It wasn’t a good week to be a bull.
Images of FedEx’s largest one-day plunge in 42 years were seared into corneas Friday, as equities limped out of what, in the end, was among the worst weeks of 2022 for US shares (simple figure below).
It was policy panic, yes. But, thanks to FedEx’s ominous macro warning, it was a growth scare too by the time the weekend rolled around.
Suffice to say stocks’ efforts to overcome a perilous seasonal were stymied. Another disconcerting CPI report short-circuited the nascent rebound from three weeks of losses, while cementing the case for the Fed’s “restrictive for longer” narrative.
Market pricing for the terminal rate moved up dramatically on the back of a monthly core CPI print that was twice as hot as anticipated. Although leading anecdotal indicators from PMI price gauges, and encouraging news on consumer inflation expectations both from the New York Fed and the University of Michigan were welcome, the Fed’s credibility deficit, incurred while defending an adjective (“transitory”), left the Committee almost entirely beholden to CPI.
If that’s a liability — if it condemns the Fed to fighting the last war — they have themselves to blame. At least in part. They boxed themselves in with forward guidance, then refused to pivot despite mounting evidence to suggest price pressures weren’t ephemeral, with the caveat that everything is “transitory” eventually.
There’s virtually no room for error if headline CPI is supposed to recede near 2% anytime soon (figure above). Again, that’s headline. Core isn’t going back to target in the near-term. As far as I can tell, the math isn’t there.
As BofA’s Michael Hartnett pointed out, event risks are myriad, starting with the September FOMC meeting. Assuming the Committee opts for 75bps instead of the full-point move markets began to price following August’s CPI report, the focus will be on the SEP, which will likely show officials dialing up their projection for unemployment and telegraphing a steeper rate trajectory. As ever, the most consequential unknown (outside the 100bps tail risk, anyway) is Jerome Powell’s press conference. He’s prone to missteps. Sometimes that’s bullish. Right now, though, he’ll be especially careful to avoid inadvertently triggering an equity rally, especially in the context of the post-FOMC stock surge in July and his terse remarks a month later in Jackson Hole.
The next day, the Bank of Japan is on deck. Kuroda is playing with fire at the juncture. Yield-curve control has indeed become unsustainable, even for the BoJ. The more staunch Kuroda’s defense of the cap on 10-year yields, the more pressure on the currency. The more pressure on the currency, the higher the scope for pass-through inflation and the more asymmetric the risks around Japan’s trade balance, especially at a time when global demand is expected to slow and energy prices are likely to remain elevated. The BoJ has to address the situation. If Kuroda continues to adopt a nonchalant approach, he risks a currency crisis. It’s just that simple. Chuckle as you will. The yen’s down 20% this year. And nobody at the finance ministry is laughing. Worse, Kuroda’s options for tweaking (let alone abandoning) YCC are all bad.
The September BoJ meeting is “very important for global markets,” BofA said. “Not budging on YCC despite all central banks in the world bar China hiking rates” risks additional overshoot for the yen, “fears of debasement and capital flight,” the bank warned.
Just a few days later, Italian elections risk another rightward lurch, and a few weeks after that is Xi’s coronation ceremony. Both of those events have potential ramifications for markets. It’s possible, for example, that China may begin to hint at a relaxation of COVID zero. Then come the US midterms.
On November 15, the G20 meeting in Bali will be “hugely important,” Hartnett went on to say, citing “new market, macro and geopolitical” realities, and suggesting markets “may pressure policymakers for a new Plaza Accord,” given ongoing tumult in FX. Obviously, the war in Ukraine will cast a pall, although I suppose the venue could present opportunities for negotiations.
Again, that’s a lot of event risk. Every outcome (or nonoutcome) needn’t be bad. The point is just that the balance of the year will be a “no rest for the weary” affair for markets. In all likelihood, Q3 earnings season in the US will be arduous, and it’ll be set against Europe’s frantic efforts to avert a humanitarian crisis in developed economies amid energy and power shortages which will, in turn, test EU solidarity.
It seems far-fetched to suggest equities — domestic or global — will somehow make it through all of this unscathed. At the least, the next several months will likely see one or more “shocks,” where that could mean any number of things ranging from the relatively benign (e.g., guide downs and a wave of earnings revisions in the US, triggering the next leg lower for the S&P) to the existential (e.g., an escalation in Ukraine as the Kremlin seeks to save face or reverse additional battlefield losses).
In that context, the last few days may be remembered as something more than just a bad week for bulls. It could be that markets are on the precipice of a quarter to remember, with this week serving as a bitter amuse-bouche. That’s not the best metaphor. You aren’t charged for the amuse-bouche, whereas this was an expensive week for some bulls.
Writing in the same note cited above, BofA’s Hartnett warned that inflation is secular. “US freight railway workers received a pay rise, US strategic oil supply is the lowest since 1984, Germany is nationalizing the utility sector, the EU steel sector is seeking government aid, the G7 is placing controls on energy prices, the UK/EU are approaching fiscal policy panic, the G7 is significantly raising military spending and China/Taiwan is moving in a bad direction,” he continued. “Peace to war, globalization to nationalism, inequality to inclusion, budget balance to fiscal panic, invisible hand to visible fist, secular deflation to secular inflation.”