Macro micro trader

Russia Ukraine war – going on but markets won’t care less. European energy crisis – came and gone. UK pension crisis – fizzled away. The bad news ain’t worse news anymore!

All that bad news that seemed end of the world for markets, didn’t result in what the bears would have otherwise wanted it to be. Except one – inflation! It still continues to run hot in most part of the world economies barring Japan, where it’s badly needed. What does it tell us about the markets and the macroeconomic landscape we are in?

First – the major macro story that continues to remain and would continue to haunt the policymakers and the market participants alike is inflation. There is (or should I say was?) a reason why the Fed and all the other major central bankers are hawkish about the interest scenario and would treat any inflationary threat with high degree of caution. The real known unknown for the markets at current juncture.

Secondly – there is a huge amount of negativity and bearishness out there in the market. Anything that’s a bit off, is treated with outright bearish views by the analysts and the economist of the world. When such a scenario is developed and everyone wants to sell any bounce that occurs, we know it is likely we have reached a short term bottom in the market, something that we’ve seen in the last few days.

I have always believed that markets are far more efficient and discounting in nature than we actually assume it to be in the real time. September CPI was bad and worse than what analysts expected it to be. Markets reacted negatively in a knee-jerk reaction and what followed was a sharp bounce. Why? All of last week (except Friday), Fed speakers continued to sound hawkish, yet there was no new lows being made. Perplexing?

Markets have discounted quite a bit already. Market now knows that inflation is here to say. But economic growth perhaps ain’t coming off the cliff as yet. Recession from technical point of view is already here, but we aren’t seeing steep job losses that we are attuned to in such a macro scenario. The all feared stagflationary scenario is already here and yet markets won’t care much now. All this clearly means that from macro perspective the short term bottom is already here. But here is what I would be cautious about!

What happened on Friday, that WSJ article, that ‘appeared’ to be pointing towards hopeful pause/pivot is what has resulted in the sharp bounce. But is it really worth celebrating? What happens when Fed pivots/pauses? What happens with inflation? Macroeconomic scenario? Is it ok to pause when inflation is still higher than the Fed Fund la rate – a sign of Fed being behind the curve? Is it ok to pivot even as the long term inflation is far above the targeted 2%? And more importantly, is 2% inflation target worth it?

I have my doubts on the seeming pause from the Fed. When you are already behind the curve, when the core inflation is still staggering high at 6+%, can the Fed afford to pause? What if it does pause? I would consider it to be the biggest policy mistake. Bigger than the “inflation is transitory” mistake and I have my reasons.

First: Yes, housing prices have started to come off big time but the rentals are not coming off. If all, it is only rising and that’s not a good news!

Second: Gas prices, which is key to tame inflation, are although lower, it ain’t coming off to the levels we are used to seeing. OPEC+ has already waged its war against the US for not letting prices come off by announcing production cut of about a million barrels a day! You don’t need supply cuts in an economy that needs more of it. Top it up with the Fed pause and you have a recipe for future spike in inflation! Other commodities too would get fire in the belly when they know that the demand side of equation won’t be as bad as it was feared when the Fed pauses it rate hikes.

In a stagflationary scenario like this, all you need is a Fed going gung-ho behind the inflation to kill it and not take a pause to reflect and see “if it would come down on its own”. Yes, the real issue is supply side, but when the demand side of the equation is still putting price pressure, as you haven’t seen the kind of job losses, there is no logical reason to not stay the hiking course. If at all, you want the target Fed funds rate to be higher than inflation to be on top of the situation and not make another mistake of being swept off your feet when inflation goes beyond control yet again.

The known known inflation story is staring at us in the future and the last thing we need is a paused Fed!