Sive Morten
Special Consultant to the FPA
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Fundamentals
Once markets start unclenching from invasion hysteria - it comes back again, right on Friday. Here, actually, we see the execution of two moments that we've talked about previously and not just once. First is the geopolitical madness stands here for the long term, it is not even started yet and we're just on preliminary steps to major contradiction. Second - the more often the US tries to switch the attention of investors out of inflation, the more we think that markets underestimate its level. Since it is more or less clear the situation around geopolitical tensions and why the US keeps them hot, we focus today mostly on financial issues, and the coming interest rate in particular.
Market overview
A gauge of global stocks fell and government debt prices rose on Friday after hopes that diplomacy might resolve the Ukraine crisis faded on news Donetsk and Lugansk republics were evacuating population to Russia (Rostov region) from in the country's east as Ukrainian artillery fire intensifies and hazard of Ukrainian invasion magnifies. Sentiment soured as shelling increased in eastern Ukraine and a rebel leader announced the surprise evacuation, a surprise development in a conflict the West suspects Russia will use to justify an all-out invasion of its neighbor.
The dollar rebounded and the safe-haven Swiss franc rose as a mood that had improved on news late on Thursday that U.S. Secretary of State Antony Blinken would meet with Russian Foreign Minister Sergei Lavrov next week darkened again. Investors are waiting for the three-day weekend to be over to assess an equity market already weaker on the outlook that rising interest rates will hurt growth stocks, said Rick Meckler, partner at Cherry Lane Investments.
President Joe Biden said on Friday the U.S. national emergency declared in March 2020 due to the COVID-19 pandemic will be extended beyond March 1 due to the ongoing risk to public health posed by the coronavirus. Biden said the deaths of more than 900,000 Americans from COVID-19 emphasized the need to respond to the pandemic with "the full capacity" of the federal government.
Federal Reserve chief Jerome Powell will testify before Congress on March 2 and 3 in what are likely to be his final public remarks on monetary policy before the U.S. central bank begins raising interest rates to fight decades-high inflation. Powell will deliver his regular semiannual monetary policy update to the U.S. House Financial Services Committee on March 2 and appear before the Senate Banking Committee on March 3. Both hearings will begin at 10 a.m., the committees said on Friday.
Powell, who has not spoken publicly since January, may use his testimony to lay out what he feels is the consensus of the Fed's 16 monetary policymakers, who will be weighing the risks of an upward inflation spiral against the possibility that tightening policy too hard or fast could choke off economic growth or disrupt financial markets.
Last week, St. Louis Fed President James Bullard called for a full percentage point worth of rate hikes over the next three meetings, a steeper path than the Fed has followed in decades.
The Federal Reserve will need to move more aggressively to remove accommodation than it did following the Great Recession by raising interest rates at a faster pace and shrinking its balance sheet more quickly, Cleveland Fed President Loretta Mester said on Thursday.
Mester also said she supports selling some of the Fed's mortgage holdings at some point to accelerate the move to a portfolio that invests primarily in Treasury securities. She is among the officials who view asset sales as a backup plan for the central bank as it shrinks a balance sheet that doubled in size during the pandemic
Federal Reserve officials on Friday squelched what had been rising market expectations for an aggressive initial response to 40-year-high U.S. inflation, signaling that steady interest rate hikes should be enough to do the trick.
Fed Governor Lael Brainard - President Joe Biden's nominee to be vice chair at the Fed - said officials will likely kick off a "series of rate increases" at their upcoming meeting in March, followed by decreases in the size of the Fed's balance sheet "in coming meetings."
Investors in federal funds futures contracts last week began leaning towards the idea the Fed would raise rates a half a percentage point in March. Those expectations have now drifted back, with a quarter-point hike now anticipated and six increases in total over the year.
In remarks at the conference in New York, Chicago Fed President Charles Evans downplayed the thought the Fed needed to get more aggressive, even though he agreed policy was "wrong-footed" with annual consumer price increases topping 7%. He said he remained convinced inflation would ease on its own.
