Is it the Fed raising rates?

Outlook: This week we get a slew of real estate data in the US (starts and permits tomorrow, exisitng homes sales on Wed, and new homes on Friday), plus PMI’s from several countries and Germany’s IFO on Friday. In the US, the big event is the Fed policy meeting that concludes on Wednesday with expectations running high of the tapering announcement but no timetable.

A bunch of other central banks meet, too, including the BoE and BoJ, both expected to stay on hold. The Norges central bank of Norway will likely keep to its word as raise rates, the first G10 country. Other central bank meets are scheduled in the Sweden, Indonesia, Hungary, Swiss National Bank, the Philippines and Taiwan.

In the US, the Fed can easily skate over bad data, like the disappointing jobless claims–and stick to its story–growth is picking up, jobs will follow and have followed enough already, and inflation is only transitory. The bond gang is on its toes but not throwing a tantrum, despite the deficit and the debt ($28.78 T as of Saturday vs. GDP at $22.73 T in Q2). Weirdly, it’s Dems worrying about the deficit these days; the budget ends on Sept 30 and everyone expects a “continuing resolution.” The House vote is this week but the Senate vote is scheduled for Sept 27 when existing budget approvals end on Sept 30.

Today TreasSec Yellen has an opinion piece in the WSJ calling for Congress to raise or suspend the debt ceiling because we will run out of money in October, with the exact date not known due to cash flow estimates being iffy. There is some small chance the Plubs will create a crisis. Again. Good grief. But note that back in the day when running out of money was a real issue (Clinton Administration), the dollar barely burped. We watch it anyway, but it’s not really important to FX as an expectation. Yet. It’s amusing that Bloomberg reminds us of the escape hatch of the Treasury minting a trillion-dollar platinum coin to pay its bills. Sounds silly but it would be legal. We sort of wish TreasSec Rubin had actually done that to end political shenanigans over the budget. (He borrowed from the Social Security trust fund instead).

Since tapering is considered a necessary precondition to rate hikes, and tapering is itself a signal to markets that worries might be real but can be set aside, the Fed may go so far as to suggest hikes are possible in Q1 or Q2 of next year. This is wildly dollar-positive. Bloomberg reports “Primary dealers surveyed by Bloomberg forecast the yield on benchmark 10-year Treasuries will rise to 1.69% by year end, with a formal announcement on tapering expected in November.”

Analysts note that Evergrande contagion is limited so far to other real estate companies, and the FT opines that if Evergrande simply declares bankruptcy, contagion is halted in its tracks. We are not so sure. Other equity indices are responding to the problem of a single company in China as though it’s a natural catastrophe that will ripple out everywhere. As noted before, we know all too little about how financial markets problems become contagious. And as Reuters reports, the offshore yuan tanked from a 3-month high on Friday to a 3-week low today on the Evergrande story.

It looks like the inflation fear can be stuffed into a bag and set aside. We say it’s hardly ended and will come back. On Friday, the preliminary University of Michigan consumer confidence index disappointed by failing to match the forecast, with “buying conditions for homes, vehicles, and household durables left all three near all-time record lows due to high prices. Also, inflation expectations for the year-ahead increased to 4.7% from 4.6% while the 5-year outlook was unchanged at 2.9%.” This is from the summary at TradingEconomics.com, containing a wealth of wonderment. It seems to show that the public intends to sit on its hands until prices fall and that will take five years.

What do they think is going to cause prices to fall over five years? Is it the Fed raising rates? That’s unlikely. The public almost certainly doesn’t understand how rising rates curb price increases. So, do they expect supply constraints to get fixed? This has a higher probability. But most of all, it means that the public has confidence that the government is going to control inflation by whatever means, that that includes taking care of the budget deficit, old and new. The Fed doesn’t really get the credit. The bond vigilantes get the credit for not throwing a taper tantrum.

We have to wait to see if China ameliorates the Evergrande bankruptcy in some way. China does not want to be the originator of a “Lehman moment” (especially after being named the originator of a pandemic). This is not going to be a normal bankruptcy. Conditions can change on a dime against risk-off if China keeps the failures limited, and also limited to its own real estate sector (and not the wider financial sector). The dollar would retreat a bit, but still have the Fed wind at its back.

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