There are understandable concerns about the high and persistent inflation rates around the globe. Much of this is to do with the spike in energy costs, but also in other commodities. Partly this is due to supply issues and increased demand as the economy bounced back from the pandemic, but there’s also the war in Ukraine to consider as well. High energy prices are proving to be quite persistent, and central bankers have been very slow and reluctant to raise interest rates in response. Their fear has been that the global economy is far from robust. But high and persistent inflation is forcing central banks, led by the US Federal Reserve, to tighten monetary policy aggressively just as global economic growth is faltering. This is causing great concern and adding to fears that the US and other countries could be heading for a recession.  Recession Stock markets don’t like recessions. Rising prices lead to a decline in consumer demand as workers struggle to pay their bills and cut back on their spending. This is exacerbated as companies are forced to make redundancies and the newly unemployed must rely on savings and government benefits. But recessions can be short and sharp, or long and drawn out. We had a short and sharp recession in early 2020 due to the coronavirus pandemic, while the recession we saw during the Great Financial Crisis of 2008/9 was relatively drawn out. But in both cases central banks and governments helped stave off the worst effects by injecting huge dollops of monetary and fiscal stimuli into the global economy. That was seen by most people as right and proper during the pandemic. After all, it was policymakers who were responsible for ordering lockdowns and the subsequent closing of many businesses. But it can be reasonably argued that much of the financial help that was doled out during 2008/9 went to the people and businesses that were responsible for the crash in the first place. This should be borne in mind when the next recession comes, because they do come around quite often. In my lifetime they have cropped up in the early 1990s, 1980s and mid-1970s. Yield curves About a month ago we saw an inversion in parts of the US yield curve. This is where the yields on shorter duration Treasuries pushed above those on some of the longer ones.  In this case, the yield on the 2-year US Treasury exceeded that of the 10-year. An inverted yield curve means something is wrong in the economy. Yields are supposed to reflect risk, and risk grows with time. The chance something bad will happen in the next 10 years is higher than the chance something equally bad will happen in the next two years. Consequently, longer-term bond investors require higher yields as compensation for that higher risk. So, what does inversion tell us? In specific cases, an inversion can be a reliable indicator that a recession will follow in 18-24 months’ time. The thinking goes that central banks will have to push up interest rates (yields) now to dampen inflation. But this will cause future economic growth to fall to such an extent that they will have to slash rates later to compensate. There’s no doubt that yield curve inversion does precede recessions. But recessions don’t always follow from yield curve inversion. The inversion must be deep and last for a significant period. The longer the inversion, the stronger its predictive value. All the recent inversions we saw reversed out again after a few days. In addition, the most reliable recession indicator is an inversion of the 3-month yield against the 10-year. We haven’t seen that happen yet - not even close.  Federal Reserve  But we all know that the US Federal Reserve has been keeping a lid on its Fed Funds rate, the shortest-term US interest rate. In March, the Fed raised it to just under 50 basis points (bps) from 25 bps. With the 10-year currently well under 300 bps, there’s a big gap to be filled, even though the 3-month is presently above the fed funds rate. But recent speculation over how aggressive the US central bank may be in raising rates to try and cap inflation has raised serious concerns. For instance, the Fed is now expected to raise rates by 50 bps in early May. On top of this and following Fed Chair Jerome Powell’s comments about ‘front loading’ rate hikes, some analysts reckon the Fed could then hike rates by 75 bps in both June and July. If so, that would put the fed funds rate at just under 2.50% or 250 bps. The current 10-year yield is 276 bps. That’s getting perilously close to inverting. all other things being equal. But such a move from the Fed would be...

