Recession > Inflation Fears as Hawkish Central Banks and Weaker Data Weigh on Risk Sentiment - MIDDAY MACRO – 12/15/2022
Color on Markets, Economy, Policy, and Geopolitics
Midday Macro – 12/15/2022
Overnight and Morning Recap / Market Wrap:
Price Action and Headlines:
Equities are lower, now off over 6% from their post-CPI highs, as a more hawkish Fed and global central bank tightening elsewhere, along with weaker hard economic data, sends the indices down to the bottom of recent ranges
Treasuries are higher, with the curve flattening as the front-end reacts more forcefully to ECB (and others) while growth worries support longer duration positions
WTI is lower, closing around $76, although higher on the week as the recent sell-off found support at $70 despite Chinese reopening worries persisting and the general growth outlook weaker
Narrative Analysis:
Weaker economic data and more hawkish central banks have equity markets down significantly today. The S&P is now lower by more than -5% from its post-CPI recent highs. Today’s more hawkish ECB, weaker retail sales and industrial productions data, and little improvement in the current conditions seen in the NY and Philly Fed manufacturing surveys were enough to break the camels back in risk markets, with growth/tech being the largest underperformers. Optionality and technicals became increasingly negative overnight, and a major sell-off began at the NY open. The Treasury curve is flatter, with the front end feeling the more hawkish central bank vibe over the last 48 hrs as investors took refuge further out the curve. Oil is down on the day, in line with the more risk-off tone, but demand and supply expectations improved over the week, helping WTI rise $6 as positioning cleaned up, and the curve moved back towards backwardation. Copper fell on the day and the week as growth sentiment, mainly regarding China and the rise in Covid cases there, remained negative. The agg complex was flat on the day but higher on the week. Finally, the dollar is stronger, with the $DXY higher by around 1% on the day, despite a more hawkish ECB.
The Russell is outperforming the S&P and Nasdaq with Momentum, High Dividend Yield, and Low Volatility factors, and Energy, Real Estate, and Utilities sectors all outperforming on the day.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 4027 while the Call Wall is 4100. Friday’s OPEX clears out all the current positioning, it should free up trading ranges into year end, meaning we could get some larger directional movement. It’s very murky post-OPEX into year-end. Not only are there likely to be some random year-end flows (non-options related), but we also have to contend with the shortened holiday week (generally an IV drag/ market support). The main area of exposure we are watching is to the downside, wherein a break of 3900 could catch many traders offside. Note this is not a prediction of markets breaking lower, more of a notation that we don’t see support below 3900.
@spotgamma
S&P technical levels have support at 3930, then 3915-20 (major), with resistance at 3975-3960, then 4000. We are still rangebound despite all the recent volatility. The S&P broke to the bottom of the green sideways channel (seen below), a range it has been in since early November. The current area must hold, though, or bears are back in charge.
@AdamMancini4
Treasuries are higher, with the 10yr yield at 3.44%, higher by 4 bps on the session, while the 5s30s curve is flatter by 5bps, moving to -13 bps.
Deeper Dive:
The continual commitment by the Fed (and other central banks indirectly) to keep financial conditions tight as they move policy towards a “restrictive enough” stance to re-trend inflation back to target will limit how far U.S. risk assets can rally (period). Add in growing recessionary fears from increasingly weakening domestic economic data, a “troubled” international macro backdrop, and growing Fed policy error fears, and it is not surprising that the S&P is back at the bottom of its one-month price range, down over -5% from its recent post-CPI high. Powell’s emphasis on labor market strength and more hawkish SEPs, which showed weaker economic growth but higher inflation expectations, and hence a higher for longer needed Fed funds level, tells us that the chance of a softer landing is quickly diminishing. We continue to be optimistic about where inflation is going, but if the Fed keeps raising the bar by moving the focus to labor, it's very likely the current rally will, at best, chop sideways into year-end and, at the worst, break down completely. It is our belief that Q1 will see a quickly changing story on the labor front as hiring intentions further stall (helping job openings drop), layoffs increase (driving existing claims higher), and turnover/quits return to a more normal level (reducing wage pressures). Firms are certainly more reluctant to lose hard-found workers, but a new year presents an opportunity to reassess headcount in the face of a growingly uncertain economic environment, and we believe year-end considerations have held off harder decisions there. As a result, when coupled with increasing drops in the prices of goods, continued weakness in housing/rents, and reduced “going-out” demand for services, likely falling after the holiday period, the Fed could still find itself only hiking one more time in Q1. However, this is now highly unlikely given the level of unanimity in the Fed funds projection. This makes for a poor risk environment tactically and leaves us overexposed to risk in our mock portfolio, with our views that a better-than-expected CPI report would help break stocks above longer-term downtrends and result in a more sustained Santa rally not coming to fruition. As a result, we must reiterate our often-sited mantra for patience and risk discipline in what will be our last Midday Macro writing in 2022.
It wasn’t just the Fed this week that came out with a more hawkish tone. A flurry of central banks followed the Fed, with Hong Kong matching the 50bp hike, Taiwan raising its key rate, and the Philippines tightening too. In Europe, the Swiss National Bank lifted by 50bps, while Norway hiked rates to the highest level in more than a decade. The European Central Bank and the Bank of England also both raised by 50bp, with the ECB especially coming across as more hawkish due to QT plans that would reduce its multitrillion-dollar bond holdings starting in March, by 15 billion euros a month on average at first. In the end, a slowing pace of hikes doesn’t help that much, particularly when the Fed and ECB will keep on with “QT” asset sales, which further reduce liquidity long after hikes stop. Central banks continue to very clearly signal a more hawkish tilt than expected (given inflation has peaked and recession odds are growing), and it’s inherently very dangerous to ignore it.
