The narrative of the July hike being “one and done” is a story, not a certainty

Outlook: This week the big data will be retail sales and maybe existing home sales. Remember that retail sales do not reflect consumer confidence or conduct because it excludes services, where the spending is going these days. We also start getting the regional Fed surveys, starting with the Empire State (New York), but they are not FX movers. The Fed backout period begins today ahead of the FOMC on July 25-26. As we know, the probability of a hike is over 90%--that’s what they said they would do, and can’t back off now or get charged with being flighty. But the probability of additional hikes this years has fallen to impossibly low numbers, which accounts for most of the flight from the dollar.

This week we also get inflation from Canada, the CPI and retail sales from the UK and weirdly important, labor market data from Australia.

Everybody and his brother is stunned by the dollar getting attacked so viciously, to the lowest since last November. The FT writes “An index tracking the currency against a basket of six peers has fallen 2.2 percent over the past five sessions, its worst run since it dropped 4.1 percent in a week in November.” As ING puts it, it’s now a “disinflationary narrative.” UBS concurs, saying “recent dollar weakness will persist.”

On top of the disinflationary narrative, the yield curve inversion still says recession is on the way. The yield curve inverted for good a year ago in July 2022, meaning a recession “should” follow about a year later—unless it’s a so-called false positive. As Kindleberger remarked decades ago, an inverted yield curve has predicted 37 of the last three recessions. While today the inversion has moderated, it’s still there.

But the Fed doesn’t consider it a crystal ball and there is no evidence it looks at it at all. Important Feds like St. Louis Pre Bullard have stopped talking it entirely. Besides, as we keep pointing out, the Atlanta Fed continues to report GDP growth at about 2.3% (as of July 10) and we get another estimate tomorrow. Granted, that’s for Q2 but note that even the grouchy Blue Chip forecast is over 1% now, up from zero in March. Recession? What recession?

We keep bringing up these basics because the narrative of the July hike being “one and done” is a story, not a certainty. We are not hearing from Fed officials that they fear over-tightening. Instead we hear only that while the Fed will be data-dependent, it intends to keep tightening. And the recent drop in some measures of inflation are nice but do not suffice because they don’t meet the 2% requirement, which has to come from the PCE deflator anyway and we don’t get that until next week.

So it’s premature to say the Fed is nearly done and therefore out of the running against other central banks that are credibly expected to keep hiking. Finally, the risk-off mood can conceivably be squashed by an Event from left field.

Besides, we have a fair amount of uncertainty about those other central banks. The Bank of Japan is now expected to alter the zero-base policy in the fall, that expectation getting pushed out every meeting since Mr. Ueda came in. As for the UK, its messaging has been less than satisfactory. Reuters reports the BoE has been reluctant to tell the truth about the outlook for inflation, which has been worse than for others (for reasons having to do with energy costs, among other factors). And it has changed the story from time to time, confusing traders and raising the volatility of bonds to the highest among G7. For an analysis of how central bank transparency, or lack of it.

Forecast: The market showed some pullback on Friday in most currencies, with the euro the exception. It’s still pressing and exceeding the B band and linreg channel tops, which tends not to persist for long. Price never move in a straight line indefinitely. We are still looking for a pullback Tuesday or sometime soon, but beware, this is the minority view. 

Tidbit: Finally, somebody else sees something we wrote ago years ago—that the pandemic and its inflation effect is critical and far more important than money supply, wage push, QE/QT or wild Covid payments to everyone. Bloomberg’s “Odd Lots” points out that those of us old enough to remember the 1907’s inflation, including the Feds, are inclined to see that history repeating. But the better historical example is the Spanish Flu epidemic of 1918, the second-deadliest pandemic in human history. “It initially caused prices to spike but was then followed by a period of double-digit deflation.” We can thanks a guy at Macquarie Capital for the work.

Sticking to the 1970’s concepts and policies risk making a big, fat mistake. This zeroes in on the risk of under-tightening having come the main fear. We quite like the chart, although we don’t but the story in its entirety. For one thing we are at war now, whether we think the absence of American boots on the ground negates that idea, whereas in 1918, the first world war was ending. For another, we have women in the workplace, a whole lot less Jim Crow, and a lot of tech replacing humans, not to mention far more safety regulations, plus globalization that cuts prices. In 1918, about three people in America had heard of Vietnam or Malaysia, and now we get out socks and T-shirts from there. 

So which to believe, the 1918 model in Tidbit 1 or Tidbit 2 that says inflation is sticky and going to stay stickier than the headlines suggest?  

Tidbit: Reminder—don’t forget that core PCE inflation is still sticky. Last week it came in at 4.62%, lower than the month before, but it was 4.88% the year before.  For perspective, see the one-year core PCE vs. the 5-year. Still think the Fed will relent? We are going to keep these charts up for the sake of context. Remember them the next time someone says “higher for longer” is a dead duck.  

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