Highlights

SGH reports are highly valued for keeping clients and policymakers informed and well-ahead of consensus and the news cycle on the macro policy events driving global markets.

2022
May 23, 2022
SGH Insight
The near-term path for rates remains unchanged. Fed speakers consistently endorse the consensus view of 50bp rate hikes at the June and July FOMC meetings. The September meeting is a potential opportunity to transition back to 25bp rate hikes if the data allows. If the Fed can’t find sufficient cover in the data to see a path back to 2% inflation within the forecast horizon, it will press forward with another 50bp. Ultimately, the decision may hinge on the September SEP inflation forecast. I think that if FOMC participants see they can hold steady or even lower the 2022 and 2023 inflation forecast, they will be inclined to transition to 25bp. However, I have been skeptical that the data will break in that direction, leaving me leaning toward another 50bp hike in September. The Fed will try to form a consensus around the September outcome at the July meeting but may not have sufficient data to establish a consensus either way. That of course would put the August Jackson Hole conference in the spotlight, although arguably it’s always in the spotlight.
Market Validation
Bloomberg 5/25/22

Here are the key takeaways from the Federal Open Market Committee’s May 3-4 meeting minutes released Wednesday.
There is a strong consensus for raising interest rates by half a point at the next FOMC meetings in June and July, given that inflation is near a four-decade high. That would bring the target rate to 1.75%-2% or the lower edge of the range of a “neutral” rate -- neither restrictive nor stimulative. That will set up an important Fed symposium at Jackson Hole, Wyoming, in late August, where Federal Reserve Chair Jerome Powell’s speech will be especially vital, and a pivotal committee meeting in September. There was no discussion of a 75 basis-point move.
While the plan is to reach “neutral” expeditiously, what comes next is far less certain. The committee expects to be “well positioned” later this year to reflect on the effects of policy tightening and assess what further moves are necessary. FOMC participants felt a restrictive rate might be necessary, depending on the evolving outlook, and they are focused on risks as well.
Read full report
May 17, 2022
SGH Insight
European Central Bank officials have rapidly coalesced around lift-off and the near-term monetary policy normalization path that we have been expecting for quite some time.

That consensus now lies squarely around a hard stop to the ECB’s Asset Purchase Program on July 1, followed rapidly by liftoff from the -0.50% deposit rate at the July 21 Monetary Policy Meeting. Barring any major shocks, that will most likely be followed by a 25-basis point hike at each of the ECB’s quarterly forecast round meetings on September 8 and December 15, to end the year at +0.25%...

...Likewise, unlike the US Federal Reserve, the ECB base outlook and consensus still leans heavily towards 25 basis point increment moves, and not 50s. Nevertheless, hawkish president of the Dutch central bank Klaas Knot noted just today that 50 basis point moves should not be ruled out if inflation fails to top out as expected.
With the ECB on path to be still adding accommodation well into next year, we believe an argument could already be made that the conditions for a 50-basis point hike are in place. That said, we do not get a vote, and we think a move to 50s is unlikely, even if not impossible. We suspect, if needed, the easier path to consensus at the ECB would be to add that fourth rate hike in October...

Market Validation
Bloomberg 5/21/22

European Central Bank President Christine
Lagarde said the first increase in interest rates in more than a
decade may come in July but downplayed the idea of a half-point
move amid concerns about economic expansion.
In a sign of the inflation concerns, the Netherlands’ Klaas
Knot this week became the first Governing Council member to
float the idea of a 50 basis-point move at the ECB’s July
meeting, though only if data worsen.
Asked about a possible increase of that size, Lagarde said
“it’s not something that I can tell you at this point in time,”
stressing that she shares “the same direction of travel” with
Knot but also that economic growth mustn’t be risked.
“We need to make sure that this is going gradually enough
so that we don’t put the break on this car that is moving,” she
said. “We have to lift the accelerator for sure to slow
inflation but we cannot be breaking any speed.”

Bloomberg 5/18/22

There’s broad agreement among members of the
European Central Bank Governing Council that policy rates should
exit sub-zero terrain “relatively quickly,” according to Bank of
Finland Governor Olli Rehn.
That’s to prevent inflation expectations from becoming de-
anchored, Rehn said in a speech in Helsinki on Wednesday.
“It is my view that it seems necessary that in our policy
rates we move relatively quickly out of negative territory and
continue our gradual process of monetary policy normalization,”
he said. “I am not alone, as this is also the indication given
by many of my colleagues in the ECB Board and Governing
Council.”
Read full report
May 16, 2022
SGH Insight
...Given the strength of the underlying economy – firms continue to add employees at a rapid pace, for example – the natural lags between policy and outcomes suggests September is still too early for a 25bp rate hike. But September could still be at a pivot point by signaling a 25bp hike at the next meeting. A transition back to a slower path of rate hikes would reduce the odds of a hard landing for the economy...

...Right now, it is beginning to feel like something of a sweet spot for the Fed where conditions have tightened enough to offer a path to trimming the demand side of the economy but not so much as to force a shift in the Fed’s rhetoric. That doesn’t mean the Fed won’t eventually need to bring rates even higher than current expectations, but it can potentially move more gradually later this year.

For now, it’s a waiting game for the Fed. Barring a market accident, the Fed is looking for clear and convincing evidence of a path to price stability to back down from 50bp rate hikes. The magnitude and speed of financial tightening will have an impact on growth. Reduced wealth due to lower equity and crypto prices, layoffs in tech as firms scale back and venture capital money dries up, higher interest rates on consumer lending, a stronger dollar, and slower global growth will weigh on spending, job growth, and, ultimately, consumer prices. But this will take some time. To be sure, the near-term data will be solid, it’s baked in the cake at this point. But we need to be looking toward the future; tightening cycles always have economic impact...
Market Validation
WSJ 5/17/22

Mr. Evans told reporters after his remarks that in terms of the pace of monetary policy tightening, he sees big moves that moderate into smaller ones as the year moves toward its close. “I’m expecting that before December, we will have completed in any 50s and have put in place at least a few 25s,” he said in reference to the basis-point size of those prospective actions.

