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Dow Future made a panic low around 31148.00 Thursday on the concern of faster Fed tightening and resultant economic hard landing. On Thursday, Dow Future made a session high around 31893.00 after less hot core PPI data, which may be an early indication of easing of core inflation that can prevent the Fed from bigger rate hikes. But Dow Future stumbled; Gold also slips after weaker than expected auction of 30Y bond, which may indicate a sign of slowing economy/stagflation in the coming days. The when-issued coupon rate for 30Y UST was +2.997%, the highest since +3.014% in Mar’19 and well above last month’s +2.815%.
On Thursday, the market focus was also on U.S. PPI data for April as it may be a proxy for inflation trend in the coming months. The BLS flash data shows U.S. headline PPI (Producer Price Index) eased to +11.0% In April from +11.5% in March, but higher than the market expectations of +10.7% (y/y). On a sequential basis (m/m), the U.S. PPI eased to +0.5% in April from +1.6% recorded in March and is in line with market expectations.
The U.S. core PPI eased to +8.8% in April from +9.6%, a record high in May, and below market expectations +8.9% (y/y). On a sequential basis, the U.S. core PPI also eased to +0.4% in April from a record high of +1.2% in March and below market expectations of +0.6%.
The average sequential core PPI rate is now around +0.74% in 2022 (till April) against +0.70% in 2021 and +0.10% in 2020. Fed needs +0.10% sequential rate in core PPI on a sustainable basis for +0.17% sequential rate in core PCE price index, equivalent +2.0% price stability (inflation) targets. Although it may be too early, the market is now expecting some easing of core PCE/CPI from June after a substantial fall in sequential core PPI rate in April.
On Thursday, Fed’s Daly said:
· The robust economy can withstand 50-basis-point rate hikes
· The April CPI data was not particularly surprising
· I still want to reach a neutral rate of 2.5% by the end of the year
· I would like to see a continued tightening of financial conditions
· The economy has a lot of momentum, and the labor market is very strong
· The debate between 50 bps-75 bps is not a primary consideration
· Going up in 50 bps increments makes quite a bit of sense
· There is no cause to change course for 50 basis points at the next two meetings
· My modal outlook is that we'll have a soft landing-- with the U.S. economy slowing to below its trend growth rate but not tipping into recession
· If there is a recession---it will be short and mild, a matter of a couple of quarters with growth just a tiny bit below zero and not enough to derail a longer-term expansion
· At the same time, businesses and households find it comforting that the Fed is raising rates. Doing so, will not just help bring down inflation that is too high, but will also serve to slow a frothy labor market
· It's premature to judge how far rates will ultimately need to rise---I will be assessing the economic impact of tighter U.S. monetary policy, Russia's war in Ukraine, and the state of supply chains
The SF Fed President Daly, a known dove, also sounded more dovish or rather than less hawkish as she advocated for +0.50% rate hikes in June and July along with a neutral rate of +2.50% by Dec’22, lower than the current market pricing of 2.75-3.50%.
On Thursday, Fed Chair Powell also popped up in an unscheduled interview to calm market apprehension of bigger (+0.75%) hikes at least in June and July.
· The labor market is healthy apart from abnormal wage growth not consistent with 2% inflation. This is a result of higher demand and lower supply of labor force
“That part of it is healthy. No, certainly from the standpoint of a worker, you see people able to change jobs, the level of people quitting to go find jobs that they prefer that pay better, maybe they’re doing the same thing but for a competitor. The quit level’s at an all-time high and wage increases are very high. You know, of course, all of us think that’s great.
When I said unhealthy, what I really meant was that there’s an imbalance between demand and supply, and companies can’t find workers. They just, there aren’t the workers. There’s more demand than there are people to supply their labor. So that’s not a healthy situation for an economy because it results in high inflation. That’s a significant part of the inflationary story.
So what we want is wages that are consistent with 2% inflation. You know, workers now are seeing their paycheck eaten up by inflation, particularly people at the lower end of the income spectrum. And, you know, that’s not a good situation, that’s not a healthy situation. A healthy situation is when supply and demand are more close to being aligned, and inflation is back down to our goal.”
· Fed may be a little late in liftoff, but certainly not behind the curve, considering the reality of the situation
“So the way I’d put it was this: We were — if you go back to the economy of February of 2020, right before the pandemic, 3.5% unemployment, inflation right on target, a little below 2%, and the economy is growing at a couple of percents. It’s a nice place. Since then, we’ve been hit with, you know, the first pandemic in 100 years, a global pandemic. And then a very, very strong response, both from fiscal authorities and from us, followed by the outbreak of inflation, followed by the war in Ukraine, followed by, now, the big shutdowns all over China. So we’ve really been hit by a series of global, really, inflation, inflationary shocks.
And so all around the world, you’re seeing economies that are struggling with high inflation. Many, many countries around the world are having the highest inflation they’ve had in 40 years and struggling with the exact same things we are. So there’s a lot of commonality, but there are some differences. But you know, Kai, I have said, and I will say again that, you know, if you had perfect hindsight you’d go back and it probably would have been better for us to have raised rates a little sooner. I’m not sure how much difference it would have made, but we have to make decisions in real-time, based on what we know then, and we did the best we could. Now, we see the picture clearly and we’re determined to use our tools to get us back to price stability.”