The Fed should begin raising rates next month and, once rate hikes are underway, begin to "steadily and predictably" trim its $9 trillion balance sheet, Williams said. Both actions, he said, will bring demand into better balance with supply.
At the same time, he said, other forces should also be bringing down inflation, with supply chains healing and consumers returning to pre-pandemic spending patterns. Williams said policymakers can speed up or slow down the pace of rate increases later as needed. A path in which the overnight federal funds rate moves to a range of 2% to 2.5% by the end of next year makes sense, he said.
Williams said he expects real U.S. GDP to grow by slightly less than 3% this year and for the unemployment rate to drop to about 3.5% by the end of the year. He projects inflation as measured by the personal consumption expenditures price index to decline to about 3% and for it to fall further next year as supply challenges improve.
But if we take a look at 3-month US Treasuries Bills, the major barometer of coming interest rate change, it shows that investors expect rate change in excess of 0.25%
In recent 1-2 sessions expectations are eased a bit on the background of running into the quality, but a few days ago expectations stand around 0.46% which suggests 0.5% rate change at least:
The Fed is likely to hike rates by 25 basis points at the end of its March policy meeting, followed by additional 25 basis point hikes in May, June and July, with another two hikes in September and December, according to Morgan Stanley.
Eurodollar futures, which reflect the outlook for U.S. interest rates over the next few years, have started to price in an incremental easing of monetary policy by the Federal Reserve in 2024. If that plays out, it would be just two years after what is expected to be the start of a Fed tightening next month. The money markets' odds on a 50 basis point-hike the last few sessions have dwindled from as high as 80% to 37% on Friday.
Market pricing for the December 2023 eurodollar contract showed an implied yield of 2.235%, which traders said can be a proxy for the federal funds rate.
That is looking likely to be the peak of the Fed-rate-hike cycle or the so-called "terminal rate," analysts said, with implied yields declining to 2.18% in the March 2024 contract, 2.125% in June, 2.095% for September, and 2.085% for December.
Fed officials estimate the long-term neutral rate, which is neither constricting nor stimulating economic growth, is 2.5%.
The roughly 220 basis points of anticipated interest rate increases over the next two years suggest a faster pace of Fed tightening that may include one or two half percentage point hikes in that period, analysts said.
The eurodollar curve has inverted a few times in the past.
In June 2018, the inversion suggested the Fed would have to cut interest rates at a time when it was in a tightening mode. Indeed, after hiking rates in December 2018, policymakers reversed course the following July with a rate cut. In 2020, the central bank cut the benchmark overnight lending rate to near zero as the coronavirus pandemic caused economic devastation around the world.
As the Fed gets set to raise pandemic-era rates, here are the estimates from major global investment banks on how far and fast rates will rise:
* JP Morgan raises its Fed call to seven 25-bp rate hikes from five previously, for a total of 175 bps of tightening this year.
* Morgan Stanley now expects the Fed to deliver six 25-bp hikes this year. It had previously forecast 125 bps of tightening via four 25-bp hikes plus a 25-bp fed funds equivalent runoff of the Fed's balance sheet.
* UBS now expects 150 bps of tightening this year via six consecutive quarter-point moves from March through November. It had previously forecast 25-bp increases in March and June, then "a potential shift toward an every meeting hike pace".
* BNP Paribas expects six hikes of 25 bps this year starting in March, resulting in a cumulative 150 bps of tightening.
* Citi now expects 150 bps of tightening this year, starting with a 50-bp move in March, followed by four, quarter-point increases in May, June, September and December.
* Credit Suisse now expects the Fed to hike a cumulative 175 bps this year, beginning with a 50-bp increase at the upcoming March meeting.
* Societe Generale now expects five rate hikes of 25 bps this year, starting in March.
* Goldman Sachs said it is raising its forecast to include seven consecutive 25-bp rate hikes at each of the remaining Federal Open Market Committee (FOMC) meetings in 2022 from a previous expectation of five hikes. read more
* BofA Global Research expects the Fed to hike rates by 25 bps at each of this year's remaining seven meetings, unchanged from its previous outlook. However, it said there is a risk of a 50-bp hike in the March meeting.