Bloomberg 5/17/22

A top Federal Reserve official downplayed deteriorating liquidity conditions in financial markets, telling an audience Monday it was to be expected given rising volatility as investors grapple with uncertainty over global events and shifting U.S. monetary policy.
“In the global environment there’s a lot of uncertainty, and a lot of events happening. We’re also seeing our actions moving monetary policy, I think, in a very strong direction, to more normal rates,” New York Fed President John Williams told a Mortgage Bankers Association conference in New York. “Some of that volatility -- in say, the Treasury market -- is really the markets digesting that information.”
Signs of deteriorating liquidity in U.S. Treasuries, such as measures of market depth and bid-ask spreads, are “more or less in line with the increase in volatility in markets,” he said. “It’s just a reflection more of: A lot’s happening with market rates moving around, and therefore you’re seeing some of these measures of liquidity deteriorate somewhat, and pretty much consistent with past experience there.”
Williams’s comments echoed a semi-annual report on financial stability issues published on May 9, and were delivered amid a broad market downturn that has seen the S&P 500 index of U.S. stocks lose nearly 17% of its value since reaching a record high in the first week of the year.
The central bank is attempting to tighten financial conditions in a bid to slow the economy and bring down inflation from multi-decade highs. Policy makers authorized a half-point increase in the benchmark federal funds rate at the conclusion of their most recent meeting on May 4, marking the largest single hike since 2000.
Fed Chair Jerome Powell told reporters after the meeting that the central bank was on track to enact additional half-point increases at the next two meetings in June and July.
Williams said Monday such a plan “makes sense” as the Fed moves rates “expeditiously over this year back to more normal levels.”
“We do need to move -- again, the word is ‘expeditiously’ -- to more normal rates this year, and we’re on our way to do that. But we also need to watch, and we need to monitor what’s happening in the economy,” Williams said.
“We’ve already seen a tightening in U.S. financial conditions that is far greater than what we saw in all of 1994,” he added, referring to an episode where, under then-Chair Alan Greenspan, the Fed embarked on a surprise tightening campaign that led bond investors to sustain heavy losses.
Read full report
May 10, 2022
SGH Insight
A soft landing does not mean unemployment rates will remain at current levels. The Fed believes that with labor demand outstripping labor supply, the economy can be put on the path to price stability by bringing down the excess demand for labor. For example, this from New York Federal Reserve President John Williams:
Although we are facing highly unusual and challenging circumstances, I am confident we have the right tools to achieve our goals. In fact, we have an advantage over previous inflationary episodes: Our monetary policy tools are especially powerful in the very sectors where we see the greatest imbalances and signs of overheating—such as durable goods and housing. Higher interest rates will cool demand in these rate-sensitive sectors to levels better aligned with supply. This will also turn down the heat in the labor market, reducing the imbalance between job openings and available labor supply.
Still, Williams added in the Q&A:
“When I think of a soft landing, it’s really a matter of, yes we could see growth below trend for a while and we definitely could see unemployment moving up somewhat but not in a huge way…I think that’s the challenge,” Williams said.
Similarly, Mester said that unemployment may need to rise, and the economy may experience another “quarter or two” with negative growth. To me, this is the Fed setting the stage to redefine a “soft landing” as a mild recession. Arguably, the shift in the Beveridge curve suggests that the natural rate of unemployment has risen, so the Fed can’t regain a healthy labor market without unemployment rising and, historically, the Fed can’t engineer a rise in the unemployment rate without a recession. I think the Fed is coming to terms that a return to price stability will require some turbulence and likely a period of very low growth at best.
Market Validation
5/18/22

“This is a strong economy and we think it’s well positioned
to withstand less accommodative monetary policy, tighter
monetary policy,” Powell said. “There could be some pain
involved to restoring price stability, but we think we can
maintain a strong labor market.”
Fed officials say they can reduce demand for jobs without
raising unemployment by much from its current level of 3.6%.
Powell, confirmed by the Senate last week to a second four-
year term at the helm, said the labor market would still be
strong even if the jobless rate was “a few ticks” higher than
that.
Read full report
May 09, 2022
SGH Insight
...To be sure, I wouldn’t read too much into this report. It’s noisy data and we already knew that productivity would be weak given the decline in headline GDP in the context of still strong job growth, and we already know that labor cost growth is elevated. Still, recent trends of persistently weak productivity and high labor cost growth suggest some firms have become overstaffed – think Amazon and tech companies. A shift back to more aggressive cost control would put some downward pressure on employment growth...

Bottom Line
The goal is to tighten financial conditions to reduce the pressure on the economy, not break the economy or the markets. Powell will need to feel his way through this process. Things I am watching include the impact of higher rates on housing, firms seeking productivity improvements via cost controls on labor, layoffs in the wake of the collapse in technology stocks, and the impact of slower global growth (lost in this discussion is the fact that both Europe and China are struggling). This doesn’t mean looking for a recession. It means looking for the space that allows the Fed to ease back on the throttle. It’s about whether the transition back to 25bp happens at the September meeting or later.
Market Validation
Bloomberg 5/17/22

E-commerce marketplace Wayfair Inc. said it’s freezing corporate hiring for 90 days, the latest pandemic winner to pause its plans for growth as businesses fret over a slowing economy.
Wayfair is in a “strong position,” a spokesperson said in response to a question about hiring. But the company sees “a great deal of uncertainty in the overall economy.” The Boston-based company has almost 17,000 full-time employees, according to regulatory filings.
Online retailers boomed during the pandemic with Wayfair and rival Amazon.com Inc. having no shortage of consumers ordering goods at home thanks to pandemic restrictions and unprecedented amounts of fiscal stimulus. That led Wayfair to report a 55% jump in revenue in 2020 to $14.1 billion in 2020 as demand boomed, but sales declined 3% to $13.7 billion in 2021.

In the current quarter Wayfair said so far revenue is down in the mid-to-high teens compared with last year. Costs associated with labor, energy and transportation will also weigh on margins, the company said.

