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On Wednesday all focus was on U.S. inflation data as eventually, it will guide Fed to tightening pace in September, November and December. Wall Street Futures, Gold, and UST stumbled, while the USD surged after hotter than expected inflation data as it may prompt Fed for bigger hikes like +0.75% (from present +0.50%) in the coming months (June, July, and September). But US stocks (Wall Street), Gold soon recovered from the panic low as Fed will not act based on only one month’s inflation or any economic data. Fed Chair Powell already affirmed that Fed will take into account several months’ inflation data to see whether it’s a durable trend or just one month's noise/whipsaw.
As highly expected, on the 4th of May, Fed hiked +0.50% and indicated further hikes @+0.50% in June, and July. Overall, fine prints of Powell’s statement and Q&A show that Fed will go for +0.50% rate hikes in June and July along with $47.5B/M QT from June-August. If there is no surprise upside in sequential core PCE inflation reading, Fed will hike normal @+0.25% in September, November, and December. Thus combining all these probabilities, Fed may cumulatively hike to +2.75% by Dec’22.
Fed will also hike the QT pace from $47.5B to $95B in September, paving the way for lower rate hikes from September. Total QT in 2022 maybe also equivalent to +0.25% rate hikes (as per Powell’s estimate). Thus US 10Y bond yield is now hovering around +3.00%, the upper range of the Fed’s current estimate of the neutral rate (2.50-3.00%) for the long run, when the economy is ideally around +2.00% inflation and maximum employment.
But Powell also didn’t rule out rate hikes beyond the current estimate of neutral rates; i.e. +3.00%. Powell said Fed will not hesitate to hike further if it sees no sustainable sign that inflation is easing. Fed will hike to slow the economy; i.e. demand, especially both labor and product market, so that the current supply will eventually match demand and inflation moderates to around +2.00%.
Powel said although the current spate of elevated inflation is a function of lower supply and higher demand, as a central bank, Fed has the only tool to influence demand, not supply. And Fed is not relying on any Congressional action to ease supply or some resolution on Russia-Ukraine/NATO geopolitical conflict. Thus Fed will do its job, which is to restore/ensure price stability because ultimately it will foster inclusive growth.
After the last Fed meeting on 4th May, Wednesday, there was a deluge of Fed speeches from Friday, essentially preparing the market/debating for bigger rate hikes as a part of the Fed’s jawboning strategy to keep prices as well as financial stability. Fed is now trying to bring down inflation expectations by ultra-hawkish jawboning. But Fed is also aiming to keep Wall Street stable by delivering lesser hikes after jawboning higher.
On Friday, BLS data shows that the annual U.S. headline inflation (CPI) eased to +8.3% in April (y/y) from +8.5% recorded in May (41-years high), but higher than the market expectations of +8.1%. The BLS said increases in the indexes for shelter, food, airline fares, and new vehicles were the largest contributors to the seasonally adjusted all items increase. The food index rose +0.9% over the month as the food at home index rose 1.0%. The energy index declined in April after rising in recent months. The index for gasoline fell -by 6.1% over the month, offsetting increases in the indexes for natural gas and electricity. Energy prices increased 30.3% in April, below 32% in March namely gasoline (43.6% vs 48%) while fuel oil increased more (80.5% vs 70.1%). On the other hand, food prices jumped 9.4%, the most since April 1981 and prices also rose faster for shelter (5.1% vs 5%) and new vehicles (13.2% vs 12.5%).
On a sequential (m/m) basis, headline CPI increased +0.3% in April, well below a 16-year high of +1.2% recorded in March, but higher than the market expectations of +0.2%. The sequential fall in CPI was mainly due to a fall in the gasoline price index (-6.1%), offsetting increases in the indexes for natural gas (3.1%) and electricity (0.7%).
Despite the slowdown in April which suggests that inflation has probably peaked, the inflation is unlikely to fall to pre-pandemic levels any time soon and will remain above the Fed's 2% target for a long time as supply disruptions persist and energy and food prices remain elevated
The U.S. annual core inflation (core CPI) also eased to +6.2% in April (y/y) from +6.5% recorded in March (40-years high), but was above market expectations of +6.0%. On a sequential basis, the core CPI surged +0.6% in April, accelerating from +0.3% recorded in March and above the market expectations of +0.4%. The sequential core CPI was boosted by indexes for shelter (0.5%), airline fares (18.6%), new vehicles (1.1%), medical care (0.4%), recreation (0.4%), and household furnishings and operations. But the indexes for apparel, communication, and used cars and trucks all declined sequentially in April.
US CORE CPI (M/M)
The focus of the Fed as well as the market is now on sequential (m/m) reading of core CPI rather than yearly (y/y) due to large base effects distortion. Fed needs around a +0.17% sequential increase in core PCE inflation on a sustainable basis, equivalent to a +2.0% reading (Fed target) on an annualized (y/y) basis. The sequential reading of core CPI was much higher than +0.17% or even +0.2% since Oct’21; it was hovering around 0.6-0.5% and was +0.3% only in Mar’22. But in Apr’22, it again jumped to +0.6%.
