How dare the Fed be mere mortals and misjudge data?

Outlook: We get PPI today alongside jobless claims, but both pale in comparison to yesterday’s worse-than-expected CPI. It puts the Fed in a bind. If it’s data-dependent, the next hike should be 100 bp. If it wants message consistency, it needs to stay at 75 bp. The airwaves are jammed with opinion on which it will be and why. One idea is that if it does 100 bp this time, it will be a bridge too far and the Fed will have to retreat faster, sooner next year.

For the market to knee-jerk jump to the 100 bp conclusion is normal but still foolish, and to say the Bank of Canada led the way is simply not true–its decision came hours after the CPI release, and besides, the US tends not to copy Canada (no offense). See the CME FedWatch tool. The probability of a 100 bp hike has jumped to 82.1%–from zero on July 7.

Several Fed funds watchers note that front-loading hikes this year removes the need for more next year. For June 2023, 31% see the rate rising only another 75 bp from 2.5-2.75% at year-end, or 100 bp up from today. A lesser percentage (27.6%) see rates up another 100 bp by mid-year. This embeds the idea that the Fed will over-tighten because it’s always behind the curve and will have to slow down dramatically next year.

We enjoy scenario-building as much as the next guy, but honestly, we should listen to what the Fed claims is its priority list: first, kill inflation, even at the expense of the labor market. Second, maintain credibility and respect, even if at the expense of getting the forecasts wrong sometimes but sticking to its broad policy forward guidance unless absolutely forced to deviate.

In a funny way, all the criticism of the Fed for getting it wrong is a tribute to the confidence even the critics do have in the Fed. How dare the Fed be mere mortals and misjudge data?

One semi-surprise is the rise in services prices even as goods prices contract a bit. See the chart from BDSwiss. Goods prices slowing down is partly a function of supply chain blockages getting resolved (and remember China is still exporting heavily to the US). The next chart, from Deutsche Bank via The Daily Shot, shows supply-sensitive vs. demand sensitive prices, and the same primary inflation source–demand, not supply.

Well, presumably hiking rates through the roof is going to moderate demand as unemployment rises. If it rises. This reliance on the Phillips curve–remember, Yellen warned against it–is going to be a big, fat worry and someday soon. If the labor market remains tight, it’s not clear demand is going to fade, even if a wage-price spiral is avoided.

All this is fun, if you are an economist with no skin in the game. We see developments down the road, like price-gouging scandals, but more importantly, data on how the US is changing structurally post-pandemic and we see the outlines only vaguely. As noted before, demographics are still a bit of a mystery–over 10,000 Baby Boomers retiring every day while women are not returning to the labor force. If the labor shortage persists, and it can, the sectors that will have to raise wages include government, education, transportation and warehousing, and manufacturing. Bottom line, we are not sure the trade-off to be watching is demand for goods, which waxes and wanes sometimes quite independently of prices. Just because Amazon’s “prime day” offers deals doesn’t mean we feel an urgent demand for those goods.

It seems obvious that if we respect the real yield differential rule as a key determinant (if not the only one) of currency fates, the CPI report buoyed up the dollar some more, especially against the stuck-in-the-mud yen and the soon-to-be-recessionary euro. (Sterling awaits a political outcome and new tax regime). The dollar is king and the euro is toast. Everyone says so. Ah, therein lies the problem. When everybody and his brother is talking about the dollar as the top currency, it’s time to doubt it.

First of all, most of these dollar-cheerleaders know very little about currencies. They see a 1-2 linkage and quit. Secondly, upsetting surprises lurk everywhere, including the chain of economic and price developments arising from a strong dollar in the first place, like commodity prices that favor emerging markets. Sometimes we see results and sometimes not. China said it’s reconsidering Australian coal but the AUD fell anyway. And just try to put the price of oil and the CAD on the same chart–the correlation is often not even there, let alone strong. And yet falling oil prices affect US CPI and then monetary policy that bleeds over to Canada. It’s a matrix of multiple, sometimes conflicting signals, not a simple 1-2 easy story.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

To get a two-week trial of the full reports plus traders advice for only $3.95. Click here!