Bloomberg News 5/16/22

China’s Economic Activity Collapses Under Xi’s Covid Zero Policy

China’s economy is paying the price for the
nation’s Covid Zero policy, with industrial output and consumer
spending sliding to the worst levels since the pandemic began
and analysts warning of no quick recovery.
Industrial output unexpectedly fell 2.9% in April from a
year ago, while retail sales contracted 11.1% in the period,
weaker than a projected 6.6% drop. The unemployment rate climbed
to 6.1% and the youth jobless rate hit a record.

Bloomberg

In its first forecasts since Russia invaded Ukraine and
confirming an earlier Bloomberg report, the EU also cut its
base-case outlook -- predicting gross domestic product will
advance 2.7% this year and 2.3% in 2023, down from February’s 4%
and 2.7%.
The revisions suggest Germany, the continent’s biggest
economy, won’t reach pre-crisis output until the final quarter
of 2022, while Spain must wait until the third quarter of 2023,
the commission said.
Read full report
May 09, 2022
SGH Insight
...For those who may not remember, the ECB stepped in on May 10, 2010, in the depths of the European sovereign debt crisis, to intervene directly in peripheral markets with the Securities Market Program (SMP), then established the European Financial Stability Facility (EFSF), which morphed in 2012 into the never-used Outright Monetary Transactions (OMT) program, and the robust and well-funded European Stability Mechanism (ESM), respectively.
In more recent memory, when peripheral European spreads came under pressure again, this time from a US bond market mini tantrum in March 2020, the ECB enhanced its Asset Purchase Program with a new Pandemic Emergency Purchase Program (PEPP) that gave it the freedom to buy bonds across jurisdictions, with little concern for “capital key” limitations, meaning of course a heavy overweight in Italian bonds.
As things stand, the ECB has committed to reinvesting these PEPP bonds proceeds, and is willing to continue to do so, flexibly if needed, to temper any fragmentation or dislocation across peripheral markets. Furthermore, a version of the PEPP program can be reactivated at any time. To think that the ECB needs to reinvent the wheel, with yet another facility, is failing to listen to what ECB officials are saying, or to acknowledge their success in managing outsize market dislocations, when necessary, for over a decade...

...In a series of reports starting in early March, we wrote that consensus across the European Central Bank was coalescing around an accelerated end to the Asset Purchase Program in July, followed by lift-off from its negative 50 basis point benchmark deposit rate in Q3 of 2022.
We followed that with reports in April flagging how momentum was building in the ECB to pull lift-off into the July 21 Monetary Policy Meeting immediately following the end of APP, which would then open the door to three 25 basis point rate hikes in 2022.
That consensus formation process appears to be now all but complete.
Indeed, without prejudging decisions that are still many months away, key ECB officials from across the policy spectrum have highlighted July as their preferred date for lift-off, along with their expectation that rates will likely be in positive territory by the end of 2022, meaning three 25 basis point hikes by then.
We expect those hikes to come at the July 21 meeting, followed by the September 8 and December 15 quarterly forecasting round meetings, with the intervening October 27 meeting as a live but much less likely option for a fourth 2022 rate hike if desired...
Market Validation
ECB MONETARY POLICY ACCOUNT
Meeting of 13-14 April 2022
Although spreads between sovereign bond yields and risk-free rates had remained broadly stable since the last Governing Council meeting, it was deemed important to address a possible resurgence of fragmentation in euro area financial conditions, if necessary, in order to ensure a continuous transmission of monetary policy throughout the euro area. Reference was made to the “separation principle”, i.e. the idea that the appropriate monetary policy stance could be set independently of the deployment of instruments designed to avoid a sudden disruption of financial markets that could be triggered by a tightening of the stance. The argument was made that flexibility should be a permanent feature of the Governing Council’s toolbox, and all of the ECB’s instruments could be adjusted within the mandate, incorporating flexibility if warranted, to ensure that inflation stabilised at the Governing Council’s 2% target over the medium term. In addition, it was recalled that the reinvestment of assets purchased under the PEPP could be used to address possible episodes of financial market tensions related to the pandemic, if needed.

Bloomberg 5/11/22

Lagarde Joins ECB Officials Signaling July as Rate Liftoff

European Central Bank President Christine
Lagarde said a first interest-rate increase in more than a
decade may follow “weeks” after net bond-buying ends early next
quarter, joining a growing crowd of policy makers signaling a
move as soon as July.
“The first rate hike, informed by the ECB’s forward
guidance on the interest rates, will take place some time after
the end of net asset purchases,” Lagarde said Wednesday.
“We have not yet precisely defined the notion of ‘some
time,’ but I have been very clear that this could mean a period
of only a few weeks,” she said in a speech in Ljubljana,
Slovenia, advocating a “gradual” normalization of monetary
policy after the initial increase.
Read full report
May 03, 2022
SGH Insight
JOLTS, Final Thoughts Ahead of the FOMC Meeting
The JOLTS report is sure to reinforce Federal Reserve Chair Jerome Powell’s conviction that the labor market is overheating. Job openings unexpectedly rose to 11.5 million, slightly surpassing the previous high of 11.4 million:
Market Validation
FOMC Press Conference

>> CHAIRMAN JEROME POWELL: For now, we are focused on doing the job we need to do, on demand, there is plenty to be done there. If you look at it essentially, it's almost two to one job vacancies to unemployed people. There is a lot of excess demand, more than five million more employed plus job openings than there are the size of the labor force. There is a imbalance that we have to work on. It's difficult situation, you would look at core inflation, which wouldn't include the commodity price shocks, and that is one of the reasons we tend to focus on that, because we can have more of a effect on that. But it would be a very difficult situation. We have to be sure that inflation expectations remain anchored, and that is part of our job too. We will be watching that carefully. It puts any Central Bank in a very difficult situation.
Read full report
May 02, 2022
SGH Insight
Higher mortgage rates should bite harder into the housing market in April (note that mortgage purchase applications have now fallen to pre-pandemic levels), but this is a very unhealthy market characterized by elevated builder costs, strong demographic demand supported by rapid job and wage growth, low inventories, and an inflationary mindset among purchasers. Odd dynamics might evolve.

