Welcome back to Market Macro Hub,
Glad to be back guys, man, it’s been one heck of a week in markets; let’s break it down here.
As I mentioned last week, I’ve been working tirelessly on a ‘ Guide For Traders Learning Macro’ for you guys to really accelerate your understanding of macros and how you can trade that in the FX & commodities markets (as I know that’s what most of you trade).
This will be out sometime next week, so make sure you’re following my Twitter and Instagram as I’ll announce details about the drop first! Oh yeah, it’s free ;)
All I ask is you continue to share this, engage and put to action what you learn here.
For now, let’s talk Fed, particularly the recent inflation print
Inflation Lower, Rates Still Heading Higher!
On Tuesday afternoon U.S CPI came in at 7.1% vs 7.3% forecast! Now, for some context the MoM CPI increase was also lower at 0.1% vs 0.3% forecast; finally core inflation also surprised to the downside ticking down to 6.0% vs 6.1% forecast. Off the back of the release U.S equities rallied hard, crypto’s were relieved from recent losses and bond yields collapsed, this bullish move into equities is known as the “vanilla reaction”, when one buys equities as a result of lower inflation, but this risk on shift in markets was shortly lived.
The bond yield collapse was shortly turned around and yields on treasuries ranging from the 1M to the 30Y treasury all received a lift in yields after Jay Powell and the FOMC forecasted interest rates to rise even further and stay at 5.1% through 2023 - so investors began pricing higher interest rates through the debt market.
On last week’s note I touched upon the 2s/10s inversion as it deepened, and from figure two you can see how yields across all instruments have risen, yet the inversion is still in the -0.7%, as we all know an inversion signals a recession, which the Fed isn’t scared of doing after listening to Jay Powell’s press conference.
Jay Powell outlined three components of inflation that he is paying attention to:
“Goods inflation” - which is expected to decline as supply chains bottlenecks loosen
“Housing services” - priced in line with rising inflation but “the rate for new leases is coming down”
“Non-housing-related core services” - A function of the labour market which is very tight at the minute.
That was it, the last component, “non housing related core services”, is what caused risk assets to quickly sell off right after the inflation release came out. The reason behind that is that non-housing related core services are the stickiest component of the inflation figure because that covers wages and labour related costs which are extremely difficult to bring down once they go up. Unlike goods inflation, which are directly affected by supply chains tightening up or flowing smoothly, wage inflation isn’t as malleable, so the only way the Fed is able to bring inflation down even further, particularly the non-housing related services inflation, is to break the labour market driving unemployment higher.
So, now you see why stocks, crypto and all risk assets done a U turn after the release; investors understand that this drop in inflation will not result in a ‘Fed pivot’ move, instead we heard from a very hawkish Federal Reserve at the press conference. (figure 3 below)
Here’s some interesting takes from their December SEP (Summary of Economic Projections)
The FOMC Federal funds rate projection for 2023 is 5.1%! As it stands the Federal funds rate is 4.50% after the recent 50bps hike; so going into 2023 we can expect a further 60bps of hikes from the Fed. The question is, can markets withstand interest rates at 5%?
In my opinion, I don’t think so. From Jay Powell’s press conference he hinted on this point every so slightly I think many may have missed:
“So, as I mentioned, it is important that overall financial conditions continue to reflect the policy restraint that we're putting in place to bring inflation down to 2 percent”
— Chair Powell, Federal Reserve
He went on to say how he believes financial conditions have tightened “significantly” in the past year, now I’m not sure how true that statement is. Let’s look at ‘07 and make a judgement.
For those who follow my articles religiously, firstly, shout out to you! My point being, you’ll be familiar with what this chart below represents, but for the new readers I’ll explain what you’re seeing:
The National Financial Conditions Index focuses purely on financial markets, and provides a weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and “shadow” banking systems.The idea is when the NFCI index is below 0, this means financial conditions in markets are particularly loose, meaning access to things such as credit, leverage and risk are widely available meaning the economy should experience periods of expansion and inflation, shown around 2007.
The opposite is true for when the NFCI is positive and well above 0, this shows periods of overly tight conditions within financial conditions. You can see, as we approached the GFC during 2007 the rate at which we saw financial conditions tighten was swift with no loosening, below 0, up until the recession was at its height and conditions had to loosen to reset the economy.
The opposite is true for where we are now.
Looking at 2022, conditions have materially tightened across the whole, and peaked around the September/October period but since then financial conditions have been loosening in the U.S. mainly access to credit and leverage. I’m inclined to account this loosening in financial conditions to the lower than expected October inflation figure we saw in November, sending markets into a positive frame that inflation is indeed on it’s way lower and that the Fed may be approaching it’s halt in hiking to eventually pivot.
Here’s a very interesting chart on Treasury yields within the U.S, I’ll let you break this down and we’ll have a further look in our next piece together!
As mentioned at the start of this piece I’ve been working relentlessly to make sure this macro guide I’m creating for you guys puts you on a straight narrow path to acquiring the understanding required to find macro plays and trades.
This is coming out next week, so stay tuned and I know you’ll gain tremendous value from this.
Until next time -