The ECB prefers to accept stagflation over a hard landing

Outlook: The euro reaching the lowest low since May was a shocker, especially because the market had under-reacted to the US CPI data the day before and seemingly missed Lagrarde’s subtlety altogether. She did say the newly higher rates would “make a substantial contribution to the timely return of inflation to the target.” She didn’t say the higher level was sufficient.

But traders elected not to find a threat of a possible additional hike in that choice of words. Given that inflation is not expected to reach the desired 2% next year, what Lagarde is saying is that the ECB prefers to accept stagflation over a hard landing—a deeper recession than already expected.

Today the US delivers a boatload of data—the Empire State, import and export prices, industrial production, consumer sentiment, even the usual Friday Baker Hughes. The autoworker strike could end up being the important thing by Monday morning if no deal is made by midnight tonight. You’d think a strike would be a negative for Pres Biden and the Dems, but maybe not. We haven’t had a big strike for decades, not since Reagan mortally wounded unions with the air traffic controllers strike in the 1980’s. The sense of grievance that workers have (that drove them to Trump) can come out in the open. We have to wonder if Pres Biden has a Plan here.

And the biggie is next week’s Fed meeting. Bloomberg writes that “A resilient US economy will prompt the Federal Reserve to pencil in one more interest-rate hike this year and stay at the peak level next year for longer than previously expected, according to economists surveyed by Bloomberg News. The Federal Open Market Committee will keep rates steady in the 5.25% to 5.5% range at its Sept. 19-20 meeting, the survey showed, and remain there until a first cut next May – two months later than the economists’ view in July.”

The Fed may say it’s going to hike one more time as embedded in the dot plot, aka the quarterly Summary of Economic Projections. But the economists surveyed by Bloomberg think the Fed won’t go ahead with a final increase.”

“In its forecasts, the committee is likely to continue to see the inflation rate as being elevated, with a year-end projection of 3.2%. The outlook for underlying core inflation, excluding food and energy, is slightly improved at 3.8%. The economists expect the policymakers to forecast reaching their 2% inflation goal in 2026.

A robust economy is shaping the September meeting discussion. The median committee member is likely to see economic growth this year at 2%, double the 1% forecast in June and compared with 0.4% seen in March. In addition, they are likely to forecast a hotter labor market, with the unemployment rate, now 3.8%, edging 0.1 point higher to 3.9%, or lower than the 4.1% rate seen in June and 4.5% in March.

Despite upgrades to growth forecasts, the Bloomberg economists are not all in the optimist camp. See the pie chart—a good 45% are sticking to the recession outlook. At least this is trending down. Those seeing recession were 58% in July and 67% in April. “Fed officials have shared in the soft-landing optimism, with the Fed staff switching from a recession forecast earlier in the year to a continued expansion.”

The divergence between the Fed’s growth outlook and the Atlanta Fed’s GDPNow is fraying. The Atlanta Fed now has 4.9% for Q3 from 5.6% previously. We know the Atlanta Fed overshoots and the forecast is for Q3, but still, the Atlanta Fed is more than double the main Fed forecast of 2%. We think there’s a problem here.

Forecast: FX traders are busily penciling in rate cuts in the eurozone next year while having pushed out the Fed’s expected cuts. For the next nine months or more, the US will have higher rates and better growth. This gives the dollar a strong tailwind. As usual, we have to warn that additional dollar gains will not be in a straight line. In particular, the Friday low is within kissing distance of the May low, or a 100% retracement from the high in July. We often see a bounce back to the upside after a chart event like that. It could even go as far as 1.0760, the previous intermediate high.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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