If there was one overwhelming theme pervading my inbox on Wednesday afternoon it was this: “I’m glad I’m not the only one.”
Apparently, not a whole lot of people have a rock solid, clean take on yesterday’s move in stocks which saw e-minis bounce some 2.7% off the post-CPI knee-jerk lows by the end of the session. We suggested equity investors are “going the wrong way!” (Planes, Trains And Automobiles reference), but then again “how do we know where they’re going?”, right?
Well, one thing we do know is that yields are still going higher (up near 2.93 on 10s now) and USDJPY is still generally going lower which, while seemingly counterintuitive when taken together, makes some measure of sense if you frame at as a “batshit fiscal policy” problem.
“Rates are moving higher on the perception there are clear signs of accelerating inflation and hence the bond bull market is dead and buried,” Bloomberg’s Mark Cudmore writes on Thursday, adding that “the U.S.’s structural deficits are apparently undermining the nation’s prospects, leading to an acceleration of reserve-diversification away from dollar assets [as] both interest rates and growth no longer drive currencies, and much higher U.S. real yields are now irrelevant, and hence so is inflation.”
There are a number of excuses you can give for why equities are acting like they’re acting and I’m not sure any of them are what I might call “satisfying.” In a separate note, Bloomberg’s Stephen Kirkland cites stocks’ ability to function as an inflation hedge, a weaker dollar being good for exporters, the gap between earnings yields and 10Y yields having widened back out, and fiscal stimulus, but again, I’m not sure any of that is sufficient to explain what we saw on Wednesday.
For whatever it’s worth, here’s BofAML’s take:
We think that coming into Wednesday’s data equity investors feared the US economy was taking off in a major way, which could force the Fed into a much more aggressive rate hiking cycle like in 1994. Recall that in 4Q 1993 US GDP growth accelerated to 5.4% from 2.0% (Figure 5), which triggered surprise Fed rate hikes starting in February 1994 and declining stock prices. Judging by Atlanta Fed’s GDPNow forecast for 1Q18 this was the exact same scenario that appeared to be playing out less than two weeks ago when the reading stood at also 5.4% (Figure 6). Although Atlanta Fed has come down the forecast was still 4.0% until Wednesday morning where the retail sales data lowered it to 3.25%. So now, while it does appear that inflation is accelerating, it appears much less likely that the economy is really taking off and forcing the Fed into a more aggressive rate hiking cycle. Hence, today ended with a relief rally in equities even though the inflation data was very strong. That also explains why counterintuitively the dollar ended lower on the day (Figure 4).
I mean, that’s all fine and good, but it seems like a stretch. That’s essentially arguing that everyone not only looked past the CPI print (something they certainly weren’t willing to do with the AHE number earlier this month) on the way to reading a dovish Fed into the weak retail sales number. I’m not sure I’m buying that and it seems even less likely when you consider how voracious the rally was and how quickly things reversed course after the initial dip in futures. BofAML’s thesis there seems a little leap-of-faith-ish as it is, and in the context of Wednesday’s huge reversal, it would constitute a damn bellyflop of trust in Fed gradualism.
Whatever the case, I think the above-mentioned Mark Cudmore probably summed things up best when he said the following earlier today:
Financial assets are trading on dissonant themes. That won’t sustain for too long so at least one sector is due some volatility in the days ahead.