US CORE PCE (M/M)
Fed goes by core PCE inflation rather than core CPI or CPI. The core PCE inflation usually comes lower than the core CPI reading. In any way, the sequential core PCE inflation was +0.5%, substantially higher than the Fed’s target of +0.17% since Oct’21 (after COVID and before the Russian invasion of Ukraine). But it came down to +0.3% in February and March’22. In his presser on 4th May, Powell was asked about this lower reading of sequential core PCE-whether this constitutes a sign of peaking/easing of inflation (core PCE). Powell replied negatively and clarified that for any sustainable trend, Fed will need to watch several months of data, not one or two months before arriving at any conclusion.
Now considering the present run rate and co-relation between sequential core CPI and core PCE rate, the April reading of core PCE, the Fed’s favorite gauge of inflation reading/indicator, may come around +0.50% from March print +0.30%. In that scenario, the annual (y/y) reading of April core PCE inflation will be around +5.05%. Even if, for any reason/distortion, the April sequential rate remains around +0.30%, the annual reading will be around +4.80%, still substantially over the Fed’s target of +2.00%. Now all focus will be on the 27th May release of core PCE data by US BEA.
US CORE CPI (Y/Y)
US CORE PCE (Y/Y)
On Wednesday, Fed’s Bostic said:
· The Fed will act to bring inflation down
· If supply-demand gaps narrow, price pressures will ease
· We understand that inflation is too high
· I back 50-bps moves until the rate is raised to a neutral level
· 75 basis points are currently not in his basis case and would be a low probability
· But I will support moving rates more if inflation persists
· The Fed will have to observe and adapt to new data
· I do not think the Fed is behind the curve
· Moves in market yields are a sign the Fed still has credibility
· The housing market has higher-quality credits than when in a crisis
· The housing-market dynamic is different from the 2008 crisis
· Housing valuations are high, but the risk is lower, and credit quality has improved compared to those before the financial crisis
· There is likely $1-2T of excess liquidity that can be removed from the Fed balance sheet
· It is difficult to know right now where to stop on-balance-sheet cuts
On Tuesday, the Atlanta Fed President Bostic said he supports Fed’s QT plan fully and also defended Fed that it didn’t overdo pandemic QE, the root cause of today’s elevated inflation (along with huge COVID fiscal stimulus and supply chain disruptions). Bostic also expressed hope that Fed will eventually control inflation. Bostic said:
“I currently see the case for further 0.50% moves in the next two to three meetings--- Let's just keep this moving and make sure that we're doing all we can to get inflation under control--- there may be pain associated with tighter Fed policy---For example, higher borrowing costs could push businesses to contract their hiring efforts, which will likely lead to higher unemployment. I think if I was going to want to do too much or too little (during a pandemic), I'd rather deal with an economy that had strong fundamentals and foundation---the alternative would have been more small business bankruptcies and more precarious household finances. And that is actually a much more painful environment to be in---- I actually don't think that the Fed overdid it (QE) ---.”
On Wednesday, Bostic said nothing new, which the market does not know already. But Wall Street stumbled mid-US session from the inflation high, while Gold didn’t move much from the post-inflation high. Although there was no clear trigger, one possible explanation may be hotter than expected sequential reading of core inflation, which may prompt the Fed to keep the pace of +0.50% rate hikes even after July (September, November and December). But Gold is also getting some boost on age-old appeal of inflation hedge asset coupled with the eternal attraction of 3D- debt, deficit and devaluation (paper currency).
But another explanation behind the sudden slump in Wall Street mid-Wednesday may be that Lorie K. Logan, the unofficial ‘queen’ of U.S. PPT (Plunge Protection Team) is to resign from the NY Fed to join Dallas Fed as President/CEO. The NY Fed has issued an official statement:
“The Federal Reserve Bank of New York today announced that Lorie K. Logan will step down from her role as Manager of the System Open Market Account (SOMA) and Head of Market Operations, Monitoring, and Analysis in the Markets Group to become President and Chief Executive Officer of the Federal Reserve Bank of Dallas.
“Lorie has a deep knowledge of capital markets, market operations, and related policy, which she has leveraged to provide expert analysis and advice to the FOMC, particularly in times of crisis,” said John C. Williams, President and Chief Executive Officer of the New York Fed. “I have worked closely with her for many years and relied on her counsel. During her tenure, I have watched her inspire, support, and develop an outstanding team, which has a deep bench supporting monetary policy implementation. While we will miss her here in New York, I’m thrilled that she will continue her exemplary career of public service to lead our Federal Reserve System colleagues at the Dallas Fed.”
