US stocks are up as the market parred back some of those more aggressive 100 bp rate hikes after St. Louis Fed President James Bullard told Nikkei that he favours a 75bp hike in July that would bring the fed funds rate to neutral. Bullard is a voter, and one of the more hawkish members on the committee, so unbelievably, hints of a  75 bp hike are welcome news to a market that thought they could run headlong into a jumbo 100 bp hike.

The OIS market is pricing 80bp of hikes for the July meeting and 69bp for September.

Under the current theme, good growth data will likely strengthen the case for “faster Fed hikes, sooner Fed cuts.” If growth data turns worse, recession worries will be fueled, which is unsuitable for backend yields. The moment of peak backend yields is approaching if oil stays lower, which is likely the case when looking at gasoline inventories. (see below)

While a 75bp hike in the July FOMC is the base case, upside surprises in today’s UMich inflation expectation and US retail sales should strengthen the pricing for 100bp.

Crude oil is still trading below $100, but more importantly, when looking at inflation ahead, it is down 12% so far in July. The US 5y5y inflation forward, at 2.45%, is lower now than heading into Wednesday’s CPI print, let alone after it. For all the fear from the June CPI data and the market looking at a 100bp hike, the inflationary signals at a macro level are pointing lower. It seems like this week will come down to the Michigan sentiment survey.

With a weak currency, sky-high inflation, recession risk due to the energy crisis and political turmoil in Italy – the ECB is facing an impossible mission to solve all its problems simultaneously with monetary policy. Front-loading a 50bp hike and revealing a solid anti-fragmentation tool seems the optimal solution for the central bank next week, but that is likely not enough to support a sustainable EUR rebound, as the BOC jumbo hike and the Loonie’s post-hike slide is an excellent example of central bank policy impulses decoupling as a driver for currency strength.

Oil is trading under $100 but recovering after the demand destruction sell-off. According to AAA data, US gasoline prices also soared to record highs in June, to > $5/gallon on average. High prices started to bite US gasoline demand, with its supply falling to 8.62Mb/d in the week to 8 July, the lowest levels for early July since 1997 (down 6% vs 2020)

 

Originally published by Stephen Inness, Managing Partner, SPI ASSET MANAGEMENT