It has been a whirlwind 24 hours in markets since yesterday’s torrid CPI print, which confirmed the highest inflation in 40 years, which was then followed by an even more extreme commentary from the Fed’s own windsock, James Bullard, who in remarks that have seen been called “immature” and “unprofessional” sparked a market panic with his calls for a 50bps rate hikes, an active sale of securities from the Fed’s balance sheet and even an intermeeting rate hike.
And despite a full-blown damage control offensive by both Fed speakers (Daly and Barkin), and the media – with CNBC’s Steve Liesman coming the closest to slamming Bullard as effectively having no idea what he is talking about – and downplaying Bullard’s “50bps green-light” (as well as talking-down an intermeeting move), we currently see Fed Funds futs at 70% odds of a 50bps March hike – which according to Nomura’s Charlie McElligott “forces the hand of the FOMC towards “hawkish asymmetry,” and who will have to “take what the market is giving them” and hike by 50bps in March, as it stands now” (although there is another CPI print before March so ‘data volatility’ remains)
Why? Because anything less, according to the Nomura x-asset strategist, would not just shock markets in the other direction (in a way that would counterproductively “ease” financial conditions which is a 100 delta “non-starter” now as they are now forced “all-in” on tighter FCI, hence Real Yields to 1.5 yr highs), but would also undermine their credibility as “inflation fighters” in what has now become a massively politicized issue that is taxing all Americans and has the Fed in the crosshairs from all parties.
Nomura economist Rob Dent elaborates on this, noting that “one underappreciated aspect of yesterday’s surprise CPI numbers is their potential to worsen the national conversation around inflation. The press widely covered the upside surprise yesterday, and Google search activity suggests the general public also showed keen interesting. Moreover, significant increases in prices have become correlated with the percent of consumers reporting hearing bad news about higher prices in the University of Michigan survey.”
On the other hand, if the Fed wishes to avoid a 50bps initial hike shock, as it remains “scared of their own FCI shadows” with fed funds now pricing ~6.5 hikes by Dec YE Fed mtg, the “7 hikes in ‘22” option is the alternative path.
With all of this said, McElligott warns that if the Fed still tries to “slow-play it” now, and only goes 25bps in March due to legacy scar-tissue from prior market “tightening tantrums,” Rates traders “would probably wreck them for it and bury them further- because this latest inflation data has now finally seen majority capitulate to the view that the Fed is officially “behind-the-curve,” should have stopped QE in January when they first had the opportunity, and are now going to have to “double whammy” us with a more aggressive tightening path running alongside BS run-off, including maybe even outright sales.”
What about the possibility of an intermeeting emergency rate hike, an option which Bullard himself brought up?
According to Nomura, “it’s doubtful, because we are (really awkwardly) still in QE and buying bonds” which is why today’s 3pm POMO schedule release is a major risk-event to watch. Here Nomura repeats what we already mentioned yesterday:
FFG2 trade an overnight low of 99.8525, which would imply a 43% of an intermeeting 25bps hike today (or even higher probability if the assumed date is later this month). This makes the 3pm POMO schedule extra important as
- the only reason to not release it would be to get ready for intermeeting hike and the Fed would likely want to inform the market before hand (i.e not a surprise at 3pm on a Friday) and
- if it is released on schedule and the operations should stretch into early March and it should calm some of the intermeeting fears
So keep an eye on what the Fed says (or doesn’t say) at 3pm ET today: a new POMO schedule which concludes the tapering of QE on schedule some time in early March will likely spark a relief rally as at least an intermeeting rate hike is taken off the table. On the other hand, if the Fed decides to withhold publishing its final tapering timeline effectively ending QE today, then all bets are off.
