RESOLVE
March 31, 2022
–It’s the last day of the first quarter and today the Fed’s preferred measure of inflation is released: PCE prices expected 6.4 yoy vs 6.1 last month, with Core expected 5.5 vs 5.2. At the last FOMC, just two weeks ago, the SEP projection for 2022 for PCE prices was 4.3% with Core 4.1%. If today’s price estimates are correct, it would take a serious slowdown for the Fed to be in the ballpark regarding its collective projection. Perhaps that will occur, as the Atlanta Fed’s GDP Now estimate is updated today for Q1, currently expected at just +0.9%. A noteworthy earnings call was flagged by BBG yesterday: the CEO of RH (previously Restoration Hardware) warning that sales are slowing rapidly and conditions are extremely challenging for all businesses.
–Yields fell across the board yesterday, with tens down 5.6 bps to 2.35%. 2/10 still hovering around zero, yesterday ending at 3. Red/gold euro$ pack spread (2nd to 5th year) again made a new historic low at -70.25. In the front end of the curve, EDM2/EDM3 one-year calendar made a new high at 164.5 bps, the highest of the cycle. The market’s perception of an aggressively tightening Fed that will lead to a severe slowdown is being hammered home every day by the euro$ curve. At the same time, the Biden admin is considering an oil release from the SPR, causing a sell-off in WTI , which is down over 5% this morning just below $102/bbl (CLK).
–Against this backdrop was a rather interesting speech by Esther George of the KC Fed. Here are couple of excerpts with my comments.
“Given the state of the economy, with inflation at a 40-year high and the unemployment rate near record lows, it is clear that removing accommodation is required. How much and how aggressively accommodation should be removed is far more uncertain.” [some of your colleagues appear quite certain that getting to neutral VERY quickly is required]
“Recognizing these risks is not an argument for stalling the removal of accommodation, but it does suggest a steady, deliberate approach for the path of policy could provide space to monitor developments as they unfold.
While many factors influence longer-term yields, including the growth outlook, foreign demand for Treasuries, and the quantity and maturity of Treasury debt issuance, the Fed’s asset holdings also play a role. These purchases aimed to depress long-term rates, and the roll-off of these assets is likely to put some upward pressure on those rates, possibly steepening the yield curve.”
[steady and deliberate is NOT what other officials are espousing, and NOT what the market is pricing]
“My concern about an inverted yield curve does not reflect its intensely debated value as a predictor of recession. Rather, my view is that an inverted curve has implications for financial stability with incentives for reach-for-yield behavior. An inverted yield curve also pressures traditional bank lending models that rely on net interest margins, or the spread between borrowing short and lending long.” [everything in finance depends on this, and the US economy is dependent on financial engineering. An inverted curve predicting recession is NOT hotly debated, it IS a predictor]
Finally,
“In the event high inflation persists while demand turns down, and the labor market falters, policymaker resolve could be tested.” The outlook demands “equal doses of flexibility and resolve”.
So there it is. RESOLVE. In 2018, policymaker resolve was tested by faltering stocks, and resolve dissolved. Resolve will now likely be tested by a stalling economy. US policymakers always want to cushion any negative events. Hence, the belief in the Fed put. Hence, considerations of the SPR release. Half the Ukrainian population has been displaced and the US response is to make sure that prices don’t go up for US consumers. Newsflash, interest rates are a price. The pithy line “equal doses of flexibility and resolve” means this: as soon as our policy is tested, our resolve will collapse.
