Inflation figures later today might be the biggest ever in living memory.
Abraham George Macro Musings
We have started the week with a lot of news and noise. There is the ongoing Russia-Ukraine issue, China lockdowns, the Elon Musk/Twitter saga and the Q1 bank earnings. But nothing is bigger than today’s (upcoming) inflation data release.
The fear of the data release is already being reflected in the markets. Stocks are down, interest rates are sharply up, dollar and gold are up. The official line is that it should come around 8.4% but now even the White House admits that the figure could be in double digits (it very well could be). It is the first inflation reading that will include the spike in oil prices from $90 to $130 a barrel. It could be the first double-digit inflation since 1981.
What is important is how the Fed handles this. With oil now back in the 90s, will they call it transitory especially with the government having released oil from the strategic petroleum reserves? Or will they err on the side of being too hawkish? This is a very tough period for the Fed to make the right decision.
Jim Bullard, St Louis Fed President and the Fed Vice Chair Person Lael Brainard have been very vocal about controlling inflation and rising rates. You couldn’t have got a more dovish person than Brainard on the Fed but she has changed her position. But listen to what Bill Dudley, the former President of Fed NY had to say, “Financial conditions need to tighten. If this doesn’t happen on its own (which seems unlikely), the Fed will have to shock markets to achieve the desired response. This would mean hiking the fed funds rate considerably higher than currently anticipated. One way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower”.
I can guarantee one thing - as a sitting Fed President, he would have never said that. As a retired president, he can say anything. As I write this, I remember sitting for a luncheon with him in Abu Dhabi when he was an Economist at Goldman Sachs in 1989.
The Fed has given the impression that they could hike eight or even nine times. But let me tell you as a person who has watched these markets for decades, it is not going to happen! If they do, they will crash the equity markets and that’s not something that they want to do on their own. At the May 15th FOMC meeting, we should expect a 50 basis point hike. If they don’t hike by 50 bps, that should be a surprise indeed.
One of the best indicators to look at in terms of what the Fed's actions could be is to look at the trend in PMI (Purchasing Managers’ Index). The PMI is falling now. In the last 50 years or so, the only time the Fed raised rates during a falling PMI was during the tenure of Paul Volcker. But Volcker was on a special mission and he fullfilled it by plunging the country into a recession. I do not think Powell is going to do anything like Volcker. There are many moving parts within the economy that will stop him from following Volcker’s style. It will be very interesting to see what will be the inflation rate in June and how the Fed could start changing its narrative.
Currently, the volatility index is at a critical trend support level and there is a chance we could bounce off this level meaning stock markets could fall further. However, I believe the support in the S&P 500 around 4300 should continue to hold.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund. Currently, he is a co-founder of a new hedge fund where foreign citizens can invest in Indian growth stocks like Tanla operating in hyper-growth markets like CPaaS.