*The pandemic and resulting inflationary pulse now has global monetary policy highly synced, with the current rush to move policy into restrive territory occurring across 80% of the world’s central banks
*A recent DB client survey found most do not expect central bank rate cuts next year despite what future markets are pricing
To be clear, the Fed’s intention to move supply and demand into a non-inflationary balance is working; hence one can understand the persistence of their hawkish posture. Goal number one is to get inflation trending lower and forward guidance, rate hikes, and QT are increasingly getting that done, even if the core-service ex-shelter side remains sticky. Hence, the December hawkish message best seen in the SEPs has an “it isn't broke, don’t fix it” policy take. Unfortunately, the unknown lagged effects that jackhammer-natured monetary policy has on the economy historically hits hard and fast. The weakness seen in softer survey-based data most of the year is increasingly showing up in harder data, such as today’s retail sales and industrial production reports. To be clear, the consumer has been much more resilient than expected in the face of multi-decade high inflation, largely due to all the known things discussed here in the past (high net wealth/savings and strong labor market). But those same known tailwinds are increasingly becoming headwinds as savings and wealth fall and the use of credit grows (while availability and borrowing costs worsen). Interestingly, consumer sentiment has improved recently due to stabilizations in inflation (drops in gas prices) and continuing positive views on labor markets, just as real activity looks to be slowing. Further, income/job security has been a driving force in keeping core service inflation elevated as improving real disposable incomes, due to lower gas and durable good prices, have allowed spending to increase there. In the end, improvements on the supply side (falling material and fuel input costs, productivity gains from Capex/automation, and a better capital/labor balance) will reduce service inflation even if demand (which is still below the pre-pandemic trend) continues to be stable due to rising real disposable incomes. It's just going to take longer. Suppose consumer sentiment sours due to higher levels of job insecurity, which should increasingly occur in Q1. In that case, things will likely adjust much quicker, allowing the Fed to declare victory sooner while the needed period of below-trend growth is much less, reducing the chances of a deeper recession. Basically, a few tremors in the labor market could go a long way in dislodging the current sticky nature of core-service inflation while also not crashing the economy.
*Excess saving, increasingly concentrated in higher income households, still exists but is projected by JPM to be back to a longer-run trend level by Q3 ’23
*Only a slight tick lower in leaving a job voluntarily in the recent NY Fed’s Consumer Sentiment survey, but we expect quit levels to drop in Q1 increasingly
Turning to the international macro backdrop, we are ending the year poorly. The excitement around China’s end to its zero-Covid policy and return to a more normal life has faded quickly as the realization that after three year’s Beijing is still rather poorly prepared to deal with the pandemic. Recently released “pre-opening” data (retail sales, industrial output, and fixed investment) all came in weaker than expected this week. Further, relations with the U.S. soured again as more Chinese entities were blacklisted, the tech embargo continued to grow, and Xi reiterated his admiration for Putin. Hence recent hopes that China would increasingly drive growth next year while geopolitical risk fell have sharply reversed. Outside of China, EM is more mixed, ahead on aggregate in their tightening cycles (to fight inflation) but still heavily dependent on Western and Chinese growth. On the other hand, Europe has proved more resilient than expected, with higher energy costs weighing less than expected on overall activity, but subpar growth remains the modal case. The war in Ukraine also shows no signs of stopping as both sides dig in for the winter, allowing momentum to reset and Putin to adjust his strategy. This increases the likelihood of a prolonged affair that will continue to cause growth uncertainty and contribute to global inflation. Elsewhere, such as in Australia and Canada, as well as Nordic nations and the U.K., tighter policy and greater uncertainty will challenge growth as consumers see higher financing and energy costs weighing on disposable incomes. In summary, the global macro backdrop continues to be a headwind to U.S. risk assets but also keeps capital allocation more overweight here.
*Beijing’s message that Covid is nothing more than a bad cold does not seem to be resonating, while vaccination programs are still falling short
*The level of stimulus does not matter as long as consumer and business confidence is low, with activity now being restrained by fears of getting sick verse being locked down
*Although certainly heading towards a period of negative growth, the EZ overall activity has been better than expected
To end our last note of the year on a positive, we came across some “Best Case” scenarios for 2023 on Bloomberg we thought worth sharing/watching for:
Oil production stateside further increases if the administration pivots to favor domestic US oil producers
Inflation levels continue to trend lower to a greater extent than currently expected
Corporate earnings and revenue growth turn out better than forecast
Real estate proves more resilient amid rising rates
Supply-chain snarls cool as businesses diversify from one-country dependency
Commodity prices stabilize or fall, though not to the point of a recession
The US dollar falls even further as geopolitical risks lessen
More workers return to the workforce as the inflation surge cuts into personal savings
*It is all about financial conditions, as Powell reiterated yesterday, and although they ticked higher this week, they are generally trending lower
*Despite this week’s pullback in equities and some vol in the VIX, both rate and FX volatility continues to trend meaningfully lower, which will allow the VIX to fall below 20 eventually
*“Poor Sales” is still a low worry among small businesses, while inflation worries will likely increasingly fall
As stated, this will be our last note of the year. It has been a humbling year as we underestimated and missed many things. However, we learned a lot too. We will be changing the macro themes and the structure of the publication. We hope to put out a shorter note early in the week that constitutes a 5-10 minute read while putting out a more detailed note, akin to what we deliver now on Fridays, intended for a weekend read. As for the macro themes, we want to ensure we challenge ourselves with new ones every year, even if some are similar to ones in the past. Thank you for reading, and please feel free to reach out with comments, questions, or suggestions.
