Equity markets continue to look vulnerable to further losses, as do bond markets, after yields ripped higher again yesterday. European markets underwent another negative session, as did US markets, falling for the fifth day in a row, ahead of today’s FOMC rate decision, where the US central bank needs to wrestle back control of a narrative that appears to be running out of control, with the US 2-year yield up over 80bps this month alone, with 50bps of that rise in the last three days.
The volatility since last Friday looks set to manifest itself into a slightly firmer European open later this morning, after Chinese economic data came in slightly better than expected.
With prices rising as they have been, the consumer has been front and centre of whether we’ll start to see demand destruction, as food and energy get prioritised over other discretionary spending. In the US, the consumer has been remarkably resilient despite crashing consumer confidence data, while in China lockdown restrictions have strangled internal demand in recent months.
At the beginning of this year there was widespread optimism that the Chinese economy would be able to grow by 5.5% this year. This goal now looks unattainable given the restrictions that have been in place since March. In March, retail sales in China declined by -3.5%, the first decline since July 2020 and the biggest decline since April 2020 when China was coming out of its first nationwide lockdown. In April we saw another steep decline of -11.1%, an even bigger decline than the -6.6% fall that was expected, while industrial production also slowed sharply, falling -2.9%, against an expectation of a small rise of 0.5%. This morning’s May numbers saw a modest improvement to -6.7%, against an expectation of a -7.1% decline, but it’s clear that demand remains weak, and it’s unlikely we will see a V-shaped rebound in the coming months. Industrial production came in at 0.7% a modest improvement from -2.9%.
On the other hand, US retail sales have been more resilient, with decent gains every month this year, despite cratering consumer confidence. The resilience of the US labour market may well be helping here but it’s hard not to escape the feeling that after a 0.9% gain in April, we are overdue a slowdown, or decline. The last few months have seen big gains in consumer credit on a level that seems unsustainable, as higher food and gasoline prices weigh on demand. Expectations are for a modest rise of 0.1%, however it wouldn’t surprise to see the first decline in US retail sales this year.
Up until a week ago it was pretty much a slam dunk that the Fed would be raising rates today by another 50bps to 1.5%, to be followed by another 50bps in July. This calculus has shifted quite sharply since last Friday’s May CPI report, to the markets pricing 75bps because of a single CPI print of 8.6%, over concerns that the Fed is falling behind the curve when it comes to addressing sticky inflation expectations.
Putting to one side why a single data point might prompt such a sudden shift, it’s been obvious for several months now that central banks have been behind the curve. This isn’t new. The reality is that central banks are so far behind the curve, that they can’t see the curve. That said, it doesn’t mean a move by 75bps today is a good idea. It’s not, coming as it does so late in the day, especially given the consistent guidance for a 50bps move over the past few weeks, and gives the impression of a Fed which is losing control of events and exhibiting a certain level of panic about the path of inflation.
It’s important for the Fed to take a step back and look at the wider picture, and in particular yesterday’s PPI numbers. These are much more of a leading indicator for CPI, and showed that inflation is already slowing, with core prices hitting their lowest levels since November last year at 8.3%.
If the Fed really wants to claim it is data dependent, then suddenly performing a policy pivot during the blackout period isn’t a good look, especially if reports are true that there has been anonymous briefing to friendly journalists, to prepare the markets for a 75bps move This is not how a central bank that wants to be taken seriously should behave in a blackout period, and this week’s bond market tantrum has been a consequence of that.
A responsible Fed would look to wrestle back the narrative and do what it said it would do, which means we need to see 50bps today, with a hawkish pivot at the very least, especially if it wants to be taken seriously when it comes to future guidance. It’s also not apparent what a pivot to 75bps would achieve when the Fed could simply deliver a 50bps hike today, and then throw the prospect of 75bps into the hat for July, as well as September. Given that market pricing had been for a possible pause in September, that is still a hawkish pivot, and guidance tends to be half the battle when it comes to policy adjustments. As such, it seems more likely we’ll see a 50bps move today, along with hawkish guidance for 75bps in July, as well as September, but that's very much dependant on the data.
In terms of guidance, much will depend on how the Fed sees fit to update its inflation forecasts, which are still well below current levels. In March, the FOMC upgraded inflation forecasts for 2022 to 4.3% from 2.6%, and in 2023 to 2.7% from 2.3%. Expect to see upgrades to these, while the FOMC downgraded GDP to 2.8% in 2022 and 2.3% in 2023. This month also sees the start of the balance sheet reduction programme starting with $47.5bn, rising to $95bn a month after three months.
EUR/USD – a move to parity remains the underlying bias through the lows last month, and the 2017 lows at 1.0340/50. This remains a key barrier for a move towards parity. Resistance now lies at 1.0630, as well as trend line resistance from the highs this year at 1.0720.
GBP/USD – the pound has seen further weakness sliding below the 1.2000 area, and falling to 1.1930, before rebounding. A break below 1.1950 opens up the prospect of the March 2020 lows. The 1.2160 area now becomes resistance, and above that at 1.2450.
EUR/GBP – surged through the 0.8600 area, overspilling towards the April 2021 peaks at 0.8720 area, before slipping back. A move through 0.8730 targets the 0.9000 area.
USD/JPY – pushed above the 135.20 area and looks set to move up towards the 137.20 area. Support back at the 133.00 area.
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