The latest US CPI report further stoked inflation fears as inflation rates spiked
Despite a safety-trade on Friday associated with the Russia/Ukraine situation, traders expect six Fed rate hikes in 2022
Wage growth acceleration points to maximum employment, an important pillar of the Fed’s dual mandate
Stocks vs bonds likely remains pressured for the balance of the year as the credit market tightens and policy stimulus gets removed
The US CPI report was seen as the only major economic data point last week. And boy did it deliver! The hotter than expected 7.5% headline YoY print was the biggest figure in 40 years and the market reaction was even more striking. The US 2-year Treasury rate surged 26 basis points on bond intense selling. It was the biggest single-day rise in short-term rates since the latter part of the Great Financial Crisis.
The 10-year Treasury yield rose above 2% last week. And it’s not just a stateside story – global intermediate sovereign rates have been on the rise for many months. Central bankers across the world are sweating at the moment given sustained inflationary pressures over the last year amid supply chain woes and strong consumer demand.
Expectations
The market has priced in more than six Fed rate hikes this year – and that market expectation was near 7 quarter-point increases before Friday’s risk-off, flight to safety trade. Volatility is alive and well in the bond market. Fixed-income investors have also discounted tighter credit market conditions via higher shadow policy rates.
Hotter, then Cooler
Still, we see inflation – while extreme over the last year – as cooling off later this year. Year-over-year comparisons become stiffer and supply chain issues should begin to ease now that Omicron wanes. We remain bullish on energy and see upside risks among commodity prices in general over the coming years. Commodities surged once again last week while large-cap US equities sold off.
A Global Checkup
Our flagship Weekly Macro Themes report dives into our latest thoughts on the Fed, credit markets, and a round-up of international stock markets (which have handily outperformed the S&P so far in 2022). Let’s talk about the Fed’s dual mandate.
Is the Dual Mandate Threatened?
The FOMC is tasked with keeping consumer prices in check while promoting maximum employment (and economic growth). They also attempt to influence long-term interest rates to a moderate range. Inflation is talked about a lot, but the labor market is also too hot to handle right now. Many indicators on the jobs front suggest the Fed is behind the curve.
Featured Chart: Rapid Wage Growth Suggests the Fed Can Safely Hike Short-Term Rates Many Times
Wage Growth Surging
Virtually every labor market economic data point shows a very tight job market. Full employment has been more than achieved. Consumer and small business surveys, as well as official data, prove the point. Moreover, wage growth is starting to really heat up. The featured chart above overlays the Atlanta Fed Wage Growth Tracker along with the Fed Funds Rate since 1997. To say today’s environment is special is an understatement.
Going On a Hike (or Six)
Speaking of special, following Thursday’s CPI report, speculation grew regarding an inter-meeting FOMC rate hike to temper inflation and cool credit markets. While that might not happen, it has become a near certainty to see a half-point rate increase at the March meeting. The rapid rate hike cycle about to be seen makes us have a bearish outlook on stocks vs bonds in the coming months, but we see opportunities in some emerging markets.
Bottom line: Wage growth is running very hot despite the effective Fed Funds rate still being near zero. That will change dramatically very soon as the market expects more than six quarter-point Fed rate hikes this year. Maximum employment, a pillar of the Fed’s dual mandate, has been more than achieved. A tighter credit market likely has bearish implications for US stocks this year.
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