Happy Holidays and New Year! - Michael Ball
*The mock portfolio took a serious hit from this week’s pullback, but we are hopeful to end the year with a positive return since inception
*Hopefully, next year will be a little less chaotic with falling inflation, stabilizing financial conditions, and still positive economic growth
Econ Data:
The Headline Consumer Price Index increased by 0.1% from the prior month in November, slowing from the 0.4% increase in October and below expectations of a 0.3% rise and moving the annual headline rate to 7.1% from 7.7% in October. Core inflation rose 0.2% on the month, moving the annual rate to 6%. The energy price index fell by -1.6%, nearly erasing the 1.8% jump in the prior month amid lower prices for gasoline (-2% vs. 4.4% in Oct) and electricity (-0.2% vs. 0.1%). Meanwhile, the cost of food rose by 0.5% MoM, slightly easing from the 0.6% jump in the prior month as costs for both foods at home (0.5% vs. 0.4%) and food away from home (0.5% vs. 0.9%) rose notably again. All items less food and energy rose by 0.2%, with used cars (-2.9%), medical care services (-07%), and commodities (-0.5%) being the most significant negative drivers. Shelter prices rose by 0.6% and were responsible for nearly half of the increase in the CPI, slowing slightly from the 0.8% rise in October, lifted by rent (0.8%) and owners’ equivalent rent (0.7%).
Why it Matters: November’s CPI report was very similar to October’s, with negative used cars and health care prices driving core lower than expected. As a result, core CPI’s monthly change was the lowest since August ’21 and negative when excluding shelter, while core goods were increasingly negative for a second month. However, the Atlanta Fed sticky-price CPI measure rose to 6.6% year-over-year, up slightly from 6.5% in October. Hence it's hard to say there is a broad-based slowing in inflation yet, especially in core services excluding shelter. More volatile “going out” categories, such as airfares and hotel prices, fell more than expected. We believe that demand for travel and leisure & hospitality will start to normalize in Q1, reducing price pressures there (helped further by falling fuel costs for airfare), but this won’t be apparent until after the holiday season. Core housing is still solid but is increasingly being discounted due to known lags in official data picking up a clear drop in prices seen in both other official and private housing data as well as private rental indices. Excluding rents, core services inflation rose just 0.1% in November, although there were again “adjustments” to healthcare services that heavily affected this, with other subcategories continuing to rise. The bottom line is that the mosaic of other quickly weakening leading inflationary readings is still not materially hitting the official CPI data. However, we expect this to increasingly change in Q1 and still believe that although there is a broad-based inflationary pulse, as seen in this week's CPI report, inflation will continue to trend towards a two-handle by the end of 2023. The risk to this is that increases in real disposable income due to falling gas and goods prices allow service inflation (outside of shelter) to remain sticky even if the overall headline and core CPI reading continue to cool. This area of core services (excluding shelter) is where Powell is most focused, so any further stickiness there would warrant a tighter-than-expected policy adjustment and hence tighten financial conditions.
*It continues to be all about shelter, with the majority of other categories slowing, although on an annual basis, almost half the components are still higher by over 5%.
*Core service CPI has yet to meaningfully peak, with expectations for increases in shelter to remain persistent for a few months longer despite what is being seen in housing and rental markets elsewhere
*On a one and three-month annualized basis, an increasing number of categories are turning negative
*Stepping back, the absolute price change since the pandemic has been a significant and broad increase in costs for the consumer
*The Atlanta Fed's sticky-price CPI, a weighted basket of items that change price relatively slowly, increased 5.5% on an annualized basis in November, following a 5.5% increase in October. On a year-over-year basis, the series is up 6.6%
Import prices decreased by -0.6% in November, following a revised -0.4% decrease in the previous month and compared with market consensus of a -0.5% fall. The cost of fuel imports fell by -2.8% as lower petroleum prices more than offset higher natural gas prices. Nonfuel import cost decreased by -0.4%, the largest decline since July, due to decreases in prices for industrial supplies/materials and consumer goods, which more than offset higher prices for foods, feeds, beverages, and capital goods. On a yearly basis, import price growth slowed sharply to 2.7%. Export prices fell by -0.3% in November, slightly below expectations of a -0.4% drop and following an upwardly revised -0.4% decline in the prior month. Declines in non-agricultural exports (-0.6%) offset the increase in agricultural exports (2.3%). On an annual basis, prices for exports are higher by 6.3%.
Why it Matters: It was the fifth consecutive month of decline in import and export prices. Excluding fuel and food, so-called core import prices fell by -0.6% MoM, after declining by -0.1% in October. Core import prices are being depressed by the dollar's strength and reduced shipping costs. On the other side, imported capital goods prices rose by 0.1% MoM, while prices for automotive vehicles, parts, and engines were unchanged. Imported consumer goods, excluding automotives, fell by -0.2%, down for a third straight month.
*Import and export prices continue to drop fast, with both not recording a positive month since June.
