The knee-jerk reaction across assets to a cooler-than-anticipated read on inflation in the US was directly contrary to the Fed’s inflation-fighting agenda.
I assume that’s obvious to most readers, but it’s worth reiterating, especially to the extent it mirrored the price action observed during and after Jerome Powell’s press conference following the July FOMC meeting.
All year, policymakers have worked to engineer tighter financial conditions. Higher yields (particularly real yields), a stronger dollar, falling stocks and modestly wider credit spreads, are all consistent with the Fed’s efforts to combat the hottest price growth in four decades.
Last week was defined by a hawkish cacophony from a bevy of Fed speakers, all of whom sought, in many cases explicitly, to dispense with the notion that anything in Powell’s remarks should be construed as indicative of an inclination to dial back tighter policy at the first opportunity. Mary Daly and Need Kashkari were very adamant in that regard.
In the wake of July’s CPI report, US equities surged, the dollar fell, commodities rallied and yields retreated, moves which, if sustained, could undermine the inflation fight, prompting yet another all-hands-on-deck effort to dissuade markets from getting ahead of themselves based on a single monthly inflation print.
The figure (above) compares the initial reaction to July’s CPI report to price action around the July FOMC meeting and Powell’s press conference.
Note that although the long-end unwound an initial bid following the inflation data (i.e., yields moved back to unchanged), that was likely due in part to concession building ahead of 10- and 30-year sales. Two- and five-year yields remained sharply lower until a new round of hawkish remarks from Kashkari and a Wall Street Journal article from “Fed whisperer” Nick Timiraos succeeded in tempering the rally at the front-end.
The move in the dollar was especially pronounced. Bloomberg’s gauge plunged the most in two years at one juncture, while the DXY was on track for one of its biggest single-day declines in nearly a decade (figure below).
Bets on an inter-meeting Fed hike were faded and swaps leaned back in favor of a 50bps move at the September meeting. Just 59bps of tightening was priced into next month’s gathering in the immediate aftermath of the CPI report, compared to 67bps on Tuesday. Futures-implied odds of a third consecutive 75bps hike dropped and terminal rate pricing receded.
During remarks at Drake University on Wednesday, Charles Evans said rate hikes will continue. Inflation, he remarked, is “unacceptably high” and the Fed will raise rates for the rest of 2022 and “into next year to make sure inflation gets back to our 2% objective.” The Committee, he claimed, is “well positioned for various scenarios.”
Some of the price action abated later in the session as traders digested Evans, Kashkari and Timiraos, whose efforts underscored the notion that the Fed doesn’t need or want an overzealous market. Stocks were undeterred. The S&P closed with its best gain since Powell’s press conference.