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Friday
Why Fed 75bp hike post-FOMC is a logical response to U Mich survey and political considerations
Since Friday’s CPI (higher CPI) and U Mich Consumer Confidence survey (rise in consumer inflation expectations), consensus expectations for June is now a 75bp hike (vs 50bp prior). This is a break from the forward guidance given by the Fed and has prompted multiple interpretations of this move.
![Markets far more de-risked into June FOMC. And +75bp brings rates closer to market expectations.](https://cdn.fundstrat.com/wp-content/uploads/2022/06/image-228.png)
- ultimately, the Fed move seems appropriate given the rise in consumer expectations for inflation
- many forward indicators for inflation point to a downturn coming, including rollovers in housing (lumber), autos/used cars (prices falling), apparel and furniture (piling inventory), supply-chain related (easing)
- inflation has been primarily goods/supply-chain driven, but the rise in gasoline and tight labor is shifting the perception towards inflation sticking.
- prior studies (below) show that consumer expectations for inflation collectively are perceptually accurate on inflation (r-squared >90%)
- and that this change in consumer forward expectations actually influences interest rates historically (2-quarter lead)
- hence, if inflation expectations are rising, this requires the Fed to act
- however, the “glitch” in this is that it seems that gasoline prices itself has a sizable influence on consumer
- in other words, the best way to contain inflation expectations is to see oil prices/gasoline level off
- as OECD notes, half of the rise in global inflation in 2022 is due to second-order effects from Russia-Ukraine war
But this is not a hopeless scenario. The Fed needs to respond to market and political concerns about inflation. Thus, raising Fed Funds gives markets, policymakers and the public the assurance that bold steps are being taken to address inflation concerns.
- we also believe underlying drivers of inflation are cooling
- and labor markets are cooling quickly, look at the rise in layoffs
- these layoffs are happening in start-ups (previously noted), crypto and housing (Compass and Redfin, etc)
- start-ups and crypto are incremental sources of capital formation, thus the first to get hit
- housing is slowing fast and this is evidenced by Compass and Redfin layoffs
- those are key since home price is a long-lead indicator of housing inflation (owner’s equivalent rent)
- and job market cooling eases concerns about wage inflation
U Mich Consumer Expected Inflation historically drives interest rates and leads CPI
Many equity investors wonder why the University of Michigan Consumer Confidence survey is so influential in monetary policy. We reached out to the researchers at University of Michigan and shared studies show consumer expectations for inflation are quite predictive. U Mich Survey study (from 1995 link –> https://data.sca.isr.umich.edu/fetchdoc.php?docid=24774)
- Consumer expected inflation leads forward interest rates by 2 quarters (hence markets should care)
- Consumers expectations about inflation lead CPI by one quarter
- Hence, a rise in forward inflation means upside risk to inflation and higher rates
- The market reaction over the past few days to the U Mich survey, therefore, seem to have better context
If one is curious, this is the actual survey question as shown below. This is a paper ballot and I believe this is now done 100% online. This sample survey, I think, is from 1995.
Gasoline seems to influence consumer views on inflation –> Russia-Ukraine war is key
The public does not necessarily think about total vs core CPI (ex-food and ex-gasoline). Thus, the U Mich inflation expectations reflect the total basket and includes food and energy. And gasoline seems to exert a substantial influence on this metric. Take a look below:
- AAA gasoline prices, absolute
- seem to lead U Mich inflation expectations 12M and 5-10 years forward
- thus, gasoline itself seems to be key to how consumers perceive inflation
Russia-Ukraine war might be the most important deciding factor for gasoline
Oil prices have been surging higher for many structural reasons, as we have highlighted multiple times over the past few years. This is a reason Energy was our favorite sector in 2021 and our top sector pick in 2022. But the Russia-Ukraine war have amplified inflationary pressures globally.
- as recent OECD report below notes, the war has doubled the rate of inflation around the world
- via food prices, oil prices and supply chain strains
- similarly, China’s lockdowns have amplified strains on the supply chain
- these are supply-related shocks driving higher prices
- which is why Fed policy actions might have less impact on gasoline
- but slowing economic growth still makes sense in easing wages pressures, housing etc
The only point we are making here is that seeking an end to the conflict will have a substantial impact on inflation perceptions and market views on risk. This is an external event that is unpredictable. But it is also a reason for investors to not view inflation as necessarily hopeless. There will be a clearing price for oil that does ultimately become equilibrium.
