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“The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.” - F Scott Fitzgerlad  

I think operating in the markets day-in, day-out poses the same challenge as suggested by America’s greatest writer of prose. How do you hold two opposite ideas, or scenarios, in your head at the same time and fully discount for both?  

  

Stocks Just Don’t Want to go Down Yet  

It was a wild ride for stocks on Wall Street yesterday as Fed chair Jay Powell laid out his position for the umpteenth time. Still markets are keen to read the glass as half full, though the pop on Wall Street at the close didn’t take the market above last week’s highs and yields, though a touch lower, are still well above where they were running into Friday’s bumper nonfarm payrolls report. Rates hikes are priced but the market doesn’t yet buy just how long they’ll stay high, and it still prices for cuts too soon.   

  

Powell Hawkish or Not?  

Jay Powell is still giving bulls enough rope to hang themselves by as he is not sounding hawkish enough. Obviously, I would question why he’s not pushing back harder – the answer is the Fed thinks it’s guiding the economy to a perfect soft landing – employment booming, disinflation taking hold.   

On the one hand he’s saying – reiterating – that rates will go up a bit more and stay there for longer than the market thinks. “I think there has been an expectation that [inflation] will go away quickly and painlessly and I don’t think that’s at all guaranteed... The base case, for me, is that it will take some time. And we will have to do more rate increases and then we’ll have to look around and see whether we’ve done enough.”  

  

Why Did Stocks Jump in the End?   

The market had been expecting Powell to come out fighting – after the monster jobs report everyone expected Powell to be very hawkish and wasn’t any more hawkish than before. That gave the market an easy reflex higher after some initial volatility around the remarks.   

Powell embraced the disinflation viewpoint again, albeit with the usual caveats, just as he did in last week’s press conference. “The disinflationary process, the process of getting inflation down, has begun and it’s begun in the goods sector,” Powell said. “But it has a long way to go. These are the very early stages of disinflation.”  

  

Gremlin Mode  

Key takeaway – the Fed is now totally data dependent. As I explained last week, the CBs have switched mode. They’ve gone from full gremlin mode in battling inflation to chilled-out fuzzy cuddly mogwai mode. Expose Gizmo to more inflation, however, and there will be gremlins aplenty. It means that instead of paying too much attention to what the Fed is saying it’s going to do, we need to look at how it thinks it will react to more inflation. And we need to of course look at the data.  

“The reality is we’re going to react to the data,” Powell said, adding that the Fed may well need to raise rates “more than is priced in” by markets.  

  

Discounting Two Events; FTSE 100 Record Intraday 

We are seeing a lot of chop in the US equity market (more on the UK below), as markets attempt to price in two very different scenarios at the same time. It’s not easy – as Scott Fitzgerald says – for the market to discount two very different outcomes. Hard landing and deflation or persistently higher inflation and rates? The point is that you cannot get inflation down without a proper hard squeeze on the labour market that creates a recession, however you want to define it.  

UK equity markets remain on the front foot though – less rate sensitive, more inclined to pick up a cue from China’s reopening and relative resilience in Europe and beyond. It’s not all about the Fed for the FTSE. Bulls pushed the FTSE 100 to a new record intraday high at 7,926 in early trading as investors continue to shrug off just about most things. 8,000 looks assured.  

  

Elsewhere… 

The dollar has eased back after sharp gains in the latter half of last week and Monday. Tuesday saw a push higher but rejection of the move above its 50-day SMA for DXY, whilst EURUSD bounced at its 50-day line around the 1.07 round number. USDJPY has also retreated from the 50-day moving average area at 132.3 to retake a 130 handle. Gold nudged up as the dollar retreated.  

Oil surged aggressively as risk caught a bid in the wake of the Powell comments. Meanwhile the raising of prices by Saudi for Asian buyers and a bullish API inventory report also lifted sentiment. 

We hear from NY Fed president Williams and Fed governor Waller later on today. There is also a 10yr bond auction in the US. 

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