Bond Blowup Meets Inflation Report In Early 2022 Reckoning

All eyes will be on US rates in the new week, as 2022’s burgeoning bond bear meets an inflation report which may show US consumer prices accelerated an annual 7% last month. A day later, data could show producer price inflation reached double digits in December.

10-year US yields are within shouting distance of 2% thanks to the worst start to a year for Treasurys on record. If the second week of 2022 is anything like the first week, the benchmark of all benchmarks may approach some analysts’ year-end targets just 10 sessions into the new calendar.

Risk assets weren’t particularly enamored with the largest one-week rise in real yields since the theatrics surrounding the onset of the pandemic. Big-cap US tech is halfway to a correction already, after falling nearly 5% (figure below).

An encore from reals would be a decidedly unwelcome development for risk, unless it could plausibly be attributed to the market upgrading its assessment of the economy (versus simply pricing in a hawkish Fed). The money tree is shaking.

March is almost fully priced for liftoff and Wall Street strategists are lined up behind that assumption. If the Fed wants to walk (or, more aptly, talk) that back, they’ll have ample opportunity in the new week. In addition to a bevy of speaking engagements (Barkin, Bostic, Bullard, Evans, George, Mester and Williams), Jerome Powell and Lael Brainard will get their nomination hearings before the Senate banking committee.

“If the FOMC doesn’t intend to follow through in March with a 25bps move, the incoming Fedspeak will need to communicate any such apprehension,” BMO’s Ian Lyngen and Ben Jeffery said. “While there are numerous combinations and permutations of hikes and balance sheet runoff announcements being pondered at the moment, in the wake of the payrolls report and subsequent price action, it seems that the consensus has quickly drifted toward quarter point hikes in March and June, followed by a September runoff,” they added, noting that “unless and until there is any meaningful push back from monetary policymakers on this timeline, we suspect it will cement into the broader market outlook.”

The December jobs report printed another woeful miss on the headline, but markets looked straight through that, focusing instead on hot wage growth, a steady participation rate (which is good enough now that the Fed has acquiesced to the reality that a return to the pre-pandemic demographic trend isn’t in the cards) and sub-4% unemployment, all of which help make the case for the Fed’s hawkish pivot.

The red squares in the figure (below) represent the last several US CPI reports. To say rates have some “catching up to do” would woefully understate the case.

As Deutsche Bank’s Aleksandar Kocic put it, “the robust one-sided divergence between inflation and rates goes beyond any recognized pattern between reality and known models.” The “disagreement” between market variables and fundamentals “can no longer be interpreted as a temporary dislocation that is likely to converge,” he wrote, in a December note.

CPI and PPI aren’t the only data on deck. NFIB and retail sales are also due this week, as is the preliminary read on University of Michigan sentiment.

Not everyone is convinced the Fed will pull the trigger so soon. “In the near term, we think that the massive surge in Omicron cases should result in a temporary slowing of growth momentum [which] should make the Fed a bit cautious in starting the hiking cycle just yet,” TD’s Priya Misra said. “We forecast the Fed to hike in June, September and December and begin communicating imminent balance sheet runoff in Q4,” she added.

In any event, if US yields do continue to reprice higher, I suppose that’s appropriate. After all, in addition to ~7% headline inflation, the US also suffers from an acute crisis of government defined by legislative gridlock and hyper-partisanship, a state of affairs befitting of an undereducated and, increasingly, ungovernable populace, a third of whom apparently think violence against the government is justified, depending on the circumstances.