Just a day after Federal Reserve policymakers delivered their biggest rate hike in 28 years, the US inflation outlook remains bleak in an obscure part of the financial market.
Traders of so-called fixings, or derivative-like instruments linked to government inflation-linked bonds, expect four consecutive months of annual headline CPIs of around 9% or higher from June through September. That would be the longest streak of such hikes since 1981 — the same year that the Fed, led by Paul Volcker, was forced to raise interest rates as high as 20%, according to FactSet data. The outlook for a CPI rate of around 9% in September has been in place since May’s CPI report was released on June 10, a trader said.
Fixing traders have proven over the past year that they have a better handle on projected inflation than most professional forecasters and even the Fed itself. That’s because they can adjust their expectations frequently and on a daily basis – unlike economists who can adjust theirs Publish forecasts less quickly. On June 15, policymakers released forecasts showing that they believe inflation will move from its preferred level to more normal levels of below 3% from next year.
“Fixing traders are saying that not only is inflation not going down, it’s probably accelerating,” said Gang Hu, a 20-year veteran of TIPS trading with New York hedge fund WinShore Capital Partners.
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The main reason for the expected surge in inflation is Russia’s war in Ukraine, which will push up food and energy costs, he said. But even core inflation, which excludes food and energy, is likely to come in at 0.5% or 0.6%m/m over the next three months, which is in line with the April and May core readings.
The 75 basis point rate hike on June 15 and the policy update by the FOMC, or rate-setting Federal Open Market Committee, “made no difference” for fixing traders, said Hu, who also trades CPI fixings. “Whatever the Fed does, it is very unlikely that they will change the CPI in the next few months as the Fed’s actions will have a lag of 6 to 12 months. Whatever the Fed does, it’s not going to massively change market thinking in two to three months.”
The signals emanating from the fixing market are worrying for a number of reasons. One is that trades in the fixing market are not readily available to anyone on the outside, which is likely to leave many investors and traders surprised at where inflation might be headed. Another reason is that while policymakers prefer core metrics as a more accurate measure, it’s the headline CPI number that drives expectations.
In his press conference after the June 15 meeting, Federal Reserve Chair Jerome Powell stressed the latter point, saying headlines are “what people are experiencing” and “expectations are very vulnerable because of high headline inflation.” .
Market implied levels for the September CPI fixing, if anything, “are marginally lower since the Fed meeting, but they’ve been up there for quite some time,” said Chris McReynolds, head of US inflation trading at Barclays.
“Monetary policy is certainly lagging and the market is saying monetary policy will not ease the oil shortage for the next two months and it will not help food prices or get wheat out of Ukraine for the next few months,” McReynolds said on March 16. June by phone. “For the next several months, the fixing market is realizing that the key sticking points of inflation are something that rate hikes won’t really address.”
A stock rally following FOMC easing on June 15 gave way to a broad sell-off on recession fears the next day. On June 16, US stocks closed broadly lower, with the Dow Industrial falling 741 points, or 2.4%, to below 30,000. The S&P 500 fell more than 3% while the Nasdaq Composite lost 4%. Meanwhile, investors flocked to government bonds, pushing yields lower through 30-year Treasuries. Oil futures climbed.
On June 16, data compiled by Bloomberg indicated that fixing traders expect June and July annual headline CPI rates to come in at 8.97% and 8.95%, respectively – up from 8.6% levels in May. From there, CPI is expected to hit 9.15% yoy in August and 9.08% in September, before gradually declining to 4.7% in May next year.
“I can’t dispute what they’re saying,” said John Farawell, executive vice president and head of municipal bond trading at Roosevelt & Cross in New York. “At the moment everything points to a recession. It seems like stagflation is already here.
“Our financial market is very resilient because the amount of cash that’s circulating is tremendous and we’re still getting money into the US from outside, but we’ll have to see how that plays out,” Farawell said over the phone. “The war in Ukraine does not appear to be ending and will continue to pressure inflation.”
This article was published by MarketWatch, part of Dow Jones