Markets this week: all eyes on the Central Banks

Neil Wilson shares his thoughts on a big week coming up at the Federal Reserve in the face of a major inflationary shock.

Photo by Jp Valery

Whilst headlines from Ukraine will be driving a lot of the market action in the coming days, especially in commodities, traders are looking ahead to the Federal Reserve, which is set to raise rates and embark on a tightening cycle. The Bank of England will also meet this week amid rising inflation pressures for the UK. 

The Federal Open Market Committee (FOMC) meeting this week marks a turning point for the Fed as it begins raising interest rates. The question is not whether it will announce a 25bps hike at this meeting, but how many more are likely to follow. “I’m inclined to propose and support a 25-basis point rate hike,” Powell said during a March congressional testimony. Chicago Fed president Charles Evans said the US central bank should raise rates close to neutral, which implies seven hikes this year. BofA: “Labour market momentum is tremendous, and we expect labour demand to continue to outpace labour supply… In short, we still expect the Fed to hike by 25bps at each of its seven meetings this year, though Russia and Ukraine add uncertainty”. Consensus is about 5 hikes. Markets will also be watching for any word about QT and what policymakers think about the economic impact of the war in Ukraine and sanctions on Russia. Presumably, it means more inflation…and hikes are coming regardless of the chance of recession. Yield curve flattening…2s10s at 25bps.

Fed will be hiking when consumer sentiment this low is like 70s/80s – lead to back-to-back recessions. The 70s stagflation + oil shock similarities today are obvious enough.

What about the ECB? Well, the taper is on: PEPP ends this month and monthly net purchases under the APP will amount to €40 billion in April, €30 billion in May and €20 billion in June. Currently it is expected to conclude net purchases under the APP in the third quarter. So, there is a timetable for the taper, albeit the ECB says it stands ready to revise the schedule for net asset purchases in terms of size and/or duration.  

The decision itself was a bit more hawkish than expected…though how buying even more bonds, further expanding the balance sheet and heaping more fuel on the inflation fire until June at the earliest can be considered ‘hawkish’ in any way is kind of ridiculous. But that is where we are right now, trying to wean the addict off the junk with methadone. 

I’m ignoring the ECB’s so-called staff forecasts…they’re not worth the paper they are written on. Here we have what could be called the ECB’s credibility gap – in December they forecast 3.2% inflation this year, now it’s 5.1%. 

Comments from officials since the statement and press conference (usual yuck fest) seem to be pushing max-flexibility for ECB as expected. But it’s clear they have no control over anything, and the presser only made it clear that  

So, a more hawkish statement saw EUR bid, Bunds offered (10yr German yield jumped 15bps), but this was all unwound by Friday with EURUSD back at 1.09 area, having traded as high as 1.1120 on the Thursday. 

Bank of England on Thursday. Before the Russian invasion of Ukraine, markets were expecting interest rates in the UK to hit 1.75% by December and 2% by the middle of 2023. Traders have pared those bets back a bit, but the MPC is still expected to vote to raise rates by another 25bps to 0.75% this week. Two-thirds of economists polled by Reuters believe the Bank will raise rates for the third straight meeting. Almost half the MPC voted for a 50bps hike last time, meaning it seems all but certain the BoE opts to hike.

Economic activity in the UK bouncing back: the economy grew by 0.8% in Jan compared with a 0.2% contraction in December…remember this meeting comes one week ahead of the Chancellor’s Spring Statement on Mar 23rd. And he has this to point to: the British economy is now larger than it was before the pandemic…. albeit this is largely due to – you guessed right – higher health spending!

But more recent real-time ONS data was also encouraging. In the week to March 3rd, the aggregate CHAPS-based indicator of credit and debit card purchases increased by 10 percentage points from the previous week, to 102% of its February 2020 average. The ONS noted increases in all spending categories following last week’s falls, the largest of which was in “work-related” spending, which rose by 24 percentage points. 

Inflation expectations hit the roof: CPI hit 7.9% in February, a new 40-year high, and March will get a lot worse too as the full effects of the commodity squeeze are felt. That marks nine months of super-hot prints…how has it taken so long to get to a hike? 

The System Average Price (SAP) of gas increased by 66% in the week to 6 March 2022 to its highest recorded level at 15.5 pence per kilowatt hour since the data time series began, says the ONS. So, what is the impact of war? Less activity, more inflation, I think. ING says oil at $150 means 9% CPI by October…happy Halloween! Can see the BoE hiking more this year, then cutting rates in 2023 after inflation tops (fingers crossed) and the economy slows. Being more active in adjusting policy might not be such a bad thing after years of being afraid to do anything. 

