Is confidence in the Fed and other central banks misplaced?
Outlook: In the US, we get the March Factory Orders, Final Durable Goods and JOLTS report, as well as Vehicle Sales. It may be too early to expect anything juicy from Ford on the new EV 150 truck, which we think will be a bellwether. The jolts will likely be a conundrum, again, as labor shortages are seen as raising wages and therefore a driver of inflation.
One finished, two left. Australia surprised with a hike ahead of an election, just days after Sweden did the same. Reuters is trying to take some advantage of the “humble pie” of central banks, which is unwarranted. But Reuters also points out that all of this aggressive policy is driving down inflation expectations, in the form of a 10-year breakeven. It was 3.02% on April 21 and by yesterday’s close it was down to 2.81%.
See FRED’s chart. The clear inference is that the market thinks central banks will be able to control inflation and approves an aggressive hike. We value “trust in institutions” as an important factor in containing risk aversion, along with real data. Here’s the question: if it’s the supply chain that’s driving inflation, what evidence do we have that it’s falling? Based on yesterday’s ISM components, none. Bloomberg reports “…it takes an average of 100 days to receive production materials, with the longest record dating back to 1987. For capital expenditures, the average commitment time has risen to 173 days, which is the highest high never recorded.”
In addition, “Some 34% of respondents to the ISM survey who are hiring indicated that they had difficulty filling vacancies, compared to 28% a month earlier. Turnover rates also remain high, illustrating strong tension in the labor market. The share of purchasing managers who said employment actually fell in April was the highest in seven months.
So is confidence in the Fed and other central banks misplaced? Maybe, but there’s another problem: clinging to that trust. El-Erian writes that the Fed and other BCs have more to do. First, take back control of the “political narrative”, which means that the market does not understand what the Fed is saying and that the Fed “has failed to influence the markets with clear and credible political safeguards “.
Second, the Fed needs full clarity on the balance sheet contraction, specific amounts and dates. It’s to avoid a temper tantrum. “It’s harder than it looks. After inflating its balance sheet to $9 trillion, there’s no historical playbook on how to handle a gradual and orderly reduction.
Third, the policy is reactive and must be proactive. The data dependency was applied carelessly and did not work. On the one hand, he focused on the demand and ignored the supply. And finally, the Fed must admit its mistakes, as the ECB just did in a bulletin last week that no one has read. Why are forecasting models so bad? It is also one of our hobbyhorses.
One of the confusing news yesterday was the idea that the market was valuing 75 basis points at the June meeting. Eh? Everyone is convinced that the Fed will do 50bp this week (for the first time since 2000), and maybe another 50bp in June, that’s front-loading! It may be a good idea that traders are waiting so long, preventing a panic. But there is no guarantee that the story of the balance sheet contraction, also expected this week, will be received calmly.
Oxford Economics writes that the Fed will likely cut its holdings by $15 billion in May and $30 billion in June, with even $60 in July still a drop in the bucket. It’s when it continues to do so each month at the rate of $60 million that the contraction becomes serious – $405 billion by the end of the year. Oxford Econ continues – mortgage-backed will even tame, “starting at $10 billion in May before climbing to $20 billion in June and then highs of $35 billion in July.”
By the end of the year, inflation will probably be 4% plus a bit, so if the fed funds rate is 2.13% by the end of the year, then 2.63 % by mid-2023, as Oxford expects, we may have tamed a few beasts, but if the bonds follow one another, is there a real return?
Bloomberg conducts a ‘markets live’ survey which shows a majority (75%) see the 10-year yield above 3.15%, while 41% expect 3.4%. “More than half of respondents expect inflation-adjusted five-year yields to turn positive by the end of June, implying a jump of around 40 basis points from To push the rate that high, that quickly, would require either a rapid rise in the nominal rate on the back of strong growth, or a decline in inflation expectations.The five-year TIPS yield jumped 19 basis points today as the 10-year TIPS yield turned positive.
It’s a battle between portfolio managers and economists.
Oxford acknowledges that the market is pricing in more gains than expected as supply chain tensions do not ease and labor shortages persist. If these things happen, “then the Fed should tighten more than expected in order to ease inflationary pressures.” The Fed fears that persistent inflation will create an inflation mentality that leads to spiraling wage prices. “Under such a scenario, the probabilities of a recession would increase, especially for 2023. Currently, our recession model, based on the US yield curve, indicates relatively low but increasing probabilities of a recession over the next 12 months. ..”
That’s about as healthy and reasonable as it gets. We continue to see possible dollar drift lower if the Fed lacks clarity in the QT department and perhaps some other disappointments.
Treat: Germany has announced it will invite India to next month’s G7 in the Bavarian Alps, “as part of efforts to steer New Delhi away from its longstanding alliance with Russia.” He also invites South Africa, Indonesia and Senegal.
This may be a good thing, as India is the largest democracy not to join Russia’s sanction for its invasion of Ukraine. Other big countries on this list include Brazil, Mexico, Saudi Arabia and the United Arab Emirates. (To see a list of countries and companies adopting sanctions.
On Sunday, Fareed Zakaria stressed that it’s not really democracies versus autocracies – they are, or should be, those who accept the international rule that it is forbidden to encroach in any way on the borders of other countries. You would think that India might appreciate this in the context of its border with China.
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