Why would the Fed be laggardly?

Outlook: We have a mishmash of factors driving markets today, ranging from the improbable (US sovereign default over debt ceiling) to the unlikely (recession) to the obvious (central bank policy intention divergence) to the immediately frightening (Covid 4th wave). Taken together, these all add up to risk-off and that is dollar-favorable, as we saw during the tenure of the previous president, even though the source of risk is largely the US itself. 

The 4th wave seems to have become a market concern in a single day but anyone paying attention saw the UK get it and then the Baltics and Eastern Europe, and so the shock in Western Europe should not have been a one-day wonder. But there it is. As Yellen had said, the only thing that can derail the robust recovery is Covid and while the US can’t be shown to be in a full-blown 4th wave just yet, it’s scary enough to drive the safe-haven narrative.

It also drives the transitory inflation story just as the Fed is starting to accept that tapering might have to be accelerated, with the first hike a bit earlier, too. If markets see the Fourth Wave as driving growth and inflation down really fast, then the original Fed story is right, just not for the same reasons. NY Fed Williams warned that inflation is getting wider and deeper, with expectations rising, too. This is a bit ironic since the Fed has also published a paper showing expectations don’t matter much to outcomes. Meanwhile, yesterday two Feds expressed agreement with the accelerated tapering idea, with Chicago Fed Evans going so far as to say the supply chain issues are going to get fixed fast. This came from a single source and we can’t find the purported comments at the Chicago Fed website, but the point is that the Fed is changing its tune. And changing the tune might be premature, not “behind the curve”—depending on Covid. 

We are still befuddled about how (until yesterday) rates at the short end were rising to reflect high inflation and expectations of monetary policy responding with accelerated tapering and/or an early rate hike, but the longer end wallowing around well under 2% and below even the levels of last March, implying the longer-end traders see a laggardly Fed. Why would the Fed be laggardly? Inflation will fall off sharply and/or growth will tank to very low levels, or both. In a word, stagnation. Let’s not lose sight of the unhappy fact that on a quarter or quarter or year-over-year basis, plenty of data will have a minus sign that is due entirely to the base effect.

We have to ask whether new fears of the Fourth Wave are justified or a one-day wonder. It all depends on whether the European experience flies across the Atlantic. Can the US, with its lesser vaccination rates, avoid it? And if not, the Big Question becomes just how long-lasting are those vaccines, anyway? If the vaccines are seen to lose effectiveness faster than we thought, panic can ensue.

If the new expectation is for a slowdown everywhere due to Covid, then inflation expectations will drop, too. That could put the Fed and BoE back on the trail we had a few months ago. Those employment and consumption/retail sales numbers will fall back so that by March, we could be questioning the timing of that first rate hike. The Fed might even start decelerating tapering. This is not to say the gloomsters were right. If they were right, they were right for the wrong reasons. Their rationale was that the markets had become too accustomed to free money and could not be weaned off it without tantrums (and destabilization).

Because next week is a short week in the US, and because the Fourth Wave scare can well be a flash in the pan, we need to be very cautious about forecasting. We guess the dollar benefits, but note that word “guess.”

Tidbit: The US Congress continues to disgrace itself with power-seeking and a stunning lack of both civility and effectiveness. This is not really new but what is new is the lunatic fringe following members’ words and actions and possibly posing a real threat to members and the public. The jackass who published a cartoon showing himself killing another member and the president was censured, which doesn’t even embarrass him. Another jackass called a Biden candidate up for Senate approval a communist for having been born in Russia. It has become common for Republicans to call all Dems “socialists” all the time (without, of course, having the faintest idea of what the term means). Separately, while the coup player Bannon was indicted for failure to respond to a Congressional subpoena, the Jan 6 investigation committee has not seen fit to charge the former Trump chief of staff with the same offense.

Meanwhile, the debt ceiling is up for more positioning or the government closes down again in about two weeks. The Republicans are again putting roadblocks in front of the president’s $1.75 trillion Build Back Better initiative (that is approved by the majority of the actual voters). This is exactly like the situation in the Obamacare case and very depressing—it drives voters away from even following politics.

Separately, we have two high-profile trials of white guys accused of murdering others, one a black guy and the others participating in a Black Lives Matter protest, in vigilante fashion. These trials are not about self-defense, vigilantes or gun laws. They are about racism. This is exemplified by one defense lawyer objecting to black preachers in the courtroom “intimidating” the jury, meaning all black men are scary. The judge threw out the objection. The judge in the other trial is so openly biased he would probably have approved it. Ironically, the reasonable judge is in the South and appointed by Trump, while the biased judge in is Wisconsin.

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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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