Market Starts Pricing-In Rate-Cuts As Hot CPI Confirms Fed Policy Error Imminent

February 12, 2022

Update (0945ET): With the odds of a 50bps rate-hike in March now almost 60% – rising in anticipation of an uber hawkish Fed trying to stomp on the 40-year high CPI – it appears the market is pricing in rate-cuts as a Fed policy error is almost guaranteed.

The forward curve is pricing in rate cuts starting around two years out…

The 1Y forward 2s30s spread (recession indicator) has inverted…

In other words, The Fed tries aggressively to stomp out inflation, crashes it all, and has to flip-flop back to rate-cuts and QE very quickly.

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Update (0855ET): Markets are not coping well with the reality that The Fed is going to have to act and act sooner and harder than expected. Given the scale of these moves, and positioning, this will no doubt spark a huge VaR shock and implicit forced derisking as the day wears on.

Bond and stock markets are not happy about the hawk-implying hotter than expected CPI print with Nasdaq tumbling into the red for Feb…

And 10Y yields rising very near 2.00%…

The yield curve is collapsing (2s10s)…

And 7s10s briefly inverted…

The last time 5s30s spread was this low, The Fed folded on its policy tightening stance…

And the dollar is spiking…

And while rate-hike odds have surged (57% odds of a 50bps hike in March)…

For context, given the current levels of inflation adn unemployment, The Taylor Rule sees The Fed 1075bps ‘too easy’ in its monetary policy positioning…

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Expectations for this morning’s must-watch CPI were a continued non-transitory acceleration to +7.3% YoY (Core +5.9% YoY), but they underestimated as the headline printed a shocking +7.5% YoY – the highest since March 1982.

Source: Bloomberg

CPI has beaten Wall Street expectations 9 of the past 11 months. This is the 20th straight monthly rise in CPI, with both goods and services costs rising…

Source: Bloomberg

Below the headline print, core consumer prices rose 6.0% YoY (hotter than the 5.9% expected and highest since Aug 1982) as food, energy, and used car prices were the biggest drivers. The energy index rose 27.0% over the last year, and the food index increased 7.0%.

Source: Bloomberg

The food index increased 0.9 percent in January. The food at home index increased 1.0 percent over the month after rising 0.4 percent in December. Five of the six major grocery store food group indexes increased in January. The index for cereals and bakery products increased the most, rising 1.8 percent over the month. The index for other food at home increased 1.6 percent in January, while the index for dairy and related products rose 1.1 percent. The fruits and vegetables index rose 0.9 percent over the month, and the meats, poultry, fish, and eggs index increased 0.3 percent. The only grocery store group index not to increase in January was the index for nonalcoholic beverages, which was unchanged.

The energy index increased 0.9 percent in January. The electricity index rose sharply in January, increasing 4.2 percent. The gasoline index fell 0.8 percent in January after rising rapidly in the autumn of 2021. (Before seasonal adjustment, gasoline prices rose 0.1 percent in January.) The index for natural gas also declined in January, falling 0.5 percent after declining 0.3 percent in December.

New and Used Cars are a major driver of this recent acceleration…

Perhaps most problematic is Shelter/Rent inflation:

Shelter inflation +4.36% Y/Y, highest since June 1991
Rent inflation +3.76% Y/Y, highest since July 2019

We also note that CPI-PPI – a proxy for margin compression – remains at extreme levels (and just this morning Unilever showed)

Source: Bloomberg

Finally, while politicians may proclaim wages are rising as a victory, the fact is that for 10 straight months, the cost of the shit you buy is outpacing the increases in incomes…