There are understandable concerns about the high and persistent inflation rates around the globe. Much of this is to do with the spike in energy costs, but also in other commodities. Partly this is due to supply issues and increased demand as the economy bounced back from the pandemic, but there’s also the war in Ukraine to consider as well. High energy prices are proving to be quite persistent, and central bankers have been very slow and reluctant to raise interest rates in response. Their fear has been that the global economy is far from robust. But high and persistent inflation is forcing central banks, led by the US Federal Reserve, to tighten monetary policy aggressively just as global economic growth is faltering. This is causing great concern and adding to fears that the US and other countries could be heading for a recession.  Recession Stock markets don’t like recessions. Rising prices lead to a decline in consumer demand as workers struggle to pay their bills and cut back on their spending. This is exacerbated as companies are forced to make redundancies and the newly unemployed must rely on savings and government benefits. But recessions can be short and sharp, or long and drawn out. We had a short and sharp recession in early 2020 due to the coronavirus pandemic, while the recession we saw during the Great Financial Crisis of 2008/9 was relatively drawn out. But in both cases central banks and governments helped stave off the worst effects by injecting huge dollops of monetary and fiscal stimuli into the global economy. That was seen by most people as right and proper during the pandemic. After all, it was policymakers who were responsible for ordering lockdowns and the subsequent closing of many businesses. But it can be reasonably argued that much of the financial help that was doled out during 2008/9 went to the people and businesses that were responsible for the crash in the first place. This should be borne in mind when the next recession comes, because they do come around quite often. In my lifetime they have cropped up in the early 1990s, 1980s and mid-1970s. Yield curves About a month ago we saw an inversion in parts of the US yield curve. This is where the yields on shorter duration Treasuries pushed above those on some of the longer ones.  In this case, the yield on the 2-year US Treasury exceeded that of the 10-year. An inverted yield curve means something is wrong in the economy. Yields are supposed to reflect risk, and risk grows with time. The chance something bad will happen in the next 10 years is higher than the chance something equally bad will happen in the next two years. Consequently, longer-term bond investors require higher yields as compensation for that higher risk. So, what does inversion tell us? In specific cases, an inversion can be a reliable indicator that a recession will follow in 18-24 months’ time. The thinking goes that central banks will have to push up interest rates (yields) now to dampen inflation. But this will cause future economic growth to fall to such an extent that they will have to slash rates later to compensate. There’s no doubt that yield curve inversion does precede recessions. But recessions don’t always follow from yield curve inversion. The inversion must be deep and last for a significant period. The longer the inversion, the stronger its predictive value. All the recent inversions we saw reversed out again after a few days. In addition, the most reliable recession indicator is an inversion of the 3-month yield against the 10-year. We haven’t seen that happen yet - not even close.  Federal Reserve  But we all know that the US Federal Reserve has been keeping a lid on its Fed Funds rate, the shortest-term US interest rate. In March, the Fed raised it to just under 50 basis points (bps) from 25 bps. With the 10-year currently well under 300 bps, there’s a big gap to be filled, even though the 3-month is presently above the fed funds rate. But recent speculation over how aggressive the US central bank may be in raising rates to try and cap inflation has raised serious concerns. For instance, the Fed is now expected to raise rates by 50 bps in early May. On top of this and following Fed Chair Jerome Powell’s comments about ‘front loading’ rate hikes, some analysts reckon the Fed could then hike rates by 75 bps in both June and July. If so, that would put the fed funds rate at just under 2.50% or 250 bps. The current 10-year yield is 276 bps. That’s getting perilously close to inverting. all other things being equal. But such a move from the Fed would be...

Gross Domestic Product declined at a 1.4% annual rate in the first quarter, far below the 1% consensus forecast. Equities, Treasury yields and the dollar rally as underlying growth appears strong.  Federal Reserve rate policy and May hike should be unaffected. Economic growth in the US contracted for the first time in two years, shrinking at a 1.4% annualized pace in the first quarter after expanding 5.7% in 2021 with the best yearly performance since 1984. The surprise decline was worse than the already low 1% forecast of the Reuters survey and even missed the Atlanta Fed GDPNow estimate of 0.4%.  From the first quarter of last year the economy grew 3.6%.  Despite the steep deceleration in growth from 6.9% in the fourth quarter, equities rallied sharply and Treasury yields and the dollar saw modest gains as traders noted several negative factors that are unlikely to be repeated in future quarters.  