Outlook: The financial press is full of analysis from the Fed, some of it really silly. The FT has a consistent explanation, although we disagree with its basic premise, that the Fed’s statement indicates that it will not tolerate higher inflation. “The Fed’s measures mark a major setback for investors who have rushed this year to buy securities that could benefit from faster inflation, betting that the combination of exceptionally easy monetary and fiscal policy and Global economy emerging from its Covid-19 lockdown would cause prices to dip. The unexpected central bank pivot has raised doubts about the inflationary pressures the Fed is truly prepared to tolerate. “
We say this is the wrong attitude because Mr. Powell has made it very clear that the Fed will indeed tolerate higher inflation in order to compensate for the very low inflation of the last few years to get an average of 2%. What about the concept of “means” that people don’t understand? The problem is probably that the Fed is not giving numbers, just as it is not quantifying “substantial progress†in employment.
The long bond has nosedived, implying confidence that the Fed will control inflation. “The yield on 30-year US Treasuries plunged to its lowest level since February and stood at 2.07% on Friday, down from 2.21% before the Fed meeting.” Commodities are the hardest hit, so “natural resources were hit the hardest, with the Bloomberg commodity price index falling 3.6% on Thursday, its biggest drop in a day in over year on year, WTI oil falling 1.5%.
“So-called US value stocks – often cheaper, less appreciated companies that are more sensitive to the pace of economic growth – fell another 1.3% on Thursday to extend the initial decline they suffered on Wednesday, the day of the Fed announcement. The MSCI Global Value Equity Index had already fallen 1.2% on Thursday. This implies that the management of inflation expectations has a decisive influence on overgrowth, something else we do not let’s not see.
Note that the 10-year breakeven point is a bit lower at 2.27% yesterday, down from 2.54% at the May 17th high. This is far from justifying the overreaction of some measures, including the giant drop in commodities.
We take off our economist hat and put on our technical analysis hat. First, overreacting to the Fed’s new stance can easily be seen by prices exceeding the “normal†range. This can be seen in the form of the standard error channel, the Bollinger band, and the ATR (average true range) channel. Breaks must be respected but remember that more breaks are false than real and more temporary than lasting; we tend to think that this one is the real deal and that it will be lasting, but others will have doubts and voice them loudly. And it wasn’t just the currencies that executed the breakouts. We have already seen breakthroughs in oil and other commodities, primarily lumber, which is now falling as it should after being severely overbought.
Even when a breakout is real, meaning it has a decent cause and marks a real change in direction, it tends to stop and reverse after a few stretches, as speculators take advantage (and some have doubts). The reversal is usually short-lived when the breakout is caused, usually happening after about 5 days. Then we all dance on the ice to see if the new movement picks up. A priori, it will resume this time, on the basis of real US growth with signs of robustness and resilience, notwithstanding the employment reports.
In other words, copper and lumber and even oil are going down because they were overbought in the first place and the Fed is just an excuse to burst the bubble. But the price increases have a genuine cause: the resumption of Covid in major economies. Oil can still go up to $ 100, as we wrote yesterday.
The Fed has not changed its policy this week. As Powell has been careful to note, dot plots are personal (and anonymous) opinions, not forecast or policy statement. The overreaction to a change in position is excessive and should correct itself. The Fed did nothing more than open the door.
Bloomberg has a relevant comment: “The spread between 5- and 30-year Treasury yields has fallen by most since February in the two trading sessions through Thursday, and is now below its starting level. year.
“This is a negative signal for global cyclical stocks, which have started to reverse but remain ahead of their defensive peers by more than 5 percentage points this year, according to Goldman Sachs gauges. Investors are now betting that a faster-than-expected pace of Fed tightening could dampen economic growth and rising inflation, and weigh on the odds of an overshoot either way. A flatter yield curve would likely favor defensive stocks like health care and consumer staples and could trigger a reversal of the inflows seen in cyclical stocks since late last year. “
What should be remembered is that the risk of exceeding inflation is now under control. This is what the world expects from its central banks. We are not “defending” the Fed. We see his words as perfectly appropriate in a world where US inflation was 6-8% (depending on how it is calculated). We think the Fed has avoided a potential crisis and poured cold water on some bubbles. That’s what we’re paying him for.
As for the dollar, it may keep gains after the usual correction. Commodity currencies will come back. MOEs can suffer from borrowing costs.
Be careful what you read Department: The WSJ has a front page article claiming to be news that reads “A booming US economy pushing up inflation around the world and pushing up the US dollar is pushing some central banks to raise interest rates despite still high levels of Covid -19 infections and incomplete economic recovery in their own country.
“Central banks around the world are clinging to how the US Federal Reserve will react to rising inflation, fearing that they will be caught in the currents of extraordinary US economic expansion. Global stock markets fell on Thursday after Fed officials signaled they expected to hike interest rates by the end of 2023, earlier than they expected in March, when the US economy is heating up.
“A global march to higher interest rates, with the Fed at the center, risks stifling economic recovery in some places, especially at a time when emerging market debt has risen.” Turkey, Brazil and Russia raise rates when they cannot afford it, and emerging market currencies suffer as their dollar borrowing costs rise. The WSJ fails to note that the inflation is that these countries are almost all driven by the domestic market and that many emerging countries enjoy higher commodity export earnings also denominated in dollars.
To add insult to injury, the WSJ ran an op-ed criticizing the Fed for being led by the nose by the market and for failing to make the rate changes this week that the inflation data calls for. In fact, the author criticizes the way the Fed interacts with the market in everything from trivial dot charts to forward-looking indications to frankness leading to temper tantrums. He is right in that the way the Fed interacts with the market is full of awkwardness and uncertainty, but he is quite wrong to say that the Fed is not in charge. The cartoon accompanying the article shows Powell napping on a lounge chair as shopkeepers revolt for attention.
It’s like saying tennis is an invalid game because scoring is stupid – what are ad-ins and ad-out, deuce and love, anyway? We note that this guy was the correspondent in Hong Kong and has apparently never been a bond trader or trader of any kind. Put him on a big bank trading desk for a few weeks and see how he changes his tone.
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