Market Validation
Rick Palacios Jr.
@RickPalaciosJr
April homebuilder survey results are here. Top themes: 1) Demand is slowing, namely entry-level due to payment shock. 2) Investors are pulling back. 3) Ripple effect of rising rates starting to hit move-up market.
Read full report
April 29, 2022
SGH Insight
The European Commission has now formally issued guidance to EU governments explaining why setting up a second, ruble account as demanded by Russia is in fact tantamount to breaking EU sanctions.
The logic, exactly as we noted when Putin released his March decree, is that while until now paying euros or dollars into an account at Gazprombank completed the transaction of buying Russian gas, after the Putin decree the purchase is only legally finalized once the euros or dollars are converted into rubles and deposited in the ruble account.
The conversion of euros or dollars into rubles is effectuated by the Central Bank of Russia, and that is the point at which the sanctions regime is broken — EU entities cannot do any business with the sanctioned Russian central bank and because the conversion is done by Gazprombank on behalf of the EU entities, they are, indirectly, doing business with the Russian central bank...

...EU sanctions on Russian oil, however, are drawing closer, with Germany declaring on Tuesday that it may be able to wean itself off Russian oil “within days,” rather than by the end of the year as declared before.
This could pave the way for some form of sanctions on buying Russian oil by the whole of the EU soon, perhaps as early as next week, maybe the week after that, depending on how quickly other countries heavily dependent on Russian oil like Lithuania, Finland, Slovakia, Poland, Hungary, Germany, Belgium, and France find alternatives.
Interestingly while the EU, and most notably Germany, as we expected has been moving closer towards sanctioning Russian oil, some of the hesitation it appears now is emanating from the White House, sensitive to its continued inability to drive oil prices lower before the US mid-term elections in November.
Nevertheless, political pressure keeps mounting to turn the economic heat up even higher on Russia, and a special summit of EU leaders to discuss Russia, Ukraine, sanctions, arms deliveries, migration, and food shortages caused by the war has been set for May 30-31.
Some EU officials have indicated to us that oil sanctions could be the big “deliverable” of that meeting, even though that is a month away. The timing is in fact hard to pinpoint, especially with EU officials aware that new, tragic developments in the Ukraine war could force their hands into a major measure more quickly than they might be prepared.

Market Validation
Bloomberg 5/4/22

Oil Rallies as EU Proposes Phasing Out Russian Supply This Year
Von der Leyen says crude purchases to end within six months
Brent surges above $110 a barrel, WTI jumps as much 5.2%

Oil extended gains from the European Union proposing a ban on Russian crude over the next six months, surging as broader equity markets rallied.
Futures in New York climbed more than 5% Wednesday, bouncing off of earlier gains as broader equity markets staged an intraday comeback. Oil advanced with the EU’s most significant plan yet to cut its energy reliance on Moscow. As well as directly banning oil imports, the EU is also targeting insurers in a move that could alter Moscow’s ability to ship product anywhere in the world.
“This will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined,” European Commission President Ursula von der Leyen said. “We will make sure that we phase out Russian oil in an orderly fashion, in a way that allows us and our partners to secure alternative supply routes and minimizes the impact on global markets.”

Bloomberg 5/2/22

The European Union will provide more detailed guidance on what companies can and can’t do under EU sanctions rules to address Russia’s demands to pay for gas in rubles, the bloc’s energy commissioner Kadri Simsonsaid Monday.
Simson told reporters that the EU needs to give companies clarity that the Kremlin’s mechanism -- that would require European companies to open euro and ruble accounts at Gazprombank -- “is a violation of the sanctions and cannot be accepted.”
EU energy ministers met Monday in Brussels to discuss Russia’s demand after Moscow cut off gas supplies to Poland and Bulgaria last week for refusing to comply with its new demands

Bloomberg 4/30/22

The European Union is set to propose a ban
on Russian oil by the end of the year, with restrictions on
imports introduced gradually until then, according to people
familiar with the matter.
The EU will also push for more banks from Russia and
Belarus to be cut off from the international payment system
SWIFT, including Sberbank PJSC, said the people, who asked not
to be identified because the discussions are private. The U.S.
and U.K. previously imposed sanctions on Sberbank, Russia’s
largest financial institution.
Russian Oil Imports
A decision on the new sanctions could be made as soon as
the coming week at a meeting of the bloc’s ambassadors,
according to the people. The proposed measures, which would make
up the EU’s sixth package of sanctions since Russia invaded
Ukraine in February, have yet to be formally put forward and
could change before that happens.
Read full report
April 26, 2022
SGH Insight
The Bank of England is set to deliver its fourth successive rate increase on May 5 as it struggles to contain inflation exacerbated by the pandemic and Ukraine invasion, whose twin price shocks are also weighing on domestic activity.
A June move still remains more likely than not, albeit less certain as we have written, and the window for the BOE’s campaign to modestly “front load” hikes is beginning to close. The Bank does not meet in July and will resume from August 4.
Some policy committee members, absent sagging activity, would prefer to move again in June, probably by bigger increments and opt to keep moving until the key bank rate ranges somewhere around a consensus estimate of neutral.
As domestic budgets become increasingly constrained, the Bank will have to face off the political blowback from its next couple of moves, before stepping to the sidelines to let households catch their breath.
The BOE is on the precipice of what we have described as a “second phase” of tightening, characterized by less frequent moves over a longer time horizon, with data dictating meeting-to-meeting outcomes.
Market Validation
Dow Jones 5/5/22

BOE Raises Rates for Fourth Time, But Signals Future Caution

The Bank of England raised its key interest rate for
the fourth time in as many meetings of its policy makers, but signaled that it
is likely to move cautiously in coming months as worries grow over a slide
into recession for the world's fifth-largest economy.


In a statement Thursday, the BOE raised its key rate to 1% from 0.75%. That
means the central bank has increased borrowing costs at four straight meetings
of its Monetary Policy Committee, a sequence unmatched since the late 1990s.

Six MPC members voted for the rate rise to 1%, while Jonathan Haskel,
Catherine L. Mann and Michael Saunders each voted for a larger rise to 1.25%.

