WHAT IS GOING ON IN THE MARKETS?
The simple answer to that must be “I am not sure”, as the USD swings up and down in big-figure moves from one trading session to the next, as stocks plunge and then rally, and commodities do their thang with massive one-day swings.
As the dust settles on the last few days, and the bulls and the bears call a truce, how does the price action relate to the fundamentals? Leaving aside the usual rumours – possible defaults by LME clients, yen intervention by the BoJ – where have the markets ended up in relation to the near term outlook?
Focusing on foreign exchange and interest rate markets, it is clear that the mood at the end of the week is almost diametrically opposite that which existed at the beginning; then, inflation was the fear closest to everyone’s trading book, with long end yields set to push through key levels, and the $ losing ground rapidly across the board on fears that the Fed was not going to be rigorous in tackling inflation. By the end of the week traders appear sanguine about the inflation outlook, and happy with the idea of the Fed supporting the economy rather than being hawkish on inflation.
But what do they base this on? It would seem that the Fed talk of a slowdown (particularly as housing cools, and the consumer – finally – reins in his horns) is deemed to point to a reduction in demand, which should cool rising prices. Thus [much] higher rates will not be required to bring CPI back to levels the Fed – and the markets – are more comfortable with.
But what if CPI is not being driven up by demand? For sure, there is evidence that strength of demand has allowed some companies to –finally- pass on some of their cost increases from higher raw material and other input prices (both in Europe and the US). But whether demand has made it possible, or if in fact it is an inevitable increase due to ever-rising input prices is almost irrelevant. Higher prices is higher prices, although it will be interesting to see if slowing demand does have much of an impact. However, although it is appealing to break economics down into simple cause-and-effect equations, in most cases there are far too many interlinked factors for that. Demand-pull might be helping prices rise, but other factors are also at work, and therein lies the dilemma: Should the Fed pause after the next hike, watch the data for a few months, and then decide on the next move? Or should it continue hiking until it knows it is in control?
The markets appear to have decided on the former. If, as I believe, inflation is alive and well and lurking in yours and my pay packets, what does that mean for interest rates and currencies? I think the markets have this one wrong; if the Fed pauses, and inflation is creeping in, it will be behind the curve, and will have to work twice as hard to dampen it again. Once the workforce believes inflation is a reality, it takes on a life of its own.
If the Fed does decide inflation is the bigger evil, and continues to hike beyond current expectations, does it mean that the consequences will be different? I believe not. In the former scenario, inflation becomes steadily more visible, the Fed is deemed to have missed its chance and the USD and $ assets become less and less attractive. The currency falls and long yields will rise – the Fed may be forced to try and protect the USD by raising rates, but by then its impact will be limited.
If the Fed continues to raise, then I think demand-destruction will surely take place. This will not, however, lead to an attractive investment scenario for the US; again $ assets will be unattractive in comparison to those in better-managed (less badly?) economies. Down goes the USD, up go rates.
So, damned if he does, damned if he doesn’t. I say, as I have since the euro/usd was trading on a 120 handle is sell the USD; if you really feel like punt, sell bonds (and bunds) as well.
As the dust settles on the last few days, and the bulls and the bears call a truce, how does the price action relate to the fundamentals? Leaving aside the usual rumours – possible defaults by LME clients, yen intervention by the BoJ – where have the markets ended up in relation to the near term outlook?
Focusing on foreign exchange and interest rate markets, it is clear that the mood at the end of the week is almost diametrically opposite that which existed at the beginning; then, inflation was the fear closest to everyone’s trading book, with long end yields set to push through key levels, and the $ losing ground rapidly across the board on fears that the Fed was not going to be rigorous in tackling inflation. By the end of the week traders appear sanguine about the inflation outlook, and happy with the idea of the Fed supporting the economy rather than being hawkish on inflation.
But what do they base this on? It would seem that the Fed talk of a slowdown (particularly as housing cools, and the consumer – finally – reins in his horns) is deemed to point to a reduction in demand, which should cool rising prices. Thus [much] higher rates will not be required to bring CPI back to levels the Fed – and the markets – are more comfortable with.
But what if CPI is not being driven up by demand? For sure, there is evidence that strength of demand has allowed some companies to –finally- pass on some of their cost increases from higher raw material and other input prices (both in Europe and the US). But whether demand has made it possible, or if in fact it is an inevitable increase due to ever-rising input prices is almost irrelevant. Higher prices is higher prices, although it will be interesting to see if slowing demand does have much of an impact. However, although it is appealing to break economics down into simple cause-and-effect equations, in most cases there are far too many interlinked factors for that. Demand-pull might be helping prices rise, but other factors are also at work, and therein lies the dilemma: Should the Fed pause after the next hike, watch the data for a few months, and then decide on the next move? Or should it continue hiking until it knows it is in control?
The markets appear to have decided on the former. If, as I believe, inflation is alive and well and lurking in yours and my pay packets, what does that mean for interest rates and currencies? I think the markets have this one wrong; if the Fed pauses, and inflation is creeping in, it will be behind the curve, and will have to work twice as hard to dampen it again. Once the workforce believes inflation is a reality, it takes on a life of its own.
If the Fed does decide inflation is the bigger evil, and continues to hike beyond current expectations, does it mean that the consequences will be different? I believe not. In the former scenario, inflation becomes steadily more visible, the Fed is deemed to have missed its chance and the USD and $ assets become less and less attractive. The currency falls and long yields will rise – the Fed may be forced to try and protect the USD by raising rates, but by then its impact will be limited.
If the Fed continues to raise, then I think demand-destruction will surely take place. This will not, however, lead to an attractive investment scenario for the US; again $ assets will be unattractive in comparison to those in better-managed (less badly?) economies. Down goes the USD, up go rates.
So, damned if he does, damned if he doesn’t. I say, as I have since the euro/usd was trading on a 120 handle is sell the USD; if you really feel like punt, sell bonds (and bunds) as well.
posted by Jambutty at 11:37 am
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