· Fed will try to ensure a soft landing while controlling inflation
“I think it’s a very challenging environment to make monetary policy. And we certainly, our goal, of course, is to get inflation back down to 2% without having the economy go into recession, or, to put it this way, with the labor market remaining fairly strong. That’s what we’re trying to achieve. I think the one thing we really cannot do is to fail to restore price stability, though. Nothing in the economy works, the economy doesn’t work for anybody without price stability. We went through periods in our history where inflation was quite high. This was back in the ‘70s, and I was old enough to remember. I’m old enough to remember that very well. And we really, we can’t fail to restore price stability.”
· Powell denied he took off about +0.75% rate hike possibility in his May post-meeting presser and he only said the FOMC was not actively considering about +0.75% hikes for May, June, and July meetings, but actively considering +0.50% hikes. Looking ahead, Fed may also hike by +0.25% or +0.50% or even +0.75% in September, November, and December depending upon the actual inflation data; if inflation is higher than expected, then-Fed the may hike by +0.75%; if it is lower than expected, then may hike by +0.25% and if stays at the current pace, then +0.50%
“Well, actually, what I ---what I said was that we were, that the committee had decided —“
“I said we weren’t actively considering that (75 bps increase). But I said what we were actively considering, and this is just a factual recitation of what happened at the meeting, was a 50-basis point increase, that’s a half a percentage point increase, the first one in more than 20 years. And that we thought that if the economy performs about as expected, that it would be appropriate for there to be additional 50-basis point increases at the next two meetings, so. But I would just say, we have a series of expectations about the economy. If things come in better than we expect, then we’re prepared to do less. If they come in worse than when we expect, then we’re prepared to do more.”
· Powell didn’t downplay the possibility of +0.75% rate hikes when asked about ‘prepared to do more’ comments. FOMC will take an appropriate decision depending upon the incoming inflation data and the evolving outlook
“What you’ve seen is, you’ve seen this committee adapt to the incoming data and the evolving outlook. And that’s what we’ll continue to do.”
· Soft landing means getting inflation under control by hiking while ensuring there is no recession and the labor market remains strong by a historical standard; i.e. unemployment rate does not jump too much above 4%. But such a soft landing is quite challenging and not guaranteed
“So a soft landing is, is really just getting back to 2% inflation while keeping the labor market strong. And it’s quite challenging to accomplish that right now, for a couple of reasons. One is just that unemployment is very, very low, the labor market’s extremely tight, and inflation is very high. So it will be challenging, it won’t be easy. No one here thinks that it will be easy.
Nonetheless, we think there are pathways, as you mentioned, for us to get there. And really what that means is just as we raise rates, we — so the problem, what causes inflation, is that demand and supply are out of whack. There’s too much demand. For example, in the labor market, there’s more demand for workers than there are people to take the jobs, right now, by a substantial margin. And, because of that, wages are moving up at levels that are unsustainably high and not consistent with low inflation. And so what we need to do is we need to get demand down, give supply a chance to recover, and get those to align.
So how might we do that? Right now, in the labor market, there are two job openings for every unemployed person. It’s historically high-level. So in principle, and I’m not saying this will be easy to do, in principle, you could moderate demand, reduce demand to the point where job openings move down substantially, and the labor market gets much closer to being in balance. And that would affect wages--- would still be moving up at healthy levels. They wouldn’t have to go down, but ultimately they would be at levels that would be consistent with 2% inflation.”
· Fed is not frustrated as it only controls the demand side of the economy; not supply and fiscal policies; Whether Fed can execute a soft landing or not may depend on factors that Fed doesn’t control
“I wouldn’t put it as frustrated. You know, I’m really honored to be able to play this role. And I just would, I guess I would say it this way: What we can control is demand; we can’t really affect supply with our policies. And supply is a big part of the story, here. But more than that, there are huge events, geopolitical events going on around the world that are going to play a very important role in the economy in the next year or so.
So the question whether we can execute a soft landing or not- may actually depend on factors that we don’t control. But we should control the controllable. And what we control is there’s a job to do on-demand, demand is out of whack with supply, as I mentioned, in the labor market, there’s more demand than there are people to satisfy that demand. And we can address that directly, and we will by trying to, you know, moderate demand in a way that lets the labor market get back in balance and help inflation get back to 2%.”
· Allowing high inflation would mean a much deeper downturn; ultimately, it would be more painful if Fed doesn't deal with high inflation and let it get entrenched
“You know, I just would say it this way: The committee and I are firmly committed to getting inflation back down to 2%. And the reason is that the economy doesn’t work for anyone unless you do that if you think about it. High inflation is not consistent with a great labor market; it’s not consistent with a sustainable level of employment. It doesn’t work for anybody. So we really, price stability is the bedrock, in some sense, on which the economy has to rest, and we’ve had it for a long time. We suddenly are hit by all these shocks and, like others around the world, we’re struggling to restore it, but restore it we will.”
