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Wall Street crumbled on Chinese war drilling and Fed jawboning

calendar 05/08/2022 - 08:06 UTC

Wall Street Futures stumbled Wednesday on Chinese war drilling over Pelosi’s visit to Taiwan and hawkish Fed jawboning. And Wall Street further crumbled Thursday as China escalates its threatening and retaliatory military drills now encircling Taiwan. Chinese state-sponsored media GT even termed current military drills involving Taiwan a rehearsal for ‘Reunification Operation by Force’ after U.S. House Speaker Pelosi visited the island nation for a few hours. China has even sent an aircraft carrier group with a nuclear-powered submarine to join the 5-day military exercise over Taiwan. The GT also noted after Pelosi's provocative and damaging visit, that such military exercises blockading Taiwan are to become routine.

Meanwhile, Japan's Foreign Ministry has said Thursday evening (JP time) that five missiles fired by China have landed within Japan's exclusive economic zone (EEZ), while Taiwan's defense ministry, has meanwhile said 22 more Chinese air force jets have buzzed its airspace. China sent hundreds of jets around Taiwan airspace as a part of a military drill and fired thousands of missiles to satisfy the domestic audience. Meanwhile, tourists in Taiwan are also scrambling to the sea beaches to observe Chinese PLA military drilling!

Taiwan's defense forces are on a heightened state of alert. On Wednesday some half a dozen Chinese jets were reported as having breached the 'median line' separating the Taiwan Strait. China has launched a series of ballistic missiles into waters off Taiwan, with some having flown over the island. Taiwan has confirmed that mainland China launched 11 Dongfeng series missiles into waters north, south, and east of the island on Thursday afternoon. The next five days will include live-fire drills and missile tests surrounding the island in these reported locations:

China is also furious over a prior day's G7 statement condemning its military drills. The G7 warned Beijing not to use Pelosi's visit as a "pretext for aggressive military activity in the Taiwan Strait". In protest, China's Foreign Minister Wang Yi canceled what was to be a face-to-face summit with his Japanese counterpart. At the same time, increased cyberattacks are being reported against Taiwan government websites.

Some military experts think that China may plan to invade/annex some barren islands surrounding Taiwan this time. The market is concerned about a bigger conflict as 3 US carrier groups namely the aircraft carrier group USS Ronald Reagan & the amphibious assault groups USS Tripoli & USS America are in the vicinity of Taiwan against similar Chinese aircraft carriers. Overall, if China ends its 5-day military drill over Taiwan by Sunday, then it will be fine and risk trade may soar from Monday; otherwise, expect more pain for Wall Street and Gold will soar further if China decides to extend the Taiwan military exercise further.

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Now, from geopolitics to economics, Wall Street was also under stress on the concern of an imminent all-out recession amid bond yield curve inversion coupled with hawkish jawboning by the Fed contrary to the earlier perception of a ‘Powell pause/put’. Also, fine details of Powell's presser/Q&A ON 27th July (post FOMC meeting) indicate Powell didn’t assure about any rate hike pause in 2022.

On Monday, Fed’s Evans said:

·         A 50 bps rate hike is a reasonable assessment for the September meeting if inflation does not improve

·         A 75 bps increase is also okay; I doubt a 100 bps hike is called for

·         Soon, we must receive reports on inflation that are less unpleasant

·         It wouldn't be unexpected if the jobless rate increased to around 4.25 percent

·         We have to be mindful that inflationary pressures may be broadening out

·         I think the unemployment rate will stay below 4% this year

·         I have slightly revised my estimates for this year's economic growth, now likely looking at 1% or less

·         It is important to keep an eye on where monetary policy has to go over the medium term

·         By the end of the next year, I predict that the policy rate will be between 3.75% and 4%

·         A recession is unhealthy, as is such high inflation

·         With economic growth near trend, I see the unemployment rate remaining below 4.5%

·         If the inflation rate doesn't decrease over the upcoming few months, we might have to reconsider raising the rate

·         There is a chance of a soft landing, but there are numerous risks

·         Monetary tightening into next year is still expected to result in a constrictive environment but allow for a rather robust labor market

·         I am still hopeful that we can do a 50 bps hike in September and then continue with 25 bps rate hikes until the beginning of the second quarter of 2023

·         Once we reach a slightly restricting level, a softer ascent might be a suitable course, but it depends on the facts

·         We may get a soft landing, but there are a lot of risks

·         We need to start getting less ugly inflation reports soon

The Chicago Fed President Evans prefers +0.50% rate hikes in September followed by +0.25% moves in the rest of 2022 till mid-2023.

