Gatorade Break

It’s fairly obvious by now that market participants doubt seriously the idea that the Fed is prepared to risk its inflation-fighting credentials in the service of whatever good might come of allowing the US economy to run super-hot for any length of time.

June CPI came in scorching. Yes, you can still plausibly claim “transitory” if you’re so inclined, but the monthly gain on core underscored the notion that liftoff will be brought forward.

“Yet another blowout inflation reading makes it increasingly difficult for the Fed to stick to its position,” ING’s James Knightley said. “Pipeline cost pressures continue to build and corporates are looking to pass them onto customers in an environment of such robust demand,” he added, calling the case for a 2022 hike “strong.”

Inflation “can probably still be viewed as ‘largely’ transitory,” TD’s Jim O’Sullivan remarked, alluding to the language from the June FOMC statement, before noting that “‘largely’ doesn’t necessarily mean ‘entirely.'” The debate is “unlikely to be resolved by this report,” O’Sullivan concluded.

Unlikely indeed. Especially not when inflation expectations among consumers are at record highs on some surveys. As you may have heard, year-ahead expectations on the NY Fed’s survey hit a record 4.8%, data out Monday showed.

Over the medium-term, expectations are still well-anchored, but… well, let’s just say that all allusions to the medium- and long-term being “what matters” notwithstanding, nobody at the Fed is likely to be particularly comfortable with the dramatic surge illustrated by the black line in the visual. Especially not when Republicans are keen to leverage the incoming data in a bid to undercut the White House’s fiscal agenda. I’d gently suggest that’s a dangerous game to play. Amplifying hot CPI prints and rising inflation expectations can easily become self-fulfilling to the detriment of everyone, but politics is war.

Anyway, yields were cheaper on Tuesday, but not because of the CPI overshoot. Yields rose only briefly after the data, quickly retracing in an apparent testament to the notion that markets may now interpret inflation overshoots as just another nail in the FAIT coffin. If that’s the case, it means incremental evidence of price pressures could be seen as growth-negative to the extent it adds pressure on the Fed to accelerate the taper and bring forward liftoff.

The long-end only traded heavy after an ugly 30-year sale, which I’d note was entirely predictable given how far yields have fallen and the lack of a concession headed in. I doubt you need annotations on the intraday chart (above) to identify CPI and the 30-year sale.

“In keeping with the recent trend, the stronger-than-expected inflation report did remarkably little to Treasurys aside from offer a temporary pause in the bull flattening,” BMO’s Ian Lyngen and Ben Jeffery wrote, in a great afternoon recap.

“The Treasury market appears to have drifted into an environment in which flatter is the default response to any meaningful macro event [with] investors content to bring forward hiking expectations at the expense of longer dated yields,” they added, on the way to saying that “investors continue to lower the bar for the needed backup in yields to bring in sidelined money,” a contention supported by Monday’s solid 10-year sale. As for Tuesday’s 30-year auction, they wrote that while “the long bond offered a reopening tail, the clearing yield of 2.0% makes it difficult to argue the takedown was a struggle.”

The market sees liftoff commencing early in 2023 and for whatever it’s worth, respondents to the July vintage of BofA’s Global Fund Manager survey generally agree (figure below).

In the same poll, expectations for a steeper curve fell dramatically. At this point, the steepener my be a tough trade. You’re contending with a short-end that will presumably respond to rising odds for a quicker liftoff and long-end yields inclined to fall on the assumed read-through of Fed tightening with the economy already past peak growth. As Cornerstone Macro put it, “the hurdle for a re-steepening of the curve is high.”

Stocks are a bit of a side show in all this. It’s likely that shares would have been higher on the day had yields remained flat. For once, Peter Boockvar’s perfunctory daily media soundbite was a semblance of useful. “Tech hung in because long rates fell pre-auction, and now that the whole yield curve is seeing a rise in rates, tech is being sold and it was the only thing keeping the indices up,” he told Bloomberg on Tuesday afternoon.

I’ll close with an anecdote. It’s a bit of a non sequitur. Or maybe not when you consider it in the context of current labor market frictions, who’s impacted by rising inflation and, more generally, in the context of America’s purported meritocracy.

This afternoon, I was standing in line at the grocery store, thumb-scrolling through news alerts and reading Cameron Crise’s long-bond auction postmortem when I was struck by the juxtaposition just up ahead.

A man in a silk button-down, khaki shorts and navy boat shoes was paying for a cart full of what looked like vacation supplies, although his tan suggested he may have been a local. His daughter was standing beyond the line, leaning against the wall, gazing flippantly around from behind a white, tight-fitting COVID mask. She wore a tie-dyed bucket hat, delicate pastels and yellow sandals. The girl scanning and bagging her father’s groceries was around her age. She was African American with braces. She wore a too-big vest emblazoned with the store logo over a weather-beaten hooded sweatshirt, screen-printed with a high school mascot. Her name tag wasn’t even hers (it was a man’s name).

As the bags piled up on the carousel next to the register, the young lady leaning against the wall looked away. Her father put in his debit card, typed in the pin and waited. The cashier handed him the receipt, then dutifully came around the counter and placed each bag in the cart, one by one. He didn’t thank her.

The American meritocratic myth tells us the African American teenager will develop character and a good work ethic on the way to bigger and better things, while our young aristocrat will eventually discover that aloofness and disdain aren’t conducive to a fulfilling life. Somehow, I doubt that’s how it’ll turn out, though.

When it was my turn to check out, I asked the cashier how her day was going. She seemed confused. “I been here since 7,” she said. “I’m going to need cigarettes!”, a lady behind me shouted at her. The girl acknowledged her, looked back at me and then motioned at the line with one hand. “Once these people is gone, I get to drink my Gatorade.”