Retail sales declined by -0.6% in November, worse than market forecasts of a -0.1% fall. It is the most significant monthly drop so far this year, with sales of furniture (-2.6%), building materials (-2.5%), and motor vehicles (-2.3%) falling the most. Other decreases were also seen at electronics stores (-1.5%), nonstore retailers (-0.9%), and sporting goods, hobby, musical instruments and books (-0.6%). In contrast, increases were seen in sales at food services and drinking places (0.9%), food and beverage stores (0.8%), health and personal care stores (0.7%), and miscellaneous retailers (0.5%).
Why it Matters: The retail sales data for November, which includes Black Friday and Cyber Monday, during which big discounts are offered, points to a slowdown in consumer spending. It also shows that holiday shopping was pulled forward into October when sales jumped 1.3%. There was a broader weakness with the "control group," which excludes volatile items such as autos, gasoline, food service, and building materials, declining by -0.2% MoM after notable gains in the prior two months. Retail sales are not adjusted for inflation, so falling prices at the pump and discounts in retail weighed on results. However, given the broad nature of declines, the consumer moved away from purchasing goods while still favoring services somewhat in November.
*Retail Sales fell more than expected, with core down -0.2% on the month after notable gains last month
*The declines were broad-based, with almost every category declining from last month's levels of growth
Industrial production decreased by -0.2% in November, following a 0.1% decrease in October and missing market expectations of a 0.1% gain. Manufacturing output dropped by -0.6% MoM, more than expectations for a -0.1% decrease. The indexes for durable and nondurable manufacturing both declined by -0.6%. Mining was down by -0.7%, while utilities rose by 3.6%. Capacity utilization moved down 0.2 percentage points in November to 79.7%.
Why it Matters: There was a broad slowing in industrial production activity, with every category lower on the month other than utilities. Industrial production was higher by 2.5% year-on-year in November, the smallest increase since March of 2021. Only home electronics improved in the durable goods category on the month, while nondurables outside energy saw every subcategory lower, even foods and tobacco. Stepping back, the harder economic data had been holding up better than expected, while manufacturing surveys have been deteriorating for some time. That is no longer the case, with actual activity data now showing a second month of contraction.
*Activity is increasingly slowing as falling demand expectation and generally high levels of uncertainty is now hitting the hard production data
The NFIB Small Business Optimism Index increased to 91.9 in November from 91.3 in October, beating forecasts of 90.4.
Inflation remains the top business problem for small business owners, with 32% of owners reporting it as their single most important problem in operating their business.29% of owners recently reported that supply chain disruptions had a significant impact on their business, with only 11% reporting no impact from recent supply chain disruptions.
Owners expecting better business conditions over the next six months improved three points from October to a net negative 43%, a recession reading.
44% of owners reported job openings that were hard to fill, down two points from October. The difficulty in filling open positions is particularly acute in the transportation, wholesale, and construction sectors. Owners’ plans to fill open positions remain elevated, with a net 18% planning to create new jobs in the next three months.
40% of owners reported raising compensation, down four points from October. A net 28% of owners plan to raise compensation in the next three months, down four points from October’s reading.
The net percent of owners reporting inventory increases rose six points to a net 5%, with a net negative 2% of owners viewing current inventory stocks as “too low” in November, down two points.
The net percent of owners raising average selling prices increased one point to a net 51%. Price hikes were the most frequent in wholesale (73% higher, 0% lower), retail (69% higher, 7% lower), construction (66% higher, 5% lower), and manufacturing (63% higher, 5% lower).
A net negative 7% of all owners reported higher nominal sales in the past three months. The net percent of owners who expect real sales to be higher improved five points from October to a net negative 8%.
Why it Matters: Overall sentiment improved due to better expectations for business conditions and a somewhat more positive inflation outlook. However, six-month-ahead business condition readings are still indicative of a recession, contrasting a historically high level of owners reporting openings hard to fill. Compensation plans, both current and future, fell while plans to raise average selling plans rose, indicating a better profit margin trend. However, profitability was still net negative, with higher costs and weaker sales being primarily blamed. Capex activity and plans improved slightly while inventory increased and stocks normalized. "The small business economy is recovering as owners manage an ongoing labor shortage, supply-chain disruptions, and historic inflation" said William Dunkelberg, NFIB chief economist. “However, inflation and worker shortages remained major issues for business owners, and most of the readings were still consistent with a recession and weak economic activity.”
*The overall optimism index continues to base after significant falls into this last summer
*Current earnings and expected sales continue to rebound
*Hiring and compensation plans both fell on the month but remain at still historically high levels
The NY Empire State Manufacturing Index dropped to -11.2 in December, well below market expectations of -1.0 and 16 points lower than last month. The New Orders (-3.6 vs. -3.3 in Nov) subindex held steady, while Shipments (5.3 vs. 8) slowed but remained in expansionary territory. Unfilled Orders (-11.2 vs. -6.8) fell further, showing capacity constraints are increasingly less of a problem. Delivery times (1.9 vs. 2.9) moved closer to unchanged. After rising sharply last month, Inventories (3.7 vs. 16.5) fell sharply, pointing to much smaller increases in inventories. Things were little changed on the price front, with both Prices Paid (50.5 vs. 50.5) and Prices Received (25.2 vs. 27.2) little changed from elevated levels. The Number of Employees (14 vs. 12.2) rose while the Average Workweek (-4.5 vs. 6.9) fell sharply. The overall and individual forward-looking subindexes notably improved, with future expected general activity, new orders, and shipment subindexes moving back into expansionary readings. Prices and employment measures also expanded, with expected future Prices Received notably higher. Capex and Tech spending intentions also rose.