“Lorie is a trusted colleague and dedicated public servant whose remarkable skill and experience with complex financial markets have informed our decisions and helped implement monetary policy to support the U.S. economy. I look forward to working with her in this new role leading the Federal Reserve Bank of Dallas, where we will continue to benefit from her analytical rigor, keen insights, and good judgment,” said Federal Reserve Chair Jerome H. Powell.
As SOMA Manager, Ms. Logan has been responsible for implementing monetary policy in accordance with the directives of the Federal Open Market Committee (FOMC). She has previously served as the SOMA Manager pro tem and the Deputy SOMA Manager. During her tenure, Ms. Logan has led operational and analytical responsibilities that include executing transactions in the open market, monitoring domestic and global markets, and producing analysis of financial market developments and emerging risks. She has played a prominent role in the development and implementation of the Federal Reserve’s crisis-era policies during both the COVID-19 pandemic and the Global Financial Crisis. Ms. Logan joined the New York Fed in June 1999.
Ms. Logan will remain in her role until August 2022 and the New York Fed will launch a search for her successor in the coming weeks. Upon her departure, Deputy SOMA Manager Patricia Zobel will become SOMA Manager pro tem.”
Logan is an experienced SOMA (U.S. PPT) head and the savior of Wall Street during crisis times. Her sudden exit from the NY Fed SOMA team; i.e. U.S. PPT maybe another big shock for the stimulus/bail-out addicted Wall Street, which is now under tremendous stress on faster tightening/QT by Fed. But being a professional team, NY Fed SOMA (U.S. PPT) would be always there to bail out Wall Street in times of crisis.
The Fed's tightening pace will depend on the U.S. inflation trajectory. The U.S. inflation will now largely depend upon the trajectory of the Russia-NATO proxy war over Ukraine and subsequent economic sanctions. Russian President Putin is now in no mood to exit from Ukraine without any major success, because of domestic political compulsion.
On the other side, U.S. President Biden is now trying to linger the proxy war against Russia by an unlimited supply of military equipment and financial assistance to Ukraine. The war of attrition between Russia-Ukraine/NATO maybe now equivalent to WW III, which may linger to Nov’22 U.S. mid-term election or even the Nov’24 U.S. Presidential election. The real WW III may not happen because of the fear of an all-out nuclear war between Russia/China-NATO.
Biden is now trying to recapitalize his falling approval rate through the proxy war against Russia and shifting the blame of ‘Bidenflation’ to ‘Putinflation’, which is now expected to be elevated till at least late 2022 or even late 2024. Biden may try to control domestic inflation by withdrawing Trump tariffs on Chinese goods (as a tax cut to hard-working ordinary Americans ahead of the mid-term election).
But China’s zero COVID lockdown policy and subsequent supply chain disruptions along with Russia-Ukraine-related lingering supply disruptions of key commodities will cause sticky fuel and food inflation in the coming days. Thus Fed may be compelled to hike @+0.50% even in September, November and December to reach a +3.50% neutral (?) rate by Dec’22 (as suggested by St’ Louis Fed President Bullard).
Fed’s Chair Powell almost assured the market about +0.50% rate hikes in June and July. Powell also indicated rate hikes @+0.25% in September, November, and December, providing a sequential reading of core PCE inflation eases as per Fed’s expectations. But Powell also kept open about the higher quantum of rate hikes in September, November and December if inflation does not ease or even accelerate. Thus Fed may also hike @+0.50% in September, November and December to reach +3.50% by Dec’22, in line with Bullard’s suggestion. And Fed may also front-load a +0.75% rate hike in September, followed by +0.50% each in November and December to reach Bullard’s latest estimate of a neutral rate of +3.75% by Dec’22.
On late Wednesday, after the closing of the U.S. market, Bullard said Fed has planned for a +0.50% rate for future meetings, although raising rates by +0.75% is not his base case. Bullard said:
· Inflation is broader and more persistent
· The Fed has planned 50 basis point raises for future meetings
· 50 basis point increases at upcoming meetings are a good benchmark for now
· I feel the goal should be about 3.5% on the Fed Funds Rate by end of the year
· The Fed must raise interest rates above neutral in order to lower prices
· Raising rates by 75 basis points is not my base case
· April inflation was high, but not far from expectations
· The Fed is on a good path in the near term, and we can adapt as we go
· The effects of Fed policy are being felt quickly in financial markets
· The risk of a recession in the United States is low right now
· The current solid job market is inconsistent with a recession
· Volatility in the Stablecoin market does not appear to be systemic, but it validates those who see them as hazardous
Overall, Bullard indicated +0.50% rate hike moves in September, November, and December too. The market is now slowly discounting about a +0.50% rate hike move in September after similar moves in June and July. The odd of +0.75% rate hikes in June and July is now rapidly decreasing.
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