Markets pull forward expected future outcomes, so there’s a sense in which you could argue the inflation shock and rates tantrum are old news. It’s all about pricing the odds of a recession now.
Indeed, market chatter over the past week revolved around a prospective Fed “pause” in September and the “peak inflation” narrative, courtesy of comments from Raphael Bostic and as-expected April PCE prints, respectively.
Financial assets and, more to the point, the people who trade them, have the luxury of looking through most adverse macro developments, a prerequisite for pricing tomorrow’s news today. For everyday people, inflation and tighter financial conditions are the furthest thing from old news. They’re today’s reality. Indeed, the market’s efforts to front run a recession are predicated on the notion that the reality on Main Street is harsh enough to make consumer retrenchment inevitable.
The problem currently is that, notwithstanding last week’s equity rally and any followup fireworks this week, a policy-induced recession to tame the hottest inflation in a generation has the potential to be pronounced. That isn’t ideal. The read-through for corporate profits in a deep recession is decidedly unfavorable, and Bill Ackman’s protestations aside, an aggressive Fed is a headwind, even if critics are correct to suggest the Volcker medicine would reduce long-term tail risks.
On Monday, there was news on the inflation and policy fronts. In Germany, CPI hit a new record. Prices rose 7.9% YoY on the national gauge and 8.7% on a EU-harmonized basis (figure below). Both prints were hotter than expected. No economist predicted a harmonized print in excess of 8.5%.
Figures out of Spain were also hotter than anticipated, dialing up pressure on Christine Lagarde, who’s made no secret of the ECB’s rate hike plans lately.
Energy prices in Germany rose 38.3% YoY in May, after 35%, 40% and 23% increases in April, March and February, respectively. Food prices rose more than 11% this month. “An inflation rate similar to that of May 2022 was last recorded in Germany in winter 1973/1974 when mineral oil prices had sharply increased as a consequence of the first oil crisis,” the Federal Statistics Office said.
The data came ahead of the bloc-wide release, due Tuesday, and amid an ongoing debate about the best way to implement an embargo on Russian crude. “Unless there’s a sharp downward correction of energy prices in the months ahead, German headline inflation will continue to increase and only start to level off in late summer,” ING’s Carsten Brzeski wrote. “Sure, the surge in headline inflation is still dominantly driven by energy and commodity prices [but] looking at available regional data, the pass-through of these higher prices to the broader economy is in full swing.”
Given onerous inflation realities, the politics around curtailing Russian energy flows are contentious, complex and circular (it was Europe’s dependence on Russian oil and gas that created the crisis in the first place). The latest plan from Brussels would confine the oil embargo to seaborne crude, sparing flows through a key pipeline that feeds Viktor Orban’s Hungary. Orban is in the process of consolidating power and seems, for now anyway, impervious to pressure.
Meanwhile, the Fed’s Christopher Waller indicated he favors 50bps hike increments until US inflation slows. “No matter which measure is considered, headline inflation has come in above 4% for about a year and core inflation is not coming down enough to meet the Fed’s target anytime soon,” he said Monday, adding that,
I support tightening policy by another 50 basis points for several meetings. In particular, I am not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2% target. And, by the end of this year, I support having the policy rate at a level above neutral so that it is reducing demand for products and labor, bringing it more in line with supply and thus helping rein in inflation.
Waller delivered the obligatory nods to data dependency, but indicated that even there, the risks are skewed to more tightening, not less.
On Tuesday afternoon, Jerome Powell will meet with Joe Biden in the Oval Office, the White House said. The topic: The economy.
“We’ve stopped digging out illustrations of the times when inflation in Germany was at comparable levels,” ING’s Brzeski went on to say, commenting further on the numbers out of Berlin. “Let’s put it like this: Most citizens and policymakers have hardly ever seen these kinds of inflation rates in their professional lives.”
In the same Monday speech, Waller said, “I cannot emphasize enough that my FOMC colleagues and I are united in our commitment to do what it takes to bring inflation down.” He was speaking at an event in Frankfurt, Germany.
markets pulled inflation forward in 3 days last week. FOMO rally starts tomorrow. be careful!
That was sooo… last week.
In NY/CT, we paid $5.19/gal. yesterday — in 50 years of driving, I’ve never paid much more than $4 for a gallon of gasoline. The path forward for the Fed? It’s a blunt tool, but Waller has it right: 50, 50, 50 hikes… until the rate is at neutral or above.
In CA, my kids recently paid $6.80/gallon. CA gas prices just crossed the line from ridiculous to ludicrous.
I still struggle to see the connection between “50,50,50”, and lower energy prices. Too many other variables, in addition to “50,50,50” that affect energy prices and – for that matter- housing prices.
I guess we will see in about 6 months, or so….
If the economy truly begins to roll over energy prices will sink like… every other asset this year.
Agree on energy. It will take a whole lot of 50s to create enough demand destruction to equal the effect of taking Russian supply out of the mix. The effect on housing is more direct, but the first thing that will happen is that sales will drop to near zero because virtually no one will sell their house for less than they thought it was worth a few months ago. The higher rates will need to be in place for a year before sellers recognize the new reality.
And why would you sell your house, which probably has a 3% mortgage, to buy a different house that will come with a 5% mortgage? 5% mortgage rates are not too bad, unless they’ve been preceded by two years of mortgage rates substantially below 5%.
We buy gas by the gallon. In many places in Europe they sell it by the liter (around a quart). To put 15 gals in one’s tank takes 60 liters at a couple of bucks each so that’s over $120 for a modest fill up.
I’m half joking, but we (meaning NATO countries) should declare war against Russia. The inflation we are seeing is substantially the result of an undeclared war we are waging in most respects except putting our own soldiers in harms way. If we acknowledged that, 1 we could sell the sacrifices to the public better, and 2 justify some level of price control on essentials, like gasoline.
If we define the enemy as Russia and the virus, substantially becomes almost entirely.
H-Man, the war on inflation is far from over. The German print simply confirms it is a worldwide problem. Everyone seems to think that banging the rate at the next couple of Fed meetings is going to put the genie back in the bottle. That will only happen when the consumer is on a bent knee crying “uncle”. My crystal ball (which is worth a cup of coffee) suggests we won’t see any relief until Q1 of 2023. So we have some rough sailing for equities for the next 7 to 9 months.