Why it Matters: A disappointing headline reading with the steepest deterioration in the overall business activity since August, with inventory, unfilled orders, and workweek sub-indexes being the largest negative detractors. However, new order and shipment readings were little changed while employment intentions grew. There continues to be a stickiness in price readings after notable declines in the first half of the year. The future outlook was significantly better, especially for demand-orientated sub-indexes, which moved back into expansionary territory. Also, increases in Capex intentions and a belief in being able to raise prices to customers contrast current slowdown fears.
*Despite a large decline in the general business conditions index, New Orders and Shipments were little changed, while the future outlook notably improved
The Philadelphia Fed Manufacturing Index rose 6 points to -13.8 in December, compared to market expectations of -10. The New Orders subindex (-25.8 vs. -16.2) decreased notably, the lowest reading since April 2020. Shipments (-6.2 vs. 7) fell into contractionary territory for the first time since May 2020. Unfilled Orders (-14.7 vs. -22.9) improved, while Inventories (-2.7 vs. -6.5) moved closer to neutral. Shipments (-6.2 vs. 7) fell notably into contractionary territory. The Number of Employees ( -1.8 vs. 7.1) dipped into contractionary territory for the first time since June 2020, while the Average Workweek (-8.9 vs. 1.4) also turned negative. The future indicators broadly improved, with both the general business and New Order readings moving back into expansionary territory. Expectations for prices also notably jumped while employment readings also rose to a lesser extent. Capex (18 vs. 6.4) intentions also jumped higher.
Why it Matters: This is its fourth consecutive negative reading and sixth negative reading in the past seven months. Around 31% of the firms reported declines in activity, while 17% reported increases, leaving the majority (51%) reporting no change. The notable pick up in future readings, especially in employment and Capex, and a return of new orders to an expansionary reading show that firms expect better times ahead. This month’s special questions focused on total production growth for the fourth quarter compared with the third quarter. A slightly higher share of firms reported a decline in production (41%) compared with an increase in production (36%). Regarding firms’ capacity utilization rate for the current quarter and one year earlier, the median current capacity utilization rate reported among the responding firms was 80% to 90%, slightly higher than the 70% to 80% reported one year ago. Most firms reported labor supply and supply chains as slight or moderate constraints to capacity utilization. Looking ahead over the next three months, most firms expect the impacts of various factors to stay the same; however, more than 26% of the firms expect financial capital impacts to worsen, up from 8% when this question was last asked in September.
*Similar to what was seen in the Empire State Survey, current and future reading diverged
*Larger drops in new orders, shipments, price readings as well as employment measures drove down the overall current general business activity index
The NY Fed consumer inflation expectations for the year ahead declined to 5.2% in November, the lowest since August of 2021, compared to 5.9% in October. The three-year and five-year-ahead inflation expectations both edged 0.1% lower to 3% and 2.3%, respectively. Inflation uncertainty also decreased. Median home price growth expectations dropped to 1%, its lowest reading since May 2020. One-year-ahead earning expectations decreased by 0.2% to 2.8% in November, while expectations that unemployment will be higher decreased by 0.7% to 42.2%. Expected household income increased to 4.5%, a new series high while spending growth decreased slightly to 6.9%. Perceptions of credit access compared to a year ago deteriorated in November, with the share of households reporting it is harder to obtain credit than one year ago increasing to a new series high. Overall, the perceptions about households’ current financial situations improved slightly compared to a year ago. Year-ahead expectations about households’ financial situations also improved in November.
Why it Matters: November’s report delivered a record month-over-month decline in inflation expectations, further strengthened by a decrease in inflation uncertainty. Views around the labor market remained strong, despite a decline in future earnings expectations, with overall UER, individual job loss, and job availability expectations all improving. Interestingly, the probability of voluntarily leaving one's job in the next year decreased by 0.9% to 18.6%, which should help reduce wage pressures. Household finance expectations were a little more mixed, with expected income increasing but spending decreasing and credit access deteriorating. In summary, the report showed a consumer reducing their inflation worries while still confident that the labor market will support household finances despite reduced access to borrowing.
*Inflation expectations fell notably in the November survey, as did inflation uncertainty, which bodes well for the Fed as it reduces de-anchoring fears
*Household income growth expectations hit a new series high, helping the perceived financial situation improve
Policy Talk:
The Fed raised its benchmark Fed funds rate by 50bp to 4.25% to 4.5% range at its December FOMC meeting this week and forecasted a more hawkish than expected set of projections. The SEPs showed a median projection for a 5.1% federal funds at the end of next year, 1/2 percentage points higher than projected in September. There was relative unanimity of Fed officials, with 17 of 19 predicting a benchmark rate above 5% for next year. Powell’s deliberately indicated that the expected peak rate next year is the same as Fed officials’ year-end forecast. In other words, they see no rate cuts later in 2023 currently. There was also a hawkish revision to the inflation forecast, with a majority of participants seeing core PCE decelerating to 3.5% at the end of 2023, rising from a projection of 3.1% in September. Finally, revisions to the GDP forecast were also hawkish, with most seeing the economy expanding 0.5%, vs. 1.2% in September, corresponding with a rise in the projected unemployment rate to 4.6% from 4.4% in 2023. Powell emphasized the historical lesson that easing too early could be a terrible mistake and stressed more evidence than a couple of good inflation reports were needed before the focus/conversation could change. He repeatedly focused on the “very strong” labor market and produced a model for inflation that implied more tight money was needed due to this. He said the greatest concern was “non-housing related core services,” accounting for 55% of the Fed’s favored inflation benchmark, which was “really a function of the labor market.”
