Inflation heating up, Fed to hike, watch for a steepening - global macro update - 3/11/2022
Dear readers,
I wrote a global macro update last night to get everyone on the same page as we head into next week’s Federal Reserve interest rate hike. The update was also published as a guest feature within my friend and bitcoin analyst Will Clemente’s excellent Substack publication.
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Fed: inflation trumps war and equity weakness
Inflation has reached a 40-year high of 7.9%, and the impact from war-driven commodity price explosions hasn’t even started yet. The reflexivity of higher inflation, tighter monetary policy, and slowing growth should theoretically bring inflation back down over the next couple years, but the next several months will see astronomical statistical inflation relative to the past decade.
This will keep the Fed completely engaged—its credibility is once again in the crosshairs, and interest hikes will be delivered by the FOMC in the face of an overheating CPI. The first 25 basis point hike is all but guaranteed for next week, according to OIS markets. Remember that OIS markets are not economist forecasts, but liquid swap markets that reference Fed Funds rates into the future. December OIS rates are holding stubbornly above 1.5%, despite war and a Nasdaq that has already entered a technical bear market. Short-term traders continue to bet on the Fed hiking rates 25 basis points each time it meets this year.
How will we know when the Fed will reverse course, or at least pause its hiking cycle? A 20% decline in tech stocks hasn’t made them flinch. High-yield bond spreads, corporate new issuance, and money market displacements (FRA/OIS) will all cause the Fed to stutter if faced with liquidity concerns—as of now, we are seeing signs of weakness in all three of these areas, but nothing close to crisis levels. Rates markets will eventually tell us that the hiking cycle is over when the yield curve begins to steepen aggressively—for now, the curve remains flat as a pancake, which is the fixed-income market’s way of telling us the Fed is still committed to tightening monetary policy.
Note to TBL readers: the steepening of the yield curve as an indicator that the Fed is done hiking and is likely to reverse policy is not something I’ve written about yet for this publication. I promise to bring more on this if and when we see any signs of the current impetus to tighten monetary policy fade.
ICYMI
I’ve started reading, hearing, and even using the Bretton Woods III terminology to describe the massive fractures in the global monetary system taking place. Bretton Woods I (1944) established a gold/dollar/FX hierarchy, while Bretton Woods II (1971) placed US Treasuries atop the layers of money. Although I do not use “BWIII” in this post, read my post from last week on our new, hybrid monetary reality:
Until next time,
Nik
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