For Weary Markets, No Respite

Those weary of inflation banter and Fed speculation will get no respite in the new week.

PPI is on deck Tuesday in the US, and it’ll be watched just as closely as CPI, or at least by seasoned market participants it will. An abatement could signal relief ahead for consumer prices, while a hotter-than-expected print would only exacerbate fears of an aggressive Fed response and everything that entails.

The release of January’s CPI data last week was accompanied by steep losses for stocks and bonds, a bad dream for multi-asset investors. Nomura’s Charlie McElligott called the post-CPI trade a “corr 1 risk-parity nightmare.” The figure (below) is a very crude representation, but it gets the general point across.

The shaded circles show February 3 (when Facebook collapsed, the BoE hiked and Christine Lagarde pivoted) and last Thursday (i.e., CPI day in the US).

If PPI shows any sign of reaccelerating, it’ll fan the flames. Recall that the headline YoY print receded slightly for December (figure below).

The New York Fed released the final monthly schedule for Treasury purchase operations as planned on Friday, so an inter-meeting, emergency rate hike is apparently out of the question. But that hasn’t exorcised all the speculation. Far from it.

Last week’s Bullard scare was evidence that anyone suggesting Fed pricing can’t possibly get more aggressive (something I’ve mistakenly argued myself) is on shaky ground. Notably, Bullard speaks twice in the new week. If his colleagues weren’t enamored with how the (already infamous) Bloomberg interview went down (i.e., like a lead balloon), expect a subtle shift in tone.

The January Fed minutes are due Wednesday, and while it might be tempting to say they’re even more relevant than usual, you could also argue they’re entirely dated. “Given the array of ‘opinions’ regarding the prospects for an inter-meeting liftoff, the emphasis on the FOMC Minutes will be elevated, to put it lightly,” BMO’s Ian Lyngen and Ben Jeffery said. “The caveat is that given the market’s focus on the January inflation data, the Minutes risk being interrupted as stale since the meeting occurred prior to the recent CPI print.”

It’s possible the rest of the Committee isn’t as concerned as Bullard. After all, market-based measures are still a semblance of anchored (figure below), no small feat considering the run up in crude prices.

That doesn’t “suggest investors are concerned the FOMC has lost any credibility as an inflation fighter,” BMO’s rates team went on to say.

The problem, though, is the curve. The market clearly isn’t buying the notion that inflation will become totally unmoored over the medium- to longer-term. And the fiscal impulse is poised to fall off a cliff. The economy, meanwhile, is losing momentum. All of that just as a series of rapid rate hikes is set to unfold.

You’d be forgiven for suggesting there’s nowhere for the curve to go but flatter with that setup. Indeed, the 5s30s is the flattest in years (figure below), will probably make a run at cycle tights and may be destined to invert.

Given this reality (recall the 7s10s inverted last week), the January meeting minutes may be more interesting for what they say about the Fed’s thinking on balance sheet runoff than for whatever it’s possible to divine about the rate path.

The Fed could attempt to use QT to put upward pressure on long-end yields, but that won’t be easy for two reasons. First (and contrary to popular belief), QE can engender higher yields, not lower, because after all, it’s stimulus. The corollary is that QT may be associated with lower long-end yields, especially considering the growth outlook is already deteriorating. Second, the idea that if the Fed gets desperate to forestall inversion(s), they might resort to outright sales from SOMA, could be highly distressing for investors, if not from a market-functioning perspective, then certainly from a psychological standpoint.

“The curve has moved a hell of a long way and this flattening is definitely a concern for the Fed,” one market participant told Bloomberg. “If the Fed really wants to effect the yield curve they are going to have to sell assets.”

Easier said than done. The “principles” released in conjunction with the January policy statement seemed to suggest active selling isn’t likely right out of the gate, but it might be seen as preferable to inversions given they can be “a self-fulfilling prophecy if investors start pulling back in anticipation of a recession,” as Bloomberg aptly put it, in the same linked article.

Retail sales are also on deck this week. Another bad miss there would heighten recession concerns. Recall that December’s figures were poor indeed, and banks have begun to cut their Q1 growth forecasts due in part to assumptions about additional retrenchment in January. The preliminary read on consumer sentiment for February showed Americans are very concerned about the impact of inflation on their financial prospects.

Also on the docket: Empire manufacturing (which posted an egregious miss in January), existing home sales, housing starts and claims. In addition to a double dose of Bullard (Monday and Thursday), markets will also hear from Mester again, as well as Evans, Waller and Williams.

Good luck out there. You’ll need it.