* HSBC expects the Fed to roll out a 50-bp hike in March and four more quarter-point rate rises in 2022.
* Deutsche Bank expects the Fed to call a 50-bp hike in March plus five more 25-bp hikes in 2022, with a hike at all but the November meeting.
* Barclays now expects the Fed to raise rates by 25 bps five times this year, up from three hikes forecast earlier.
The producer price index for final demand jumped 1.0% last month, the biggest advance since May, after climbing 0.4% in December, the Labor Department said. In the 12 months through January, the PPI rose 9.7%. That followed a 9.8% surge in December. Year-on-year PPI is slowing as last year's large increases drop out of the calculation. Economists polled by Reuters had forecast the PPI would gain 0.5% on the month and advance 9.1% on a year-on-year basis.
With the CPI and PPI data in hand, economists are estimating the core PCE price index rose by about 0.6% in January. That would result in the year-on-year rate increasing 5.2%, which would be the largest gain since early 1983. While the Institute for Supply Management (ISM) surveys and data on inventory accumulation have suggested some easing in supply constraints, that has not been evident in the PPI data.
The European Central Bank has been right to maintain its easy money policy as inflation is set to fall after "transient boosts" from supply snags that may extend into next year, the International Monetary Fund said on Thursday. The Washington-based institution said past data suggested that wages in the eurozone would rise only modestly and that inflation, which hit 5.1% last month, would fall back below the ECB's 2% target.
The IMF's post was based on a new paper estimating that eurozone GDP would have been 2% higher last year had it not been for supply constraints, caused by lockdowns and by shortages of everything from containers to skilled workers. This supply shock accounted for half the increase in euro area producer price inflation excluding energy prices last year, the IMF said.
It warned that bottlenecks may last longer than expected and possibly into 2023 due to the spread of the Omicron variant of the coronavirus, posing a challenge for central bankers trying to support the economy while keeping a lid on inflation.
Keen to downplay anxieties about the war in Europe, global investors appear to fear a monetary policy miscalculation even more. Their problem is that the two are hugely intertwined right now. World markets gyrated over the past week as fears of a standoff between nuclear powers in NATO and Moscow.
But where to focus? More global fund managers surveyed by Bank of America this month identified "monetary risks" - as opposed to geopolitical, credit, business cycle, or trade risks - as the biggest threat to financial market stability than at any point in near 20 years of polling. Although the survey was conducted before the latest ratchet in Ukraine tensions, a net 64% of respondents saw either hawkish central banks or inflation as the biggest "tail risks". Just 7% opted for the Russia-NATO conflict.
All this angst led to the highest net cash reading in portfolios since the pandemic first unfolded, heightened recession fears, and the biggest net share of funds betting on a flatter yield curve since 2005. But the worry list speaks loudly to investor fears of central bank policy errors, in part due to the still wild pandemic-related and now geopolitical distortions. Misinterpret the inflation surge and tighten too much or too hastily - or even underestimate it, allow high inflation to fester and then have to squeeze harder eventually to wrest back control.
Bullard said he favoured a full percentage point increase in the Fed's main interest rate by midyear - mainly because the Fed's "credibility is on the line".
While some investors doubt the Fed will be that aggressive, it's unnerving to think central bankers might act just to be seen by markets, governments and the public to be "doing something" - even as their own analysis shows there's little they can do to ease an energy supply or geopolitical shock.
What's more, spooking markets in that direction can have a dynamic of its own if authorities then feel they then need to catch up.
But all the furtive movement of tanks and troops in eastern Europe does have a role in seeding such a mistake. Although concerns have risen about broadening price pressures, the assumption in market and policymaking circles late last year was that even a flatlining oil price would see annual base effects get crushed early this year and take pressure off headline inflation rates everywhere in 2022.
And so these monetary and geopolitical risks are joined at the hip and hard to disentangle completely. War and an energy shock could simply up the risk of hawkish error. Avoiding those may be needed to confirm the still-benign year end forecasts.
