Powell made clear last week that headline CPI is his top concern. As myopic as that seems, they know our inflation expectations are set by headline data. Not many of us get into the details — we just look at the price of gasoline and think “inflation forever.”
“Look at life through the wrong end of the telescope.”
— Dr. Seuss
Friday Telescopic Charts
This was the week the market officially started worrying about recession.
Energy shares seem to be pricing in $50 oil; forwards markets are pricing in sub 2% inflation; and eurodollar futures (whatever they are) show Fed Funds peaking by the end of this year.
But all that market evidence notwithstanding, the Fed itself remains laser focused on CPI — to the extent there was even talk of another 75 bip raise following Powell’s Senate testimony this week.
Is the captain of the ship looking through the wrong end of the telescope?
That’s a fine thing to try for both the readers and writers of children’s books. But not so fine for Fed chairs (or pirates).
Powell made clear last week that headline CPI is his top concern. As myopic as that seems, they know our inflation expectations are set by headline data. Not many of us get into the details — we just look at the price of gasoline and think, “Inflation forever.”
Let’s flip the telescope around and see if we can spot some more useful indicators.
Tech shares were up nearly 8% this week while energy shares fell 6%. That could be a one-week phenomenon, just because people got over-positioned in those two sectors. Or it could be that the market has charted a new course in the direction of lower rates.
The case for over-positioning:
Soc Gen notes US equities have derated at the fastest pace on record. So this week’s move may just be a small reversion back toward the mean.
The case for course correction:
History suggests there’s a good chance that the sell-off in energy shares is telling us inflation is about to start surprising on the downside.
Futures markets agree:
No one other than Jeff Snider really knows what eurodollar futures are, but they seem to be telling us that the Fed will be done raising by the end of the year — far earlier than the Fed itself thinks they’ll be done.
The TIPs market is sending a similar message in a bottle:
The market for two-year forward, three-year breakevens (try saying that three times fast) shows that inflation is expected to be below the Fed’s 2% target within two years.
So, while the Fed continues to lose sleep over inflation, we should probably start losing sleep about recession, instead:
New manufacturing orders are already into contraction territory. The S&P Global PMI survey found that factory production "fell to a degree only exceeded twice in the 15-year history of the survey, at the height of the initial pandemic lockdowns in 2020...and the global financial crisis in 2008."
CEOs are likely feeling it already:
Citi’s Earnings Revisions Index has turned negative, suggesting that companies will soon be talking less about inflating costs and more about deflating earnings.
The market rallied this week on lower inflation risks — but recession risks are rising, so there’s still plenty of things to keep us up at night.
But at least we have something new to think about while we stare at the ceiling.