The consensus view on the direction of US interest rates is that new Federal Reserve chairman Kevin Warsh is going to hike at the next meeting of the Federal Open Market Committee on 29 July.
The rhetoric is that inflation has been on the rise and is ‘higher for longer’ while, at his first press conference, Warsh struck a hawkish tone that took many by surprise as he was expected to be ‘Trump’s dove’. Pursuant to this, the market has two hikes priced in – yet that seems unlikely to be the way things will play out.
So why do we say inflation has peaked? Our own macro process is based upon the rates of change of growth and inflation. Regarding inflation, the most important input to the model is the oil price – and that has fallen some 40% from its recent peak.
This will drag down Consumer Prices Index inflation significantly when it is next reported on 14 July. Additionally, we use Hedgeye Risk Management’s algorithm to track these rates of change, and their models have been incredibly accurate in measuring and mapping inflation up from the lows and now as they peak. Still, what other signs can we look to?
“Bond yields are usually a good inflation ‘tell’ and both the 30-year and the 10-year yields peaked in mid-May and are someway off their highs.
The equity market has begun to respond to this new paradigm of falling inflation and sectors that benefit explicitly from this factor have started to stir from their longstanding slumber.”
Bond yields are usually a good ‘tell’ and both the 30-year and the 10-year yields peaked in mid-May and are someway off their highs. What about the dollar? Well, that has been strengthening – another hawkish signal.
Joining the falling oil price is practically the whole of the rest of the commodity complex – with both ‘softs’ and metals in downtrends. Even gold is now 30% off its peak in January and Bitcoin has been in crash mode for some time now.
Dovish surprise
The equity market has begun to respond to this new paradigm of falling inflation and sectors that benefit explicitly from this factor have started to stir from their longstanding slumber. Housing-related equities have started to move and signs of life are beginning to be evident in the ‘bond proxy’ sectors, such as staples, Reits and utilities.
The set-up is for a dovish surprise. The prevailing narrative may say two rate hikes – the market, however, suggests cuts are much more likely.
And what of Warsh himself? He may have leaned hawkish last month but, as we are due to receive the next CPI reading before the next Fed meeting, he will have plenty of room to pivot dovish and present the president with a falling inflation story paired with a rate cutting environment that will be welcomed as the mid-term elections come into view in November.
Felix Wintle is the manager of the VT Tyndall North American Fund