The central bank also said it has asked its staff to prepare a plan for
selling some of the bonds it bought as part of its past stimulus programs.
That plan will be outlined in August, but bond sales would start later.

However, the central bank indicated that it is likely to raise rates more
slowly, if at all, in coming months, with the very high energy prices that
have followed Russia's invasion of Ukraine set to squeeze household spending
power and weaken economic growth.

In its statement, the BOE said further rises in its key rate "may still be
appropriate" in coming months, but added that two of its policy makers didn't
support that guidance and instead thought it likely the key rate would stay at
1%.

*POUND EXTENDS LOSSES, FALLS MORE THAN 2% AGAINST THE DOLLAR
*U.K. BONDS EXTEND SURGE, TWO-YEAR YIELDS FALL 20 BASIS POINTS
Read full report
April 25, 2022
SGH Insight
While Macron’s La Republique en Marche party might secure a majority on its own in these elections, it appears as things stand that he may have to enter in coalition with the far-left’s Jean-Luc Melenchon.
Melenchon’s party, La France Insoumise, currently holds just 17 of the 577 Assembly seats, but with a strong 22% third place showing in the first round of the presidential elections, he is hoping to unify support of other voters from the left. Melenchon has expressed an ambition to serve essentially as an opposition Prime Minister if Macron were to be forced to invite him into the coalition, as has, incidentally, Le Pen.
They would make for strange bedfellows.
Market Validation
Reuters 5/4/22

France's Socialist Party and the hard-left La France Insoumise (LFI) party reached an agreement in principle on Wednesday to form an alliance for June's parliamentary election.

The coalition pact, which the Greens and Communists agreed to earlier this week, is an attempt to deprive Macron of a majority in parliament in the June 12-19 vote and block his pro-business agenda, after he was re-elected president in April.

"We can and will beat Emmanuel Macron and we can do it with a majority to govern for a radical programme," LFI lawmaker Adrien Quatennens told Franceinfo radio.

If the agreement between the LFI and the Socialists is confirmed, the French left will be united for the first time in 20 years.
The deal was shaped under the leadership of LFI's firebrand chief Jean-Luc Melenchon, who broke from the Socialist Party in 2008 after failing to dilute its pro-European Union stance. He wants to "disobey" the bloc's rules on budget and competition issues and challenge its free-market principles.

Read full report
April 25, 2022
SGH Insight
If You Don’t Have Time This Morning
The Fed’s near-term path is clear, with a series of likely three and maybe more 50bp hikes beginning at the May FOMC meeting. Although it seems like there should be a point we should stop pricing in additional rate hikes, it is difficult to shift gears until the data shows signs of moderating inflationary pressures. Otherwise, the Fed has been remarkably complacent in validating seemingly any market pricing. Higher interest rates should start showing some results.
Recent Data and Events
We are at the stage of the cycle where the game becomes watching the data for signs that spending is beginning to crack under the weight of higher interest rates. Housing becomes the central focus given the short channel between policy signals and mortgage rates, the latter rising sharply in recent weeks. Now we need to sort through the consequences. At a basic level, the rise in rates will shake out the weaker players and stem the pace of home price appreciation, but as I have written in the past factors such as income growth, demographics, and inflation expectations lean the other direction. About inflation expectations, for example, though the increase in long rates has been rapid in both nominal and real terms, 30-year real mortgage rates remain in their recent range while 5-year ARMS are still a relative bargain:

New buyers could reasonably take on ARM financing on the expectation that over the next five years the Fed induces a recession and presents buyers an opportunity to refinance into a 30-year rate at that point. This would help mitigate the immediate impact of higher rates – at least until ARM rates rise further.

...Fed Speak and Discussion

Federal Reserve Chair Jerome Powell wiped away any residual doubt about the near-term policy path. Last Thursday, Powell said that a 50bp hike was on the table for the May meeting. While he wouldn’t say if 50bp was already a done deal, he effectively took the guidance one step further, saying “[t]here’s something in the idea of front-loading” rate hikes, which speaks to the expectation for a string of 50bp rate hikes. There really is no question about what is happening here – moving “expeditiously” to a more neutral policy setting by the end of the year requires stepping up the pace of rate hikes to 50bp increments. As of now, 50bp rate hikes in May and June are all-but-certain, July very likely, and August, assuming the inflation or employment data continue to dispel hope that price pressures will endogenously moderate enough to put the Fed’s inflation target in sight...

...An even bigger hike of 75bp is not happening. St. Louis Federal Reserve President James Bullard has discussed the possibility of the larger hike, something former Federal Reserve Chair Alan Greenspan pushed through in 1994, and an option we questioned Bullard on at an SGH/Columbia event on February 17th. Bullard looks favorably on the 1994-95 cycle as an example of where the Fed managed a soft-landing in the context of aggressive policy action on both sides of peak rates for a cycle. That said, the consensus at the Fed is not eager to surprise markets with a bigger move at the next meeting. That includes the generally hawkish Cleveland Federal Reserve President Loretta Mester who made clear last Friday that in her view 75bp was not needed. Remember, the Fed wants to move expeditiously but doesn’t want to break the economy or markets in the process. Still, arguably Bullard has planted the seeds for the bigger move at the June meeting, and it may be a more attractive option at that point, just as the possibility of 50bp moves was scoffed at back in January, although I find it unlikely...

