Trader thoughts - why wait, get rates up hard and now
After the US May CPI print came in at 8.6%, marrying with a record low in the Uni of Michigan confidence print, the playbook has changed. The market is now seemingly actively wanting rate hikes – in a complete change from the script we’ve seen since 2008, the calls for the Fed to hike the fed funds rate (now at 100bp or 1%) above 2.5% into restrictive territory are growing louder and louder – why wait they cry, get the fed funds rate above 2.5% as quickly as you can and show everyone you mean business on inflation.
If we’re going there anyhow, the sooner we can get from A to B, the greater the chance we can get to the circuit breaker – that being, a series of lower inflation prints.
It seems odd that the Fed hiking by 75bp or more this week could get the markets to rally, but that is where we are. They should absolutely go 75bp, and there are even calls for 100bp, but the strong probability is they hike by 50bp, and offer a hawkish outlook that opens the door to a 75bp hike in the meetings ahead.
Again, why wait? Well, they are so scared of losing the credibility they’ve created around its key policy tool - that being forward guidance – the communication tool they used effectively to guide the markets to a 50bp hike at this week’s FOMC meeting. So, despite new information (the May CPI print) suggesting the facts have indeed changed, and the need to hike has radically increased, they will worry too much that the market will no longer follow their guidance as intently and they’ll lose control of its key policy tool here.
Anyhow, it’s dark in the markets.
Talk of poor liquidity in the underlying is compounding the issues, but there are many little side battles - we’ve a market taking on the BoJ, with the BoJ being forced to respond by buying over JPY1t, as bond sellers push bond yield to the upper limit of the BoJ’s yield curve control program - USDJPY tested 135.19 a new 20-year.
We’re seeing the market taking on the Italian sovereign debt markets – this is the elephant in the room. With Italian 10yr BTP’s trading at 3.86%, we see this blowing out to 232bp vs German bunds – not great for a country with 160% debt-to-GDP.
We see the US 2’s vs 10s Treasury yield curve going inverted today, with 2-yr Treasuries being punished and now trading +16bp at 3.21%. Credit spreads are blowing out, crypto is getting destroyed and equities are taking full notice, and they just can’t find a friend.
The market’s price in a rising recession probability by the day, not just in the US but many other G10 economies - but the most prominent factor is the circuit breaker isn’t there – why buy risk when global growth is slowing, and central banks have no grip on the situation? Traders have a need to price risk but there is such limited visibility it makes this consideration very challenging, so they pull their bids, and this is a short seller's paradise. Sentiment is so bearish and while this has been the signal for contrarian traders it feels like we are in the eye of the storm.
These are the times when it is advantageous to be in front of the screen - swing traders become day traders – going with the flow of capital is as prudent as it comes and momentum strategies shine – mean reversion can obviously work but that timeframe needs to come in.
Return of equity over return on equity for the investment crowd. For traders, it's about reading the room, following the flow, and nailing both the risk and position sizing. To some, these conditions are where real alpha is made, to others, it's about survivorship. These are tough times and a market that is asking a lot of questions and getting few answers is a market that needs respect.
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