There Has Been No Coherent Market Narrative Other Than Simply Waiting For Risk Events To Emerge

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by Tyler Durden
Wednesday, Dec 15, 2021 - 03:03 PM

By Stefan Koopman, Senior Macro Strategist at Rabobank

This week’s flow of macro-economic news has thus far not been able to change the push-and-pull price action in the markets. Even as realized volatility is relatively high, in particular in the equity space, current market movements predominantly reflect position-shuffling ahead of today’s Fed decision and tomorrow’s ECB meeting, and amidst the pressure to close books before year-end. There has been no coherent narrative other than simply the wait for these risk events to materialize.

This insouciance persisted after the release of some punchy US producer prices for November, which ‘unsurprisingly surprised’ to the upside. The PPIs were firmer across the board; the core index rose from 6.8% y/y to 7.7% y/y, whereas a rise to 7.2% y/y was forecast by analysts. The almost comparable rise in the CPI demonstrates the ability of US firms to pass those added costs on to consumers. Yet, the November NFIB-index showed that inflation weighs on sentiment nonetheless.

As with the PMIs, the rise in the NFIB to only a so-so reading of 98.4 actually papers over some truly pessimistic details. Small business owners overwhelmingly expect business conditions to worsen in the months ahead: the score of a net negative 38% was tied for a 48-year record low. Moreover, a net 54% of the respondents plans to raise prices further in the months ahead, which was a 48-year record high and clearly suggests that US inflation won’t suddenly roll over. Finally, it’s worth noting that only 9% of small business owners reported to have experienced no impact from recent supply chain disruptions.

These numbers will surely feed into today’s FOMC decision and may produce some wild dots. In any case, this opinion piece of Narayana Kocherlakota illustrates how fast minds can change in the face of new evidence. He was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015 and one of the leading doves during his tenure, but now sees the risk of a self-reinforcing upward spiral due to rising wages and increases in sticky prices. He proposes that the Fed should launch “meeting-by-meeting” interest rate increases in the first half of next year and to “keep going until inflation comes back down near 2%”. If the FOMC indeed moves to take up his advice, it will trigger a major blow-up in financial markets and probably engineer a global recession.

The economy of the UK joined the >5% inflation club this morning as well. The largest chunk of the price increases remains concentrated in goods and energy, which are priced globally, and the simultaneous rise in its PPIs suggests there is more to come on this front. On the other hand, the costs of services, which are priced domestically, didn’t increase as much at all in November. The Bank’s MPC has pretty much signalled they want to wait on how Omicron plays out as it is reluctant to risk an already stuttering recovery. That said, if the impact of Omicron on the economy is fairly mild, as most economists still expect, the pressure to act sooner than later will increase once more.

It’s worth noting the IMF felt the need to rub some extra salt into the Bank’s wounds by warning it should avoid the 'inaction bias’ on inflation. Yet the IMF ignored the trade-off that hiking interest rates in response to global price pressures means sacrificing domestic employment and output growth. In the UK, where (global) prices are rising faster than domestic wages, the risk of second-round effects remains limited. Even as the labor market is tight in a few key sectors, evidence that pay rises respond to higher prices is still scant. This means that the UK faces its third real wage squeeze in little more than a decade, and unless pay does pick up markedly in the next few months, the gloomy outlook for living standards continues well into next year. Is a dose of monetary austerity on top of already fading fiscal support then really what it needs?

Another wild card for the UK economy is –once again– political uncertainty. Yesterday evening 98 Tory MPs voted against Johnson’s plans to introduce Covid vaccine passes. This is a huge Tory rebellion, with only 20 fewer rebels than his predecessor May had over her proposed way out of the Brexit conundrum. In 2019 this eventually triggered a leadership crisis. A loss in tomorrow’s by-election in North Shropshire may strengthen the criticism around Johnson. The underlying irony is that he may have lost his parliamentary authority on one of his more sensible proposals. That is just one of those unpalatable side-effects of Brexit, we guess.

Day ahead

Back to the US, where Congress gave its final approval this morning to raise the debt ceiling by USD 2.5trn. This should be just enough to put this matter to rest until after the 2022 midterm elections.

The Fed will probably suck all the air out of the marketplace today as it reaches its crucial policy decision. Following Powell’s hawkish pivot earlier this month, an acceleration in the tapering of its asset purchases from the current pace of USD 15bn per month is pretty much fully priced in. We think that doubling this pace to USD 30bn per month would make most sense, because it creates the option of a first hike on March 16 and allows the FOMC to escape from its straitjacket. We do, however, expect hikes to occur in June and December. Please see Philip’s preview here.