtually nobody’s surprise, the Fed left policy rates on hold yesterday after what has been characterized by many as a hawkish pause.  This seems a fair assessment given the effort by Chairman Powell to stress that inflation remains too high and has not been falling as rapidly as they would like to see.  For instance, comments like the following during the press conference were quite clear:

 

“If you look at core PCE inflation over the last six months, you’re not seeing a lot of progress. It’s running at a level over 4.5%, far above our target and not really moving down. We want to see it moving down decisively, that’s all.”

“We’re two-and-a-quarter years into this, and forecasters, including Fed forecasters, have consistently thought inflation was about to turn down and typically forecasted that it would, and been wrong.”

“What we’d like to see is credible evidence that inflation is topping out and then getting it to come down.”

 

These were just some of the comments but give a flavor for what the mindset appears to be in the Eccles Building.  Looking at the dot plot, the median expectation is for two more rate hikes in 2023 and there were zero expectations of a rate cut.  The point is that higher for longer, which is what they have been preaching for upwards of a year, remains the mantra and given how robust the employment situation remains, they do not seem likely to change that view in the near term.  A quick look at the Fed funds futures market shows a market probability of 71% for a rate hike in July where things peak, and then pricing for a cut in January.  However, as I have maintained, I see inflation remaining quite sticky and the probability of a rate cut as far lower than that.

 

The market response was perfectly sensible in the bond market, where yields continue to climb, and the yield curve inversion increased to -91bps.  2-Year yields are now back to 4.73% as traders and investors price in a much higher probability that even if rates don’t rise much further, they are unlikely to fall back.  In fact, 10-Year yields around the world have all risen further as the global tightening cycle seems set to continue.  Recall, we saw Canada, Australia and now the Fed come out hawkishly and this morning the ECB is set to follow suit with a 25bp rate hike.  At this stage, there are no G10 central banks that believe they have solved the inflation problem…and they are right.

 

A quick look at European sovereign yields ahead of the ECB announcement shows they have risen between 5bps and 10bps this morning as there is clearly an expectation that after the extremely hawkish commentary from Powell yesterday, Madame Lagarde will be forced to follow suit.  In truth, that seems a reasonable expectation and when looking at the OIS market in Europe, expectations appear to be for another one or two hikes after today’s move.  Given that inflation remains sticky there too, that doesn’t seem far-fetched.

 

On last thing regarding central bank hikes is the Bank of England next week, where a 25bp hike is fully priced, but more impressively, an additional 4 hikes are priced in by the end of the year.  Inflation in the UK has clearly been even more problematic than in the Eurozone or the US, while the Old Lady has been lagging lately so this does make sense as well.

 

There are, though several places where tighter policy is not on the cards, namely China and Japan.  Starting with Japan first, YCC remains the current policy framework and there is no indication they are going to change things anytime soon.  10-year yields there remain well below the YCC cap and there is much more discussion regarding the potential for a snap election in Japan than about monetary policy.  The yen (-0.8%) is weakening further today as the more hawkish Fed combined with the continued dovishness of the BOJ weigh on the currency.  We’ve seen this movie before when the dollar ran up above 150 in October, and while that is still a long way from today’s price, the trend since March has been very clear.  Absent a major policy change from either the Fed or the BOJ, look for a weaker yen over time.

 

As to China, they did cut their Medium-Term Lending Facility rate by 10bps last night as widely expected although the currency did not really move as it was fully priced already.  However, the Chinese government is clearly flailing about for ways to support the economy without increasing the leverage that already exists.  The problem is that the PBOC toolkit, as well as the CCP toolkit, relies on centralized direction not market activity, and it appears that the limits of those policies are starting to be reached.  There is little reason to believe the renminbi is going to rebound in the short-term as a weaker currency is the only outlet valve they have.  Given measured inflation in China has been so low, I expect we can see a continued grind lower (dollar higher) in the second half of the year.  Think 7.50 by Christmas.

 

With all that news, US equity markets had a mixed picture yesterday with the NASDAQ continuing its run higher with a small (0.4%) gain, but the rest of the market under more pressure.  Chinese equities responded quite positively to the rate cut there with substantial gains, but the Nikkei was simply flat on the day.  And now, European bourses are in the red by about -0.7% with US futures also pointing lower.

