- Wall Street entered bear market territory overnight
- Initial confidence in Europe quickly dissipates
- Recession fears growing
Last year I warned that the inflation narrative was inevitably going to shift from transitory to supply side problems to demand/wage spiral. We are now approaching the climax with wages. UK wages rose 6.8 per cent in April. Ok, this was down from the last month, and it wasn’t as high as expected. But tell me this – how do central banks get inflation down to 2 per cent if wages grow at 6 per cent without a commensurate increase in productivity? And, if you don’t think this is recessionary – regular pay excluding bonuses fell 2.2 per cent when adjusted for inflation, the steepest decline since 2011. Meanwhile, job vacancies surged to a record high 1.3m... tight labour market and inflation + recession. Yuk. Let’s just move quicker to get it all over with so we can start to be optimistic again. Despite talking about the narrow path to tread to battle inflation without stoking a downturn, the BoE only has one course. After hinting at slowing down the pace of hikes last month, the BoE will be forced to go a lot further with hikes, and do it quicker.
Also this morning German inflation surged to 7.9 per cent year-on-year in May, up from 7.4 per cent in April. Month-on-month was up 0.9 per cent! It’s not peaked yet. Wages will be the last to tame which will require central banks to not simply tighten but engineer a recession – they are trying to do this as softly as possible, but it is about as difficult a job as you can imagine. Not that it’s anyone’s fault but theirs. Central banks sat for too long – they didn’t suck the money back out as quick as they had injected… they now need to hike into a meltdown.
Stock markets in Europe attempted to rally early on Tuesday after what looked like near capitulation in the market yesterday. The major bourses opened about 1 per cent higher as buy-the-dip mentality persists, but this was strength was later sold into as the indices came off their opening highs. Yesterday the S&P 500 closed in a bear market – that is down 20 per cent from its high. Usually these last about 2 years and we could see another 20 per cent decline if it’s ‘average’. Asian markets fell sharply overnight.
How washed out are we? Vix higher but not exactly showing extreme stress... suggests market participants are resigned to the bear trend and are not paying up for protection because they are not in and don’t plan to be. Or it’s just there is still too much complacency – buy-the-dip merchants still active. Either way the bottom isn’t in yet. Also look to massive Vix options expiry Wednesday and yuge ($3.2tn) OpEx on Friday to unleash more volatility.
Why is the bottom not in? First of all, the Fed is not riding to the rescue. It will not be bothered too much by the stock market. The macro outlook is like nothing we have seen since at least the 1970s, perhaps the period that most resembles the current setup. Inflation is so bad – and probably worse than the official estimates indicate – that a recession is coming. And until inflation is in check the Fed cannot move to help. And then earnings are about to get crushed.
I forgot yesterday to mention the University of Michigan inflation expectations. Whilst consumer sentiment plunged to a record low because of inflation, I omitted to mention what those expectations look like: 5yr inflation expectations shot up to 3.3 per cent from 3.0 per cent a month before, whilst the 1yr rose back to the cycle high 5.4 per cent. There is much for the Fed to do. Markets now price in Fed to go as high as 3.9 per cent by in June next year, pricing in an additional 100 bps in just over two weeks.
Huge move for bond markets as the front end was aggressively sold as markets repriced Fed rate hike expectations. The 2yr spiked 30bps in a single session and briefly rose above the 10yr, the first such inversion since April. The US 10yr rose 24bps to 3.39 per cent, the biggest move since March 2020. Italy’s 10yr rose above 4 per cent for the first time since 2014 – remember it’s the spread with the German bund that matters for the ECB due to what people call ‘fragmentation risk’. And on that front, although the spread has widened a lot this year, it’s still only back to where it was in March 2020. This morning the bond sellers are just easing up a touch with yields coming back a bit, but the pressure remains.
The Fed kicks off its two-day policy meeting today. Odds of 75bps rose to 95 per cent from 9 per cent pre-CPI. Lots of banks are updating forecasts towards 75bps, some even talk about 100bps. A WSJ report by ‘well-informed’ Nick Timiraos suggests the Fed will go with 75bps... lots of chatter that he’s floating a trial balloon on behalf of the Fed since it’s the blackout period before the meeting during which officials cannot discuss monetary policy. For what it’s worth I don’t think the Fed goes all in at 75bps yet. Under Powell the Fed has guided again and again very carefully not to expect a surprise. I think the more likely outcome is that the Fed sees more chance of 3 more 50bps hikes this year, by teeing up 50bps in September to add to the expected hikes in June and July. I don’t think it matters too much how quickly they get there are such. 75bps smacks of panic.
Interesting the latest fund manager survey from BofA says 50bps in June might be risk-off as it would leave the Fed behind the curve, whilst 100bps would be more risk-on by being ahead of the curve. I’m not fully convinced of this idea – I don’t think either option is good (risk on).
Also from the FMS, subtitled ‘Summer of Volcker’: “The US stock market officially enters a bear market as the June BofA Fund Manager Survey (FMS) signals deeper investor misery; BofA Bull & Bear Indicator is down to 0.2; Wall St sentiment is dire but no big low in stocks before big high in yields & inflation, and the latter requires uber-hawkish Fed hikes in June & July. On Macro: all time low in global growth optimism (net -73 per cent), stagflation fear highest since June ’08, profit outlook worse since Sept ’08.”
In FX land, the dollar has not run fully rampant yet. Having sunk to a new YTD low, sterling has tried to put in a bottom just above 1.21 which is holding for now, whilst the euro is holding onto the 1.04 handle for the time being. Yen weaker again as slips back to 134 and a peak again at the 135 handle.
Bitcoin hanging is on by a thread, hit $20,826 overnight and is down by a third from its week-ago high. The collapse in crypto is made worse by some very suspect plumbing but chiefly it’s all related to the same thing: inflation, rising bond yields, the Fed and an abrupt decline in liquidity. At $21k we’re at the level where MicroStrategy (MSTR) faces a possible margin call on Bitcoin investments. The stock fell 25 per cent yesterday amid the crypto carnage. Coinbase (COIN) fell 11 per cent.
And finally, this absolute legend was still buying 2,800 shares of Tesla yesterday… still burning the inflows for 75bps. Thanks very much.
Neil Wilson is the Chief Market Analyst at markets.com