Trade and inventory The trade deficit widened in the first two months of the quarter as importers sought to overcome supply-chain problems and exports fell. In the government’s economic accounts trade deficits subtract from GDP. Businesses slowed inventory acquisition from the rapid pace in the second half of last year. Together these two items, trade and inventories reduced first quarter growth by about 4%. Real final sales, a category that excludes trade and inventories, accelerated to a 2.6% yearly rate.  Government spending has also faded as the stimulus and infrastructure packages from last year reached the end of their funding. Consumer spending, the warp engine of the US economy, expanded at a 2.7% annual rate in the last quarter, compared to 2.5% in the fourth quarter. Purchases of consumer goods were little changed while spending in the service sector added 1.9% to GDP.  Business investment for equipment and research and development was robust,  rising 9.2%. Private demand  expanded at a 3.7% rate in the first quarter, more than double the 1.8% pace the Fed considers likely over the long-term. Markets Stocks were dramatically higher with the Dow gaining 1.85%, 614.46 points to 33,916.39 and the S&P 500 adding 103.54 points, 2.47% to 4,287.50. The Nasdaq was the equity leader, rising 3.06%, 382.60 points to 12871.60, helped by a strong earnings report from Meta Platforms, the parent company of Facebook.  S&P 500 CNBC Treasury yields rose modestly with the 10-year about 1.5 basis points higher at  2.832% and the 2-year climbing 5 points to 2.629%.  The US dollar rose in all major pairs except the USD/CAD where the loonie was buoyed by a 2.6% gain in West Texas Intermediate (WTI) to $104.20 and the Bank of Canada’s (BoC) recent and anticipated rate increases. The EUR/USD closed at 1.0498, its first finish below 1.0500 since early January 2017. Dollar yen rose 1.8% on the day, ending at 130.80, its highest in two decades as the Bank of Japan (BoJ) reaffirmed its dovish monetary policy on Thursday in Tokyo. The USD/JPY is  up a remarkable 13.9% since the open at 114.81 on March 7 fueled by the surge in US Treasury rates while yields on Japanese Government Bonds (JGB) have been largely unchanged. The USD/CAD dropped 19 points to 1.2805. The AUD/USD dropped 0.4% GBP/USD fell 0.6% even though the Reserve Bank of Australia (RBA) and the Bank of England are expected to hike rates 25 basis points and 15 basis points next week.  The GDP report is not expected to alter the Federal Reserve’s plans for a 0.5% increase at Wednesday’s meeting. Treasury futures predict an 81.5% chance that the fed funds rate will be at 2.75% or higher by this year’s final Fed Meeting on December 14. Conclusion Inflation is the economy’s wild card. So far the year-long tidal wave of price increases washing over every sector of the consumer economy has not deterred household spending. One key to consumer resilience is the job market. Employment is easy to find. The number of positions on offer has averaged over 11 million for ten months, an all-time record. Unemployment claims were 180,00 in the latest week, also very near the record low, and wage gains are strong. Average Hourly Earnings were up 5.6% in March, though that was overwhelmed by the 8.5% headline inflation rate. Over the prior year consumers lost 2.7% in purchasing power.  As long as Americans continue to fund the economic expansion, the Fed’s hope that it can curtail inflation without instigating a recession can remain alive. 

Outlook: Today we get US GDP for Q1 and remember that yesterday, the Atlanta Fed GDPNow had lowered its forecast from 1.3% to 0.4%, on consumer lassitude. (Tomorrow’s eurozone GDP is expected at 0.3%, by the way.) The Conference Board has 1.5%. We also get the usual jobless claims today, which show the rearview mirror of Q1 GDP likely not having any influence on sentiment at all. When jobs are still on the upswing, despite peculiar participation rates, it’s hard to talk of a slowdown. Besides, in Q1, we were still coming off the latest Covid surge, which peaked around the first week of January. The relative return theme attracts a higher number of traders every day with no end in sight. He who has the highest rate wins and notice that’s nominal rates, not the real ones. So, with the US about to raise by 50 bp, the dollar wins regardless of any other “high-frequency” data. Canada loses, but only a little because it intends to copy the US, as does Mexico. The Brazilian central bank, in contrast, has been dealing with high inflation from the cradle and is getting weary of hikes. Japan stands out with its stubborn adherence to the idea inflation is transitory. Not using that exact word doesn’t alter the fact that the BoJ feels the Japanese economy has been mired in deflation for decades and this burst of higher prices will not contaminate the Japanese economy. If Mr. Kuroda and his economists are right, what is it about the Japanese economy that has inflation-proofed it? And can we get some? It’s worth noting that the latest stimulus program gives cash to Japanese families (a little under $400 per child). The last time we saw this, it was $200 and most of it was never spent and the coupons expired worthless. At the time there was a lot of talk about Keyne’s “pushing on string.” We wrote that this shows Japanese are not materialistic as are Americans, and in part because they literally lack the space to put Stuff. Europe is somewhere in never-never land. The latest idea from ECB chief Lagarde is that asset purchases will, maybe, end in July, after which the bank can consider raising rates. Caution on Lagarde’s part is probably warranted considering Europe is at war, whether it admits it and names it that. There is a whisper of hope that opening the fiscal purse will “take care of” donations to Ukraine, for those excellent German tanks or some country’s gas or whatever (not to mention the cost of refugees). Lagarde doesn’t speak of inflation as transitory