“Once an economy reaches a certain level of acceleration... the Fed is no longer with you... The Fed, instead of trying to get the economy moving, reverts to acting like the central bankers they are and starts worrying about inflation and things getting too hot.”
— Stanley Druckenmiller, Hedge Fund Manager
Risk-On Suggests Weaker CPI Figure?
If you’re like me, you were probably wondering what on Earth were the markets so excited about yesterday, and for equities the past week?
Lend me your attention for a few minutes…
Why the optimism in markets you may ask?
If we recall inflation within the U.S, up until this point, we can see it has been a very steady rise across the board; we saw a peak in June followed by the first sign of a slowdown in July. This was mainly attributed to the slowdown in inflation across energy prices only rising 32% vs 41% YoY in June, with gasoline seeing a slowdown to 44% from June highs of 59.9%.
So now, back to the question.
Why the positive shift in markets?
Let’s look at this from an investor’s point of view; if inflation is cooling down what does that have direct implications on? The Federal Reserve interest rate decision. More importantly, the level of how aggressive the Fed will be when it comes to tackling inflation, as we heard from the Jackson Hole event a 75bps hike isn’t off the table, in-fact, its back on with greater probability. Since July ‘22 the Fed removed forward guidance acting on a “meeting by meeting basis”. Which, if you would like that translated means, “things might get even more out of hand, so let’s just save ourselves and play it by ear”. Pretty accurate if you ask me.
So, the removal of forward guidance means one thing to the market, increased volatility surrounding such economic releases and today’s CPI release will finalise what Fed we will see at the September Fed decision.
Now, as you already know, the bond market is a great forward looking indicator into the mind of investors and where they see either near term or long term rates going.
Here we have the 1 year treasury bond which has priced interest rates to be at 3.6% in 12-months time. How may this and other debt instruments be affected by tomorrow’s figure?
Simple, if we see CPI come in below, which is what the market has already priced in, then we can expect the short end of the yield curve to remain relatively stable/potentially decrease allowing the yield curve to move away from an inversion or a curve flattener. Simply pricing in less hawkish central bank action at following meetings.
Now if CPI surprises us to the upside, well, just expect to see the 2s & 10s inversion deepen even more and long end yield curves to take a decline pricing in the aftermath of a deep recession.
Notice how yields are pricing themselves ahead of the release. What trade could come off this? Good question, we’ll visit some ideas on Friday!
A Cold Winter For Europe
What exactly do you do when 40% of your energy consumption comes from one country?
You make peace with the Russian’s and come to an agreement; there’s no other way this ends.
Figure 5 just puts into perspective how deep in the well Europe is with it’s reliance on Russia for crucial commodities of natural gas and oil.
Now, although Europe will bear the brunt of the energy crisis you have to remember that Europe was Russia’s top trade partner before restricting and eventually cutting off Nord Stream 1. Figure 6 shows you to what extend Europe & Russia were engaged.
Nearly ¾ of Russia’s total gas exports last year went directly to Europe. Of recent we have seen China & India become particularly close with Putin; trade agreement talks and China receiving more of Russian LNG & gas has been Putin’s execution plan to tighten trade strength with the non-westerners.
As the situation evolves, there will be more to analyse and depict but for now a short view on Eur/Usd remains predominantly my bias for the near to long term.
Thanks for lending your attention to me! Don’t just stop there, make sure to share & subscribe if you haven’t already!
We’ll be back on Friday with a detailed piece — Look forward to it
Joe