...While the idea of “neutral” sounds like a promising pausing point, the Fed lacks confidence that it can pause at neutral. Fed speakers repeatedly discuss the possibility of moving past neutral, something already evident in the March Summary of Economic Projections but even those forecasts are all-but-certainly too optimistic if unemployment keeps falling while inflation remains stubbornly high. I think the Fed knows this but remains wary to push this story too far because it is obviously in tension with the soft-landing story it is trying to sell.
Moreover, neutral is a moving target. Clients frequently ask if the Fed’s view of neutral is moving, and the answer is that we don’t see any indication that is happening yet. Fed speakers have largely centered that on a 2.25-2.5% range for some time now. Thinking on it, I don’t think the Fed can easily change this estimate. Consider that it follows from a forecast of the real neutral rate plus the Fed’s inflation target. The former is difficult to observe in real time and the latter is fixed. A more appropriate estimate of the inflation component is arguably derived from 10-year TIPS break-evens, currently 3%. Subtracting 30bp as a rough conversion from CPI to PCE inflation makes that 2.7%, which combined with a 0.5% real rate suggests the true neutral rate is currently around 3.2%. The same exercise using the 5-year breakeven suggests a neutral rate of 3.6%. Arguably, these are estimates of the near- or medium-term neutral rate, while the Fed’s reported number is a long-term estimate. Still, this exercise suggests to me that monetary policy will remain stimulative until policy rates climb above 3%...
Market Validation
Policy Validation @LenKiefer 5/11/22

reARMing the U.S. mortgage market share of mortgage applications with adjustable rate increases to over 10%, highest share since 2008

Bloomberg 5/4/22

The Federal Reserve raised interest rates by the steepest increment since 2000 and decided to start shrinking its massive balance sheet, deploying the most aggressive tightening of monetary policy in decades to control soaring inflation.
The U.S. central bank’s policy-making Federal Open Market Committee on Wednesday voted unanimously to increase the benchmark rate by a half percentage point. The Fed will begin allowing its holdings of Treasuries and mortgage-backed securities to roll off in June at an initial combined monthly pace of $47.5 billion, stepping up over three months to $95 billion.
“The committee is highly attentive to inflation risks,” the Fed said in the statement, adding a reference to Covid-related lockdowns in China that “are likely to exacerbate supply chain disruptions.” That comes on top of Russia’s invasion of Ukraine and related events, which are “creating additional upward pressure on inflation and are likely to weigh on economic activity.”

FOMC Press Conference
>> CHAIRMAN JEROME POWELL: I don't think one month, one month is not, no, one month's reading would not, doesn't tell us much. We want to see evidence that inflation is moving in a direction that gives us more comfort. We have got two months now, where core inflation is a little lower but we are not looking at that as a reason to take some comfort. We need to really see that our expectation is being fulfilled, that inflation in fact is under control, and starting to come down. But again, it is not like we would stop. We would just go back to 25 basis point increases. It will be a judgment call when these meetings arrive. But our expectation is if we see what we expect to see, we would have 50 basis point increases on the table at the next two meetings.

Bloomberg 5/4/22

White-pack (Jun22-Mar23) eurodollar futures outperform across the strip after Fed’s Powell says 75-basis-point rate hike moves are something the FOMC is not actively considering.
Jun22 eurodollar futures flip to higher by 11bp on the day and outperform across white-pack futures as rate-hike premium continues to ease out of the front-end of the curve
Further out 2-year yields richened by up to 12bp on the day at around 2.66%, steepening 2s10s curve sharply wider -- to steeper by 7bp on the day; further out, the 5s30s curve widens 9bp on the day amid front- and belly led gains

FOMC Press Conference
>> CHAIRMAN JEROME POWELL: So, neutral, when we talk about the neutral rate, we are talking about the rate that neither pushes economic activity higher nor slows it down. It is a concept. It is not something we can identify with precision. We estimate it within broadbands of uncertainty. The current estimates on the committee are two to three percent. That is a longer run estimate. That is a estimate for a economy that is at full employment and 2 percent inflation. The way, what we are doing really is we are raising rates expeditiously to what we see as the broad range of plausible levels of neutral. But we know that there is not a bright line drawn on the road that tells us when we get there. We are going to be looking at financial conditions. Our policy affects financial conditions and financial conditions affect the economy. We are going to look at the effect of our policy moves on financial conditions, are they tightening appropriately. We are going to be looking at the effects on the economy. We are going to be making a judgment about whether we have done enough to get us on a path to restore price stability. It's that. So if that path happens to evolve levels that are higher than estimates of neutral, we will not hesitate to go to those levels. We won't. But again, there is a false precision in the discussion that we as policymakers don't really feel, it's you are going to raise rates and going to be inquiring how that is affecting the economy through financial conditions, and of course if higher rates are required, then we won't hesitate to deliver them.
Read full report
April 22, 2022
SGH Insight
Though BOJ officials expect a temporary bump in inflation in the next few months as government cuts to mobile phone fees roll off, underlying inflation as reported by the central bank is still only around 0.5%. There is furthermore an understanding that headline inflation pressure on energy prices and consumers is not just the result of a weaker yen but fueled also by Russia’s invasion of Ukraine and the rush toward green energy policies by the European Union.
Intervention Noise and Yen Weakness
So even as the US Federal Reserve and other central banks (outside China) lean into tightening cycles, Bank of Japan Governor Kuroda has continued to pledge to keep Japanese short-term rates firmly anchored to the floor, or to be more precise just below the floor, at -0.1%.
Out of contention as well is an “early” end to the BOJ policy of yield curve control on the long end that has been in place since 2016, which is considered by Kuroda to be a critical backstop against a “premature” exit from accommodative policy. That however has not precluded speculation that the 25-basis points YCC band around 10-year JGBs could be widened.
Something will give after the collapse in the currency.
The first shoe to drop we expect will be the psychological 130 yen to dollar threshold that has held to date.
Market Validation
Bloomberg 4/28/22

The Bank of Japan sparked a sharp slide in
the yen and a currency warning from an official after doubling
down on its promise to defend a rock-bottom yield target that
leaves it as a dovish outlier among major central banks
tightening policy.
The central bank said it would buy an unlimited amount of
bonds at a fixed rate every business day to protect a 0.25%
ceiling on 10-year government debt yields as part of its
stimulus measures.
The BOJ’s decision prompted a day of rapid market moves
that ultimately triggered the strongest words yet from Japan’s
finance ministry as the yen shed 2% of its value against the
dollar.
The bank kept its main yield curve control settings and the
scale of its asset purchases unchanged, according to a statement
Thursday. That decision had been widely expected by economists,
although there had been speculation that the BOJ would do or say
something to try and halt the slide in the currency. Instead,
the policy decision and following press conference only
accelerated those losses.
The currency weakened sharply against the dollar after the
decision and breached the 130 mark mid-afternoon in Tokyo,
before touching 131 early in the evening. Those levels compared
with around 128.67 immediately before the BOJ issued its
statement.
Read full report
April 20, 2022
SGH Insight
Pushing rates to neutral by the end of the year requires a series of 50bp rate hikes, which we know begins at the upcoming May FOMC meeting. Speakers have positioned the Fed for 50bp rate hikes at the May and June meetings, and I believe the Fed will know at the June meeting if it plans to hike 50bp a third time in July as well. That sets the stage for the equivalent of ten 25bp rate hikes in the June dots, with the risk at that point that the Fed already believes it needs to get rates above current long-run neutral estimates by the end of the year, meaning a fourth and even fifth 50bp hike added to the series. That, however, is only speculation at this point. There will be a lot of data to process between now and then.
Market Validation
Bloomberg 4/21/22

