It will be the third 75 bp hike in a row and take Fed funds to the highest since 2008
|Outlook: The Fed meeting starts today. We get housing starts and building permits, and Canadian CPI data (all three versions).
Ahead of the Fed rate announcement (and dot-plot) on Wednesday, the 10-year yield surpassed the June high at 3.514%, if briefly, and then surged ahead overnight to an even higher number.
Only a little weirdly, most currencies rallied in what could be a hint of a monstrous pullback Tuesday. If so, this suggests everyone has already positioned for the 75 bp Fed rate hike and willing to exit early. This is the phenomenon of “everyone who was going to buy has already bought.”
We continue to buy the consensus story that it will be 75 bp (and not 50 or 100) because the Fed shies away from surprising the delicate markets like a cat from a snake. It will be the third 75 bp hike in a row and take Fed funds to the highest since 2008.
More interesting will be the dot plot showing where the FOMC members see rates by year-end, likely 4%, and next year, likely 4.5%. What about inflation and GDP growth (not to mention unemployment)? The financial press is curiously silent on what the new numbers will show but firm in the opinion that the June dot-plot was far too low, maybe ridiculously so. The June projection for inflation at 5.2%, for example, will certainly revised higher. As for the soft landing with GDP around 1.2-1.7%%, bah. But can the Fed project recession? Not likely.
The market is coming to accept that even if we have seen peak inflation, this year is not going to see the start of easing. That will have to wait for 2023 and likely the second half. Before then, we could even get another 75 bp at the November meeting if inflation fails to respond the way the Fed would like—to the Fed, credibility is the name of the game as much as meeting the mandates.
And when it comes to housing, which is one-third of the CPI, the Fed is not doing anyone any favors. Bloomberg’s Authers notes that “The housing market is a critical area where tighter monetary policy can have a big effect, with a lag. Turning to the rental market, Zillow’s index of the rate of inflation in leases taken out each month is inflating much more slowly than at the peak last fall. The bad news for the Federal Reserve, and for those thinking of renting a house, is that monthly inflation continues to be significantly greater than it was in the years before the pandemic. There is a way to go before rental inflation (which accounts for about a third of the Consumer Price Index) is stamped out as the Fed must wish.” See the chart.
Across the Atlantic, sterling is weighed down by the prospect of vast new budget deficits to pay for energy cost subsidies without windfall taxes on suppliers, not to mention dock strikes and another railroad strike, probably. In Germany, the government agreed to spend a ton of money to build up gas storage even more. Bloomberg reports “Initially, 1.5 billion euros ($1.5 billion) had been set aside for gas buying, but with that funding nearly exhausted, the government has added another 2.5 billion euros, according to a document seen by Bloomberg. Altogether, credit lines of as much as 15 billion euros were set aside to fund the purchases.” The question remains of whether this gets the country through this winter, with Russian supplies cut off in December, but doesn’t help at all for the following year, hence “too short-term.”
We remain puzzled by the euro’s resilience and the seemingly excessively pessimistic view of the pound. Nobody knows what to think about the yen. And emerging markets are peculiar. Yesterday the peso jumped for no reason to be found in the US press (and the traders aren’t talking). We must, unfortunately, expect excessive volatility tomorrow. If the dollar follows the Swedish currency, a jumbo rate hike is not necessarily followed by a currency gain with any lasting power.
Tidbit: Gold holders are in distress. With inflation high everywhere, why is gold falling? It’s supposed to be a haven against inflation. Well, one reason is falling demand from big buyers in India and China, including retail. But the real reason is likely the rising and perhaps too-strong dollar. Bloomberg has a cute editorial saying “… long-term price protection shouldn't be confused with short-term price stability, and on the latter case, bullion has a very patchy track-record. In fact, gold prices tend to be very weakly correlated with a whole range of assets, but with a strong inverse relationship to the dollar. And right now, even on a very long-term basis, it looks highly priced on an inflation-adjusted basis.” See the nifty chart.
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