By Michael Every of Rabobank
“And now abideth faith, hope, charity, these three; but the greatest of these is charity.” - 1 Corinthians 13:13
FAIT, hope, and charity
Yesterday’s Fed meeting saw the Fed’s FAIT (Flexible Average Inflation Targeting) tested. As Philip Marey notes in his coverage, the updated economic projections of FOMC participants showed upward revisions to GDP growth and the Fed’s favourite PCE (and core) inflation measures in 2021, but the revisions for 2022, 2023 were only minor, and longer run projections were unchanged. Nevertheless, the median rate projection for 2023 was revised upward by 50bp. The dot plot also shifted upward aggressively, not only implying two 25bp rate hikes before end-2023, but also getting closer to a rate hike in 2022. It takes only two more participants to shift toward a hike in 2022 to make it a split 9-9 committee.
As a result, US 10-year Treasury yields spiked 10bp, and the dollar jumped, while equities initially wobbled – then bounced, before closing slightly down. Oh ye of little FAIT! We are still talking about no rate hike for two and a half years, most probably; and more importantly, there won’t be any tapering of the $120bn of QE a month until “substantial further progress” has been made toward the Fed’s maximum employment and price stability goals. What does “substantial further progress” mean? We don’t know. What does $120bn times 18 months mean? $2.2 trillion. And where will it go? Stocks, housing, and commodities.
On QE tapering, Philip notes US labor supply distortions could last until early September, when enhanced federal unemployment benefits are scheduled to end and schools are expected to start reopening fully. This means that the fog over these key data will not dissipate until the November meeting of the FOMC. However, a statement in November about a tapering decision in December or January is not be very much of an early warning signal for markets who will need it to avoid a Taper Tantrum – which brings us back to August (Jackson Hole) or September (FOMC meeting, with new projections) as potential dates to flag tapering. Or, we get a much longer period of time before we even start to talk about tapering – and that $2.2 trillion, for example.
But what of charity, which is greater than FAIT(H)? To quote Philip: “For almost a year the Fed said it would use FAIT to help fight unemployment of minority groups, which tend to get last hired first fired. However, a few unexpected data points and they are the first to be sacrificed by the social justice warriors with the wobbly knees.”
There is always hope, of course. Chinese Premier Li Keqiang yesterday stated “China should keep grain prices at reasonable levels”, as fertiliser and urea costs spiked 10% in the first 10 days of June. But how? By selling off state reserves. Yet stocks are finite, while QE and *global* demand are far less so, even if yesterday’s data say Chinese demand may be ebbing. In which case, Bloomberg reports “China’s Campaign to Control Commodities Goes Into Overdrive” and “China is Quietly Stepping Up Its Interventions in Markets”. However, such steps cannot work in a *global* market where commodities are priced in US dollars. And meanwhile, Turkish exporters are being forced to use wooden pallets to replace steel containers given the lack of them. Until they run out of wood.
Or, for the RBNZ, excuses: Q1 GDP was up 1.6% q/q vs. 0.5% expected and 2.4% y/y vs 0.9%, despite the global backdrop. They had already flagged six hikes by end-2024 – and now the Fed are shifting and GDP booming, why not move now? **cough** Housing/NZ$ **cough**. Brazil just hiked rates 75bp to 4.25%, a third consecutive move, taking cumulative hikes to 225bp, the most in the G20 this year: countries with real experience of inflation are more willing to act on rates than ones who talk about inflation but haven’t seen it for more than a generation. BRL had broken the psychological 5 barrier just prior to the Fed announcement – but then again, this is exactly what the RBNZ et al., don’t want to see happen.
Elsewhere, “Nadezhda” надежда is hope in Russian – and that is probably all we have to show for the Geneva summit. US President Biden losing his temper at a CNN reporter got the social media focus, rather than anything agreed with Putin. However, Biden handed over a list of 16 types of critical infrastructure which are off limits to the cyberattacks Russia denies it is ever responsible for – or the US will respond. So ‘rules of the game’ were perhaps laid down; but is everything else in the US fair game(?) Let’s see how Russia behaves in the next few weeks before making any judgements on the pow-wow.
And not just Russia, of course, as we circle back to FAIT, but this time in the form of US Senator Hawley, who last week introduced the Taiwan Defence Act to the Senate, which states: “It shall be the policy of the United States to maintain the ability of the United States Armed Forces to deny a fait accompli by the People’s Republic of China against Taiwan.”
This is against the backdrop of the G7, NATO, and the EU-US summit all mentioning Taiwan, and defense analysts arguing that too weak a US signal towards it could encourage China to make a provocative move - and yet so too could too strong a US signal. It also comes after Bloomberg reported “A Far-Flung Taiwan Island Risks Triggering a US-China Clash”, noting the US has stepped up surveillance flights near Pratas, a Taiwanese island nearer to Hong Kong, and quoting Ben Schreer of Macquarie University’s department of security studies and criminology that: “There is now a serious possibility that China seeks to occupy one of the outer islands. If that happens, what is the international community going to do? What is the US going to do?”
We all hope for the best, of course. But if you think we have logistical and inflation problems now, you really don’t want to contemplate those fat tail risks. The Fed certainly isn’t.