To be continued
Once markets start unclenching from invasion hysteria - it comes back again, right on Friday. Here, actually, we see the execution of two moments that we've talked about previously and not just once. First is the geopolitical madness stands here for the long term, it is not even started yet and we're just on preliminary steps to major contradiction. Second - the more often the US tries to switch the attention of investors out of inflation, the more we think that markets underestimate its level. Since it is more or less clear the situation around geopolitical tensions and why the US keeps them hot, we focus today mostly on financial issues, and the coming interest rate in particular.
Market overview
A gauge of global stocks fell and government debt prices rose on Friday after hopes that diplomacy might resolve the Ukraine crisis faded on news Donetsk and Lugansk republics were evacuating population to Russia (Rostov region) from in the country's east as Ukrainian artillery fire intensifies and hazard of Ukrainian invasion magnifies. Sentiment soured as shelling increased in eastern Ukraine and a rebel leader announced the surprise evacuation, a surprise development in a conflict the West suspects Russia will use to justify an all-out invasion of its neighbor.
The dollar rebounded and the safe-haven Swiss franc rose as a mood that had improved on news late on Thursday that U.S. Secretary of State Antony Blinken would meet with Russian Foreign Minister Sergei Lavrov next week darkened again. Investors are waiting for the three-day weekend to be over to assess an equity market already weaker on the outlook that rising interest rates will hurt growth stocks, said Rick Meckler, partner at Cherry Lane Investments.
President Joe Biden said on Friday the U.S. national emergency declared in March 2020 due to the COVID-19 pandemic will be extended beyond March 1 due to the ongoing risk to public health posed by the coronavirus. Biden said the deaths of more than 900,000 Americans from COVID-19 emphasized the need to respond to the pandemic with "the full capacity" of the federal government.
Federal Reserve chief Jerome Powell will testify before Congress on March 2 and 3 in what are likely to be his final public remarks on monetary policy before the U.S. central bank begins raising interest rates to fight decades-high inflation. Powell will deliver his regular semiannual monetary policy update to the U.S. House Financial Services Committee on March 2 and appear before the Senate Banking Committee on March 3. Both hearings will begin at 10 a.m., the committees said on Friday.
Powell, who has not spoken publicly since January, may use his testimony to lay out what he feels is the consensus of the Fed's 16 monetary policymakers, who will be weighing the risks of an upward inflation spiral against the possibility that tightening policy too hard or fast could choke off economic growth or disrupt financial markets.
Last week, St. Louis Fed President James Bullard called for a full percentage point worth of rate hikes over the next three meetings, a steeper path than the Fed has followed in decades.
The Federal Reserve will need to move more aggressively to remove accommodation than it did following the Great Recession by raising interest rates at a faster pace and shrinking its balance sheet more quickly, Cleveland Fed President Loretta Mester said on Thursday.
Mester also said she supports selling some of the Fed's mortgage holdings at some point to accelerate the move to a portfolio that invests primarily in Treasury securities. She is among the officials who view asset sales as a backup plan for the central bank as it shrinks a balance sheet that doubled in size during the pandemic
Federal Reserve officials on Friday squelched what had been rising market expectations for an aggressive initial response to 40-year-high U.S. inflation, signaling that steady interest rate hikes should be enough to do the trick.
Fed Governor Lael Brainard - President Joe Biden's nominee to be vice chair at the Fed - said officials will likely kick off a "series of rate increases" at their upcoming meeting in March, followed by decreases in the size of the Fed's balance sheet "in coming meetings."
Investors in federal funds futures contracts last week began leaning towards the idea the Fed would raise rates a half a percentage point in March. Those expectations have now drifted back, with a quarter-point hike now anticipated and six increases in total over the year.
In remarks at the conference in New York, Chicago Fed President Charles Evans downplayed the thought the Fed needed to get more aggressive, even though he agreed policy was "wrong-footed" with annual consumer price increases topping 7%. He said he remained convinced inflation would ease on its own.
The Fed should begin raising rates next month and, once rate hikes are underway, begin to "steadily and predictably" trim its $9 trillion balance sheet, Williams said. Both actions, he said, will bring demand into better balance with supply.
