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SUMMARY: ECB commentary has been hawkish and the ECB’s developing aggression is being discounted by markets – rate-hike expectations by year-end are up +100bps from the start of this year (and +30bps in the past week). There are plenty of Dollar tailwinds, but the recent USD increase has been extreme and a narrower short rate differential between the EU and US is a USD headwind.
Target reported a big miss in earnings this morning, citing margin pressure from input costs and an inventory glut. As an aside, avoiding earnings misses has become more important and neither TGT nor Walmart were on our list of low quality, low sentiment retailers. Our Pricing Power Portfolio has stalled recently as concerns over broad-based pricing power (inflation) have intensified. Pricing power should matter when inflation is moderating and picking the remaining companies that retain pricing power is important.
April retail sales data was very strong, including a large revision to March. Strong activity pushes recession risk out, which helped risk-on sentiment yesterday. Market internals have been consistent with a recessionary outcome lately, illustrating the focus on and concern over recession risk. But ultimately, hot data begets a tougher Fed (more on that below). Inflation expectations are stable – so hotter data and a more hawkish Fed leads to higher real yields. Longer-term, higher real yields support continued outperformance of Value over Growth.
Powell’s interview with the WSJ yesterday was stark. Powell expressed comfort over financial market turmoil. There is no Fed put to alleviate secondary effects on net household wealth from equity losses because the Fed is transparently more concerned with inflation.
Gerard noted Powell maintained his “incoherent” deflection about bringing inflation back to target without spurring a rise in unemployment. It is unlikely, to be generous, the Fed can tame inflation without weakening the labor market. And that comes with heightened recession risk. Ultimately, the markets will price reality more than the fib. Yesterday stayed risk-on despite Powell’s commentary while futures have reversed this morning; expect more narrative-driven volatility. To be clear, and as we said yesterday, we expect the Fed to accept closer to 3% inflation and let an eventual recession take inflation back to target, which helps relative recession odds. That should support a reversal of recent recessionary internal performance.
MARKET VIEWS: ECB officials were out overnight pushing rate hikes. And yesterday, the ECB’s Villeroy predicted an “active summer.” The ECB’s developing rate aggression is being discounted by markets – 2022 rate-hike expectations up +100bps from the start of this year (and +30bps w/w). There are plenty of Dollar tailwinds – Europe recession risk, geopolitical conflict, China growth, general flight to safety – but the recent USD increase has been extreme (MoM 88th percentile) and a narrower short-rate differential between the EU and US is a USD headwind.
Target reported a big miss in earnings this morning, citing margin pressure from input costs and an inventory glut. TGT echoed a lot of WMT’s miss yesterday. As an aside, avoiding earnings misses has become more important and HD & LOW were highlighted in Monday’s Quant note on Retailers (and others) that could benefit from increased market dispersion. Our Pricing Power Portfolio has stalled recently as concerns over broad-based pricing power (inflation) have intensified. Pricing power should matter when inflation is moderating and picking the remaining companies that retain pricing power is important. Constituents HERE.
April retail sales data were very strong, including a large revision to March. Strong activity pushes recession risk out, which helped risk-on sentiment yesterday. Market internals have been consistent with a recessionary outcome lately, illustrating the focus on and concern over recession risk. But ultimately, hot data begets a tougher Fed (more on that below). Inflation expectations are stable – so hotter data and a more hawkish Fed lead to higher real yields. Longer-term, higher real yields support Value over Growth, though short-term Growth gains should be expected as macro cross currents ease.
Powell’s interview with the WSJ yesterday was stark. When asked whether he’s worried that raising rates could causes financial turmoil but not bring inflation down Powell said “Markets are orderly… They’re functioning and are processing the way FOMC is relaying policy pretty well. The idea is for financial conditions to tighten to the point where growth moderates and inflation comes back to 2%.” Do not look for a Fed put to be triggered by equity market declines while the FOMC is transparently more concerned with inflation.
On Monday, we illustrated the estimated effect from equity losses and home appreciation to the growth in net worth. That point is worth more detail. Stocks and mutual funds represent a small portion of the increases in net worth from 2019 for most households. The increases in home equity is more significant; rapid home price appreciation is helping fuel excess demand. The Fed will take this on, even at the expense of equity portfolios, to cool demand and inflation.
Gerard noted Powell maintained his “incoherent” deflection about bringing inflation back to target without spurring a rise in unemployment. It is unlikely, to be generous, the Fed can tame inflation without weakening the labor market. And that comes with heightened recession risk. Ultimately, the markets will price reality more than the fib. Yesterday was risk-on despite Powell’s commentary while futures have reversed this morning; expect more narrative-driven volatility.
Powell’s posturing about the labor market will cede to the Fed’s goal to fight inflation. “This is not a time for tremendously nuanced readings of inflation,” Powell says. “We need to see inflation coming down in a convincing way.” Broad inflationary pressures remain. To be clear, and as we said yesterday, we expect the Fed to accept closer to 3% inflation and let an eventual recession take inflation back to target, which helps relative recession odds. That should support a reversal of recent recessionary internal performance.
