Regardless of how things turned out on Wall Street Friday, risk sentiment was plainly on the back foot again in the latter half of the week, as markets grappled with the prospect of more rate hikes and central bank forecasts which suggested humbled policymakers now harbor reservations about the timeline for inflation’s assumed return to target.
The concern, in short, is that central banks have now belatedly come to terms with something markets realized nearly a year ago — namely, that inflation is at least a semblance of entrenched, and to the extent central banks have the capacity to completely dislodge it, it’ll come at the cost of growth, it’ll require hiking rates deeply into restrictive territory and, quite possibly, keeping them there for an extended period. It’s not the policymaker epiphany that’s problematic. It’s the “belatedly” aspect that has markets worried.
The cadence employed in Thursday’s ECB statement was almost vengeful and Christine Lagarde’s press conference bordered on menacing, or as menacing as the famously eloquent Lagarde can be. European shares touched a six-week low Friday (figure below).
Preliminary December PMIs for Europe suggested the downturn eased early this month, but composite, manufacturing and services gauges for the bloc, as well as those for Germany and France, remained in contraction territory across the board. Indeed, the French economy decelerated further this month, S&P Global’s surveys suggested.
Between the ECB’s aggressively hawkish bent and updated inflation forecasts from ECB staff and the Fed, the raucous CPI cocktail party that should’ve been was replaced by a more somber scene this week — forlorn singles at a mostly empty bar stirring half-melted ice cubes around a rocks glass of well bourbon with their pinky fingers.
Asian shares notched their first weekly loss since October (figure below) and the dollar was on pace to reclaim losses from earlier in the week.
“Let us not forget that the risk of overtightening isn’t unique to the FOMC. Half-point hikes from the Bank of England, SNB, and the ECB also speak to the collective (not coordinated) effort of the global central banking community to curtail the decades high level of consumer price inflation,” BMO’s Ian Lyngen and Ben Jeffery wrote. “The US has been exporting inflation, thereby contributing to the case for tighter monetary policy abroad.”
The losses for global equities this week weren’t egregious by any stretch and might even be described as “healthy.” But, again, this was the week when markets received all they wanted for Christmas: A second straight cooler-than-expected US CPI report. It should’ve been a good week.
On Friday, SocGen’s Kit Juckes summarized the situation by way of Charles Dickens. “If Jerome Powell were a Dickensian character, he would be Samuel Pickwick, a fundamentally decent man who desires maximum rather than full employment even if he knows he has to defeat inflation to get it,” he wrote. The rest of his literary analogy is below.
The market understands that the Fed will pivot (properly) when growth slows enough and thinks that this will happen before we to 5% rates. The result is the gap between dots and the market, and the sogginess of the dollar. In the UK, terminal rates have been pushed up a modest 2bps in the last week which is still too high. The FX market clearly knows this and rather than asking for more, Like Oliver Twist, wants less rate-hiking. Andrew Bailey is Mr. Bumble, on that basis. One glance at the data and it’s clear that the recession is deepening and the Bank’s Victorian policymaking isn’t helping. Canceling Christmas won’t bring inflation down any faster than it’s going to fall anyway. The ECB has managed to persuade the market to re-price terminal rates up by 30bps over the last week. They are now priced to peak above 3%. That alone casts Christine Lagarde as Mrs. Scrooge, who would cancel Christmas in a flash if she thought she could get away with it.
Oh God not well whiskey.