Yesterday, when looking at the divergence between the slowing US economy and the Fed's insistence on hiking rates, Bank of America's David Woo asked if there is a different motive behind the Fed's tightening intentions, namely is the Fed trying to pop the market asset bubble:
"Can it be the case that its hawkishness was prompted by something other than its reading of the economy? For example, is it possible that the Fed has become concerned about the recent surge in the equity market, especially tech stocks that has been feeding off low interest rates and low volatility? According to our equity strategists, the P/E of the tech sector (19x) is currently at its highest levels post-crisis while the EV/Sales ratio is at the highest sinec the Tech Bubble"
Today, in a note which may have been inspired by BofA's rhetorical question, SocGen's FX strategist Kit Juckes picks up on what Woo said and notes that "Whether the Fed is raising rates too fast given their inflation mandate or not, they are raising them too slowly to contain asset price inflation." Which, incidentally is confirmed by the latest Goldman data on financial conditions, which since the Fed's 2nd rate hike of 2017 have continued to loosen and were "easier" by anotehr 5.4 bps
There's more. In his note titled "A real test for the party mood", Juckes highlights the divergence between 10Y TIPS and the dollar, and wonders if the yield on the inflation indicatior, which has broken away from the dollar in recent months, is about to push the greenback far higher. Or vice versa:
There's been a big de-correlation between the dollar and TIPS, which is also visible if I compare the dollar index to a weighted real yield spread. If the 50bp resistance level we are testing in real yields holds, I think the dollar's mini-bounce over the last day or two is likely to run out of steam. A break, on the other hand, would make me worry about the FX market playing catch-up and the dollar staging a more sizeable bounce.
In other words, which way this divergence snaps will have a broad impact on not only FX markets, but potentially the broader stock market, and thus on future Fed policy whose actions have been largely ignored by the market due to recent poor inflation prints.
Excerpts from his note below.
A real test for the party mood?
The yield on 10-year TIPS is threatening to break above 50bp, which would take it above the downtrend formed by the three descending peaks we have seen in real yields since the US presidential election. The real yield move may be more important for the dollar than what is happening in nominal yields. 10yr TIPS at 50bp are a combination of nominal yields in no man's land at 2.18%, and 10year breakeven inflation at 1.69%, back at pre-election levels.
Is SPX going to drag TIPS though 50bp?
As Larry Summers criticises the Fed for tightening too much, too soon in the absence of inflationary pressures, a debate is beginning to rage about how much slack there is in the economy. Bill Dudley came out on the opposite side of the debate from Mr Summers, expecting a tightening labour market to result in a rebound in inflation in due course. Meanwhile it has taken fewer than three trading days for the S&P500 to reach new highs. Whether the Fed is raising rates too fast given their inflation mandate or not, they are raising them too slowly to contain asset price inflation. And while the FX market was getting a bit nervous, with falls for the RUB, ZAR and the TRY yesterday, the emerging bond market community was getting excited about 100-year, dollar -denominated debt issued by Argentina.
It's in the context of general yield-hunting investor behaviour that I think the rise in real yields is important, at least in the short term. There's been a big de-correlation between the dollar and TIPS, which is also visible if I compare the dollar index to a weighted real yield spread. If the 50bp resistance level we are testing in real yields holds, I think the dollar's mini-bounce over the last day or two is likely to run out of steam. A break, on the other hand, would make me worry about the FX market playing catch-up and the dollar staging a more sizeable bounce.