Jerome and the three bears

Powell testimony soothes markets

Federal Reserve Chairman Jerome Powell, testifying at his confirmation hearing on the Hill, soothed markets overnight in a performance worthy of Goldilocks and the Three Bears. Mr Powell noted that the Fed could hike rates to rein in inflation, intended to start the balance sheet run-off sooner rather than later, but also said inflationary pressures would peak mid-year. What he didn’t say was also important. He didn’t back four rate hikes in 2022, nor a March start to hikes, nor did he give any details on when the Fed balance sheet run-off would start.

It was a masterful performance really, leaving the bowls neither too full nor too shallow; but just right from the financial market’s perspective. Ignoring recent comments from hawkish FOMC members while reinforcing that the Fed has likely accomplished its employment objective and was well aware of the inflation one. Certainly, if Mr Powell believes inflation will peak in H2 2022, there seems no need for a panicked start to hikes in March, let alone four of them. If anything, that the Fed has shown over the past two years, it is an abundance of caution and patience.

That was enough to unleash the buy-the-dip gnomes, who had been straining at the leash these past few sessions. Equities rallied, oil rallied, US yields fell, the US dollar fell, and even gold rallied. As Goldilocks as it gets. Even if the Fed hikes to 1.0%-1.25% this year, real US yields will still be very negative. Hardly corporate finance Armageddon. The music can still play in equity markets in 2022, it’s just that we’ve likely seen the best of the technology gains, and markets will see a lot more two-way price action to keep them honest. Nor am I ruling out a 10-15% drop in US markets and other Caligula’s of Valuations, they would still be comfortably in a longer-term bullish uptrend.

Today has seen a few data releases from Asian heavyweights China, South Korea, and Japan. All of which sounded cautious notes for varying reasons. China’s YoY Inflation Dec came in at 1.50% vs 1.80% exp. South Korean Unemployment crept higher unexpectedly to 3.80%. In both circumstances, the blame can be laid on omicron restrictions crimping domestic economic activity. Cases are quietly climbing in mainland China and Hong Kong, along with widening restrictions, and with Covid-zero policies in place, omicron presents a serious growth risk to China if it fully jumps the fence.

Conversely, Japan’s Reuter’s Tankan Index fell to 17.0 for January from 22.0 in December as Japanese businesses grappled with rising prices. That’s correct, your eyes are not deceiving you. Japanese businesses are grappling with rising prices and may have to raise prices. That will be a 30-year shock to the system but don’t expect any action from the Bank of Japan. The pandemic may have finally done the job that the Ministry of Finance and bank of Japan spent decades failing at.

India releases inflation later this evening and there are definite upside risks to the expected 5.80% print. Throw in rising omicron cases into a low vaccination population, and new social restrictions in cities such as New Delhi, and the ingredients are there for a stagflationary surprise. A high inflation print tonight will do the INR and Sensex no favours tomorrow.

We also get German Wholesales Prices and Eurozone Industrial Production this afternoon, but the main event will be the US Headline and Core Inflation YoY for December, expected at 7.0% and 5.40% respectively. Although Mr Powell managed to goldilocks the market overnight, keeping his three bears at bay, if US inflation tops 7.0% this evening, all his good work could be undone.

Source: https://www.marketpulse.com/20220112/jerome-three-bears/