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