 

Oil prices (+0.75%) are edging higher but that is after a reversal yesterday brought them back below $70/bbl.  There remains a great deal of controversy over just how badly demand is going to be hit given the lackluster Chinese economy and the huge split on views regarding the US and Europe with a recession call still quite popular although there are those who are now calling for a successful soft landing by the Fed.  Precious metals are a little less precious this morning as are base metals which are indicative of dollar strength I believe.  However, net, I would say the commodity space is more in the recession camp than not.

 

Finally, the dollar is stronger vs virtually all its EMG counterparts with HUF (-1.25%) the laggard as market participants take profits in anticipation of a rate cut from Hungary vs. the Fed’s tough talk.  But the bulk of the bloc is weaker across all three regions.  In the G10, while the yen is worst off, we are seeing weakness almost everywhere except NOK (+0.3%) which is clearly benefitting from oil’s modest rally.  Given the Fed’s unambiguous hawkishness, I suspect the dollar will remain better bid than not for a while yet.

 

On the data front, there is a lot coming today as follows:  Retail Sales (exp -0.2%, +0.1% ex autos); Initial Claims (245K); Continuing Claims (1768K); Empire Manufacturing (-15.1); Philly Fed (-14.0); IP (0.1%); and Capacity Utilization (79.7%).  At this point, the Retail Sales data is likely the most important as the discussion regarding a recession will hinge on whether or not economic activity is still improving.  Remember, though, this data is nominal, not inflation adjusted.  On a real basis, Retail Sales have been falling for 6 months straight, not a good sign.  As to the Fed speaking slate, nobody is on the calendar today, but we will hear from three (Bullard, Waller and Barkin) tomorrow, with all likely to be focused on reiterating the hawkish message.

 

A hawkish Fed bodes well for the dollar going forward, so unless (until?) something in the US economy breaks, my money is on higher rates and a stronger dollar.

 

Good luck

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Quite a Surprise

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This morning’s report on inflation
Is forecast as verification
The Fed is behind
The curve and must find
The will to cease accommodation

While last night from China we learned
The trend in inflation has turned
In quite a surprise
It fell from its highs
A positive for all concerned

Ahead of this morning’s CPI report (exp 7.0%, 5.4% ex food & energy) investors around the world have been feeling positively giddy about the current situation.  Sure, China’s growth forecasts have been cut due to omicron infection outbreaks and the Chinese response of further lockdowns, but that just means that combined with the first downtick in PPI there since February 2020 (10.3%, exp 11.3%, prev 12.9%), talk has turned to the PBOC cutting interest rates next week by between 5 and 10 basis points.  So, while many other nations are aggressively fighting inflation (Brazil, Mexico, Hungary) or at least beginning to tighten policy (UK, Sweden, Canada), the market addiction to ever increasing liquidity may now be satisfied by China.  While it is still too early to know if lower interest rates are coming from Beijing, what is clear is that the credit impulse in China (the amount of lending) seems to have bottomed and is starting to reverse higher.  That alone augers well for future global growth; so, buy Stonks!

Meanwhile, I think it is valuable to consider what we heard from Chairman Powell yesterday at his renomination hearings, as well as what the two erstwhile hawks, Esther George and Loretta Mester, had to say about things.  Mr Powell, when asked why the Fed was continuing to purchase assets with inflation well above target and unemployment near historic lows inadvertently let the cat out of the bag as to the most important thing for the Fed, that if they were to move at a more aggressive pace, it could upset markets and there could be declines in both the stock and bond markets.  Apparently, the unwritten portion of the Fed’s mandate, prevent markets from falling, remains the most important goal.  While Powell paid lip service to the idea that the Fed would seek to prevent the inflationary mindset from becoming “entrenched”, he certainly didn’t indicate any sense of urgency that the Fed’s glacial pace of change was a problem.

