A simple recap
What I’m watching
For this holiday shortened week we had the all important CPI and PPI numbers which showed that inflation is still running above target. As a result, the market has aggressively priced in rate hikes over the coming FOMC meetings, with implied probability of a hike at nearly 90% during next week’s meeting. As of the end of the week, there is about 50% chance of a combined 2 hikes during the next 3 meetings, and about 30% of 3 hikes.
With the labor market apparently in full or near full, and with inflation running above target, and with Warsh’s hawkish speech on inflation during the Jackson Hole meeting, it would seem that the Fed is almost certain to be delivering a hike. And if they did, I believe “the president will have something to say about it”, I quote NEC director Hassett.
Beyond the inflation data and the Fed, we also saw massive escalation in the Middle East, as Houthis took control of a Yemeni port city on the Red Sea, threatening the Bab Al-Mandab strait which is the alternative to the Hormuz Strait. They also launched attacks against Saudi energy infrastructure. These escalations pushed Brent crude prices over $100 per barrel and also diesel prices above $6 a gallon, which further put pressure on the inflation prospect. Not good for the Fed or the stock market, as the Fed really can’t help too much with a supply crunch other than tightening demand.
ORCL released earnings on Thursday and while good and the stock rallied about 8% after earnings, all the gains were given back during the day on Friday. Overall this week stocks haven’t been doing so swoon other than today which I think is more of a relief from CPI release. Volatility also started to pick up this week as people prepare for the CPI and the FOMC next week with all eyes on Warsh.
A position or thesis
Warsh has got to make a decision. The market has already made the decision for him anyway.
If the committee votes to hike, which is as expected by the market as of this week, then the thing to watch out for is if he guides on future trajectory until the end of the year. To me, given the fact that Trump is pressuring him and the Fed, maybe not directly but very much publicly, and Warsh himself also voiced against forward guidance, it would seem to me that it’s unlikely for him to voice continued hawkishness, even if they deliver a hike next week. In this case, it would seem possible that the market might be flat to slightly higher, as the market is now pricing in more than 1 hike for the year. But it all depends on his stance and tone. If he sounds much more hawkish and remains firm on the inflation then the market might need more repricing to do.
If the committee somehow votes not to hike, then it likely will bring about big moves in the markets. Risk assets are likely to spike and gold will probably be the strongest. There will be questions about Fed independence, and as a result long term bonds might instead take more fire with yields higher, signaling policy mistake. To me this scenario is much less likely.
What I got wrong or updated
Nothing major changed this week. All eyes are on the Fed and Warsh and about how he views the inflation and rate trajectory.
The Ephemeral Tourist 