Stock market sentiment contaminates everything else

By on May 10, 2022 0

Outlook: It’s a week of slow news. Ahead of tomorrow’s inflation report, we need to think about the Atlanta Fed’s GDPNow model. It estimates Q2 at 1.8%, compared to 2.2% last week, driven by “real gross private domestic investment growth deteriorating from -1.3% to -2.8%”. We receive another estimate next Tuesday.

The lull provides time to read editorials and opinion pieces, which the FT excels at. One is a critique of the Fed by fund manager Richard Bernstein. He says the real federal funds rate is more negative than at any other time in history, at -7.5% versus a 50-year average of 1%. In contrast, the real Fed funds rate was above 10% at the height of the Volcker regime.

“Some economists are defending the Fed’s timid actions by suggesting that inflation will ease once current supply chain bottlenecks ease. However, supply disruptions have been behind of the worst episodes of inflation in the U.S. The oil embargoes of 1973-74 and 1979 fostered a real wage and price spiral It is important to note that the current supply disruptions have already lasted longer than oil embargoes of 1973-74 and 1979 combined and that supply chains still remain locked in. It is remarkable how investors, and the Fed for that matter, downplay one of the most important economic events in the United States history.

Bernstein called the Fed “timid” and said, “The Fed wants to be seen as a conscientious inflation fighter, but the extremely negative real fed funds rate indicates otherwise. Despite the jawbone of the Fed, they are what their actual fed funds rate indicates they are.

We could argue that the Fed has always and repeatedly said it can’t do anything about oil prices or supply chains, and that it’s unfair to blame them or even talk about them in terms of crisis when she cannot offer any help. Furthermore, the supply-driven oil crisis of 1973 and 1979 unfolded under very different conditions than today, notably the United States having become self-sufficient in energy. The truly significant event is not oil per se, but Europe’s first land war in over 75 years.

It is becoming increasingly clear that the sentiment in the stock market – extreme fear bordering on panic – is contaminating everything else, including FX. In another analysis, Barclays’ head of research told the FT that the S&P fell 4.6% in the first quarter and 9% in April, the worst monthly performance since March 2020. …

“Corporate profits are not to blame. According to Barclays estimates, companies are beating earnings forecasts at a record pace in the United States and Europe. But stocks are ignoring earnings and taking their cue from bonds, which are having a horrible year. Yields on the 10-year US Treasury have jumped 80 basis points since early April to above 3% for the first time since 2018. It is now near a decade high.

The rapid change in sentiment is not due to inflation, which is falling, nor to average hourly wages, which are stabilizing. This is due to the bond market’s extreme response to the Fed, which sees the Fed giving up “everything it takes” to get inflation under control and avoid ruining the economy by being too aggressive. The fear is that if inflation is 3% by the end of 2023 but the economy collapses, the Fed will quit. This makes the bond market volatile and disorderly. “But if markets remain uneasy in the coming weeks, the Fed may feel compelled to react. And surprisingly, and perhaps counterintuitively, the right approach this time – unlike in the past – could be to emphasize its commitment to 2% inflation rather than a soft landing.

This is a second opinion calling the Fed timid and not aggressive enough. Sorry, but that’s too complex. Yesterday we said the world was trying to disambiguate the message from the Fed. But in the process, it’s about overthinking the message and making it more ambiguous, not less, or at least less clear. The problem is that analysts place too much weight on the neutral rate, which today should be ridiculously high and certainly above 2%.

It’s like they don’t believe the Fed can imagine an economy with somewhat high inflation (like 3-4%) that doesn’t require further hikes. They also seem to assume that the Fed places great importance on GDP numbers when those numbers only keep a particular type of score and not the most relevant scores, which are more likely a set containing wage growth and government spending. ‘investment. For example, trade deficits subtract from GDP. On the face of it, that doesn’t pass the Fed’s “so what” test. If the economy advances at (say) 0.75% and trade subtracts 0.75%, does the Fed just stop climbing? No.