· The process of getting inflation down to the fed's 2% goal will include some pain to the labor market (like job loss) and the overall economic activity; i.e. economy may slow down
“We fully understand and appreciate how painful inflation is, and that we have the tools and the resolve to get it down to 2%, and that we’re going to do that. I will also say that the process of getting inflation down to 2% will also include some pain, but ultimately the most painful thing would be if we were to fail to deal with it and inflation were to get entrenched in the economy at high levels, and we know what that’s like. And that’s just people losing the value of their paycheck to high inflation and, ultimately, we’d have to go through a much deeper downturn. And so we really need to avoid that.”
· Fed has the tools to get inflation under control and will do that. Thus Fed is communicating with the market and the U.S. public that inflation will be under control
“Well, I hope we are. So you know, most of the people who listen to the press conference and follow our communications very carefully are market participants or economists, Fed watchers of various kinds. And I thought it was important to try to speak directly to the public that we serve and tell them that we understand that inflation is very painful, that the Fed is accountable to get inflation down to 2%, and that we have the tools and we have the, you know, the strong desire to get inflation under control. And we’ll do that.”
· Fed will ensure no ‘Volcker shock’ therapy and a recession because the underlying economic and political situation is quite different. But like Volcker, now Powell will also not take any path of populism
“Yeah-- So that’s a good point. I do admire Paul Volcker. I think everyone admires Paul Volcker now. So I’m not to be singled out in any way for admiring him, you know. He was a truly great public servant and person. And the point was that he did what he thought the right thing was, and he was prepared to be unpopular for that, because he was looking at the medium and longer-term, well, for the country. And I don’t have any, you know, I think that’s a good thing to keep in mind as you do public service jobs, is don’t think about what’s popular, do what you think is right and let everything else take care of itself. I take it as a general principle. It doesn’t provide any; it doesn’t shed any light on the current situation. We have to make an assessment of what the right thing to do is in the current situation. We know that what Paul Volcker did was right in his situation, and it’s something like that might turn out to be right here. But I don’t think we know that. I think we have a lot to learn about what the path ahead looks like.”
· Powell’s five words mantra: “get inflation back under control.”
On late Thursday and Friday, Wall Street recovered from ‘bigger rate hikes’ panic low after Powell reiterated that Fed has no plan to hike by +0.75% in June and July despite higher sequential reading of core CPI in April as the Fed will not take decision barely one or two months of data. Fed will consider at least one-quarter of inflation data and evolving outlook for the next quarter. Thus Powell also didn’t take off the possibility of +0.75% rate hikes in September, November and December. Powell clarified that for these three meetings, Fed may hike at lower rates (+0.25%), if core PCE inflation data comes lower than being expected by the Fed, but may also hike at bigger rates (+0.75%) if it comes higher. And if inflation data continues to come as elevated as currently, then Fed will also continue to hike @+0.50% in September, November and December.
Thus, Fed will now watch actual core PCE/CPI inflation data for April-August/September and depending upon the data and evolving outlook may hike by +0.25% (if inflation eases significantly), +0.50% (if inflation does not ease or accelerate significantly) and +0.75% (if inflation accelerates further significantly). Thus the estimated neutral rate may be +2.75% or +3.50% or even +4.25% by Dec’22. But 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 as a +4.25% neutral rate may invite another ‘Volcker Recession’, which Biden/Democrats may not allow ahead of Nov’24 Presidential election.
In any way, before Nov’24 election, Biden has to face Nov’22 mid-term election, in which he is set to lose the trifecta. Powell also knows that unless the problem of supply chain distortion and elevated commodity prices normalized because of Russia-Ukraine/NATO geopolitical tensions and economic sanctions, it will be very tough to bring down inflation by solely curtailing demand. This will also result in an economic hard landing/stagflation or even an outright recession, negative for Biden in Nov’22 mid-term election.
Thus Powell virtually called for a resolution of the Russia-Ukraine war. And on Friday, in an unexpected move, U.S. Defence Secretary Austin (who is leading the U.S. proxy war against Russia) called his Russian counterpart and urged for an immediate ceasefire and to keep the communication channel open. This also follows after Russia threatened an all-out Nuclear war (WW III) for U.S./NATO proxy war against Russia by continuous supplies of military equipment, training and providing mercenaries to fight for Ukraine against Russia.
Despite a die-hard attempt by French President Macron and German Chancellor Scholz for a negotiation/ceasefire between Russia and Ukraine, nothing is happening as Ukraine/Zelensky admin will do nothing without the tacit approval of Biden admin. For any peace/ceasefire agreement between Russia and Ukraine, active participation and willingness of the U.S. are essential. Although Biden will use the anti-Russia narrative in the Nov’22 mid-term election to restore his falling approval rate/popularity, he may not linger Russia-Ukraine war further as it’s already affecting the U.S. as well as the global economy significantly contrary to earlier perception.
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