Fed’s Daly Says a ‘Couple’ of 50 Basis-Point Rates Hikes Likely

Federal Reserve Bank of San Francisco President Mary Dalysays half-point interest-rate hikes are ‘likely’ at a couple of meetings as the U.S. central bank marches rates higher to curb inflation.
Daly speaks in interview with Yahoo! Finance
“We will likely be taking a 50 basis-point increase in a couple of the meetings, also starting our balance-sheet reduction program”
Asked about hiking by a larger amount, Daly says “the tactics about is it 50 (basis points), is it 25, is it 75, those are things I’ll deliberate with my colleagues.
*FED SWAPS FULLY PRICE IN THIRD HALF-POINT RATE HIKE IN JULY

Read full report
April 19, 2022
SGH Insight
...That said, a senior official concedes, as we have written, that April may indeed prove to be the toughest month for economic growth this year. He goes on to suggest that China’s State Council will step up fiscal, investment, and monetary stimulus efforts if consumption during China’s five-day International Labor Day holiday, starting on May 1, falls short of expectations...
Market Validation
Bloomberg 5/20/22

Chinese banks cut a key interest rate for
long-term loans by a record amount, a move that would reduce
mortgage costs and may help counter weak loan demand caused by a
property slump and Covid lockdowns.
The five-year loan prime rate, a reference for home
mortgages, was lowered to 4.45% from 4.6%, according to a
statement by the People’s Bank of China Friday. That was the
largest reduction since a revamp of the rate in 2019. A majority
of economists surveyed by Bloomberg had predicted a cut by five
to 10 basis points.
The cut is a significant move to boost loan demand, as
consumer and business confidence has been battered by Covid
lockdowns and a downturn in the property sector that has seen a
string of developer defaults and falling home prices. The lower
rate will be applied to new mortgages immediately, while
existing mortgages won’t be repriced until next year at the
earliest.

Read full report
April 18, 2022
SGH Insight
Bottom Line: The Fed continues to press forward with its plan to get rates to neutral this year with front loading rate hikes. That sets us up for a series of 50bp moves, starting in May. The Fed has yet to commit to any steps beyond that point, with the consensus wary about pushing rate hike expectations too much above neutral until it has a clearer sense of the level of underlying inflation. Now we wait, tracking the inflation data and any wobbles in activity triggered by the rise in market interest rates that have already occurred. My expectation is that the Fed will eventually need to take rates above the current estimate of neutral, and there is a reasonable chance that the neutral rate has risen. That’s speculation, however, and if true the Fed and market participants will need to learn their way to that outcome.
Market Validation
Policy Validation

Bloomberg 4/19/22

Fed’s Evans Expects Interest Rates to Rise Above Neutral Level

Federal Reserve Bank of Chicago President Charles Evans said that interest rates will probably rise above the level that neither restrains nor speeds up the economy -- but how much higher will hinge on whether inflation cools as expected

“Probably we are going beyond neutral. That’s my expectation,” Evans said Tuesday during a moderated discussion at the Economic Club of New York.

Fed officials estimate the neutral rate lies around 2.4%. Evans, echoing other Fed officials, said he supported getting the target range their main policy rate up to around 2.25% to 2.5% by year end. It currently sits at 0.25% to 0.5%. Fed officials next meet May 3-4 and have said that raising rates by a half point, versus the quarter-point move they made last month, would be on the table for debate.

They expect higher rates, in addition to shrinking their balance sheet, will see price pressures that are currently the highest in four decades start to ease.

“On the way to December you’d be looking for any confirmation of the storyline,” Evans said. “It could be that short-term neutral is actually lower, and that by the time we get to 2.5, it’s actually contractionary for a variety of reasons. It could go the other way too,” he said.
Read full report
April 14, 2022
SGH Insight
China will cut its Reserve Requirement Ratio tomorrow, as we have been anticipating and is increasingly expected by markets.

At a State Council Executive Meeting on April 13, local time, Premier Li Keqiang decided “to give greater weight to lower[ing] the provision coverage ratio of large-sized banks with high provisioning levels in an orderly manner and to cut banks’ reserve requirement ratio in a timely way in order to boost financial services for the real economy, especially for micro, small, and medium-sized enterprises (MSMEs).”
Market Validation
Bloomberg 4/15/22

The Chinese central bank cuts reserve
requirement ratio by 0.25 percentage point for all banks and
additional 0.25 percentage point for some banks, according to a
statement from PBOC.
* The RRR cut will release 530b yuan of liquidity

Read full report
April 14, 2022
SGH Insight
...while the ECB has punted the decision on which specific month in Q3 it will end APP purchases until its June 9 forecasting round meeting, as things stand and barring some massive unforeseen shock, we fully expect the last 20-billion-euro monthly round will be purchased in June, and APP will stop as of July 1.

Of course, the last time the ECB hiked rates was in 2011, and a decision as momentous as lift-off into a rate hiking cycle will ideally need to be tied to a forecasting round, no matter how flawed, and that presents an interesting timing dilemma. Namely, with the need to move off negative interest rates so glaringly obvious, can the ECB make a case in June that the conditions are met for the end of APP, but not yet for liftoff in July, and wait another full three months for lift-off?
We’ll see, but we suspect not...

