Wall Street Gripped By Policy Panic, Stagflation Fears

Friday brought gloom and doom aplenty for the US economy, where price pressures continue to percolate according to a truly harrowing CPI report, which suggested Americans found no respite from generationally high inflation last month.

Soaring prices for necessities, including gas, groceries and electricity, weighed heavily on consumer psychology in early June. The preliminary read on the University of Michigan’s gauge for this month showed sentiment dropped to the lowest levels on record.

All in all, it’s difficult to escape the conclusion that the US economy is destined for stagflation. Indeed, I’d argue stagflation is already here.

The read-through for equities is bleak. Friday’s inflation report piled pressure on the Fed ahead of next week’s policy meeting. The more aggressive they are into the teeth of a burgeoning economic slowdown defined by pervasive consumer pessimism, the higher the odds of recession. Margin headwinds for corporates are gale-force.

Friday brought fireworks in rates, as two-year US yields soared, reaching 3%, the highest since 2008 (figure below).

What was a pedestrian twist-flattening quickly morphed into a vicious bear flattener.

Although long-end yields eventually moved higher, the 24bps jump at the front-end dwarfed the cheapening further out the curve. The 5s30s inverted. Two-year yields in the UK rocketed 20bps higher.

“It’s straightforward bad,” Dennis DeBusschere told Bloomberg, of the CPI report. “The reaction in the front-end was massive.”

Two-year yields were on pace for their largest weekly increase in more than a decade (figure above).

Swaps leaned towards pricing a 75bps move from the Fed in July. Through the September meeting, traders saw 165bps of rate increases, up 20bps from pre-CPI pricing. As I put it early Friday, you can forget about the “Bostic pause” for now.

True, a lot can happen in 14 weeks, but it’d take a dramatic improvement in the inflation trajectory and/or an equally dramatic deterioration in the economy, to give the Fed the kind of plausible deniability they’d need to take a break in September.

In all likelihood, inflation won’t slow enough by then to warrant a pause, and neither will the economy. Instead, monthly inflation prints will probably remain sticky regardless of what the 12-month figures show, and the economy will slow just enough to validate recession calls, but not enough to trigger the elusive policy “put.”

If Democrats want to avoid a bad outcome in November, they’ll need to make sure the Capitol riot hearings are worthy of the prime time TV slots they were afforded.