All Things in Moderation

Vital Statistics:

Stocks are flattish this morning on no real news. Bonds and MBS are up small.

Yesterday’s inflation numbers caused the Fed Funds futures to recalculate their assessments for what the Fed will do this year. The March futures were predicting a 90%+ chance of a 50 basis point hike at the March meeting. The December futures are now predicting the Fed Funds rate will be at 1.75% by the end of the year. That is a lot of tightening, along with the tapering.

I would note that the current Fed funds futures prediction is WAY out of step with the dot plot from the December FOMC meeting. Here is the dot plot:

The Fed voters see the end of year Fed Funds rate at 75 basis points, while the market sees them at 175 basis points. That is a big delta between the market and the Fed. There has been the perception that the Fed is behind the curve, and I think that reflects this. Regardless, if the increase in inflation is mainly due to supply chain issues that work their way out over the summer, then I have to imagine the markets are too aggressive.

Ordinarily, an aggressive pace of tightening risks a recession in the following year. Watch the 10 year bond yield: if the Fed Funds rate begins to equal the 10 year bond yield, or even increase above it, that is a recessionary sign.

That said, this isn’t just a US phenomenon. Global sovereign yields have also increased over the past month or so. The Japanese Government Bond is yielding 23 basis points, the highest since 2016. The German Bund yields 25 basis points, the highest since 2019. Big picture, the world has been supporting weak economies by issuing lots and lots of debt, and we are probably now going to go into a deleveraging. And deleveragings are never fun.

Consumer sentiment crashed in February, according to the University of Michigan’s Consumer Sentiment Survey.

Sentiment continued its downward descent, reaching its worst level in a decade, falling a stunning 8.2% from last month and 19.7% from last February. The recent declines have been driven by weakening personal financial prospects, largely due to rising inflation, less confidence in the government’s economic policies, and the least favorable long term economic outlook in a decade. Importantly, the entire February decline was among households with incomes of $100,000 or more; their Sentiment Index fell by 16.1% from last month, and 27.5% from last year. The impact of higher inflation on personal finances was spontaneously cited by one-third of all consumers, with nearly half of all consumers expecting declines in their inflation adjusted incomes during the year ahead. In addition, fewer households cited rising net household wealth since the pandemic low in May 2020, largely due to the falling likelihood of stock price increases in 2022.

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