On Tuesday and Wednesday Fed’s Daly said:

·         I do not anticipate a substantial increase in the unemployment rate

·         I anticipate a modestly cooled-off labor market

·         Work on inflation is nowhere near almost done

·         We have a long way to go on the task

·         We're looking for incoming data to decide if we can downshift the rate hikes

·         I anticipate a slower economy here

·         My modal outlook is we raise interest rates and hold them there for a while

·         Evaluating incoming data to determine whether to slow down rate increases or keep them going at the current rate

·         It would be a mistake to get overconfident that we have already found the solution

·         A respite will come from the decrease in gas prices, and the housing market stalling is also a good indication

·         There is a long way to go on that task

·         We remain steadfast and entirely committed to attaining price stability

·         The job on inflation is far from finished

·         We have a lot in the pipeline in tightening but are yet to see that in data showing a slowing of the economy

·         Consumers want to see directional improvement, not getting prices lower than they were some months ago

·         This is a journey, not going to happen overnight

·         I expect the unemployment rate to rise a bit as we slow the economy

·         I don't see people experiencing recession right now

·         Not sure if jobs data due this week will show an easing of hiring yet, still demand workers outstripping supply

·         Haven't seen a single piece of data yet indicating we're near a pain point on joblessness

·         About 50% of the elevated inflation we're seeing is from demand factors, 50% from supply factors

·         Firms are reducing vacancies, not laying off workers en masse, which supports optimism for a soft landing

·         A 50 bps hike would be a reasonable thing to do in September but if we see inflation roaring ahead undauntedly then perhaps a 75 bps hike would be more appropriate

·         Keeping rates high for a while could go longer than the period markets have begun to price in for rate decreases

·         3% inflation is still too high, which is why we have a 2% average goal

·         I don't think we should raise rates quickly and dramatically simply to decrease them a few months later

·         We're not even in neutral yet

·         I am optimistic that we can bring inflation down while avoiding a deep recession

·         Nothing in the lines of sight right now indicates that a soft landing is not possible

·         I do not consider rate hikes from this point to be restrictive, but rather 3% rather than 2.5%

·         Not every hike is into restricted territory

·         The first signs of inflation progress must be visible in the data

·         In my book, 3.4% is a feasible rate for us to reach by the end of the year

·         We are not finished fighting high inflation

·         I haven't seen a single piece of evidence showing that we're approaching a tipping point in terms of joblessness

Overall, the SF Fed President Daly prefers +0.50% rate hikes in September followed by +0.25% each in November and December unless inflation further surges abnormally

On Tuesday and Thursday Fed’s Mester said:

·         I believe unemployment will rise as we progress through this cycle, but we need to have that happen to make sure we get back to price stability

·         I haven't seen any evidence that inflation has even begun to level off

·         Since the inflation has not changed, we still have work to do

·         These are unusual and difficult occasions to successfully read data

·         Typically, a recession coincides with a worsening job market, but that is still a pretty significant indicator

·         Investment, consumer expenditure, and housing are all starting to decline

·         Currently, you must use some caution when using models from the Fed

·         We are dedicated to controlling inflation

·         Inflation has not decreased at all

·         We'll be growing below trend this year

·         There hasn't been a significant decline in US activity

·         Currently, the US labor market is in great shape

·         The US doesn't have a slowdown in its labor markets

·         I don't think there is a recession right now

·         We have more work to do because we have not seen that turn in inflation

·         It's got to be sustained several months of evidence that inflation has first peaked - we haven't even seen that yet - and that it's moving down

·         A soft landing is still possible

·         Recession risks have increased

·         We are not in a recession right now

·         We must accept supply limits as a given because they are likely to persist for some time

·         Companies I've spoken with are still having difficulty finding workers

·         I need to see several months of falling inflation

·         However, moderating demand is not affect inflation yet

·         Evidence that our demand-side policy is working

·         Given the size of the balance sheet, we should consider selling some MBS

·         Higher interest rates are needed to reduce demand

·         I don't think the yield curve is a good predictor of where the economy is headed

·         The magnitude of future rate hikes will be determined by the course of inflation

·         We must accept supply limits as a given because they are likely to persist for some time

·         We aim to reduce our balance sheet to $6.5-$7 trillion. However, we do not know the ultimate size. Once there, we will have to see

·         I aim to reduce the balance sheet to $6.5-$7 trillion

·         Companies I've spoken with are still having difficulty finding workers

·         My rate path could be more frontloaded and data dependent

·         However, there are lessons to be gained in not having so stringent forward instructions in the future

·         We need to witness several months of monthly changes lowering inflation

·         We will need to raise interest rates and then maintain them for some time

·         Business contacts tell me that they are not looking for as many workers as they were previously

·         However, these are simply preliminary indications. The labor market remains robust

·         Interest rates are expected to climb further this year and throughout the first half of next year, after which they will likely begin to fall

·         I would pencil in going a bit above four as appropriate

·         It's not unreasonable I think to maintain that as where we're getting to and then we'll see

·         It's not unreasonable to think we might have to do a 75 (basis point move) but I can imagine it could be a 50. We'll just have to look at the data as it comes in

Overall, the Cleveland Fed President Mester batted for +0.50%/0.75% rate hikes in September followed by +0.50% each in November and December for an above 4% terminal rate by Dec’22.