but seems to think it must be borne with clenched teeth because of other factors. She may be right. As we have said before, the dollar’s rapid and steep rise is wildly abnormal and will correct at some point, possibly when the Fed actually delivers that 50 bp (“buy on the rumor, sell on the news”). Whenever the timing, come it will. Pullbacks are normal, although this one could be a doozy. Start shaking in your boots. Technical analysis king Larry Williams says “buy high and sell higher” for occasions like this, and he’s not wrong, as long as you know your last trade is going to be a giant loss. The guture of Europe We keep writing that the Europe of the Maastricht Treaty in 1993 is gone. The Russian invasion of Ukraine and the first land war in Europe in more than 75 years has altered “Europe” in ways that can never be turned back. Solidarity with Ukraine is heart-warming and noble, but misses the point entirely–f something named “Europe” is to come out the other side, it has to change in some fundamental ways nobody is yet willing to admit. Foremost is the concept of union and what that means. EU and EMU critics have long bemoaned that federalism was adopted in only a few areas, like the Schengen passport rules and the currency. But a true federal union, like the US, has a lot more both on the surface and under the skin. Economists name nationwide unemployment insurance and Social Security for example, not to mention various forms of health and safety regulations, health care, food stamps and a dozen other things. Just social security pensions alone have been political nightmares in Italy and France, for example. We don’t have that in the US. We also don’t have a national security or foreign affairs function at the state level. In the current situation, it’s nice that the European governments are banding together, but they shouldn’t have to. A European foreign policy should already be in place. (Why is Ireland not a member of Nato?) To be fair, the US has been an obstacle to federalism in Europe. So far...

A combination of factors dragged EUR/USD to a fresh five-year low on Thursday. Concerns about the economic fallout from the Ukraine crisis weighed on the euro. Aggressive Fed rate hike bets continued boosting the USD and contributed to the fall. The EUR/USD pair continued losing ground for the sixth successive day and dropped to its lowest level since March 2017, around the 1.0500 psychological mark during the Asian session on Thursday. The shared currency was weighed down by concerns that the European economy, which relies heavily on Russia to meet its energy needs, will suffer the most from the Ukraine crisis. The worries resurfaced after Russia announced a plan to halt gas flows to Poland and Bulgaria amid a standoff over fuel payments from “unfriendly” buyers in rubles. It is worth mentioning that the EU gets about 40% of its gas and 30% of its oil from Russia and has no easy substitutes if supplies are disrupted. The risk of an energy crisis could make it difficult for the European Central Bank to tighten its monetary policy, leaving it lagging far behind the Fed. The US central bank is widely expected to hike interest rates by 50 bps when it meets on May 3-4, and again in June and July, and ultimately lift rates to around 3.0% by the end of the year. The bets were reaffirmed by the recent hawkish comments by influential FOMC members, including Fed Chair Jerome Powell, last week. Apart from this, the deteriorating global economic outlook boosted the US dollar's reserve currency status and pushed it to the highest level since March 2020, which exerted additional pressure on the pair. The prospects for rapid interest rate hikes in the US, the prolonged Russia-Ukraine conflict and the latest COVID-19 outbreak in China have been fueling fears about stalling global growth. That said, signs of stability in the equity markets could act as a headwind for the safe-haven buck and extend some support to the pair amid extremely oversold conditions. The fundamental backdrop, however, remains tilted firmly in favour of bearish traders and suggests that the path of least resistance for the pair is to the downside. Market participants now look forward to the release of the prelim German consumer inflation figures for some impetus ahead of the key US macro data. The US economic docket highlights the release of the Advance Q1 GDP report and the usual Weekly Initial Jobless Claims. The data could influence Fed rate hike expectations and drive the USD demand. This, along with fresh developments surrounding the Russia-Ukraine saga, should allow traders to grab some short-term opportunities around the pair. Technical outlook From a technical perspective, acceptance below the 1.0500 round figure would mark a fresh bearish breakdown and make the pair vulnerable. The subsequent downfall has the potential to drag spot prices towards intermediate support near the 1.0450 area en route to the 1.0400 mark and 2017 low, around the 1.0340 region. That said, RSI (14) on daily/weekly charts is already flashing extremely oversold conditions and warrants some caution for aggressive bearish traders. This makes it prudent to wait for some near-term consolidation or modest recovery before positioning for the next leg down. On the flip side, the 1.0550 area now seems to act as an immediate resistance, above which a bout of short-covering could lift the pair back towards the 1.0600 mark. The recovery momentum could further get extended, though it runs the risk of fizzling out rather quickly near the 1.0640-1.0650 area. The latter should act as a pivotal point for short-term traders, which, if cleared, will suggest that the pair has formed a near-term bottom and pave the way for additional gains.

