Divination

There’s quite a bit to process in the new week.

The July Fed meeting presents something of a communications challenge. Obviously, no actual policy change is in the offing and nothing definitive is expected, but traders will need to summon their inner tasseographer. Policy is at an awkward juncture, meaning every turn of phrase is potentially market-moving.

That probably sounds overwrought, but remember, communications missteps are often just as important as deliberate attempts to guide the market. I’m not suggesting it’s incumbent on traders to divine anything like wisdom from the July statement or from Jerome Powell’s press conference. Often, the most important part of the FOMC divination process involves knowing when the divinities misspeak. Perhaps the most important skill when it comes to trading the Fed is assessing, in real time, which of the invariable communications blunders will need to be subsequently walked back, in this case before Jackson Hole.

The spread of the Delta variant introduced additional uncertainty and that’ll almost surely be acknowledged. “Regardless of the Fed’s thinking on the ultimate impact from the latest mutations of the coronavirus, to not acknowledge the concern would further exacerbate the late-June ‘policy error’ fears,” BMO’s Ian Lyngen and Ben Jeffery wrote. “Moreover, developments which risk preventing workers from reengaging in the labor force come the autumn months could easily undermine the outlook.”

The “policy error”/”growth scare” optic that emerged following the June FOMC is still with us. Indeed, last Monday’s equity selloff may have marked “peak summer growth scare,” if you will. Bond market vol has moved up (figure below).

The market currently expects the first hike in March of 2023.

Delta variant concerns were insult to injury for bond shorts, burned by the combination of worries that a Fed which abandons FAIT at the first sign of hot inflation will undermine the medium-term growth outlook and the realization (hardly a revelation) that Q2 already marked peak growth in the US. The 5s30s is ~120bps (figure below). That’s off the lows, but nearly 50bps from 2021 wides.

When you look at that chart, recall that the annotations are there as a kind of ironic reminder of what happened following the initial CPI surge: In fairly short order, market participants decided that the Fed would be loath to surrender its credentials as an inflation-fighting institution. The hawkish pivot at the June meeting seemed to validate that view.

A Fed that reverts to pre-FAIT operating procedure would tighten sooner, undermining the macro thesis built on the notion that the “new” Fed would allow the economy to run hot in perpetuity. As BofA noted last week, “upward revisions to 2022 US GDP have stalled” (figure below).

Speaking of GDP, the advance read on Q2 growth is also due this week. Obviously, the figures are backward-looking, but they’ll be parsed for any indication that the second quarter was weaker than the blockbuster analysts generally expect.

Consensus wants to hear the economy expanded at an 8.5% annualized clip (figure below).

Personal spending and income data for June would typically be irrelevant as it’s released the day after GDP, but market participants will been keen to get a look at the accompanying monthly inflation figures.

Powell’s recent congressional testimony mostly echoed the dovish contingent at the Fed. There’s a growing sense (indeed, it might even be the consensus), that a taper unveil won’t come until December — that the September meeting will be used to set the stage. I’d view that as an extremely dovish outcome given the June dot plot shift, the onset of the taper discussion and calls from some officials to begin tapering sooner rather than later.

This goes in the “broken record” file, but measures of inflation which strip out anomalies are far better behaved (figure below).

“We expect Powell to acknowledge ongoing Committee discussions about tapering plans, but that reaching the standard of ‘substantial further progress’ still remains a ‘ways off,” TD’s Jim O’Sullivan said. “Powell is likely to reiterate that the recovery remains on track despite the rising Delta threat, and continue to judge the surge in inflation as ‘largely’ transitory.”  The bank “doesn’t expect the July FOMC meeting to be a significant Treasury market mover unless Chair Powell suggests imminent tapering.”

Note that the Delta variant and slowing vaccination rates in the US could further delay labor market normalization. If labor market frictions remain, so too will pressure on employers to offer incentives and increase wages. That’s also something the Fed needs to consider.

It’s pretty clear by now that many Americans have decided not to be vaccinated thanks, in part anyway, to ceaseless propaganda (see this unnerving article in the Times, for example) that the government pretends to have no capacity to curtail. Freedom of speech isn’t (or shouldn’t be) freedom to endanger public health and safety with misinformation produced for profit. That seems obvious (and uncontroversial) to me, but apparently not to everyone else. Let’s not kid ourselves: If everyone were truly armed with good information and facts, the vast majority of Americans would be vaccinated. And we could be confident that those who weren’t had actually made an informed decision. That’s “liberty.” Being tricked into making an objectively dangerous decision about your own health by misinformation isn’t liberty. It’s just gullibility. If I convince you that Vitamin C will turn you into a frog and you end up with scurvy, that outcome doesn’t represent the triumph of liberty. It represents the triumph of stupidity.

In any event, also on the docket this week: New home sales, durables, Case-Shiller, Conference Board confidence, pending home sales, the final read on University of Michigan sentiment and the last of July’s coupon auctions (2s, 5s and 7s). Oh, and tech earnings.

Don’t forget: Life is what you make it.