“Fed officials won’t relent on path to 4.5% and may move higher,” one headline declared over the weekend.
When you read those sorts of proclamations, it’s important not to lose track of where rates are now, what’s almost guaranteed to be delivered in terms of hikes by the end of this year and the fact that it’s nearly mid-October. You’re not saying a lot when you insist the Fed “won’t relent” until rates are another 150bps higher when 125bps of that is virtually assured to be delivered over the next 65 days.
The question isn’t so much about whether the Fed will manage to pull rates up somewhere close to the terminal rate implied by the dots (they will), but rather how long they manage to hold it and what happens to markets over that period.
With apologies to brave-talking folks like Chris Waller (who last week said, “Until we see any signs of inflation beginning to moderate, I don’t know how we pause”), convincing evidence that inflation is definitively and sustainably moving back towards target probably isn’t forthcoming in the near-term, and maybe not in the medium-term either. If that turns out to be the case, continuing to ratchet rates higher in perpetuity will result in catastrophic damage to a thoroughly financialized global economy. A true Volcker-style assault would lay waste to the entire system.
On that happy note, it’s CPI week in the US. Spoiler alert: The 12-month core print will probably be higher than the prior month’s. It’s expected at 6.5%, which would be the hottest annual pace since March (figure below). Things are getting worse, not better.
The Cleveland Fed’s nowcast had core at 6.64% as of Friday’s update (and running at 6.58% for October, by the way). Headline is seen at 8.1%.
When taken in conjunction with September payrolls, the figures will doubtlessly cement an already fully-priced 75bps hike at the November policy meeting.
The mainstream media headlines will lament another 8% headline print, and that’ll be bad optics for the White House with less than a month to go before the midterms. It doesn’t help that OPEC+ is, arguably, attempting to influence the outcome.
What really matters in the CPI report, though, is the MoM core print. You’ll recall that an extremely hot monthly core reading for August prompted traders to price some chance of a 100bps hike at last month’s FOMC meeting. At least one major bank adopted a full-point move as their base case on the heels of August’s scorching-hot core read.
Consensus expects a downshift to a 0.4% pace for September (figure above). Headline is seen rising 0.2% from August.
Another upside surprise on the monthly core print could be very bad for risk assets, particularly in conjunction with the downtick in participation and unemployment from the jobs report. Lower participation, a 50-year low jobless rate and another hot MoM core CPI print would be a hawkish hat trick.
“The bar is high for CPI to derail another three-quarter point move. We’re certainly cognizant that investors are eager to see the Fed pivot to a less hawkish stance, even if it only takes the form of a downshift to a half-point hike [but] the incoming Fed commentary has reinforced the Committee’s position that the battle against inflation is an ongoing effort and will be accompanied by further hikes that bring policy rates deeper into restrictive territory,” BMO’s Ian Lyngen and Ben Jeffery said. “September’s CPI will be an incremental input into the Committee’s thinking on the topic but given the trajectory of core consumer price gains throughout this summer, another 75bps will be an investment in Fed credibility if nothing else.”
Again, I should emphasize that sooner or later, the tension between a highly leveraged world, a relentless Fed and ever higher US reals will become untenable. SocGen’s Subadra Rajappa spoke of “no pain, no gain,” a reference to the sacrifices we’ll need to make along the road to lower inflation outcomes.
“Global central bank policy tightening, geopolitics and higher commodity prices are likely to further contribute to the bearish momentum in bonds,” Rajappa said, adding that the sharp rise in reals and rate hike expectations have pressured breakevens, an ostensible vote of confidence in the Fed’s capacity to control price growth (figures above).
However, she’s clearly cognizant of the risks. “Higher mortgage rates and a stronger dollar are direct consequences of tighter policy [and] the end goal for the Fed and global central banks is demand destruction,” Rajappa went on to say, before noting that “aggressive policy action increases the odds of a hard landing.”
The timeline for a recession may be brought forward, she remarked, which should be reflected at the long-end, while front-end rates remain hostage to a hawkish Fed. Curves, Rajappa said, may stay “significantly” inverted for the “foreseeable future.”
Coming full circle, the question we’ll all need to ponder eventually, is how to respond in the event inflation doesn’t. Respond, I mean. What if “no pain, no gain” turns into “a lot of pain, but no gain”? Where do we go from there?
Also on deck in the US this week: NFIB, PPI, retail sales and the preliminary read on University of Michigan sentiment for October. Fed speakers include Mester, Kashkari, Barr, Bowman and Cook.
I’m sure you have discussed this and it went over my head but why wasn’t a recession called when we had two quarters of negative growth.