...On a final note, we would like to toss out the “scoop” reported by a wire service about an emergency program in the works at the ECB to stop fragmentation of Eurozone markets as an utter non-story.

Since well before the conclusion of the ECB’s Pandemic Emergency Purchase Program (PEPP) program in April of this year, ECB officials have talked about the desirability of retaining optionality in the case of an emergency to purchase sovereign bonds on a more discretion based, flexible manner, meaning away from the ECB’s self-imposed Capital Key restrictions. The PEPP, of course, did just that.

This appears to have morphed into a wire article about an emergency program in the works evoking former ECB President Mario Draghi, the OMT program, “everything it takes” vows, and other such trips down memory lane and the European debt crisis. Having intervened multiple times in the course of its history to manage fragmentation and spiking yields in times of crisis, one would think the ability of the ECB to do just that if needed would be glaringly obvious to all. Indeed, when asked about it multiple times, Lagarde merely shrugged.

Market Validation
Bloomberg 4/21/22

The European Central Bank should be able to
phase out asset purchases in July to pave the way for an
interest-rate increase as early as that month, according to Vice
President Luis de Guindos.

Any decision will hinge on the ECB’s economic forecasts at
its next policy meeting in June, though it’s already “crystal
clear” that higher inflation and lower growth will be part of
the mix, Guindos said in a Bloomberg interview. He discounted
the chance of a recession and stagflation in the euro area.
“I see no reason why we should not discontinue our Asset
Purchase Program in July,” Guindos said. “

Bloomberg 4/21/22

On concerns that the ECB’s exit path could put more highly
indebted countries in the euro area under pressure and lead to a
new debt crisis, Wunsch said there’s “quite broad” consensus
within the central bank that “unwarranted fragmentation” on bond
markets would be addressed. But he cautioned that policy makers
shouldn’t “over-engineer instruments because we need to be able
to react to specific circumstances.”
Read full report
April 12, 2022
SGH Insight
On Friday, April 8, nine government departments submitted their economic analysis reports to China’s State Council, inputs which will be also incorporated into the country’s aggregated National Bureau of Statistics reports due to be released on Monday, April 18.

Of the nine departments, seven estimated that China’s Q1 2022 GDP had grown by more than 5.0%, with estimates ranging from a low of 4.8% to a high of 5.4%. Notably, our understanding is that China’s foremost economic planning department, the NDRC (National Development and Reform Commission) pegged Q1 GDP growth at 5.2%, with the People’s Bank of China estimates coming in a bit lower, at 5.0%.

While the NDRC report voiced confidence that the country would achieve its growth target of “around 5.5%” this year, a view that is not shared by many private sector forecasters, it also acknowledged that the solid Q1 growth numbers – initially expected to come in as low as 4.0% — were largely due to a strong recovery in January and February.
Market Validation
Bloomberg 4/12/22

China’s better-than-expected economic data
on Monday prompted questions from analysts who pointed to
inconsistencies with alternative statistics that paint a grimmer
picture of the economy.

Gross domestic product growth rose 4.8% in the first
quarter from a year prior, the government announced Monday,
picking up from a rate of 4% in the October-to-December period,
and beating a consensus 4.2% rate among economists surveyed by
Bloomberg.
Read full report
April 11, 2022
SGH Insight
The explosion in headline inflation in March will feed into the story that the worst is behind us on a year-over-year basis. Further feeding into that story would be any downside miss on the core number attributable to falling used car prices, something foreshadowed by the Manheim index:

(See graph on full report.)

One inflation view is that inflation is primarily not a macro event, but a micro, supply side event. That view still holds onto a decline in used vehicle prices leading the way back to a primarily transitory inflation story.
While a miss on core driven by used prices would be welcomed by the Fed, I think overall the consensus at the Fed will lean towards caution. From a pure symmetry perspective, the fact that the Fed looked through the rise in used vehicle prices last year means it should look through any decline this year. More importantly though, no one expects inflation to remain running over 8% annually...

...That said, the speed at which rates are moving will eventually cause some heartburn for the Fed. For now, it is full steam ahead for monetary policy. The Fed wants to push rates to neutral, and even a little beyond, but hopes that enough of the inflation surge will be transitory and that a soft-landing can be achieved with only modestly tight monetary policy. Too rapid of a rise in rates, however, may become disruptive for the economy and raise concerns that the Fed is prematurely courting a recession. There will be a limit to how much tightening the Fed will tolerate being priced into markets in the near term. The trick of course is that we don’t know where the limit is, only that we are closer to it than three months ago.
Market Validation
Reuters 4/12/22

A second straight monthly decline in prices of used cars and trucks restrained the core CPI to a 0.3% rise after increasing 0.5% in February. Core goods fell 0.4%, the biggest drop since April 2020. That blunted part of a 0.5% gain in shelter costs, which accounted for nearly two-thirds of the rise in core CPI.

WSJ 4/12/22

"I don't want to be too rigid in how I think about the appropriate course of policy over the remainder of this year and into next year," she said. "By moving expeditiously towards a more neutral posture, it provides the committee with optionality in either direction."
Ms. Brainard said demand was likely to moderate this year amid a drop in federal stimulus and increase in borrowing costs. In recent days, mortgage lenders have said 30-year fixed-rate loans now carry rates of more than 5%.
Any softening in consumer demand and an increase in the number of Americans seeking jobs could cool labor demand and ease price pressures.
"The U.S. economy enters this period of elevated uncertainty with a very strong labor market and significant underlying economic momentum," Ms. Brainard said. "And that, I think, bodes well for the ability to bring inflation down while also continuing to sustain the recovery."

Bloomberg 4/12/22

The Federal Reserve should raise interest
rates to the neutral range as quickly as possible and can move
above that should price pressures persist, Richmond Fed
President Thomas Barkin said.
“The best short-term path for us is to move rapidly to the
neutral range and then test whether pandemic-era inflation
pressures are easing, and how persistent inflation has become,”
Barkin said Tuesday, referring to level of rates that neither
speed up nor slow down the economy. “If necessary, we can move
further,” he said in remarks at an event organized by the Money
Marketeers of New York University.

Read full report