*Significant downgrade to next year's growth didn’t lower inflation expectations, while the UER level also rose
*The market continues to discount how high the Fed funds rate will be at the end of ’23 and ’24 despite the more hawkish and united December SEP projections
On the face of it, the Fed amped up its hawkish rhetoric as much as it possibly could without endangering its credibility, given the significant improvement in reported inflation in October and November. Chair Powell’s remarks may open the Fed up to more critique from doves, who may argue that the Fed has overreacted and is pushing the economy into recession with its overly aggressive policies. Markets initially somewhat shrugged off the more hawkish message as the talking points were so hawkish and repeated so robotically that traders simply didn't take it seriously, instead trusting their own models showing an imminent recession and need for the Fed to cut rates as seen in future markets. It is our view that this will be the last overly hawkish message from Powell, given it will become increasingly harder to justify increases in the inflation projections (from which all else follows) given recent data and our expected future declines, even in core services and wages. We also have more confidence that policy rates are close and the message will now be more geared towards discouraging anticipation of premature easing. The repeated reference to the unimportance of speed leaves the door open to downshifting to hiking 25bps at the next FOMC meeting if the data are supportive, and in Powell’s own words, no one knows if a recession is coming next year and hence whether policy easing will be warranted by the end of next year.
“We're getting close to the level of sufficiently restrictive. We laid out today what our best estimates are to get there. It boils down to how long we think the process is going to take."
“Financial conditions both anticipate and react to our actions. I would add that our focus is not on short-term moves but on persistent moves. And many, many things, of course, move financial conditions over time. I would say it's our judgment today that we're not at a sufficiently restrictive policy stance yet, which is why we say that we would expect that ongoing hikes would be appropriate.”
“The third piece, which is something like 55 percent of the index, PCE core inflation index, is non-housing-related core services. And that's really a function of the labor market, largely, at the biggest cost by far in that sector is labor. And we do see a very, very strong labor market, one where we haven't seen much softening, where job growth is very high, where wages are very high… But there's an expectation, really, that the services inflation will not move down so quickly so that we'll have to stay at it so that we may have to raise rates higher to get to where we want to go.”
“…our focus right now is really on moving our policy stance to one that is restrictive enough to ensure a return of inflation to our 2 percent goal over time. It's not on rate cuts. And we think that we'll have to maintain a restrictive stance of policy for some time. Historical experience cautions strongly against prematurely loosening policy.”
So, I think our policy is getting into a pretty good place now. We're restrictive, and I think we're getting close to that level of sufficiently restrictive.”
“So I just don't think anyone knows whether we're going to have a recession or not and if we do, whether it's going to be a deep one or not. It's just it's not knowable. And certainly, you know, lower inflation reports, were they to continue for a period of time, would increase the likelihood of a, put it this way, of a return to price stability that involves significantly less, less of an increase in unemployment than would be expected given the historical record.”
*The Fed’s forecasting ability has been unusually poor this year. Will this be the case next year as things slow and easing needs begin to materialize?
*Goldman expects three more 25bp hikes from the Fed
*A Bloomberg survey found Federal Reserve Chair Jerome Powell and his top two lieutenants are watched for the most explicit communication on monetary policy, but leading hawks provide guidance that's almost as important.
*Historically, there is a five-month lag between the peak CPI and the last Fed hike
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and on the week, and Large-Cap Value is the best-performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are lower on the day and slightly lower on the week.
5yr-30yr Treasury Spread: The curve is steeper on the day but flatter on the week.
EUR/JPY FX Cross: The Euro is stronger on the day and the week.
Other Charts:
The S&P forward P/E started the week at 17.3, but is now slightly lower
Options expiring in less than 24 hours are increasingly dominating SPX volume
"From rents to watches to gasoline, inflation is cooling. And given the monetary tightening backdrop, which works with one and two-year lags, it's likely to continue to cool," Ed Hyman, Chairman of Evercore ISI, says, concluding in a note last week that "this doesn't look like the 1970s."
“The most highly anticipated recession, at least since the Philly Fed started their Survey of Professional Forecasters. Below is the survey-based probability that the US economy is in recession one year later.” - @nicholastreece
With the Fed's own recession probability models flashing warning signs, there may be increasingly vocal diverging/dovish views from parts of the FOMC - @nicholastreece
Rental prices continue to fall, with the latest readings dropping again last month, indicating that official shelter costs in the CPI report should begin to fall faster
This week’s NFIB Small Business Survey indicated a reduced level of job openings, indicating December’s JOLTs data should fall further
With the Quits rate dropping, wage pressures will be reduced. In the end, lower turnover may be more important than the UER in reducing wage pressures.
China's vaccination campaign is certainly taking off: daily new vaccinations since start of H2 2022 - @Vincent_WDB
The crude shunned by Europe has been diverted to Asia, with tankers delivering cargoes to India and China, with the continent now the destination for almost 90% of Russia’s seaborne crude.
