Keeping At It

Broad macro views. Not investment advice. Views are my own.

There’s plenty of debate about how strong the US NFP number really was given seasonal factors ect. Although either way US unemployment has still fallen to 3.4%. The labor market is extremely tight. Forward looking indicators for growth are also bouncing. ISM Services bounced to 55.2. This bounce in activity will reassert inflation pressures as shown in the ISM Prices Paid index coming in at 67.8.

This is exactly what the Fed has been trying to avoid, the same mistakes made by predecessor Paul Volcker. Paul Volcker wrote a book called “Keeping At It” where he outlined the importance of keeping policy tight to bring inflation persistently down. Powell has referenced Volcker many times during his own battle against inflation but recent easing in US Financial Conditions show that he is not Keeping At It enough. Inflation in the 1970’s showed itself to be like a fire. When its oxygen is constrained it dies down but as soon as you allow the air to flow again it can reignite abruptly. I feel the recent easing is US financial conditions is at risk of reigniting the fire of inflation. It has already reignited Animal Spirits in markets with meme-stocks and Crypto back in vogue and the strength in the data shows that is also impacting the real economy. So far this year the market seems to have assumed that because inflation has peaked it will move down linearly. I feel this assumption is a big mistake as inflation is a lot more complicated than that and will take more persistent tight monetary policy to be extinguished completely.

Markets have lifted the pricing for the terminal rate in the US to 5.05% which brings it more in line with FOMC projections. Although there are still cuts priced into the end of the year with the Dec Fed Funds Futures trading at 4.7%. I still feel there is room for this to lift to 5%. It will be interesting to hear from Powell tomorrow (he speaks to David Rubenstein in an interview at 5pm LDN time) to see how he feels about the market reaction to the FOMC and what he thinks about the stronger data.

This data surprise comes at a time when the market had been expecting US data to turn weaker and the Fed to pivot to dovish in response. The market is still long risk assets and short USD. The “soft landing” trade has been the main view of the market to start off 2023. The stronger US data has therefore caused some pain for that trade and I feel that there is more to come so I like to remain long USD against growth currencies. I also like long USDJPY. The market has assumed that the rate divergence gap between the Fed and the BOJ is set to close this year as the BOJ turns hawkish whilst the Fed reaches the end of its hiking cycle. Although it now seems like the Fed may have further to go and BOJ policy may be stuck on hold even with a change of governor. There was a Nikkei report out over the weekend that suggested Amamiya could be the next BOJ governor. He is the most aligned with Kuroda so it could suggest a continuity of BOJ policy. The official BOJ nominations will be announced next week. I feel the market is hasty to assume the next BOJ governor will tighten policy. The BOJ projections for inflation remain below target in 2024 so there is not an imminent pressure to adjust policy. I expect USDJPY to trend higher with US yields. I remain long AUDUSD downside.