Treacherous Vibes

The specter of ongoing rate hikes set against decelerating economic activity and persistent inflation isn’t exactly a friendly environment for investors, which goes a long way towards explaining the risk aversion that defined this week’s post-Fed trade.

Christine Lagarde’s overtly hawkish messaging Thursday was insult to injury in the wake of Jerome Powell’s generally recalcitrant demeanor following the the final FOMC meeting of 2022.

I realize ECB decisions don’t make for the most compelling reading, but there’s a reason I featured coverage of the bank’s December statement (and Lagarde’s remarks) prominently on Thursday — the GC could scarcely have been more adamant, and the new staff projections painted a picture of stagflation, although policymakers are always loath to employ that term.

TD’s James Rossiter called Lagarde’s hawkish turn “stunning.” “The ECB out-hawked the Fed this week, effectively pre-announcing a series of 50bps hikes, alongside a QT program,” he wrote, on the way to describing the press conference as “incredibly hawkish.”

The selloff on Wall Street, when taken with Wednesday’s swoon, summed to more than 3%. US equities have notched meaningful two-session declines following each of the last three FOMC meetings (figure below).

Delivered as it was less than 24 hours after Powell’s press conference, a lackluster read on US retail sales was taken at face value — that is, there was no “bad news is good news” trade Thursday. Said differently, the proximity of Powell’s “higher for longer” messaging made it difficult for stocks to trade the surprisingly large drop in nominal consumption bullishly. Not surprisingly, the curve flattened.

“Higher real borrowing costs have already been weighing on asset valuations in the housing market and domestic equities. The next leg will be erosion of demand,” BMO’s Ian Lyngen and Ben Jeffery said. “Higher real rates, lower breakevens and stocks under pressure all resonate with the hawkish central banking impulse and the flattening of the curve has once again brought cycle flats in 2s10s within striking distance.”

Tellingly in the context of Powell’s messaging from Wednesday, big-cap US tech had its worst session since his November press conference (simple figure below).

That’s probably frustrating for those who assumed a cooler-than-expected CPI print this week would be a green light for risk assets, and particularly for those that suffered the most this year from the Fed’s tightening efforts. In the context of this week’s key event risks, the CPI-FOMC downshift conjuncture proved to be a “buy the rumor sell the fact” scenario.

“The shift in the market’s focus from its infatuation with inflation and the Fed to the economic growth momentum was on full display, mainly through the lens of the markets’ adverse reaction to a fragile set of macro data points,” SPI Asset Management’s Stephen Innes remarked. “November headline and core retail sales came in weaker than expected, hinting that the resilience of the US consumer, which has underpinned stocks and recent risk appetite, is under scrutiny.”

The more concerned the market becomes about the health of the consumer, not to mention the long-awaited corporate earnings “reckoning” and, eventually, the labor market, the more traders will doubt the Fed’s insistence on holding terminal in 2023. Market pricing still indicates more than 50bps of cuts between June and December (figure below).

Powell would very much like to disabuse the market of the idea that cuts are coming at any point next year. Or maybe he’s just being coy, buying time.

To the extent Powell does want traders to stop betting on a 2023 pivot, he can probably forget about it, because ironically, the harder he pushes the envelope, the more convinced the market becomes of a hard landing.

“The big question remains ‘How long at terminal before the Fed can actually ease again?’ and, of course, in the minds of so many, we are still looking down the barrel of an economic and earnings recession,” Nomura’s Charlie McElligott wrote Thursday.

“The vibe still feels treacherous,” he added. “Which is why we keep seeing buyers of VIX upside.”