At the same time, he said, other forces should also be bringing down inflation, with supply chains healing and consumers returning to pre-pandemic spending patterns. Williams said policymakers can speed up or slow down the pace of rate increases later as needed. A path in which the overnight federal funds rate moves to a range of 2% to 2.5% by the end of next year makes sense, he said.
Williams said he expects real U.S. GDP to grow by slightly less than 3% this year and for the unemployment rate to drop to about 3.5% by the end of the year. He projects inflation as measured by the personal consumption expenditures price index to decline to about 3% and for it to fall further next year as supply challenges improve.
But if we take a look at 3-month US Treasuries Bills, the major barometer of coming interest rate change, it shows that investors expect rate change in excess of 0.25%
In recent 1-2 sessions expectations are eased a bit on the background of running into the quality, but a few days ago expectations stand around 0.46% which suggests 0.5% rate change at least:
Morgan Stanley expects the U.S. Federal Reserve to raise interest rates six times this year for a total of 150 basis points, a faster increase than previously predicted, according to a research report from the bank on Thursday. Major investment banks have been penciling in an increasingly strong run of interest rate hikes for 2022 after hotter-than-expected inflation data ramped up pressure on the Fed to take a firmer stand against soaring prices.The Fed is likely to hike rates by 25 basis points at the end of its March policy meeting, followed by additional 25 basis point hikes in May, June and July, with another two hikes in September and December, according to Morgan Stanley.
Eurodollar futures, which reflect the outlook for U.S. interest rates over the next few years, have started to price in an incremental easing of monetary policy by the Federal Reserve in 2024. If that plays out, it would be just two years after what is expected to be the start of a Fed tightening next month. The money markets' odds on a 50 basis point-hike the last few sessions have dwindled from as high as 80% to 37% on Friday.
Market pricing for the December 2023 eurodollar contract showed an implied yield of 2.235%, which traders said can be a proxy for the federal funds rate.
That is looking likely to be the peak of the Fed-rate-hike cycle or the so-called "terminal rate," analysts said, with implied yields declining to 2.18% in the March 2024 contract, 2.125% in June, 2.095% for September, and 2.085% for December.
Fed officials estimate the long-term neutral rate, which is neither constricting nor stimulating economic growth, is 2.5%.
The roughly 220 basis points of anticipated interest rate increases over the next two years suggest a faster pace of Fed tightening that may include one or two half percentage point hikes in that period, analysts said.
The eurodollar curve has inverted a few times in the past.
In June 2018, the inversion suggested the Fed would have to cut interest rates at a time when it was in a tightening mode. Indeed, after hiking rates in December 2018, policymakers reversed course the following July with a rate cut. In 2020, the central bank cut the benchmark overnight lending rate to near zero as the coronavirus pandemic caused economic devastation around the world.
As the Fed gets set to raise pandemic-era rates, here are the estimates from major global investment banks on how far and fast rates will rise:
* JP Morgan raises its Fed call to seven 25-bp rate hikes from five previously, for a total of 175 bps of tightening this year.
* Morgan Stanley now expects the Fed to deliver six 25-bp hikes this year. It had previously forecast 125 bps of tightening via four 25-bp hikes plus a 25-bp fed funds equivalent runoff of the Fed's balance sheet.
* UBS now expects 150 bps of tightening this year via six consecutive quarter-point moves from March through November. It had previously forecast 25-bp increases in March and June, then "a potential shift toward an every meeting hike pace".
* BNP Paribas expects six hikes of 25 bps this year starting in March, resulting in a cumulative 150 bps of tightening.
* Citi now expects 150 bps of tightening this year, starting with a 50-bp move in March, followed by four, quarter-point increases in May, June, September and December.
* Credit Suisse now expects the Fed to hike a cumulative 175 bps this year, beginning with a 50-bp increase at the upcoming March meeting.
* Societe Generale now expects five rate hikes of 25 bps this year, starting in March.
* Goldman Sachs said it is raising its forecast to include seven consecutive 25-bp rate hikes at each of the remaining Federal Open Market Committee (FOMC) meetings in 2022 from a previous expectation of five hikes. read more
* BofA Global Research expects the Fed to hike rates by 25 bps at each of this year's remaining seven meetings, unchanged from its previous outlook. However, it said there is a risk of a 50-bp hike in the March meeting.
