The June Fed “isn’t a game changer.”
That, in a nutshell, is how JPMorgan sees things a few days on from a dot plot shift which catalyzed a rather abrupt reversal for various reflation favorites, including and especially curve steepeners. Some of the post-FOMC moves were themselves reversed early this week. TD, for example, reinitiated a 5s30s steepener Monday citing cleaner positioning and a pair of familiar catalysts.
For JPMorgan, the wobble in the reflation trade complex was technical, and should prove short-lived. “The reflation trade experienced a sharp technically driven pullback, but we expect the trade to resume and see this move as an opportunity to add exposure to cyclical equities and commodities,” analysts including Marko Kolanovic and Nikolaos Panigirtzoglou wrote.
The bank reiterated that more inflation surprises are likely. “Inflation is likely to continue to realize above both the Fed’s and markets’ expectations, driving bond yields higher and Value outperformance,” the same note said. The bank sees the first rate hike in 2023 with the taper commencing next year, a timeline they say isn’t likely “to hurt our bullish view on DM equities.”
A hot topic late last week (and certainly in these pages over the weekend) was the notion that the Fed’s reaction to scorching inflation prints in April and May suggested the Committee may not have the stomach to follow through on average inflation targeting, let alone pursue the myriad social justice promises implicit in the tweaked language introduced alongside AIT (e.g., fostering a more inclusive labor market).
Regular readers are by now well apprised of my view. I expressed considerable doubt about the notion that the June FOMC was in any way “momentous” and suggested that the about-face for various reflation trades represented a positioning-driven washout more than a fundamentals-inspired reevaluation. That said, I was keen to emphasize that, from a 30,000-foot perspective, the Fed and other major DM central banks have no hope of achieving across-the-board, long-term policy normalization. We’re just too far gone for that.
For JPMorgan, the June FOMC didn’t represent a retreat from AIT. Crucially, Kolanovic and co. emphasized that because the Fed has never really defined how the Committee intends to calculate, they retain quite a bit of flexibility. “On a three-year rolling basis for example, core inflation would be averaging close to 2% before the end of this year, so there would be theoretically no need for the Fed to overshoot its inflation target over the next three years,” the bank said, before noting that “on a 10-year rolling basis, the story is different of course, but the Fed never clarified what look-back period they look at.” For right now, it’s difficult to draw any conclusions (figure below).
Notably, JPMorgan seems to think the “catch up” evident in the sharp upward revisions to the Fed’s inflation projections for this year didn’t go far enough. “If our forecasts are right, the bar appears low in terms of the Fed getting surprised by inflation outcomes over the coming months and quarters especially given the upside risk we see on our own inflation forecasts,” the bank said.
That would be the real test of the Fed’s mettle. They appeared to waver (at least a little bit) in the face of upside prints in April and May. If inflation surprises persist, it would cast doubt on the “transitory” narrative, and one question worth asking is how many more surprises it would take to push the 2022 dot up.
In any event, JPMorgan went on to say that for all the rancor, cross-asset volatility was relatively contained post-Fed (figure below, for example), which is “supportive of risk assets such as credit and equities.”
As for the dollar and real yields (both of which rose markedly for obvious reasons), the bank sees “plenty of upside” for 10-year reals as well as “further upside for the dollar and downside for gold.”
That outlook needs to be squared with their bullish take on commodities, which have stumbled of late after a dramatic run-up.
Despite the (negative) read-through of a stronger dollar for commodities, JPMorgan says the impact “should be of secondary importance relative to the support we see… from demand/supply imbalances and a further build up in investors’ commodity allocations.”
That said, the China factor isn’t lost on JPMorgan’s strategists. “We admit however that industrial metals such as copper are more susceptible to China’s credit tightening,” they said.
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