Outlook: We get PPI today alongside jobless claims, but both pale in comparison to yesterday’s worse-than-expected CPI. It puts the Fed in a bind. If it’s data-dependent, the next hike should be 100 bp. If it wants message consistency, it needs to stay at 75 bp. The airwaves are jammed with opinion on which it will be and why. One idea is that if it does 100 bp this time, it will be a bridge too far and the Fed will have to retreat faster, sooner next year.

For the market to knee-jerk jump to the 100 bp conclusion is normal but still foolish, and to say the Bank of Canada led the way is simply not true–its decision came hours after the CPI release, and besides, the US tends not to copy Canada (no offense). See the CME FedWatch tool. The probability of a 100 bp hike has jumped to 82.1%–from zero on July 7.

Several Fed funds watchers note that front-loading hikes this year removes the need for more next year. For June 2023, 31% see the rate rising only another 75 bp from 2.5-2.75% at year-end, or 100 bp up from today. A lesser percentage (27.6%) see rates up another 100 bp by mid-year. This embeds the idea that the Fed will over-tighten because it’s always behind the curve and will have to slow down dramatically next year.

We enjoy scenario-building as much as the next guy, but honestly, we should listen to what the Fed claims is its priority list: first, kill inflation, even at the expense of the labor market. Second, maintain credibility and respect, even if at the expense of getting the forecasts wrong sometimes but sticking to its broad policy forward guidance unless absolutely forced to deviate.

In a funny way, all the criticism of the Fed for getting it wrong is a tribute to the confidence even the critics do have in the Fed. How dare the Fed be mere mortals and misjudge data?

One semi-surprise is the rise in services prices even as goods prices contract a bit. See the chart from BDSwiss. Goods prices slowing down is partly a function of supply chain blockages getting resolved (and remember China is still exporting heavily to the US). The next chart, from Deutsche Bank via The Daily Shot, shows supply-sensitive vs. demand sensitive prices, and the same primary inflation source–demand, not supply.

Well, presumably hiking rates through the roof is going to moderate demand as unemployment rises. If it rises. This reliance on the Phillips curve–remember, Yellen warned against it–is going to be a big, fat worry and someday soon. If the labor market remains tight, it’s not clear demand is going to fade, even if a wage-price spiral is avoided.

All this is fun, if you are an economist with no skin in the game. We see developments down the road, like price-gouging scandals, but more importantly, data on how the US is changing structurally post-pandemic and we see the outlines only vaguely. As noted before, demographics are still a bit of a mystery–over 10,000 Baby Boomers retiring every day while women are not returning to the labor force. If the labor shortage persists, and it can, the sectors that will have to raise wages include government, education, transportation and warehousing, and manufacturing. Bottom line, we are not sure the trade-off to be watching is demand for goods, which waxes and wanes sometimes quite independently of prices. Just because Amazon’s “prime day” offers deals doesn’t mean we feel an urgent demand for those goods.

It seems obvious that if we respect the real yield differential rule as a key determinant (if not the only one) of currency fates, the CPI report buoyed up the dollar some more, especially against the stuck-in-the-mud yen and the soon-to-be-recessionary euro. (Sterling awaits a political outcome and new tax regime). The dollar is king and the euro is toast. Everyone says so. Ah, therein lies the problem. When everybody and his brother is talking about the dollar as the top currency, it’s time to doubt it.

First of all, most of these dollar-cheerleaders know very little about currencies. They see a 1-2 linkage and quit. Secondly, upsetting surprises lurk everywhere, including the chain of economic and price developments arising from a strong dollar in the first place, like commodity prices that favor emerging markets. Sometimes we see results and sometimes not. China said it’s reconsidering Australian coal but the AUD fell anyway. And just try to put the price of oil and the CAD on the same chart–the correlation is often not even there, let alone strong. And yet falling oil prices affect US CPI and then monetary policy that bleeds over to Canada. It’s a matrix of multiple, sometimes conflicting signals, not a simple 1-2 easy story.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

To get a two-week trial of the full reports plus traders advice for only $3.95. Click here!