Fed: "The Need for Speed"

Good morning, everyone. CPI crushes it. The ECB speaks about market fragmentation as peripheral spreads get leveled. Long time coming.

10-year BTPS (Italy)

Let's Take a Look

The Eurozone is dealing with 8-10% inflation. Italian short end yields are up by another 25-basis points. The Euro lower again despite the signal from the ECB about higher rates ahead. The European economy is in for a very tough road ahead. These rate market moves are extreme and dislocated. And the only way the get inflation down is through recession. Keep in mind, unlike the Fed, the ECB has a single mandate: inflation with a 2% target. No way, no how. But like we've seen in the US with the Fed, markets are doing the work for central banks. The mere sign from former ECB Mario Draghi that "we'll do whatever it takes" with liquidity has turned hard left the other way. Years and years of excessive buying. Negative yielding assets down from $17 trillion to practically nothing in the blink of an eye over inflation.

Negative Yielding Asset Pool: Chart Says it All. Risk Assets are on the other side of this chart.

This is all about financial conditions. This notion of neutral from the Fed is a farce. Expeditiously to a rate level which is obscure even by the Fed's own words. The Fed is not moving expeditiously. What's moved expeditiously are financial conditions.?Quicker and faster than anything we've seen in the past and reflective of the damage of "inflation colliding with excessive liquidity globally" for decades.?

The mark to market move in public markets has been extreme. And it's the private markets where the true risk likely lies. Suddenly, JPM chief Jamie Dimon went expeditiously from a rosy outlook to warning of economic hurricanes. And the likes of Elon Musk turning very cautious and warning of layoffs and more. I'm listening closely. And we've warned of the economic and market fallout from this extreme central bank global pivot. The Bank of Japan standing very lonely right now. And looking more so by the day.?

The Fed needs to deliver now, and they will. In their Summary of Economic Projections next week they will lift rates for this year and next. And signal moving beyond their definition of neutral (2.25-2.50%) into 2023 with the Fed Funds rate moving above 3%. Pricing terminal back closer to 3.50% which makes sense. And today's number matters more so beyond the next two meetings. The new inflection point of September and beyond.

My sense: Jay Powell would like to move off 50-basis point moves after the next few meetings. Bullard and Waller not so much. Bullard wants to hit it very hard for 2022 with the notion of recalibrating in 2023 if needed. He is likely right in our view. He's been right. But Chair Powell is still living with the memories of 2018, market dislocation, and financial conditions moving too much. Chair Powell is likely right too. But he gave away his ability for too much flexibility. If the economy slows, along with slowing but elevated inflation, he will have his window to shift gears a bit lower. But that is not the moment at hand. We are running inflation at 10% on a short term basis.

The risk of extreme market dislocations spilling over into the real economy in unintended ways is very likely. Globally. But markets have led. And will continue to do so. That's what the Fed wants. It's what the ECB wants too. Tighten financial conditions. But to what extent? A recession is the way out.

On the ground:

We've written about the market's quest for the 2018 yield highs. As we write, 2-year UST approaching 3%.

Global short end rates continue to reprice. We have favored re-flattening with the risk of another inversion in UST 2/10. The 5/10 UST curve already there. Energy prices remain extremely elevated. Jay Powell has indicated inflation would be down by mid-2022. And it's not. There should be nothing but an open mind right now. Even indicating a pause is absurd. Vice Chair Brainard squashed it and Chair Powell will too. And if inflation remains elevated into the summer months, the Fed will do more not less looking forward. And we expect to hear that next week too. It means higher rates across the curve with a flattening bias if it plays out this way. JP: "Inflation remains the top priority and the economy can handle higher rates". Inflation over growth despite the shift in May toward growth concerns.

Practically, we are priced for "next week". Clearly, it's all about the presser and the potential for a more hawkish DOT plot on the terminal rate. In terms of risk assets, we've been defensive and remain so. Much of the move stocks has been around the discounting impact of higher rates. In credit: increased volatility. We haven't priced in the impact of a real economic downturn. And the macro-outlook in our view is still not constructive, remains highly and with unknown, unknown. Risk appetite needs to come back for a meaningful shift. And right now, the needle remains pointed the other way as we watch 2020 and 2021 continue to come home to roost.

?Have a great weekend!