Foreword
This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.
Yesterday, CPI reported consumer inflation at the highest level in about 40 years — since 1981. Instead of the expected flattish reading of 8.3%, inflation was reported at 8.6%, a level that must certainly be ringing some alarm bells at the Fed.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Expectations
Prior to the release of CPI numbers, economists were predicting that inflation was turning, that May’s CPI print would confirm a slowdown, which could signal the start of disinflation.
Listening and reading to various financial analysts over the past month or so, almost everyone has been positioning for a gradual end to inflation. The thinking is that the Fed will eventually raise rates to around 2-2.5% (from 1% now) sometime near the end of the year or early 2023, realize that they’ve overdone it, and start the next round of QE + rate cuts.
To that end, a lot of fund managers initiated positions in TLT (long duration Treasuries ETF), thinking that with the Fed tapering the rate hikes, TLT will bottom out soon.
Instead, we had a scorcher of a print, at a level way higher than anything seen so far in this inflation cycle.
Fed
I had previously expected the Fed to start the rate hike cycle much earlier, obviously that was wrong. The thinking was that the Fed needed to shock the market into reducing liquidity conditions, so as to reduce the velocity of money and thus inflation. The sooner they did so, the less they’d need to do in actual hikes, as market expectations will do most of the work for them.
However, the Fed has, thus far, taken relatively mild steps with regards to hikes, often telegraphing their intentions well ahead of time, effectively losing the shock and awe factor which I feel is needed for the Fed to regain the narrative over inflation.
Prior to the CPI print, the Fed hinted strongly at another 50bps hike this coming FOMC meeting (next week, June 14th and 15th). With the print, the media is speculating that the Fed may have to do 75bps.
Which is to say, a hike of 50bps next week could potentially be seen as dovish, and a 75bps hike may be seen as “expected”.
If the Fed wants to shock the market, then the next alternative is a 1% hike.
For those speculating on the markets, what do you think the Fed will do? Do you feel lucky, punk?
Janky Thoughts 