Steel yourself for a week that will invariably be dominated by an endless (and largely pointless) debate about the meaning of the word “transitory”.
Jerome Powell’s characterization of the factors weighing on inflation as “transient” catalyzed a sharp reversal in rates during last week’s post-FOMC press conference and this week’s CPI report will now be viewed through that lens.
It’s still unclear what exactly Powell was trying to accomplish during the presser. In all likelihood, the idea was simply to dispel the notion that an “insurance cut” predicated on subdued inflation is imminent and to provide a gentle counterbalance to a statement that leaned dovish on the inflation front. Instead, some folks interpreted Powell’s remarks as some kind of critical pronouncement that perhaps suggested markets are woefully offsides when it comes to pricing the Fed.
Read more: ‘Plain English’ Goes Awry – Again
Of course, it’s going to take more than one press conference to shake traders’ faith in the rate cut narrative and indeed, the bar for a cut still seems much lower than the bar for a hike, especially considering the political environment and how late we are in the cycle. Powell’s contention that the Fed doesn’t see a strong case to move in either direction doesn’t mean that the committee doesn’t view the case for a cut as more compelling than the case for a hike – it just means that neither case is compelling enough to warrant serious consideration at the moment.
Ultimately, this entire discussion is absurd, because a common sense read on the situation is that while you can certainly make the case that the Fed’s efforts to consistently deliver when it comes to meeting their inflation goal have met with limited success, trying to argue that the situation is dire enough to warrant rate cuts when unemployment just printed another 49-year-low and the economy is growing at a 3.2% clip is patently ridiculous on any surface-level assessment.
The Fed is reviewing their inflation framework and that’s likely to produce some kind of rethink whether it’s countenancing overshoots as a “make up” strategy, allowing the labor market to run super-hot, etc., so it could well be that Powell is just buying time right now, at the possible risk of setting the stage for a more dramatic pivot to easing down the road if the Fed sits on its hands and price pressures never materialize.
Whatever the case, this is an utterly soul-sucking debate and it will be painful to watch this week as market participants pretend one CPI print is going to materially alter whatever the “final” outcome/resolution to this situation ends up being a year from now.
The latest read on CPI does have near-term implications for the dollar and probably for the front-end, though (see chart below, which shows the ~10bps reversal in 2-year yields that played out on Wednesday as traders grappled with a dovish statement and then a hawkish presser).
“The dollar had a winding trip last week, weakening with improving global data and in anticipation of the Fed meeting, strengthening after Chair Powell downplayed low inflation as held down by transient factors, and weakening again after the strong April payroll report showed no pressures on wage growth”, Barclays wrote Sunday, adding that “the Fed’s perceived comfort with current inflation dynamics did not reduce market expectations of a cut by year-end, despite the significant undermining of the case for a ‘insurance cut'”. This is overtly silly:
Stocks ended up largely flat on the week, after Friday’s jobs rally erased the mild selloff that accompanied the Fed (and the follow-on positioning adjustments Thursday).
One key question from here is whether the resilient dollar ends up denting emerging market sentiment. EM FX logged its first weekly gain in three last week while developing nation equities have risen in four of the past five weeks. South Africa votes on May 8 and there appeared to be a new escalation in Turkey on Sunday, as Anadolu reported that 43 polling station officials stand accused of having links to Erdogan’s archenemy Fethullah Gulen. That comes ahead of a closely-watched determination from the high election board on whether to allow a re-run of the Istanbul vote.
“We believe that financial markets are underpricing the risks associated with a poor election outcome [in South Africa] and that risk-reward favors long USDZAR and a more defensive stance on rates”, Barclays said over the weekend, adding that “in Turkey, the ongoing challenge to Istanbul’s election results, diplomatic tensions with the US and lack of clarity on CBT’s reserve management have weighed on TRY and likely will keep volatility elevated.”
When it comes to the “dovish pivot” narrative from global DM policymakers, the RBA and the RBNZ are both in the spotlight this week.
There’s rampant speculation that a rate cut from Australia is in the cards with a sharp slowdown in inflation serving as the latest confirmatory evidence.
Read more: Meanwhile, Down Under…
The RBA’s U-turn started in early February when comments from Philip Lowe tipped a pivot to a neutral stance and as BofAML wrote Friday, the central bank “could easily justify a cut after [the] surprisingly weak 1Q inflation data (see the linked post above).
That said, BofA reckons the RBA is “more likely to wait as policy guidance is evolving gradually and there is a period of assessment underway to gauge growth and labour demand.” The Australian economy is sending some of the same mixed signals as those the Fed is coping with stateside.
Markets are pricing a roughly 50% chance of a move. If there’s no cut, expect the forward guidance to be dovish. Last month, when the inflation miss stoked further rate cut speculation, domestic equities surged to the highest in 11 years. 10-year Aussie yields fell to their lowest on record during the late-March DM bond rally.
The RBNZ’s dovish pivot has grabbed headlines of late as well. The bank leaned dovish in late March, tipping the next move would likely be a cut. Last week’s labor market data helped make the case.
“There is a stronger argument for a move next week considering the near-recessionary level of business confidence that threatens hiring and investment, and a preference for weaker financial conditions”, BofA wrote last week, adding that “momentum in the labour market also appears to have weakened in 1Q that finally pushed market pricing for a cut above a 50% probability.” The kiwi has performed poorly since the RBNZ’s dovish pivot.
For what it’s worth, Barclays is expecting both the RBA and the RBNZ to remain on hold. To wit:
The RBNZ is unlikely to cut rates at its meeting on Wednesday, but it will maintain its stance that the next move in OCR will be down and communicate that the easing bias remains. We think the data since the last meeting have not deteriorated sufficiently to call for an urgent cut and we would fade market pricing of about 14bp of cuts in May. We recommend paying NZD rates. We expect the RBA to stay on hold and continue to emphasize a data-dependent approach, given conflicting domestic activity signals. Australian rates markets continue to imply about 40bp of cuts over the next year despite a recent improvement in domestic and global data, and we recommend long AUDUSD.
The Norges Bank is on deck as well – you’re reminded that they are the outlier (i.e., going against the dovish grain when it comes to policy bias).
Expect trade talks to be especially tense in the days ahead. On Sunday, Donald Trump inexplicably took to Twitter to deliver some fightin’ words, threatening the most consequential escalation in months, warning that if talks don’t speed up, the US will more than double the tariff rate on $200 billion in Chinese goods from Friday. That, frankly, is just about the last thing anybody wanted to hear.
In the same series of tweets, Trump also said that Robert Mueller shouldn’t be allowed to testify on Capitol Hill. That would appear to suggest that the administration is inclined to take an even more adversarial approach going forward when it comes to Democrats’ efforts to discern precisely what took place between Mueller and William Barr in the days and weeks following the attorney general’s delivery of the infamous four-page summary of the special counsel report to Congress.