![Markets far more de-risked into June FOMC. And +75bp brings rates closer to market expectations.](https://cdn.fundstrat.com/wp-content/uploads/2022/06/image-232.png)
Policymakers grossly underestimated inflation impact from war… suggesting seeking end to war coming sooner than later
But this is where one needs to be “half-full” — as this Bloomberg story below notes, the White House privately acknowledges the “collateral” damage is far greater than expected:
- not sure why White House didn’t think cutting off food and energy supplies would not cause inflation surge
- but this admission means policymakers are now closer to “seeking an end” to the war, rather than prolonging the war
- ending the war would be a major reversal of how markets and the public view inflation risks
- thus, this is a big deal
![Markets far more de-risked into June FOMC. And +75bp brings rates closer to market expectations.](https://cdn.fundstrat.com/wp-content/uploads/2022/06/image-237.png)
STRATEGY: Raising 75bp puts Fed funds rates in zone better than post-May –> recall, markets rallied throughout most of May
Markets have fallen 10% in the past 3 days in horrific price action. Given inflation is a “single voter issue” for markets, and given concerns central banks are behind markets, investors are not focused on valuation or even risk/reward. Instead, investors have been selling whatever they could.
- take a look at Fed Funds vs 2-year notes prior to each of the last 6 FOMC meetings
- and the spread, both before and 5D after the FOMC
- into June FOMC, the spread between FF and 2-yr is +260bp
- if Fed raises +75bp, this narrows the spread to 185bp
- this is narrower than the spread post-May FOMC
- recall, equities found footing throughout most of May
- hence, we think the odds are that high markets will see the Fed funds rates as closer to market expectations
- setting the stage for stocks to rise, based on normalization of positioning
Investors are far more de-risked into June FOMC… arguing for better outcomes than May
As this tweet by @SpecialSitsNews highlights, Goldman Sachs GS -0.02% prime brokerage data shows net selling of equities was the largest 2-day ever.
- z-score was 4.5
- meaning, this was nearly a 5 standard deviation event
- that is massive massive de-risking
- into June FOMC
![Markets far more de-risked into June FOMC. And +75bp brings rates closer to market expectations.](https://cdn.fundstrat.com/wp-content/uploads/2022/06/image-235.png)
And Deutsche Bank systematic equity positioning shows a similar -2 standard deviation low
- again, massive derisking
- far more than into May FOMC
…Mark Newton also highlights high equity put-call ratio and TRIN readings
Investors have been whipsawed and therefore are wary of trusting any market bounce. And our Head of Technical Strategy, Mark Newton, notes that he expects equities to find better risk/rewards towards the end of June.
- He notes that stocks are getting close to lows, but not quite there yet
- Multiple factors cited including VIX, TRIN and put-call ratio
- But if his central view of late-June bottom is realized, this technical view is consistent with economy reaching a soft landing
Below is the put-call ratio (weekly) noted by Newton.
STRATEGY: While markets fearful of a “hard landing,” a soft-landing is already discounted in equities
No doubt many investors have lost all hope for the economy and markets after the horrific market selling over the past few days. As data from prime brokers show, the magnitude of the selling was capitulatory.
- after all, only massive liquidations like this take place when investors need to get out
- but further downside exists if the current economic and financial conditions lead to a larger economic downturn
- while leverage exists today, it is much more in the hands of the public sector (governments) and central banks, and less so for corporates and households
- moreover, while many fret EPS forecasts are too high, corporations earn nominal profits, and thus, elevated inflation is actually supporting nominal EPS.
- this circles back to the notion of “unkillability” — companies might weather this rise in inflation and even soft landing better than expected
- and if so, much of the bad news is discounted today
STRATEGY: We lean relatively “bullish” into 2H2022 (but also 2Q22), but warn of jagged next few months… Stick with BEEF
To recap on equity strategy, we are leaning bullish into 2Q2022.
Stocks have continued to be treacherous in 2022. Investors are on a hair trigger.
– this is in context to a challenging 1H2022
– so jagged next 3 months
Broadly, our existing sector strategy of BEEF remains valid. Even in war. Even with inflation. In fact, the last few weeks are strengthening the case for our “BEEF” strategy. That is, BEEF is
– Bitcoin + Bitcoin Equities BITO -0.78% GBTC -0.97% BITW -2.01%
– Energy
– FAANG FNGS 1.35% QQQ 1.15%
Combined, it can be shortened to BEEF.
Why is this making stronger BEEF?
– Energy supply is now a sovereign priority
– this helps Energy stocks
– Ukraine and Russia both want access to alternative currencies
– this strengthens case for Bitcoin and bitcoin equities
– if Global economy slows, growth stocks lead
– hence, FANG starts to lead FB AAPL -0.43% AMZN 3.74% NFLX 1.11% GOOG 0.88%
All in all, one wants to be Overweight BEEF
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31 Granny Shot Ideas: We performed our quarterly rebalance on 4/5. Full stock list here –> Click here
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