By Michael Every of Rabobank
Thursday was another crazy day in markets. The S&P was -3.3% and is now -23.1% year-to-date while the Nasdaq was -4.1% and is -32% YTD. The equity bulls are in a ball hugging their knees in the corner, shaking their heads and staring into space.
US Treasury yields were all over the place: up again (nearly 18bps), then hugely down (almost 30bps) to close 9bp lower overall. Japanese 10-year JGBs briefly got as high as 0.285% before Yield Curve Control (YCC) controlled them again. In Europe, we saw German 2s rise 23bps, then drop 15bps from that high, while 10s went up 29bps, then rallied 20bps from that point. In Italy, 2s started at 1.74%, leaped 13bps, slumped 16bps, rose 10bps, and fell 9bps to close at 1.72%, while 10s started at 3.76%, rose 22bps, but ended back at 3.74%. Clearly the market is (in)digesting what the ECB is cooking up re: anti-fragmentation actions for next month.
The US dollar had a bad, bad day due to chaos in other markets.
Oil was down big, at first, with Brent tumbling from $120 to below $116, but then bounced to $120 before closing around $119. US Energy Secretary Graham is to meet refining executives on 23 June: hopefully she will have read the explanation they just sent to President Biden explaining how the energy market actually works. Other commodities were mixed, with metals down mostly a little, but softs up on the day as the dollar dipped – which alongside oil refusing to stay down, is still a warning for those still hoping the Fed can ease off quickly.
Indeed, as my colleagues and I were discussing yesterday, let’s presume the Fed tightens to the point where we get recession and deflation, i.e., CPI goes from nearly 10% y-o-y to -2%. Then the Fed eases monetary policy again aggressively while the supply side remains constrained: wouldn’t you just get 4-5% inflation straight away, taking base consumer prices to even higher highs? A projected glide-path back to 2% CPI “because DSGE models” and “because no geopolitics” risks being as inaccurate as “inflation is transitory”. That implies risks of higher rates ahead, and for longer. “Higher for longer” is not what we are used to in markets, is it?
On crypto, that cutting-too-early scenario might mean a 2024 bid. But for now, it’s “Do you want DeFis with that?” for holders likely to soon boost the size of the US labor market again.
One of the proximate causes of the sell-off yesterday was not just post-Fed 75bps gloom, but even the stolid Swiss rolling us by hiking an unexpected 50bps. It wasn’t quite as large a market shock as the SNB’s dropping of the CHF peg a few years ago, but it was still big. Indeed, the SNB not only took their key rate closer to positive territory but underlined that CHF has depreciated in trade-weighted terms and is “no longer highly valued,” so imported inflation has increased: that implies CHF needs to be more highly valued to deal with inflation; and that suggests the SNB will be selling, not buying US stocks and other assets, now they aren’t needed to keep CHF down.
In short, we are in a period of inverse FX wars, where everyone now needs a stronger currency. Actual wars naturally lean in that direction. The same post-2008 finance generation who think FX war is actual war(!) again don’t understand how things really work. It isn’t about ‘export competitiveness’ in the face of supply constraints and bullets flying. It’s about cheaper key imports to fight, and to allow low enough borrowing rates to fund long-term war spending; or it’s about running a trade surplus, and so a strong currency as a result, which allows money-printing (i.e., MMT) to pay for said defence spending. That is to say we are in an inflationary, FX, and geopolitical reversal of what we knew as the ‘new normal’ – and all three are linked.
Quite literally on that front, France’s, Italy’s, and Germany’s leaders all visited Kyiv yesterday and jointly pledged Ukraine would be accepted as a candidate for EU membership ahead of the expected EU decision on that matter today. If so, it makes the battle taking place more existential for the EU, as it is obviously is for Ukraine. Yet as EU gas prices spike again thanks to Russia, which says it has a perfectly-good Nord Stream 2 to replace the suddenly malfunctioning Nord Stream 1, cynical geostrategists note either the EU steps up the supply of military support to Ukraine, or it risks finding that while it wanted to offer it EU membership, sadly it is no longer in a physical position to accept it. In short, as on rates, real action now matters, not jawboning.
As such, don’t expect the recent dollar weakness to last. The Fed is moving 75bps while others are doing 25bps or 50bps. And if a US recession is coming, a global recession is coming too. While the US will suffer, net exporters with less fiscal flexibility will suffer far more. Risk will be very off in very many places.
Indeed, the BOE only offered up a feeble 25bps hike to 1.25% at their meeting. GBP/USD was still up from a low of 1.2050 to nearly 1.24 at its peak just because everyone, temporarily, wanted out of the dollar, but this won’t last. As Stefan Koopman notes, the MPC also updated its guidance, and is no longer telling markets “some degree of further tightening” is needed in order to bring inflation back to target, but that “the Committee would be particularly alert to indications of more persistent inflationary pressures, and would if necessary act forcefully in response.” He adds that this change in guidance has sown confusion: it is not 100% clear why it was made in the first place, and it is not 100% clear if this is dovish (i.e. only forceful action if there is more persistent evidence) or hawkish (i.e. a signal that 50bps increases are on the cards if m/m rates of inflation don’t fall soon). For now, markets are inclined to believe the latter.
He concludes, “We expect one more 25bps hike in August, before the MPC takes a pause and re-assesses. The risk is that the market will not allow the central bank to pause… This places the central bank in a perilous spot: if it does too little, imported cost pressures keep flowing in, if it does too much, it will only intensify the recession. Welcome to Stagflation Nation!” At least in that regard, it truly is Global Britain.
Today, the market turns to the BOJ, where the betting is increasingly that they too will have to abandon their YCC policy and let the 10-year JGB yield rip – which will let JPY rip and destroy lots of carry trades people won’t be expecting until they do. When that unwind happens there will also be cross-selling of whatever is still liquid and not too beaten-up. In short, the BOJ may join the rest of the central banking world today in tightening policy one way or another, creating yet more havoc. Indeed, at time of writing, the 10-year JGB was already above the 0.25% target again, as people again tried the long-time ‘widow-maker’ trade.
Yet recent comments from Finance Minister Suzuki suggest the BOJ may still stick to their guns. If so, they are pulling even further on a monetary elastic band that will hurt far more when it does inevitably come snapping back the other way.
Happy Friday. Try not to get Swiss rolled as the market embraces a yen for change.