In a wonderfully ridiculous example of fitting a narrative to a given day’s price action, traders on Thursday “took a more sanguine view to price pressures,” according to one market wrap.
Spoiler alert: Nobody was any less (or more) “sanguine” about inflation on Thursday than they were on Wednesday.
A far better take came a few paragraphs later, when the same recap noted that rising rising breakevens and sideways nominals continues to pressure reals to record lows, pushing everyone into risk assets.
10-year breakevens hit a 16-year high earlier this week. Morgan Stanley expects US real yields to rise “as growth improves and breakevens moderate” in the first half of the new year, according to the bank’s 2022 outlook. After that, the bank said reals and the dollar should reverse “as the Fed fails to hike.”
For now, “still strong growth and anchored real yields” are keeping Goldman “pro-risk” in their asset allocation, the bank’s Christian Mueller-Glissmann said. “We’re likely to see markets squeeze higher into the new year supported by negative real rates,” Peter Oppenheimer remarked.
As for Joe Biden’s Fed pick, articles documenting what a Brainard-led Committee might mean for markets will probably turn out to be a waste of digital ink. And I emphasize “probably.”
Replacing Powell would be seen as an overtly political move and could exacerbate inflation worries, especially to the extent right-wing media outlets exploited the situation, fanning public angst. The Wall Street Journal‘s Editorial Board ran a scathing Op-Ed on Wednesday describing Brainard and Powell as “Tweedledum and Tweedledee.” Irrespective of your views on the Fed, most serious people can agree that respected media outlets should avoid trafficking in petulant derision. That’s the kind of silliness that can, over time, undermine the diligent work of the Journal‘s reporters, many of whom are very capable. In my opinion, the paper would do well to spin the Editorial side off into a separate business — there’s a raging bull market in partisan rancor, after all. They’d make more money running it as a separate entity.
In any event, Powell’s renomination seems likely. “Our baseline assumption is that it will be a bearish event for Treasurys [but] not a range-defining backup in rates,” BMO’s Ian Lyngen and Ben Jeffery said. They mentioned “a kneejerk downtrade in 5s that serves to counter the bias toward lower rates” as “the path of least resistance,” while noting that “this is a matter of great nuance” because whoever gets the nod, markets will quickly move on to the debt ceiling and the December dots.
Note that for all the talk of inflation being “permanent” and the accompanying Fed blame-casting, market participants actually don’t believe that story. Or at least not according to some surveys. For example, yield curve flattening expectations increased again in the November edition of BofA’s Global Fund Manager survey. The net percentage of investors expecting a steeper yield curve “has fallen drastically to 9%,” the bank’s Michael Hartnett remarked. That’s the lowest in almost two years (figure below).
Some of that is short-end expectations, but the point is that if market participants truly believed inflation was poised to spiral, they’d be expressing that via hand-wringing over a bear steepener. Especially given that a vicious bear steepening episode could be catastrophic considering the amount of duration embedded across assets.
“Inflation continues to rise and long rates continue to hesitate,” Deutsche Bank’s Aleksandar Kocic said, in a Wednesday note, adding that “since the beginning of March, core CPI practically tripled from 1.6% to 4.5%, an unprecedented rate of increase contested only by one episode in the early 1970s, while long rates remained stubbornly within a relatively tight range, currently 20bps below their March levels.”
I talked at length about this on Wednesday in “‘Dreamland,’ Nobody Knows Anything.” It’s not so much that markets have lost the plot. Rather, it seems the plot no longer includes the economy or the macro.
The figure (above, from Kocic) shows the interaction between CPI and 10s over the past three decades.
“Had the historical relation held, rates should have recorded a steady rise to above 7%,” he wrote. “Instead, the 2021 rates/CPI trajectory is a straight horizontal line.”
Fed Chair: Why not Yellen? Give Brainard Financial Supervision role. Move Williams into Clarida spot and put someone is more of a market person at NY Fed or at least someone who has a Bloomberg terminal on his/her desk…On Yellen, it seems as if she does not relish the roll of shilling for politics and would enjoy coming back to the Fed and the confirmation would be easy.
Whats wrong with Powell, though? Why change at all? He screwed up in Q4 ’18 but seems reasonably well adapted to today’s environment?
The WSJ is owned by Rupert Murdoch and the articles they publish reflect that ownership. Every month we see inflation rise and every month we are told it’s transitory. It really does feel like we are destined for a crash course with stagflation and regardless of how frequently the data warns us of this, we remain naively hopeful that inflation will magically improve. Cases are starting to spike around the world again as we enter winter months, this will no doubt impact supply chains again and further exacerbate the problem. Meanwhile continued Fed accommodation means that the market can’t care about the plot, macros, or the economy because that money has to go somewhere. The question we have to ask is, is it still a market if nothing that should impact valuations does?
Yes, yes, yes… However, if the inflation is mostly due to excess saving and supply sided snags are only a minor/sector specific issue, then inflation ought to be transitory – even if it takes 2022 for the excess spending to be digested…
The next decade will not look like the last decade- in terms of monetary policy. It will be too difficult, if not impossible, to fit everything back into that box.
The Fed will keep interest rates as low as possible, for as long as possible, and Congress will have to get their act together and (effectively) send money to those who are hardest hit by inflation and can’t afford to live on their salary.
This will place the hardship of low (negative real) interest rates on foreign owners, not American citizens.
We have a long way the Fed can go. If the Fed’s balance sheet is 37% of GDP, what is wrong with 45% or 50%? UK is at 49%, ECB is over 70% and Japan is at 125%.
We will continue to pretend that the Fed is independent.
Good article thanks. As you indicate there is a vast chasm between WSJ reporting (very good) and its editorial pages (nobody to the left of kevin mccarthy cares what they think). I had to nuke my WSJ subscription because I could not bear supporting Rupe. Barrons probably goes next.
…and Fox broadcasts of the NFL (which is a barbaric sport anyhow).
The real question in my mind is not what inflation does because in many respects its far less important. It seems to me the real question is how does the global supply chain knit itself back together without any concerted policy from world governments driving it. You can lament the temporary or permanent inflation all you want but at least it is money chasing goods giving producers a signal to spend to recover. Once THAT signal flatlines then we have real trouble. I think the total amount of money consumers are sitting on may burn up by the end of the Christmas season especially with the unemployment boost months in the rear view and student loan withdrawals resuming. Then what? All the sudden consumption tanks, lock downs from renewed pandemic waves hit further damping spending. No more stimulus is likely to get passed at this point as it would be too good for Biden for the GOP to tolerate. So in 3-6 months companies already struggling to get critical deliveries in and out see future demand plummet and begin to cancel orders triggering a Tsunami of unemployment and losses. Then you hit rampant inflation due to supply deterioration as the already crippled system comes apart at the seams. Nothing to do really with money printing or interest rates but with a simple lack of will to coordinate for long term prosperity instead of chasing quarterly profits.