Fed lift-off coming soon?

Morning Note

Will the Fed raise rates sooner than expected? Inflation the highest in 30 years, a labour market tighter than at any point since the great financial crisis and no Fed action – yet. No wonder we are starting to see them talk about a quicker taper, which would provide the ‘optionality’ to maybe raise rates a bit sooner than expected. We’ve been saying for some time that the Fed cannot ignore all this hard economic data, yet it seemed to be turning a blind eye to all the evidence. Recently though we have seen that it can adjust its uber-dovish stance to something less accommodative, albeit the pace of such transition has been glacial.  


But the Fed is going up a notch. We got really the first big ‘inflation alarm bell’ if you like from the FOMC, as minutes from the last Fed meeting said: “Various participants noted that the Committee should be prepared to adjust the pace of asset purchases and raise the target range for the federal funds rate sooner than participants currently anticipated if inflation continued to run higher than levels consistent with the Committee’s objectives”. Wow, that is a step-change and shows at last the persistence of the inflation and inflation expectations dynamics are starting to worry them.


Inflation is super-hot: Month-over-month deflator at 0.6%, up 5% year-on-year, hottest since 1990 and up from 4.4% in Oct. Core up 0.4% m-o-m, up 4.1% y-o-y from 3.7% in Oct, also the highest in 31 years. Consumer spending is strong – was up 1.3% in October, ahead of the 1% expected and up on the +0.6% last month. Consumer inflation expectations are rising, if not particularly market-based measures, with the University of Michigan 5-year outlook up to 3% from 2.9% and the one-year climbing to 4.9% from 4.8%. 


Labour market is exceptionally tight: US initial jobless claims fell to 199k, their lowest level since 1969 – jobs everywhere, but no workers to fill them. Things look very tight indeed and such a strong position for the labour market indicates that the Fed, as consistently argued here, has been too slow to react and is now chasing events. Also, yesterday the Fed’s Daly said she sees the case for speeding up the taper – USD liked that and EURUSD sank to a fresh 16-month with 1.11. She also said that while wage inflation is higher than normal, there are no signs yet of a ‘wage price spiral’. 


Anyway, the US data and Fed minutes indicate that a faster taper + earlier hike are potentially on the cards: good news is bad news. But it also pointed to relatively robust growth and consumer health: good news is good news. All in, we have seen a big pop in rates already this week and the recent jump in bond yields cooled, so the kind off rotation we saw the last few days flipped a bit and we got some payback for financials. 2yr yields are hovering around 0.65%, not making much further progress, whilst 10s have stalled around 1.64%, from a high of 1.67% post-Powell. Bit of dip buying, bit of positioning for the seasonal tailwinds ahead of the holiday (US basically out of action until Monday). High beta tech recovered a notch, and ARK’s Innovation ETF (ARKK) rallied almost 2%. The S&P 500 rallied a quarter of one percent, whilst the Nasdaq Composite climbed almost half of a percent. The Dow made a tiny retreat, snapping its two-day win streak. Holiday-thinned futures indicate the S&P 500 around the 4,700 again, an area it’s effectively been stalled at since the start of November. Thanksgiving today should keep things quiet. 


In Europe, stock markets are trading broadly higher on Thursday morning, with gains of about 0.5% for the Stoxx 50 and CAC 40. Smaller gains for the FTSE 100 and DAX. The dollar is giving back some ground, allowing the euro and sterling to mount mild rallies this morning, though the bullish momentum for the greenback remains intact. We hear from both Christine Lagarde and Andrew Bailey later today. Minutes from the most recent ECB meeting are due to be published. Earlier this morning German consumer sentiment data showed a sharp fall, whilst Q3 GDP figures were revised lower as the supply chain problems facing the global economy affected the country’s manufacturers and exporters. 


Oil – OPEC looking to meet fire with fire and respond to Biden’s puny release of crude reserves. OPEC+ is said to be reacting to the SPR release by the US and others by looking at slowing the rate of production increases when it next convenes. OPEC+ meets next week and could easily frame a pause to output hikes as a response to the rising covid problem in Europe and new restrictions to movement. US crude inventories rose by over 1m barrels last week, vs an expected draw of 1.8m barrels. Crude prices have paused, with WTI (Jan) holding around $78.30, from a high yesterday at $79.20.