The NBER doesn’t use that definition or any other definition for that matter. It’s a subjective, after-the-fact determination based on their assessment of the factors listed here: https://www.nber.org/research/business-cycle-dating/business-cycle-dating-procedure-frequently-asked-questions
The two-quarter “definition” is, for lack of a nicer way to put it, a lie. There’s no such rule at the NBER.
https://heisenbergreport.com/2022/07/28/dont-call-it-a-recession/
https://www.npr.org/2022/06/24/1107581150/recession-referees
In short, there is no strict “two quarter rule”. A committee of academics at the NBER decides whether a recession has started. They operate on a significant lag and don’t publish their thought process. They may end up saying that we are currently in a recession, or they might decide that hot nominal growth and a strong labor market mean that the recession hasn’t started yet.
No way to know, and it probably doesn’t matter.
Still the “best” preemptive NBER recession call of all time:
https://heisenbergreport.com/wp-content/uploads/2018/12/Kudlow.png
The Fed won’t slow down unless either core and headline inflation dramatically slowdown, or inflation steadily drop for 3-6 months, or we get a blowout in credit spreads in many markets indicative of a financial meltdown. Because of the lagged effect of owners equivalent rent in the inflation stats, it looks like it will take a financial meltdown via spread blowouts to slow down the fomc. So far the us mortgage market and British financial markets have hit the wall in a fashion. My best guess is there will be a complete meltdown in lower tier corporate credit. You are starting to see it now but we are not far from a complete shut down in corporate credit. That would lead to a contagion event and a pause.
I’m starting to fear a hard landing might be the best we can hope from the Fed’s race to regain credibility. A depression is now a possible outcome in my opinion, US core PCE as of now sits at 4.91% YoY, high no doubt but we must consider that this number presumably reflects not only all the pandemic related disruptions to supply-demand but also the effects of the fiscal and monetary stimulus that took place from 2020 to 2021. Consensus is monetary policy works on a lag, so the insanely fast hikes of the last 6 months won’t really be evident in our economy for another 8-14 months, how does that world look like? I have a hard time believing growth will merely slow down, the housing market and some developing economies already show severe signs of stress, add to that continuos and relentless global tightening, prohibitive costs of debt, obliterated retirement savings and a hit to corporate earnings, just as inflation overshot to the upside we could have a hard swing towards actual deflation on a global scale. War and the energy crisis are big wild cards but both can contribute to a deflationary spiral depending on how policy and populations react to a severe and sudden deterioration of quality of life in the developed world. There will be pain and no winners, except perhaps for the former president and other autocrats around the planet, a depression will provide fertile ground for their populist message and their skills at selling fear.
I agree wholeheartedly with your statement that monetary policy works on a lag (except maybe for housing and credit), so the insanely fast hikes of the last 6 months won’t really be evident in our economy for another 8-14 months.
So more than likely some external shock/event will occur that will bomb/hit/impact the monetary/financial markets like a sledgehammer. And certainly well before the Fed rates take full effect.
And inflation will then necessarily fall as a result (demand will fall off a cliff) and all agencies/central banks/governments will take credit for a job well done. While blaming external factors out of their control for the disastrous fallout.
The root cause, when historians and financial analysts look back at the over-leveraged financialized markets, will be traced back to the period of several years (from about 2007 – 2015 and from 2019-2020) when the FED chose to keep rates an insanely low levels. The availability of “cheap money” resulted in excessive government spending with no financial discipline, high risk and mal-investment in search of yield, over-leverage and negative interest rates (a concept I still do not understand)
Points HS has raised in many of his articles.
As a Canadian, the housing bubble in major metropolitan centers of Toronto and Vancouver and the huge debt piled up by our federal government were ever-present in the past several years.
in fact, on a per-capita basis, our federal government over the last several years was the champion of deficit – spending!
I’ve been struck with a thought lately about why inflation has been so sticky. My peer group (middle aged homeowners with mortgages) all refinanced in the past two years when rates were low. For me (and I know many) it was the largest raise I’ve ever gotten. My refinanced payment is 600 a month lower. That’s a massive stimulus that continues to accrue monthly. Even with inflation, I’m much better off financially.
Not only that, but I refinanced my truck loan too, saving 50/month. And again, so did a lot of my friends.
Eddie Z, this is a very interesting comment- which led me to look up the following:
Residential mortgage debt was $11.18T as of Q1, 2022 according to the Federal Reserve Bank of NY.
Residential refinanced mortgages totaled $2.8T in 2020 and $2.7T in 2021.
Assuming homeowners don’t have to sell, this might indicate higher home prices are pretty sticky.