* HSBC expects the Fed to roll out a 50-bp hike in March and four more quarter-point rate rises in 2022.
* Deutsche Bank expects the Fed to call a 50-bp hike in March plus five more 25-bp hikes in 2022, with a hike at all but the November meeting.
* Barclays now expects the Fed to raise rates by 25 bps five times this year, up from three hikes forecast earlier.
The producer price index for final demand jumped 1.0% last month, the biggest advance since May, after climbing 0.4% in December, the Labor Department said. In the 12 months through January, the PPI rose 9.7%. That followed a 9.8% surge in December. Year-on-year PPI is slowing as last year's large increases drop out of the calculation. Economists polled by Reuters had forecast the PPI would gain 0.5% on the month and advance 9.1% on a year-on-year basis.
With the CPI and PPI data in hand, economists are estimating the core PCE price index rose by about 0.6% in January. That would result in the year-on-year rate increasing 5.2%, which would be the largest gain since early 1983. While the Institute for Supply Management (ISM) surveys and data on inventory accumulation have suggested some easing in supply constraints, that has not been evident in the PPI data.
The European Central Bank has been right to maintain its easy money policy as inflation is set to fall after "transient boosts" from supply snags that may extend into next year, the International Monetary Fund said on Thursday. The Washington-based institution said past data suggested that wages in the eurozone would rise only modestly and that inflation, which hit 5.1% last month, would fall back below the ECB's 2% target.
The IMF's post was based on a new paper estimating that eurozone GDP would have been 2% higher last year had it not been for supply constraints, caused by lockdowns and by shortages of everything from containers to skilled workers. This supply shock accounted for half the increase in euro area producer price inflation excluding energy prices last year, the IMF said.
It warned that bottlenecks may last longer than expected and possibly into 2023 due to the spread of the Omicron variant of the coronavirus, posing a challenge for central bankers trying to support the economy while keeping a lid on inflation.
Keen to downplay anxieties about the war in Europe, global investors appear to fear a monetary policy miscalculation even more. Their problem is that the two are hugely intertwined right now. World markets gyrated over the past week as fears of a standoff between nuclear powers in NATO and Moscow.
But where to focus? More global fund managers surveyed by Bank of America this month identified "monetary risks" - as opposed to geopolitical, credit, business cycle, or trade risks - as the biggest threat to financial market stability than at any point in near 20 years of polling. Although the survey was conducted before the latest ratchet in Ukraine tensions, a net 64% of respondents saw either hawkish central banks or inflation as the biggest "tail risks". Just 7% opted for the Russia-NATO conflict.
All this angst led to the highest net cash reading in portfolios since the pandemic first unfolded, heightened recession fears, and the biggest net share of funds betting on a flatter yield curve since 2005. But the worry list speaks loudly to investor fears of central bank policy errors, in part due to the still wild pandemic-related and now geopolitical distortions. Misinterpret the inflation surge and tighten too much or too hastily - or even underestimate it, allow high inflation to fester and then have to squeeze harder eventually to wrest back control.
Bullard said he favoured a full percentage point increase in the Fed's main interest rate by midyear - mainly because the Fed's "credibility is on the line".
While some investors doubt the Fed will be that aggressive, it's unnerving to think central bankers might act just to be seen by markets, governments and the public to be "doing something" - even as their own analysis shows there's little they can do to ease an energy supply or geopolitical shock.
What's more, spooking markets in that direction can have a dynamic of its own if authorities then feel they then need to catch up.
But all the furtive movement of tanks and troops in eastern Europe does have a role in seeding such a mistake. Although concerns have risen about broadening price pressures, the assumption in market and policymaking circles late last year was that even a flatlining oil price would see annual base effects get crushed early this year and take pressure off headline inflation rates everywhere in 2022.
And so these monetary and geopolitical risks are joined at the hip and hard to disentangle completely. War and an energy shock could simply up the risk of hawkish error. Avoiding those may be needed to confirm the still-benign year end forecasts.
To be continued
