On the one hand, it sounds ludicrous to say the macro environment is improving, given the widespread assumption we are either in recession or about to be in one; rock-bottom consumer confidence; and the biggest stock-market wealth destruction we have possibly ever witnessed.
On the other hand, it would have been a far more provocative suggestion a week ago, before stocks rallied back by 5-6%. But either way, there are some encouraging signs out there that the Fed is actually helping to positively reset the macro landscape, now that it's finally serious about catching up with and conquering inflation.
Most striking is the drop in the market's inflation expectations. They peaked at around 3.6% expected annual inflation over the next five years back in late March--nearly a full point higher than where we were in January. They have since retraced all the way back to 2.8%, still above the Fed's 2% inflation target, but a sizeable improvement nonetheless.
Going out from five to ten years, things have also improved; the market is pricing in 2.3% annual inflation during that period--pretty close to target--down from almost 2.5% back in late April. This is the clearest sign so far that the Fed's increased hawkishness is working. And it's finally helped rein in bond yields, with the benchmark 10-year Treasury down from almost 3.5% before the Fed's super-sized 75-basis-point rate hike two weeks ago, to around 3.16% as of this morning.
There are signs of disinflation elsewhere, too; especially in commodities. The price of a barrel of WTI oil has fallen from over $120 pre-Fed meeting to about $108 today, and oil has started tracking with the "risk-on, risk-off" days in the stock market again, unlike earlier this year. There are still reasons to be bullish on energy (and extremely concerned about global energy shortages in the coming months), but the Fed has broken the back of the one-way trade for at least the time being.
And it's not just oil. Metals prices broadly are down about 20%, notes MKM's Michael Darda. "Commodity disinflation" has been mentioned in almost every market commentary I read over the weekend. Copper prices are now down 15% year-to-date. Plenty of people will point to this as a recessionary indicator, but it's exactly how you'd want the market to reset in order to take the heat out of the inflation trade.
So again, some encouraging signals that may help explain why stocks are suddenly starting to get their mojo back. But there are three significant challenges that remain. One, keeping energy prices from spiking and shortages from occurring (a combined geopolitical and global demand effort). Two, pressing ahead with the Fed's tightening until the same disinflation is apparent in the labor market, or else the effort thus far is moot. And three, not getting spooked or confused by "recession signals" that are actually "disinflation success stories."
Remember, consumer confidence already hit a record low. The best chance for improvement from here is for these hard-fought gains to keep price hikes at bay, giving some breathing room and signs of hope to households in the months ahead. That should help the final piece fall into place, which would be a significant moderation in consumers' inflation expectations to mirror the market reset that's already taken place.
So many people were quick to take the drop in Friday's consumer inflation expectations as a sign that the Fed should (a) not have done a 75-basis-point hike two weeks ago after a higher reading, or (b) immediately back off. That is to confuse cause and effect. Oil prices (and inflation expectations) have not fallen because the Russia-Ukraine situation has suddenly improved, but rather because the Fed is slowing demand. Stopping that slowing because it's showing very early, tentative signs of working seems illogical and wrong-headed.
Heck, even Bitcoin prices have stabilized lately. A massive, almost unprecedented reset (read: loss) in asset prices has just taken place. The riskiest time for investors--when the price of everything was at an all-time high--is already history.
See you at 1 p.m!
Kelly
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