Macro update 8.8.22
Economic reality could be catching up with market sentiment, with several Fed officials firmly stating that inflation remains the key concern and that significant tightening was needed to tame it. Friday’s strong labour-market data also supports this. This week’s CPI data (Wednesday) is likely to further highlight the dichotomy between market sentiment and economic reality.
Whatever it takes 2.0
We believe these themes are likely to turn the market’s attention towards a less optimistic scenario. Specifically, that the Fed and other central banks will keep policy unusually tight (compared to the past 20 years) for an extended period of time. Indeed, the Bank of England’s (BoE) forecasts last week implied a prolonged recession in the UK and this is something that the Fed may yet choose to communicate about the US too. That is, explicitly and firmly state that they will do “whatever it takes” to bring inflation down even if there is economic pain, i.e. RIP soft landing! The BoE meeting was a wake up call: a central bank siren wail.
Indeed, while there has been a narrative around supply chain improvements, equity-market pricing suggests these related price pressures are unlikely to abate (see chart below). This may be due to such pressures being structural rather than cyclical due to issues ranging from China’s zero-COVID policy to lack of investment in the energy sector to insufficient storage capacity (wheat in Ukraine).
The chart below shows the difficulty facing central banks. If month-on-month inflation is 0.3% mom (as predicted for the July data) for the rest of 2022, CPI will still be 5.9% yoy in Q1 2023 (see chart below).
More aggression than the market currently expects is likely to be needed from the Fed to get inflation down quickly. As a result, a recession, like the one projected by the BoE, may be forthcoming in the US and this means that EPS and the market have much further to fall in H2 (see chart below).
Finally, sentiment looks like it has already overshot and is vulnerable to a correction (see chart below), so reality may catch up to the market sooner rather than later.
There were a number of stories last week suggesting the rails for institutional adoption are being setup, ranging from BlackRock allowing its institutional clients to use Coinbase Prime to access crypto to Brevan Howard raising $1bn for its crypto focused hedge fund and the CME rolling out euro-denominated BTC and ETH futures later this month. However, the reaction has thus far been muted. Indeed, we expect macro to dominate micro developments and, as is the case for TradFi markets, further downside seems likely for digital assets.
Chief Economist and Project Specialist
Disclaimer: The content above does not constitute investment or financial advice. All statements are opinion and not statements of fact.