February 21, 2023
US inflation data dominated the macro last week and continued to support the peak inflation view, with the headline rate coming in at 6.4%, down from 6.5% the month prior. This is the 7th consecutive month of inflation printing lower. Core inflation meanwhile at 5.6% is at its lowest levels since Dec 2021.
The numbers however came in hotter than expected and on a monthly basis were up 0.5% Vs 0.1% in December, but with most of the increase coming from the lagging housing sector. Core services, ex-shelter (which JPow has said he’s focused on) came in at 0.27% MoM, the lowest level since October 2022. The Atlanta Fed’s core “flexible” CPI (a weighted basket of items that change price relatively frequently) also released last week came in at just 0.1% on a 12 month basis, down from as high as 19.7% in Feb 2022
Overall, little to really alter the view at the Fed that “the disinflationary process has begun,” however progress remains slow and a strong retail sales print added weight to the view that the consumer remains strong amidst a solid labor market. Fed speak this past week also continued with the hawkish tone, emphasizing a willingness to do more should inflation remain above target.
Markets consequently continued to re-price rates, with a terminal rate now priced around 5.3%, suggesting 2 more 25bp hikes with a small probability of a third. Only 10bps of cuts are subsequently priced by Dec, down from over 50bps just a few weeks ago when recession fears were a dominant narrative.
This is a HUGE re-pricing in rates 🤯 and warrants caution to the positive risk view. The “peak rates” narrative is not dead, but it’s under some threat and is working against an otherwise supportive risk backdrop. Indeed, I was relieved to see 10yr yields peak out around the 30th Dec highs and reverse lower. 2yr yields similarly faded ahead of the Nov highs.
Make no mistake, a continued push higher to new yield highs and something will start to break. However, the rates move in response to a few strong data points has been sharp and it’s difficult to see the momentum sustaining.
In terms of the shifting macro dynamic that I’ve previously outlined as we transition from the sharpest Fed hiking cycle in history to the eventual pause, the timing of that pause may have been pushed out, but it’s still coming and the rate of change of rate increases has slowed. A re-acceleration in inflation of course could change that perspective, but we’re not there yet and with real incomes continuing to squeeze, inventory levels remaining high and still the lagged impact of monetary policy to be felt, it feels the market has gotten ahead of itself in this rate repricing.
Why then has crypto continued to pump and risk staying supported?
Despite the move in rates, which, ceteris paribus, should have hit risk and crypto hard, liquidity 🌊 is providing a powerful off-set. I’ve written previously how the balance sheet contraction of the Fed and ECB is being off-set by the PBOC and BoJ.
On Friday, the PBOC injected a RECORD net 632bn Yuan via its 7 day reverse repo. With the TGA drawdown also an off-set to QT in the US, currently the liquidity picture is vastly improved from the drain witnessed in 2022 and continues to support risk assets.
Other risk measures also remain muted keeping financial conditions easy and adding to an improved liquidity backdrop. Expected Equity and Bond market volatility as measured by the VIX and MOVE Index, respectively, whilst off the recent lows remain at comfortable levels which facilitates greater leveraged allocations of risk. These are powerful flow dynamics that short term will likely to continue to frustrate the bears 🐻
Oil is also interesting. Despite the improved global growth outlook, oil continues to trade heavy, getting hit last week on the large inventory build. Oil is typically a good lead on inflation expectations (as proxied by 5yr US inflation breakevens) and it’s important oil stays low to sustain a peak inflation narrative and to maintain stability in the bond market. Last week's move suggests inflation expectations should get pulled back lower which I expect will also help bring US yields lower in tandem.
Back in Crypto Land
Back in crypto land, Fintwit talk that Hong Kong will allow the retail purchase and sale of crypto drove a midweek pump that off-set the SEC driven FUD as Gensler loosely applied the “securities” tag to issue a Wells notice to Paxos for the Binance stablecoin issuance. Interesting perhaps, the limited impact the SEC headlines have had on crypto. Sentiment towards this asset class continues to improve in 2023 and whilst US headline risk remains high, sensitivity appears lower. News also that Binance expects to pay penalties to resolve US investigations could also prove pivotal should that quell the on-going Binance FUD.
Heading into a quieter week on the macro front, with FOMC minutes and US PCE the key releases, liquidity can perhaps exert greater dominance over the negative rates dynamic that has recently formed. Should US rates cool down off last week's highs as I suspect given oil and likely lower breakevens, then a nice tailwind could help BTC and ETH make a clean break of the 25k and 1700. Our flows at Paradigm certainly appear to be positioning for another leg higher 👀