Oil is in its steepest ever backwardation, which isseen as a sell signal for many but fundamentals still very, very tight…seem to be shrugging off total Russian ban as Europe is not on side with the idea. Demand in India (a huge importer) is at a 5-yr high, rebounding 10% in February. No signs of OPEC stepping in yet… can’t see much respite. Who’s incentivised to pump? No one…banks are still focusing on net zero – only on Thursday Credit Suisse set new targets to halve its exposure to the financing of emissions from oil, gas and coal between 2020 and 2030. Has Debit Suisse been watching the news? 

Italy’s PPI hit a staggering 41.8% in January – simply beyond belief. And this was before the Ukraine war. US PPI numbers are out this week. Last month the BLS said the Producer Price Index for final demand increased 1.0 percent in January, seasonally adjusted.  This rise followed advances of 0.4 percent in December 2021 and 0.9 percent in November. On an unadjusted basis, final demand prices moved up 9.7 percent for the 12 months ended January 2022. 

And just a final thought on inflation and taking a broader view as we look at the Russia-Ukraine effect on commodities in a wider context: de-globalization. This trend has been taking shape for some years – peak was maybe 2015 and the European migrant crisis; 2016 with Brexit/Trump marked the shift…and it continues. Implications for long-term supply chain trends. Consumers are the losers. 

Food prices: “The index for meats, poultry, fish, and eggs increased 13.0 percent over the last year as the index for beef rose 16.2 percent.” Only going to get worse as feed stocks get pricier. Wheat/corn surely can only go higher as the war lasts and planting in Ukraine is missed, sanctions prevent Russian exports.

Consumer confidence is taking a beating: University of Michigan consumer sentiment fell to a new post-2011 low, one-year consumer inflation expectations rose 5.4%, the highest since 1981 and highest ever number saying they expect their finances to worsen over the next 12 months. 

Some commentary from UoM here that I fully agree with: 

“Consumers held very negative prospects for the economy, with the sole exception of the job market. Consumers were slightly more likely to anticipate declines rather than increases in the national unemployment rate. This underlying strength in jobs comes at the cost of pushing inflation even higher due to unrelenting pressures on aggregate demand and supply lines. The persistent strength in demand was a critical factor that shaped the last inflationary age from 1965 to 1982, with stagflation peaking only near its end. Current expectations are consistent with heightened pressures on wages to meet the continued growth in demand. Like the game of musical chairs, everyone continues racing around the circle of rising prices and higher wages. Although everyone knows the game will end, everyone still wants to obtain the highest income possible before they exit. The game is moderated by fiscal and monetary policies, which now favor increased federal spending and full employment over price stability, enabling ever more rounds of the game.” 

Goldman Sachs have cut their US growth forecast for this year to 1.75% from 2% but warn there is a roughly one-in-three chance of recession in the next 12 months. Wells Fargo downgraded US real GDP growth in 2022 to 3.0% from 3.7% 

Markets: Commodity markets of course remain sensitive to developments in Ukraine, the West’s sanctions and any counter measures from the Kremlin. Last week saw high levels of volatility in various markets including oil, palladium and wheat as markets responded to events in Ukraine and worried about the potential loss of supply from sanctions. Putin retaliated with bans to timber and fertiliser exports – food prices are going to get even higher. How does it end? Russia has stepped up its attacks and says it will target Western arms shipments to Ukraine – evidence on Sunday came with a missile strike at the Yavoriv military facility near the Polish border. 

What we noticed last week was just how willing the market was to latch onto any good news…the Wednesday rip in particular. Apparent emollient comments from Putin on Friday sent stocks up…E-minis hit highest in a week on the news Putin said “certain positive shifts” have occurred in the talks, but it’s all headline driven machine trades that ignore the fact that even if the war ends today (it won’t) we are heading into stagflation. Untradeable markets when they are like this because you can get a 65pt swing in SPX futures in 15 minutes.

Bond yields were on the move last week as the ECB and CPI numbers came in Thursday. 10s rose above 2% for the first time since Feb 25th – war premium for bonds erased on soaring inflation which is partly due to the war…30s at 2.4% is the highest since May 2021.  

Investors are dumping European equities at the fastest rate ever, but indices held up over the course of last week (left chart). One-month losses are, however, considerably higher for Europe than the US. And they’re pouring record amounts into materials – hard assets are king.

Elsewhere…China tech is imploding, somewhat hidden by Ukraine, and credit spreads widening… BofA saying 9th straight week of big outflows from investment grade and high yield bonds. 

And Goldman Sachs says global financial conditions are at the tightest since 2009, having tightened 130bps since the invasion.

Bitcoin...that Executive Order from the White House told me two things: one is that they’re acknowledging that crypto is here to stay…the other is that they are exploring a U.S. Central Bank Digital Currency (CBDC). A CBDC can be programmed by the government; it is not like cash.  

Which leads us on to confiscations…increasingly governments are expropriating assets of those they don’t like. Could be Russian, could be a trucker threatened with financial ruin, whatever… But CBDC takes this state power to another level…which is probably good for Bitcoin. 

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