The Fed's
hawkish turn was extended. It
now seems clearer to more participants that to maximize the Fed's flexibility
later in the year, it will need to raise rates in March. With the Fed
still buying bonds, albeit at a slower pace, the January 26 meeting is all but
ruled out. The pricing of the Fed funds futures reflects more than a 95%
chance of a hike at the mid-March meeting. The futures strip favors a
hike each quarter. It has three hikes fully discounted and about an 80%
chance of a fourth.
This adjustment that arguably began in September
rippled through the capital markets, sending interest rates higher and equities
lower. It also
seemed to underpin the US dollar. However, the market may be ending this
particular adjustment phase. Even with the 7% CPI, a 39-year high, the
market could not extend its move. The US 10-year yield stalled near
1.80%, which incidentally is around the average of the past four years. In
fact, it slipped lower after the December CPI report and finished the week
little changed, slightly below 1.77%. The 10-year breakeven, the difference
between the yield of the inflation protected issue and the conventional note,
eased two basis points after the CPI. It is a little more than 10 bp
lower since the end of 2021.
Chair Powell's remarks at his confirmation hearings
were meant to persuade the Senators (and the wider public) that the Fed would
act to prevent inflation from becoming entrenched. Without adding many specifics, he lent credence
to market speculation that the balance sheet would likely begin shrinking later
this year and probably at a quicker pace than after the Global Financial
Crisis. We have argued that turning the tap on and off quickly, like
the federal government's balance sheet, is part of the process by which QE
is normalized.
The Fed has been clear that the Fed funds will be the
main tool of monetary policy. Still,
if the Fed begins to allow maturing issues to roll-off and reduce the balance
sheet around the middle of the middle of the year, it may supplant a fourth
rate hike. Meanwhile, some outspoken critics of the Fed, like the former
NY Fed President Dudley, former Treasury Secretary Summers, and noted fund
manager El-Erian continue their campaign about the Fed being behind the curve
and making a policy mistake. Still, most private sector economists seem to
agree with Powell (and Yellen's suggestion) that price pressures will ease in
the second half of the year. Of course, they do not characterize it
as transitory as they did previously, but the general view just pushed out the
peak in prices six to nine months.
Dudley writes that the Fed's latest set of projections
point to above-trend growth while having inflation "melting away." Of all people, he ought to know not to use the
Summary of Economic Projections like they are the Fed's forecasts. Most
regional Fed presidents do not have Dudley's experience as an economist at
Goldman. The skills needed to become a regional Fed president are often far
removed from economic forecasting.
The forecasts that the individual Fed members provide
are for annual growth. In his
polemic, Dudley did not appear to consider the trajectory of growth. The
median projection for this year is 4.0%, falling to 2.2% next year. Isn't
slowing growth a reason to expect less price pressures? The base effect
will also likely help dampen the 12-month measure of inflation. In
addition, there are good reasons to expect supply chain disruptions to ease.
Such disruptions boost prices and ostensibly create incentives to new market
entries.
There is a potential source of inflation that rarely
has entered the discussions: Corporate consolidation and concentration. Reuters reports that last year, mergers and
acquisitions in the US reached a record of almost $2.6 trillion and accounted
almost half of all the global activity. The previous record was set in
2015 at a little less than $2 trillion. The M&A activity was
widespread. There was some 20k transactions, around two-thirds more than
in 2015, according to Bloomberg data. Records were set in several industries,
which coincidentally are experiencing strong price pressures now, including
consumer goods and industrials. Consolidation in the tech sector also
reached a record.
Six months ago, Summers recognized that market
concentration could spur higher prices, but more recently claimed that using
antitrust to combat inflation is "science denial." A few weeks ago Matt Stoller calculated that
on the eve of the pandemic, nonfinancial corporate profits in the US were about
$3081 per capita and last year reached $5207. This alone, he argues could
account for almost 45% of the increase in the general price level (inflation).
Moreover, it challenges the wage-push inflation narrative that has gained
currency. The unvarnished truth is that the pandemic has been good for
corporate profits. Market concentration can lead to pricing power
directly and by rationalizing (reducing) capacity.
When Dudley was at the Fed, it is understandable that
he focused on monetary policy.
That was his job. But there is no reason in discussion of the economic
and inflationary outlook not to mention fiscal policy. The US is
beginning to experience one of the sharpest declines in the budget deficit
ever. Consider that the 2021 deficit looks to have been around 12.5% of
GDP. It is expected to be almost halved this year. The median
private sector economist forecast in the Bloomberg survey, for whom Dudley
writes, has it falling to 6.4% of GDP in 2022. Some fiscal support is
already being withdrawn. Extending the enhanced child tax credit was in
the Build Back Better bill, which appears to have stalled. It expired
with the last checks sent out around mid-December.
After the employment and inflation reports, the week
ahead for US economic data pale in comparison. The January Empire and Philadelphia manufacturing surveys may be
too early to generate a reliable insight given the disruptions caused by
absenteeism spurred by the Omicron. Anecdotal high frequency data warns
of downside risks to these surveys. Perhaps the most substantive new
information will come from the December housing starts. However, they
surged 11.8% in November, the first increase in three months, and it seems more
a question of how much they slowed.
As a measure of residential investment, it may help
fine-tune Q4 US GDP estimates, though the dismal retail sales (-1.9%) and
manufacturing output (-0.3%) will encourage a downward drift. The median (Bloomberg survey) is for 5.9%
annualized growth after a disappointing 2.3% pace in Q3. The early call
for Q1 is around 4.5%. Note that the World Bank cut its US growth
forecast for this year by 0.5% to 3.7% from its mid-2021 forecast.