Perhaps more surprisingly, neither Mester nor George were particularly hawkish, with both explaining that the Dot Plot from December was a good guide and there was no reason to consider a rate hike as soon as March.  Regarding QT, neither was anxious to get that started either although both wanted to see it eventually occur.  Finally, this morning, former NY Fed President (and current Fed mouthpiece) Bill Dudley explained in a Bloomberg column that there was no hurry to reduce the size of the balance sheet and that when it begins, the impact would be “like watching paint dry.”  Now, where have we heard that before?  Oh yeah, I remember.  Then Fed Chair Yellen used those exact same words to describe the last attempt to shrink the balance sheet right up until Powell was forced to pivot after the equity market’s sharp decline in 2018.  Apparently, the dynamics of drying paint are more interesting than we have been led to believe.

For those seeking proof that investors welcomed yesterday’s comments, one need only look at market behavior in their wake.  US equity markets rallied after the testimony and never looked back all day.  Treasury bonds did very little, with the sharp trend higher in yields having hit a key resistance and unable to find the will to push through.  Finally, the dollar took it on the chin, declining vs virtually every major and emerging market currency yesterday with many of those moves continuing overnight.  Recapping: higher stocks, unchanged bonds and a weaker dollar are not a sign that the market expects much tighter policy from the Fed.

Ok, so how are things looking this morning?  Well, in the equity market, the screen is entirely green. Last night, Asia followed the US lead  with gains across the board (Nikkei +1.9%, Hang Seng +2.8%, Shanghai +0.8%), and European bourses are also higher (DAX +0.35%, CAC +0.5%, FTSE 100 +0.7%) as data from the continent showed much better than expected Eurozone IP growth (2.3% vs 0.2% exp) as well as the first indication that inflation might be peaking in Germany with PPI there “only” printing at 16.1%, down from last month’s record 16.6%.  As to US futures, they are modestly higher ahead of the data, between 0.1%-0.2%.

In the bond market, while 10-year Treasury yields have edged higher by 0.7bps at this hour, they remain just below 1.75% and have shown no inclination, thus far, of breaking out much higher.  Arguably this implies that market participants are not yet full believers in the Fed tightening policy aggressively, and after yesterday’s performances, I think that is a good bet.  Meanwhile, European sovereign bonds are all rallying with yields falling nicely (Bunds -1.8bps, OATs -1.7bps, BTPs -1.3bps) as it remains clear that there is not going to be any tightening of note by the ECB this year.

On the commodity front, we continue to see strength in energy (WTI +0.5%, NatGas +5.2%) as well as industrial metals (Cu +2.9%, Zn +2.2%) although both gold -0.2%, and silver -0.2% are consolidating after strong moves higher yesterday.

Looking at FX markets, I would say the dollar is modestly weaker overall, albeit only in a few segments.  In the G10, NOK (+0.7%) and CAD (+0.2%) are the largest movers, by far, with both benefitting from oil’s continued rise.  The rest of the bloc, quite frankly, is tantamount to unchanged this morning.  In emerging markets, the picture is a bit more mixed with both gainers and losers about evenly split.  However, only 3 currencies have shown any real movement, BRL (-0.4%), KRW (+0.4%) and CLP (+0.3%).  The real seems to be consolidating some of its massive gains from yesterday, when it rallied 1.7% on the back of central bank comments implying that though inflation would fall back in 2022, it would require continued tight policy to achieve that outcome.  On the flip side, the won benefitted from a better than expected employment report showing more than 770K jobs added in the last year and indicating better economic growth going forward.  Finally, the Chilean peso seems to be benefitting from copper’s strong rally today.

Aside from this morning’s CPI report, we also see the Fed’s Beige Book at 2:00pm which has, in the past, been able to move markets if the narrative was strong enough.  Only one Fed speaker is on the docket, Kashkari, and even he, an uber-dove, is calling for 2 rate hikes this year as per his last comments.

The Fed tightening narrative is definitely having some difficulty these days which implies to me that the market has fully priced in its expectations and those expectations are that the Fed will not be able to tighten policy very much.  If the Fed is restrained, and tighter policy continues to get pushed further out in time, the dollar will suffer much sooner than I anticipated.  For those with opex and capex needs, perhaps moving up the timetable to execute makes some sense.

Good luck and stay safe
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