Outlook: Yesterday’s data was mostly ignored, including the Atlanta Fed’s GDPNow, down to a lousy 0.4% for Q1om 1.3% last time. We get another estimate today. The drop was due to “yesterday’s annual revision to retail sales by the US Census Bureau showing real personal consumption expenditures growth declined from 3.8 percent to 2.4 percent.” In other words, the consumer is flagging. The relationship between the dollar and the stock is a weird one. Just about anything you want to say about it will be true for one period or another, and you will see strongly held views on the subject that are very hard to argue with.  For many years, they were inversely correlated—stock market up, dollar down. This was weird and somewhat inexplicable, and had nothing to do with international capital flows. For the past decade or so, the two markets have been positively correlated, if not very closely. See the monthly chart (the green candles are the dollar). We have been keeping an eye peeled for a spillover in sentiment from equities to the dollar, and are tentatively deciding it’s there now, if not every day. Yesterday is a good case in point—all the equity indices down by a lot but the dollar up on the day. Still, there’s a bit of leakage there. It shouldn’t come as a surprise—both markets respond to the same factors—the Fed, bond yields, growth prospects, geopolitics. But the self-interest is not the same, and of course things like important company earnings are of only secondary interest to FX (and tucked away as a growth factor).  The FX market doesn’t need any uncertainty fuel from equities—it’s generating enough of its own. We are seeing multi-year lows in the euro with some wild-eyed folks mentioning the old lows around 1.0350 (December 2016) and perhaps parity. Sterling is also on the ropes but note that on the weekly chart, it’s nearing the 62% retracement level of the rise off the April 2020 Covid freakout level. There was no data reason driving the pound down, just the Crowd. Here’s the thing—we almost always get a pushback higher off that 62% line. Softly, softly.   It should go without saying that trend-following charting fails when you don’t have trendedness, and also when you have moves in the same direction as the trend but breaking the norms as shown by bands and channels. Those speed limits lose their usefulness when the FX market is in full freak-out mode, and that what we see today. Only the yen, pulling back as it “should,” has any semblance to normalcy. Even if the analysis, such as it is, justifies the move, as we see with Europe likely going into recession later this year and the ECB falling farther behind the Fed, the FX moves are excessive. Watch out! A backlash against the dollar is on the agenda. Tidbit: The WSJ writes that China is serious about getting growth better than the US, despite the US surpassing China is Q1 with 5.5% and China, 4.8% President Xi tells his government this will prove “that China’s one-party system is a superior alternative to Western liberal democracy, and that the U.S. is declining both politically and economically.” So, China plans to ramp up big construction projects and issue coupons to individuals to boost spending, plus regulatory loosening in real estate. The target is 5.5% in GDP this year—but the IMF sees 4.4%, which will still beat the US with 3.7%, if the IMF is right, although it might not satisfy Mr. Xi. Russia’s invasion of Ukraine is a distraction from the authentic threat posed by China, not least because they steal every invention and innovation they can get their hands on, according to the FBI. Now we have a new book by trade expert Fred Bergsten, The United States vs. China: The Quest for Global Economic Leadership, published April 18. It’s getting rave reviews. According to the Peterson Institute (which Bergsten founded in 1981), “Bergsten calls on China to exercise constructive global leadership and on the United States to reject a policy of containment, avoid a new Cold War, and instead pursue ‘conditional competitive cooperation’ to work with its allies and China to lead, rather than destroy, the world economy.” Wonder what ‘conditional competitive cooperation” means… The Petersen Institute is holding a discussion with bigwigs today from 10 to 11 am, including Larry Summers. Tidbit: Why is the US not pumping massive amounts of oil and shipping it to Europe? The NYT has a sensible explanation—producers fear the high prices won’t last. The US is pumping a mere 2% more since Dec and only 11.8 million bpd, compared to 13.1 million bpd in March 2020 (the record). The Dallas Fed surveyed 141 oil companies in mid-March and found 60% of them gave the price reason. They need...