And besides, a trade deficit does NOT subtract from GDP, as almost everyone reports. When GDP came out last week, all major news outlooks reported that trade subtracted 3.2% from GDP, even from supposedly economically capable outfits like the WSJ and Bloomberg.

But listen to the St. Louis Fed: “To be clear, buying domestic goods and services increases GDP because it increases domestic output, but the purchase of imported goods and services has no direct impact on GDP. The United States is the quintessential country in which a deficit means that the economy is strong (and also that the currency is not overvalued).

Then there’s that soft landing. What, exactly, is a soft landing? It is a slowdown in the economy that avoids a recession. A recession is a decline in economic activity measured by GDP that lasts longer than two quarters. But what did we just say about GDP? It’s an artificial construct that doesn’t do a very good job of defining “activity”. You can have a technical recession with negative GDP but still have critical components springing up like mushrooms. At the top of this list is consumer spending. Last week, vehicle sales lifted real personal consumption spending from 3.6% to 4.4%, which was enough to lift the Atlanta Fed’s GDPNow for the second quarter by 1, 4% to 2.2%.

A third and final piece from the FT is titled “Soaring dollar raises specter of ‘reverse currency war’”. What is a Reverse Currency War? To begin with, a currency war is a government that deliberately devalues ​​its currency to create a trade advantage.

A reverse currency war is the opposite – forcing a higher currency to earn a gold star for investing in the currency itself. This idea is based on the assumption that central banks have a “long-standing preference for weaker exchange rates”.

Raising real differentials is a by-product of fighting inflation. “The dollar hit its highest level against a basket of rival currencies in 20 years this week as traders react to the Federal Reserve’s attempt to cool inflation with sharp rate hikes. central bankers outside the U.S. might have embraced the wild dollar, they now feel that exchange rate swings have added further pressure to keep pace with the Fed… “The strength of the dollar explains in part why you see very limited investment in the markets,” according to BlackRock.

The idea of ​​a reverse currency war seems to have come from Goldman, but everyone agrees with the fanciful term. In the United Kingdom, for example, fighting the devaluation of the pound sterling is a form of fighting inflation. Moreover, “The Swiss National Bank, which for so long has been one of the most active currency warriors, with its policy of not allowing the franc to appreciate too much, has also changed its tune. SNB board member Andrea Maechler said this week that a strong franc has helped stave off inflation, which has risen in Switzerland this year but far less than in the neighboring euro zone.

Well. Not to be too picky, but a war is something that is deliberately chosen. War consists of specific actions taken consciously with various consequences listed and weighed. So if we have a Fed that deliberately plans to aim for a stronger dollar, that assumes a consciousness of intent. This is simply not the case in the United States. The Fed is not in charge of the dollar. It’s the Treasury. We would give ten bucks to anyone who found a single Fed official who said a single word out loud about the dollar in the past six months. Some backroom economists have said, “yes, higher rates, stronger dollar,” but that’s certainly not a stated or deliberate political goal.

Moreover, if the other central banks follow the Fed pari passu, there should be no currency effect. It is the gap that counts and, in fact, it is the change in gap that counts. If the ECB and the BoE were in phase with the Fed, the currencies would not move, at least not for reasons of the yield differential.

Even the ECB is reluctant to talk about currencies in the context of interest rate policy or direction. There was a big crisis when Duisenberg was head of the ECB and before that the foreign exchange market was shaken up during the Clinton years when the TreasSec Rubin said that “a strong dollar is in the interest the United States”.

Those who do not remember history are doomed to repeat it. Central banks are moving as far away as possible from monetary issues. Accusing them of “war” is, pardon the crudeness, stupid. Marc Chandler is more diplomatic: “Is this a useful or precise framing of the question or is ‘war’ an incendiary image which is the material equivalent of click-bait?” Yes, “click-bait” is less obnoxious but the gist is the same – the pros blowing a raspberry at the whole idea.


This is an excerpt from “The Rockefeller Morning Briefing”, which is much larger (about 10 pages). The Briefing has been published daily for over 25 years and represents experienced analysis and insight. The report offers in-depth information and is not intended to guide FX trading. Rockefeller produces other reports (spot and forward) for trading purposes.

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