Article by Macro Themes:
Medium-term Themes:
China Macroprudential and Political Situation:
Unprepared?: China’s Rapid Covid Reversal Sparks Whiplash as Cases Surge - Bloomberg
Covid is rapidly spreading through Chinese households and workplaces after the country’s pandemic rules were unexpectedly unwound last week, sparking confusion on the ground as ill-prepared hospitals struggle to deal with a surge in cases. Long lines have formed outside of hospitals, and people are struggling to find medicine, while delivery services have been interrupted as couriers become sick. State media is urging people not to call the capital’s emergency medical hotline unless they are severely ill, cautioning that an influx of requests for help is preventing those in critical need of assistance from getting through.
Why it Matters:
Intelligence from inside the healthcare system points to a substantial increase in infections that has rendered official numbers (that show national infections at the lowest in a month) meaningless. However, China’s Covid shift is playing out in different ways across the country, in a likely reflection of how the coming months will unfold. Some hospitals in large cities, including Guangzhou, Wuhan, and Shijiazhuang, near Beijing, reported staff shortages of as much as 20% as workers fall ill or are deployed to makeshift Covid hospitals, local media, including Caixin, reported. Facilities are delaying or suspending treatments such as dialysis or chemotherapy, it reported. After almost three years of draconian rules that crippled the economy, separated families, and even killed pets, China is amazingly still poorly prepared for Covid. And the West continues to worry about the rise of China?
Longer-term Themes:
National Security Assets in a Multipolar World:
Challenge: China Says It Has Taken U.S. Semiconductor Rules to WTO – WSJ
China’s Ministry of Commerce said it had filed a complaint against the U.S. at the World Trade Organization in response to new controls from Washington on semiconductor trade with China, describing the action as a response to trade protectionism. Beijing will use the WTO’s dispute settlement mechanism to challenge U.S. export controls on products such as chips to China to defend its rights and interests, its Ministry of Commerce said in a statement posted to its website. The challenged rules require U.S. chip makers to obtain a license from the Commerce Department to export certain chips used in advanced artificial intelligence calculations and supercomputing.
Why it Matters:
The Chinese Commerce Ministry said that in recent years the U.S. has expanded its concept of national security, abused export-control measures, hindered the normal international trade of semiconductors and other products, threatened the stability of the global industrial supply chain, and taken other steps that disrupt the international economy. It said the U.S. actions violate international trade rules and laws, harming global peace and that the U.S. has conflated economic development and trade protectionism with its activity. A spokesman for the Office of the U.S. Trade Representative confirmed that the U.S. had received a request for consultations and noted: “these targeted actions relate to national security, and the WTO is not the appropriate forum to discuss issues related to national security.”
Hearts and Minds: An Alternate Reality: How Russia’s State TV Spins the Ukraine War – NYT
As Russian tanks were stuck in the mud outside Kyiv earlier this year and the economic fallout of war with Ukraine took hold, one part of Russia’s government hummed with precision: television propaganda. Spinning together a counternarrative for tens of millions of viewers, Russian propagandists plucked clips from American cable news, right-wing social media, and Chinese officials. They latched onto claims that Western embargoes of Russian oil would be self-defeating, that the United States was hiding secret bioweapon research labs in Ukraine and that China was a loyal ally against a fragmenting West. To create this narrative, producers at the state media company cherry-picked from conservative Western media outlets like Fox News and the Daily Caller, as well as obscure social media accounts on Telegram and YouTube, according to the records.
Why it Matters:
The New York Times created a search tool to identify material from the 750 gigabytes of files related to the buildup to the war and its earliest stages from January to March 2022, when the available documents ended.The materials provide a rare glimpse into a propaganda machine that is perhaps Russia’s greatest wartime success. Even as the country faces battlefield losses, mounting casualties, economic isolation, and international condemnation, state-run television channels have spun a version of the war in which Russia is winning, Ukraine is in shambles, and Western alliances are fraying.The Kremlin’s tight control of the media has increased since the invasion of Ukraine, but people’s trust in what they are watching is falling the longer the war goes on and its violent realities become harder to hide, said Vera Tolz, a professor at the University of Manchester who has studied Russian media for the British Parliament and European Union. “There are cracks,” she said.
Electrification and Digitalization Policy:
Publicly Available: Rise of Open-Source Intelligence Tests U.S. Spies – WSJ
Supercharged by the Ukraine war, the rise of open-source intelligence, or OSINT, which comprises everything from commercial satellite imagery to social media posts and purchasable databases, poses revolutionary challenges for the Central Intelligence Agency and its sister spy agencies. By some estimates, more than 80% of what a U.S. president or military commander needs to know comes from OSINT, and not from foreign agents, spy satellites, or expensive eavesdropping platforms.
Why it Matters:
The CIA is simultaneously dealing with a closely related challenge: it is pivoting from two decades focused on terrorism toward spying on a new primary intelligence target, China. But some officials say the technological tsunami facing U.S. intelligence agencies poses a more fundamental challenge than merely swapping priorities. “The agency is used to running this way and that, depending on what the demand of the day is,” said Paul Kolbe, a former CIA officer who directs the Intelligence Project at Harvard Kennedy School’s Belfer Center. But the growing dominance of open-source data represents a uniquely difficult test, particularly for the CIA, he said. That means that the CIA and other agencies need to prioritize vetting and sifting through troves of OSINT that range from YouTube videos to publicly posted genetic databases, or else risk missing the next threat or looming global crisis. And they need to do so faster than U.S. rivals, principally China.
