Outlook: Today we get new homes sales, the Conference Board consumer confidence, and the Richmond Fed manufacturing index—nothing of much interest to FX except maybe consumer confidence. We have pretty much lost all confidence in polls and surveys but when they influence others, need to be heeded.
Likely getting some attention today will be JP Morgan chief Dimon telling the Times of India that the world is not ready for a worst-case scenario in which the Fed takes rates to 7% and we get stagflation.
Bloomberg reports: “Dimon, who has said rates may need to rise further to fight inflation, added that the difference between 5% and 7% would be more painful for the economy than going from 3% to 5% was.
“…. If the key rate climbed to 7%, it would have serious implications for American businesses and consumers. Already, economists put the probability of a US recession over the next 12 months at 60% — and that’s more optimistic than Bloomberg Economics’ prediction of a slump as soon as this year.
“A rate of 7% would douse recent optimism among Fed officials about their ability to engineer a soft landing in the economy with the unemployment rate still very low at 3.8% and signs of prices easing. ‘Going from zero to 2% was almost no increase. Going from zero to 5% caught some people off guard, but no one would have taken 5% out of the realm of possibility,’ Dimon said. ‘I am not sure if the world is prepared for 7%.’”
Separately, Minneapolis Fed Kashkari said he expects one more hike this year. And this guy used to be a dove. Chicago Fed Goolsbee was also hawkish, reminding us that the Fed can’t be seen to undershoot.
Dimon’s 7% is going to be seen in the rearview mirror as fear-mongering, although it must be admitted the probability is not zero. The bond market is on fire. The 10-year hit a 16-year high at 4.566% overnight, or up 25 bp in just a week, as Reuters reminds us. “As Deutsche Bank notes, this is historically significant territory as the average of the 10-year yield going back to 1799 is around 4.50%.” We’re not sure historical comparisons are useful, but it’s a cool comment.
And the 30-year is up more than 30 bp in just one week to a 12-year high of 4.6840%. Even TIPS is getting in on the act, up 26 bp to 2.20%, the highest since 2009. “Significantly, this is shifting the deeply-inverted 2-to-10 year yield gap-- which has for more than a year indicated recession ahead but which now looks to be closing that negative spread to its smallest since May.”
If Dimon’s worst-case forecast comes true, these moves will seem reasonable. If not, then they will appear the product of hysteria and need to get taken down a peg. Nerves are fraying.
But let’s return to the Fed, which is as close to a “manager” of the economy as we can get. The important message from the Fed is that “higher for longer” means a plateau of high rates and not a sharp peak with quickly descending rates. We do not know, and nobody knows, how long the Fed would have to keep rates at the plateau while we wait for lags and other adjustments to catch up and deliver a sustained move in inflation in the right direction and to the right level. We may still be recovering from the excessive inventory build that followed the supply chain shortages, or some other semi-cyclical thing might be going on that nobody has identified as central. The Fed may acknowledge these while still sticking to its knitting. And yet rates at 7% seems ridiculous.
In a way, the almost certain government shutdown is an anti-growth respite. We get the Atlanta Fed GDP Now tomorrow. It was over 5% for a while and 4.9% last time. It’s not the only GDP forecast out there but has recently gotten a lot of attention. The Dimon worst-case scenario depends on growth being abnormally high considering the rate hikes. It’s not a little strange to be hoping for lower growth.
Forecast: Price changes are still modest, as expected, but anticipation of something Big is on the rise, in part because of so many overbought/oversold conditions.
We still worry that a possible blow-up is brewing in the yen. Japan declined to deliver with intervention or a nudge off zero and seems not to mind dollar/yen perilously close to 150 again. This was the round number that likely set off the MoF last fall. Similarly, nobody knows whether the ECB will stay in step with the Fed—one more hike this year—although chief Lagarde said so yesterday. European inflation on Thursday may be no help.
Bottom line, uncertainty everywhere you look and that is dollar-supportive, overbought or not.
Tidbit: If the US government is shut down, as now seems the most likely outcome of the stupid things going on in Congress, the cost is higher than just federal employee salaries, although that’s a big number (over 400,000). Museums and national parks will close. Consumption will fall. Our economic data will be delayed (oh, dear).
Food will not be inspected for safety. Other federal safety regs will go unexamined and unenforced. You think the feds over-regulate? Just wait ‘til the bridge you are driving on falls into the river or the chemical factory down the road explodes or your kid catches salmonella.
Of most interest to us is a possible credit rating downgrade, as Moody’s warned yesterday. Strangely, even a downgrade may not do much hard to the dollar—it’s a risk, and safe-haven buyers flee risk even it means buying into the source of the risk. This is one of our top cases of FX perversity.
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