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Issue 6: CPI Report & Fed Pivot Hopes

November 14, 2022

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CPI Report & Fed Pivot Hopes

Headline October CPI data was 7.7%, down from 8.2% in September.
The core CPI was 6.3%, less than economists’ forecasts. In the wake of the softer-than-expected inflation print, stocks had their biggest rally of the year, while Treasury yields fell and the dollar dropped. Although topline CPI appears promising, around 60% of the CPI basket is still running at 5%+ inflation. Moreover, while inflation in goods did slow, price pressure has spread to the services sector—where inflation tends to be sticker once it gets rolling—in part due to a tight labor market, which the Fed is closely monitoring.


At the FOMC meeting weeks ago, Jay Powell delivered a message for markets:
US rates will rise slower, but they’ll stay high longer. Traders have priced higher rates into futures (see below). Former US Treasury Secretary Lawrence Summers said the terminal rate could hit 6% or more. Stress from this rapid increase in rates is liable to ripple through the financial system, with the recent sell-off in gilts offering a glimpse of how strained liquidity can unexpectedly shock even decidedly safe assets.

Figure 1 Powell's Comments Push Futures

According to Fed estimates, as of mid-2022, household wealth had increased by nearly $25 trillion since 2019.
Businesses were also able to lock in lower borrowing costs when interest rates cratered in 2020 and 2021. Fueled by pandemic subsidy savings and a strong labor market, individuals and businesses are less sensitive to tighter credit conditions, which allows rates to grind higher with much less pain.


The expectation of a slower pace of Fed rate hikes has led to dollar weakness.
Despite the dollar predictably sliding as investors priced in more optimism with respect to inflation and rates, we expect dollar weakness to be short-lived in the absence of clearer evidence of a Fed pivot or an improved global growth outlook.

China Reopening?

Investors in China have been searching for clear signs China is moving away from its strict COVID controls.
Chinese stocks recently rallied on unverified rumors of a government plan to reopen. Beijing squashed those rumors, sending stocks back down. As of last week, nationwide new cases ran over 3,000 per day and accelerating, making it the biggest spike since May.


Don’t look for a dramatic ‘about-face’ on zero-COVID.
While we believe authorities are well aware that growth won’t bounce back under harsh COVID policies and will plot a path to reopening, the preferred strategy remains very gradually scaling back the current zero-COVID program, extinguishing local outbreaks and pushing for better drugs/vaccines, rather than a sudden U-turn and chaotic reopening.

Midterm Elections & Policies Outlook

The US midterm elections will likely lead to a divided government.
For the past two years, Democrats have controlled Congress and the White House, allowing them much more leverage in setting the policy agenda—notwithstanding troubles with the third branch in a conservative Supreme Court. The unfortunate upshot for Dems has been perceived accountability for the country’s economic woes, including inflation biting American households. In the short run, a divided government could lead to volatility (e.g., the increasingly business-as-usual ‘debt ceiling’ drama), but a longer-term concern is whether bipartisan policy will be possible in the face of some serious macro challenges, not least of which is the looming possibility of a painful recession.


Greater policy restraint likely to prevail.
The painful memory of high inflation—distant as that may be—and the economic hardship experienced by constituents of both parties will likely make policymakers more reserved in their handling of the next crisis, regardless of which party controls Congress or the White House. In the early-2020 COVID crisis, US leaders acted boldly, rolling out unprecedented QE and fiscal stimulus. This time around, we expect legislators and the President will grudgingly give the Fed sufficient latitude to crush inflation, even though it will come at the cost of a recession and painful bear market.