Make a Deal: EU Advances Its Data-Flow Deal After U.S. Makes Surveillance Changes – WSJ
The European Union took a significant step toward completing a deal with the U.S. that would allow personal information about Europeans to be stored legally on U.S. soil, reducing the threat of regulatory action against thousands of companies that routinely transmit such information. The agreement would re-establish a framework that makes it easy for businesses to transfer such information again following the invalidation of a previous agreement by an EU court in 2020. As part of the new deal, the U.S. is offering, and has started to implement, new safeguards on how its intelligence authorities can access that data.
Why it Matters:
If concluded, the deal could resolve one of the thorniest outstanding issues between the two economic giants. Hanging in the balance has been the ability of businesses to use U.S.-based data centers to do things such as sell online ads, measure their website traffic, or manage company payroll in Europe. Blocking data transfers could upend billions of dollars of trade from cross-border data activities, including cloud services, human resources, marketing, and advertising if they involve sending or storing information about Europeans on U.S. soil, tech advocates say. The U.S. in October began implementing the deal on its side, including an executive order signed by President Biden that gave Europeans new rights to challenge U.S. government surveillance.
Sheeple: Uncertainty, Social Media, and the Radicalization of the US - Wired
All across the country, there are signs of a more radicalized American populace. It’s become impossible to ignore over the past few years. The US has witnessed an insurrection, the rise of QAnon, increasing anti-Semitism, attacks on the LGBTQ community, and more. While radicalism has risen to some degree in many other Western nations, this trend has been exceptionally more pronounced in the United States.
Why it Matters:
Rapid changes in technology, major shifts in the labor market and the economy, the Covid-19 pandemic, and more have caused many Americans to feel unanchored. This creates a situation where extremism can flourish. “Many of these conspiracy theories, most of them, I would think, do that.” “In the past, when transmission of ideas was slower, the ideas had a chance to evolve as they were being transmitted. This would sometimes create a sort of moderating influence,” J. M. Berger, an author, and researcher who focuses on extremism, says. “With social media, ideas move so fast that there’s really no prospect for moderation. Even the most extreme ideas can spread incredibly quickly.”
Commodity Super Cycle Green.0:
Growing Demand: Germany will promote blue hydrogen for the first time in new update of national H2 strategy, Berlin confirms – Hydrogeninsight
The German government is planning to introduce new legislation, a Hydrogen Acceleration Act, in the first half of next year to set new rules and regulations for hydrogen infrastructure. Blue hydrogen will also be promoted for the first time as part of a new update of the national hydrogen strategy. As seen in an initial draft of the new hydrogen strategy, new infrastructure will include 800km of new hydrogen pipelines and 1,050km of natural gas pipelines that would be converted to transport H2.
Why it Matters:
The new Hydrogen Acceleration Act, which is being worked on by five government ministries, would set the framework conditions “to accelerate planning and approval procedures for infrastructure construction,” the BMWK told Hydrogen Insight. This will include speeding up the construction of new hydrogen import terminals and building H2 pipelines to neighboring countries, such as the UK and Norway, and nations further afield, such as Ukraine, Morocco, Tunisia, and Algeria.
ESG Monetary and Fiscal Policy Expansion:
Carbon Imports: EU Nears Deal on Landmark Carbon Levy as Trade Tensions Rise – Bloomberg
The European Parliament and member states aim to reach a tentative deal on putting a carbon price on imported goods coming from third countries, giving the bloc a powerful tool to shield its industry during an unprecedented green transition while helping deter pollution in other parts of the world. The Carbon Border Adjustment Mechanism will impose a levy on carbon-intensive imported cement, steel, aluminum fertilizers, and electricity production. Parliament’s negotiators also want to include plastics and hydrogen while trying to ensure that EU exporters aren’t penalized by higher costs and phasing out free allowances for CBAM-covered sectors in the bloc’s emissions trading system.
Why it Matters:
A deal on the carbon measure would be a major victory for one of the EU’s more controversial proposals when it was announced last year as part of the bloc’s package to cut emissions by 55% by the end of the decade. The proposal tabled by the European Commission in 2021 envisaged that the importer would be entitled to account for the pollution costs paid in the country of origin if it has carbon pricing. The EU plans have already caused diplomatic unease in China and India. The mechanism also comes amid growing tensions over the U.S. government’s Inflation Reduction Act which provides subsidies only to American manufacturers to develop some clean technologies, including electric vehicles. The EU sees that as a possible infringement of WTO rules.
Pushing Back: Germany Backs National Action in Green Subsidy Dispute With US - Bloomberg
Germany plans to respond to the US’s green subsidy push by streamlining how existing European Union funds are distributed and increasing incentives at the national level, pushing back against calls from countries, including France, for more aggressive bloc-wide measures. Chancellor Olaf Scholz and Economy Minister Robert Habeck don’t see an urgent need for an EU-wide subsidy program as there are still billions of euros of untapped funds in existing programs. They are also against introducing protectionist provisions that oblige manufacturers to use European products as that would undermine the EU’s free-trade agenda.
Why it Matters:
The new proposal from the German government is in reaction to President Joe Biden’s $369 billion climate law dubbed the Inflation Reduction Act, which the EU says provides unfair subsidies to American manufacturers, according to people familiar with the plan. However, the new German plan could irk countries pushing for a more rigorous EU-wide response since not all nations have the same fiscal capacity to support their domestic companies. As a result, European Commission President Ursula von der Leyen has endorsed re-examining state-aid rules and creating a European fund to invest in clean tech.
Appendix:
Current Macro Theme Summaries:
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