On Wednesday, Fed’s Bullard said:

·         We're going to move inflation back to 2% over time

·         I still want to get to 3.75 to 4% this year; I prefer this type of frontloading

·         US jobs market is so strong

·         US job growth is slowing to a trend pace

·         I still think we'll get positive GDP growth in the second half of this year

·         The second quarter slowdown was more concerning than Q1

·         With the job growth in the first half, it's hard to say that there's a recession

·         The US is not in a recession right now

·         Fed will continue raising rates until it sees compelling evidence that inflation is falling

·         I expect another 1.5 percentage points or so in interest rate increases this year

·         I think we’ll probably have to be higher for longer to get the evidence that we need to see that inflation is turning around on all dimensions and convincingly coming lower, not just a tick lower here and there

·         We’re not in a recession right now. We do have these two-quarters of negative GDP growth. To some extent, a recession is in the eyes of the beholder

·         With all the job growth in the first half of the year, it’s hard to say there’s a recession

·         With a flat unemployment rate at 3.6%, it’s hard to say there’s a recession

·         We’re going to follow the data very carefully, and I think we’ll get it right

Overall, the St. Louis Fed President Bullard batted for +0.50% rate hikes in September, November, and December unless inflation further accelerates.

On Tuesday, Fed’s Barkin said:

·         Recession worries are incongruous with job growth

·         The Fed can control inflation, but a recession is possible

·         The rate of inflation normalization is unpredictable

·         Returning to normal surroundings doesn't have to necessitate a precipitous drop in activity

·         The Fed is credible in delivering lower inflation

·         Fed may not get help from global events and supply chains but it has the tools and credibility to deliver that outcome

·         Expect inflation to come down but not immediately, not suddenly and not predictably

·         Seeing inflation coming down due to flattening demand, supply chain improvements, and easing of commodity pressures

·         Recession fears are a little inconsistent with monthly jobs growth of nearly 400,000, a 3.6% unemployment rate

·         Returning to a normal environment doesn't have to require a calamitous decline in activity

·         We are committed to returning inflation to our 2% target and have made clear we will do what it takes

   On Thursday, Fed’s Kashkari said:

·         We still need to get inflation down to 2% in a supply-constrained world

·         It will most likely take several years to return inflation to 2%

·         According to the best available data, inflation expectations remain anchored

·         A soft landing is possible, but we don't know how likely it is

·         There will eventually be a tradeoff between employment and inflation

·         I'm unsure what markets are looking at

·         The more likely scenario is that we hike rates and sit there

·         It's a highly implausible possibility that the Fed will decrease rates next year

·         The Fed may activate a counter-cyclical buffer for banks

·         More capital for US banks is likely to necessitate a congressional act

·         It is high time the Fed makes full use of its tool

·         Fed moved too slowly in 2021 in tackling high inflation

·         Inflation is dragging wages up rather than the other way around

·         Wages are climbing; the risk of this goes to a wage-driven inflation story

·         Concerning inflation is spreading; we need to act with urgency

·         We are laser-focused on getting inflation down

·         Very unlikely scenario Fed will cut rates next year

·         The more likely scenario is we raise rates and then sit there

·         I am not sure what markets are looking at

·         Where will eventually be a tradeoff between employment and inflation

·         The best data we have says inflation expectations are still anchored

·         It will probably take several years to get inflation back to 2%

Conclusions:

Fed is set for +0.50% or +0.75% rate hikes in September depending on the inflation trajectory. Then Fed may go for +0.25% or +0.50% rate hikes in November and December subject to the inflation trajectory. Fed may also go for +0.75% rate hikes in November and December if inflation accelerates further.

Overall, the Dec’22 terminal rate may be +4.00% to +4.75% as per the actual inflation trajectory, if Russia-Ukraine/NATO geopolitical tensions and subsequent economic sanctions continue. Moreover, if China invades Taiwan, then it will result in another wave of economic sanctions and supply chain disruptions, resulting in elevated inflation.

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