The eurozone data on tap, including the November
current account and construction output, are not market movers. Still, the November trade balance (not
seasonally adjusted), reported before the weekend, unexpectedly swung into
deficit for the first time in early 2014. Meanwhile, the attempt to find
some assurances for Russia stopped short of ruling out eventual NATO membership
for Ukraine and Georgia, which keeps the threat of war elevated. Also,
Italian politics will likely return to the fore as the presidential contest
approaches. Draghi became prime minister a year ago (February 2021) and
is widely given high marks. However, the best may be behind Italy, and
the 10-year premium over Germany (~130 bp) is wider than when Draghi took
office.
An SWG poll released last week showed that a little
more half of the Italian population supports Draghi for president. With Berlusconi's maneuvers, a snap election
would seem to be the most likely outcome to find a new prime minister.
The election "distraction" and the results could endanger the
implementation of reforms that are necessary to secure EU Recovery Funds.
Some worry that if Draghi does not become president, his political clout will
be diminished.
Norway's central bank, the Norges Bank, meets January
20. The swaps market has
about 75 bp of tightening priced in this year. However, it hiked rates in
December and has not moved at back-to-back meetings since 2015, which were cuts.
Norges Bank has not raised rates at consecutive meetings since 2009. That
said, December headline and underlying CPI (which excludes energy while
adjusting for tax changes) were stronger than expected. Although
the overall economy contracted in October and November, the mainland economy
has been more resilient and has not contracted since Q1 21.
The Bank of Japan's two-day meeting concludes on
January 18. The BOJ will not be
adjusting policy, but it will update its forecasts. Given the rise of
fresh food and energy prices, the central bank may tweak its inflation
forecasts a bit higher. The iteration from late last year saw prices flat for the fiscal year ending in March. Recall headline inflation was below zero
from October 2020 through August 2021 and turned positive to reach 0.6% in
November. The December estimate is due early on January 21 in
Tokyo. There has been some talk that the BOJ could raise rates before
core inflation hit the 2% target. That may indeed be the case, but not
this year. The swaps market is buying it and continues to price in steady
policy rates.
The BOJ had forecast that the world's third largest
economy would growth 3.4% in 2021 and slow to 2.9% this year. It seems a bit high. The OECD sees 1.8%, which we suspect is more likely. Yet, the vagaries of covid and
Prime Minister Kishida's fiscal stimulus means that Japan may be one of the few
high-income countries that grows faster in 2022 than 2021. The OECD
projects a 3.4% expansion this year and the IMF is at 3.2%.
The People's Bank of China does not meet. But the softer than expected CPI, downside
risks posed by the recent Covid-related lockdowns and the disruption to the
property market, coupled with the yuan's persistence have boosted speculation of
easier monetary policy by the start of the Lunar New Year celebration at the
end of the month.
Another cut in reserve requirements can happen at any
time, and it is also possible that a token cut in the 1-year Medium-Term
Lending Facility (2.95% since March 2020) can be delivered. The new week will start with Q4 GDP (~1.2%
quarter-over-quarter after the lowly 0.2% print in Q3) and some details (investment
in fixed assets and property, industrial production, retail sales, and surveyed
unemployment). Note that last week, the World Bank shaved its forecast
for China's GDP this year to 5.1% from 5.4%. The median forecast in
Bloomberg's survey is for 5.2%.
The UK and Canada report retail sales and CPI. The UK also provides the latest reading on the
labor market. Outside of some headline risk, and barring some major
shock, the data is unlikely to change the trajectory of monetary policy.
The market leans heavily (~85%) toward a February 3 rate hike by the Bank of
England. The swaps market has four hikes fully priced in for this
year.
Canada's headline CPI looks poised to cross above the
5% threshold for the first time two decades. The full-time job growth has been simply spectacular
of the last third of 2021. Around 432k full-time positions were
filled. Proportionately, it would be as if the US created 4.7 mln jobs.
Instead, US non-farm payrolls rose by nearly 1.48 mln in the last four
months. The market expects the Bank of Canada to be more aggressive. Five
hikes are fully discounted, and the market has begun pricing in a (~25%) chance of a sixth
hike this year. There is a reasonable chance (~40%) that the Bank of
Canada delivers the first G7 hike of the year when it meets on January
26.
Australia reports its December jobs on January 20 in
Sydney. The central bank
has emphasized the importance of normalization of the labor market as it leans
against market speculation of a rate hike. The swaps market has about 35
bp of tightening discounted in the next six months and 60 bp in H2
22.
After losing about 360k jobs in August through
October last year, as social restrictions hit, the re-opening saw all the jobs
return in November (366k). Economists
(Bloomberg survey median) expect a 70k increase, but the data may be too
distorted to offer market participants or policymakers much insight. In
the middle of last week, Australia reports more than a million cases, a
dramatic surge in the country that had a zero Covid policy. Prime
Minister Morrison said that 10% of the work force was on leave at any one time
due to the outbreak. The transportation sector appears to be hit considerably harder (the local news claimed it was closer to 50%). The absenteeism was
threatening food supplies and the government eased the quarantine rules for
those transport and freight workers who came in contact with the
infected.
Disclaimer
Reviewed by Marc Chandler
on
January 15, 2022
Rating:
