By Michael Every of Rabobank
The Plot Against America
How quickly things escalate into situations we previously thought unthinkable.
So warns ‘The Plot Against America’, a 2004 alternative history novel by much-lauded US author Philip Roth, where FDR is defeated in the 1940 election by pro-Nazi aviator Charles Lindbergh, crying “America First”. In 2022, half of America thinks the other half are Nazis for saying the same, despite the slogan not originating with Trump or Lindbergh, but with Wilson, and having also been used by Reagan and Clinton; a minority thinks all those presidents were as bad as Lindbergh; Kanye West says he loves Hitler and the Nazis; and Philip Roth is being cancelled.
This shifting backdrop both reflects and influences society, the economy, and markets: but we are where we are, which is the Fed having hiked 50bp to take Fed Funds to 4.50% - and they are not done yet. As the Wall Street Journal’s Fed Whisperer Nick Timiraos tweets, “The Federal Reserve has raised rates to levels this year that didn't fit on the Summary of Economic Projections y-axis scale nine months ago. Today, the FOMC projected raising rates next year to levels that didn't fit on the SEP y-axis six months ago.”
Indeed, all the focus was on the updated Fed dot plot of the projected path of rate hikes. The only place this saw unanimity was for 2022. After that, the dispersion of views looks like the random collection of dots economists like putting a line through, a silly R-squared on top of, and calling it support for a whacky theory, usually to give the rich more money.
- In 2023, the most dovish member predicts rates will end at between 4.75% and 5.00%, while the most hawkish members predict between 5.50% and 5.75%, which means no 2023 rate cuts unless rates have been raised further first.
- In 2024, the most dovish member predicts rates will end at between 3.00% and 3.25%, while the most hawkish member predicts between 5.50% and 5.75%, so at least one current voter thinks no rate cuts in 2024 either.
- In 2025, the most dovish member predicts rates will end the year between 2.25% and 2.50%, while the most hawkish member again predicts between 5.50% and 5.75%, so at least one current voter thinks no rate cuts in 2025 as well.
- Over the longer-term, the most dovish see Fed Funds back at 2.25%, so an implied real Fed Funds rate of 0.25% vs. a 2% CPI target, and the most hawkish at 3.25%, so an implied real rate of 1.25%. Whether we ever get to the long-term given how wildly things can move over 20 years, or even 2 years, remains to be seen.
To markets, this is a dot plot against America, or at least the one they hold dear: of easy money, easy returns, and an easy life; 100-year Argentinean bonds; Dogecoin; FTX and SBF; Madoff; Enron; ‘The Big Short’; and Pets.com. Naturally, they therefore ignored the hawks and everything Powell said about rates going higher and no cuts in the near term. They even ignored him saying, “If markets ease financial conditions, the implicit notion there was that just means we’re going to have to do more to make financial conditions tight.” In our view, he might do it in 25bp steps, but that doesn’t mean he won’t do it.
Indeed, the only thing the markets seized on was a slip from Powell when asked about potential changes to the 2% inflation target, which he suggested might be something looked at one day “as part of a longer-term project.”
Yet even that should warrant longer Treasury yields moving higher and curve steepening: who wants to hold long bonds if the Fed is going to accept higher long-run rates of inflation? (Indeed, if you want a plot against America, try changing the inflation target!) There is thus a huge disconnect between markets, which say we are in the same world as 20 years ago, where rate cuts always rapidly follow rate hikes, and lower rate lows come after lower rate highs, and the Fed, which says this is not the case, and is acting on it.
As Philip Marey warns, this looks like a ‘Collision Course’ ahead for 2023. Not that the US is alone in this, of course:
The BOJ is to undertake a policy review in 2023, likely after Governor Kuroda steps down in March, which could potentially see it drop elements of its yield curve control and QE. The implications are enormous, both for Japan and other markets. Can they exit from their current one-way trajectory? How? How without blowing either themselves or other markets up? Yet how can they stay on their current trajectory without the same thing happening? The recent JPY rally is not about any fundamental improvements so much as a market refusing to read the Fed dot plot. Note that the Japanese government is now talking about sustaining massive increases in defence spending via taxation (including a floated spike in corporation tax) rather than just relying on money-printing: a sign of things to come, or just a trial balloon?
China reportedly ordered its banks to buy government bonds as yields there soared, a trend which will only continue on economic reopening (after the chaos of everyone getting Covid at once is out of the way): that’s a different tactic to how the BOE handled the same problem. The need to reopen was underlined by November data. New home prices were -0.3% m-o-m; industrial production 2.2% y-o-y vs. 3.5% expected; retail sales -5.9% y-o-y vs -4.0%; fixed asset investment 5.3% y-o-y year-to-date vs. 5.6%, with property investment -9.8%; and even the unemployment rate ticked up from 5.6% to 5.7%. The challenge will now be to somehow show ‘reopening’ December figures are good, despite everyone being at home sick, so Q4 GDP is high enough to make 2022 not a bad year overall. Of course, both fake and genuine Chinese reopening --and any stimulus-- will complicate things for the Fed as well as Chinese banks. It will also complicate them for markets, who want to be simultaneously optimistic on China reopening and the Fed cutting rates, when they can’t have both.
New Zealand Q3 GDP jumped 2.0% q-o-q vs. 0.9% expected, taking the y-o-y rate up to 6.0% vs. 5.5% consensus. Yes, it’s a small place, and one might joke the overshoot was because a visiting coach party spent more in the gift shop than expected. However, that kind of data print will clearly keep the RBNZ hiking ahead.
Aussie jobs data were up 64K vs. 19K expected with a surge in the participation rate, which means the RBA are running out of excuses to keep pretending that they are a special case who doesn’t have to raise rates as much as the others. The pain of mortgage resets from low fixed-rate deals is only just beginning: so is the RBA’s dilemma.
The BOE meet today to hike again despite the somewhat lower (though still ridiculously high) CPI print yesterday: the market expectation --and our own (see ‘A Tumultuous Year’)-- is a 50bp move to take rates up to 3.50%. That is as austerity is embraced, and the half of the economy not disabled by a sprinkling of snow being out on strike in protest. Are higher rates a plot against the UK, given how fractious its politics are, and how unhappy Scotland already is even despite England losing to France?
The ECB meet too, and are seen hiking 50bp to 2.50%, although we would not fully discount the possibility of a surprise 75bp, which would take us closer to our expectation of a 3% terminal rate in 2023: we could also see quantitative tightening run at a monthly pace of €25-30bn, and have pencilled in a Q2 start date. As our ECB preview notes, despite a first easing of headline inflation, Eurozone core inflation is still high. New ECB staff projections will include a 2025 forecast, but given recent forecast errors the ECB should err on the side of caution as long as upside inflation risks remain. Notably, a slower rate path does not mean a lower terminal rate - but conveying this message will be a key challenge for Lagarde, as it is proving for Powell. The message also needs to be transmitted that a 3% rate is not a plot against the Eurozone periphery.
I end as I began, but noting how quickly things escalate into situations we previously thought unthinkable. France being in the World Cup final again really was very much as expected though
