Ok, so the knee-jerk reaction to a hotter-than-expected CPI print was as expected much to the chagrin of everyone who (probably correctly) said the market was making too big a deal out of a single data point.
But again, you can’t really blame people for being nervous. I mean, the whole narrative here is rising inflation exacerbating the ongoing bond selloff and it’s that bond selloff that was the proximate cause for the global equity market correction that unfolded this month. So you know, one data point may not confirm of disconfirm a narrative, but it does affect asset prices, and you can’t generally expect people to not be sensitive to that expected reaction.
Of course the commentary is coming in hot and heavy.
“What impacted futures is the combination of higher CPI and weaker retail sales. That is the higher inflation per unit of growth backdrop that many macro investors focused on last week,” Evercore ISI’s Dennis Debusschere said, adding that “it would imply Fed tightening even as consumption slows. The bigger risk to stocks is a continued move higher in Treasury yields driven not by better growth prospects, but by an increase in the term premium over concerns about inflation and growing U.S. deficits.”
Right. And of course that’s what everyone has been warning about for months. What happens when the interpretation of higher yields changes from “barometer of the robustness of the recovery” to something else not as sanguine where “something else” is tied to inflation running away from the Fed and an unfavorable fiscal backdrop characterized by deficit spending?
There’s always some irony in this. Recall what we said late last month as it became readily apparent that the bond rout was about to spill over:
We’ve spent the better part of a decade trying to engineer inflation, but the problem is that the policies we’ve employed in the service of that goal will be rolled back if “victory” is ever achieved. Because those policies have served to underpin the rally in risk assets, it stands to reason that in the final analysis, no one really wants to declare victory over deflation if that means calling an end to the stimulus that’s underwriting the rally.
Underscoring that is Baird’s Bruce Bittles. “For the past nine years central banks have been buying bonds for the sole purpose of driving the economy away from deflation, and that exactly what’s happening now,” he notes, adding that “the fact that the market is reacting like this is premature.” His take: start getting worried if we see 3% on 10s. Not exactly an Fields-worth observation, but he’s right.
The bottom line here is that while the Fed should, on the surface, be pleased with this development as it suggests they are closer to declaring “victory”, it is by no means clear that “victory” is desirable from perspective of risk assets. This was always the worry.
As Deutsche Bank’s Aleksandar Kocic wrote last summer, “in essence, it is all about diluting the possible downside of stimulus unwind — an attempt to have an option to obfuscate without losing one’s credibility [and] with traditional market rules and relationships breaking down, central banks appear to be chasing the illusive target, which means that victory and the final goal are not well defined, which in turn insures the persistence of the ‘battle’ and indefinite continuation of the state of exception.”
What happens when the battle is “won” and there’s no room left to obfuscate in the service of keeping risk assets at ease about the danger inherent in stimulus unwind?
That’s the question.