The Fed desperately needs a break from hot US economic data.
Monday’s large upside surprise in pending home sales suggested the housing market is on the verge of turning a corner, and it’s not even spring yet.
As discussed here, Jerome Powell can’t lose the disinflationary tailwind from housing. If that goes, it’s not clear what’s left. The Committee can’t rely on goods deflation anymore, and considering all that’s going on geopolitically, the goods side of the equation could be very volatile for the foreseeable future. And by every account (including Powell’s) there’s no progress whatsoever yet when it comes to the collection of categories that constitutes “services ex-housing.”
It seems to me that February’s data is make or break. If those who insist the January figures were distorted by weather and statistical quirks are vindicated, then perhaps 25bps hikes and no change to balance sheet policy will work. If not, and the data remains robust, the Fed will likely consider a re-escalation to half-point increments, particularly given that at least two prominent voices (Bullard and Mester) might’ve supported a 50bps move at the February meeting if they were voters.
For now, though, it’s probably fair to assess that the repricing in rates has run its course, and if that’s the case, we could see a stalemate for at least a week or two. “Now that the macro rates repricing and flow catalysts hav[e] largely played out and achiev[ed] the correction, it’s back to cash while awaiting further range-trading opportunities,” Nomura’s Charlie McElligott said Monday, in the course of documenting just how meaningful February’s repricing really was.
I’ve utilized the same chart on a number of occasions over the past few weeks, but it’s worth highlighting again, and this time I’ll include Charlie’s annotations.
To call the re-steepening in M3Z3 “dramatic” would be to understate the case. Both the scope and rapidity are remarkable. That’s traders pricing out the “H2 rate cut” narrative almost entirely, and in a helluva hurry. The red arrow shows a 50bps correction in the space of a little over three weeks.
Now, though, we’re left to stare at a mirror image of where things stood when the new year dawned.
“Given the magnitude and velocity of [the] repricing… further economic data upside will be increasingly challenging to come by, as economists ‘chase’ and readjust,” McElligott went on to say, noting that the US Economic Surprise Index is now registering in the 91%ile, which plainly sets the market up for downside surprises going forward.
When you consider that against the possibility that January’s data was, in fact, skewed by warm weather and statistical tinkering, we’re potentially looking at a “reversal of the reversal,” so to speak. That is: Disappointing data for February reflecting a hangover from the warm weather pull-forward in January, for example.
What does that mean for markets? Well, it’s hard to say. But, as Charlie wrote Monday, the upcoming data “would need to stay [very] hot to merit a further repricing in rates,” which means bonds and yields may “consolidate at this ‘priced-to-perfection’ juncture,” removing one tailwind for cross-asset vol.
If that means we’re set for a relatively “boring” week (or two) ahead of Powell’s congressional testimony and February payrolls, that’s fine. After all, you get paid almost 5% to sit on the sidelines now.
Speaking of sitting on the sidelines, The Wall Street Journal has recently started running a Monday poll on some pithy subject or other. Today’s poll asked people to respond to the question of whether Wall Street should go to four-day weeks for the markets. I was shocked to see that the yeas and the nays were split 49.5 to 50.5 respectively. I guess half the folks don’t mind the idea of the sidelines so much. I expected nays to pound he yeas but they didn’t.
My God, don’t those who voted “yes” realize just how expensive setting up and running a high frequency trading operation is??
Perhaps Wall Streeters voting for three day weekends?
I see Bloomberg is starting to float the idea that the Fed is, or may soon be, done with hikes because “at their most basic level, monetary conditions are tighter than they were last year.” Referring to something we’ve discussed before, namely that Powell sees financial conditions as tighter regardless of street FCI indicies indicating looser. https://www.bloomberg.com/?sref=eCUg41rA
Another narrative trotted out to support asset prices? Right after the “the Fed might be okay with higher inflation after all” narrative? Sigh.
At the end of the day, I think inflation is what matters to the Fed. If inflation is not convincingly declining toward the Fed’s previously stated target, Powell has to turn the dials available to him. He has two dials: FF rate and QT.
He cannot move the goalposts; that is an admission that the Fed cannot, in fact, achieve price stability. He cannot leave the dials where they are; that is an admission that the Fed has reverted to trusting its inflation models.
I also think inflation is pretty much all that matters right now, simply because nothing else is causing enough pain to elbow inflation aside as Matter #1. Looking over the fully employed, house chasing, stock trading, car buying, profit reaping, US economy, where is the serious economic pain – other than inflation’s effects on those vulnerable to its corrosion? I can’t see it.
I realize this makes me sound like A Simple Man, but as Inspector Callahan said, “A man’s got to know his limitations.”