Mid-Week Update

April 15, 2024

Let's give Caesar what Caesar's is.

I ask myself:

These days, Bill Gross's heirs should migrate en masse to Mount Tibet.

No, bond traders must continue to do their hard work, and we are called upon to recognize that being a bond trader today is not a simple business like sitting on the seashore and imagining what tomorrow holds for all of us while, in the distance, the sun observes us lovingly.

What is their principal occupation? Their worry?

The Federal Reserve's monetary policy, without stocking up on mystical veils, has kept the fact that it is in no hurry to cut rates without first having clear evidence of a drop in inflation in its pocket.

In April, benchmark 10-year U.S. Treasury yields rose 50 bps to a high of 4.7% before dipping back to 4.5% at the start of the current month.

So far, 2024 has brought a no-nonsense bond market to the table, presenting ongoing developments and upheavals, such as short-term bond yields outpacing long-term bonds.

Jay's shadow is the target of any bond trader's gaze, but it's not easy to keep an eye on; news of changing timelines continues to come from that shadow, with the result that the much-infamous cut continues to be moved possibly further away from us.

What do we have now?

We have a script that shows an inverted yield curve in our hands. Let's try imagining his dilemma. Where can he go?

Well:

• Hypothesis 1)

If the market believes the Fed wins the battle against inflation, short-term yields would fall to standardize the curve.

• Hypothesis 2)

The curve will normalize if the inflation scare is not put to rest because long-term rates will rise.

There's no denying it; being a bond trader today doesn't allow you to leave even the last of your neurons on the bench. When the going gets tough, everyone's contribution is needed.

From the ECB:

The minutes of the last meeting of Lagarde and associates highlight a significant point: the hypothesis of a reduction in the cost of money in the Old Continent for the meeting on 6 June is considered 'plausible'. This is based on the evidence provided by the moderation of consumer prices, a key indicator for monetary policy decisions.

From the Fed:

Lorie Logan, of the Dallas Fed, was clear in his stance: “It is too early to think about a cut in interest rates”. He expressed optimism regarding the drop in inflation to 2%, an objective of the Federal Reserve. However, this optimism is not expected to bear concrete fruit in the very short term, indicating a cautious approach.

From the BoE:

The Bank of England kept interest rates at 5.25%. Still, it clarified that the first cut (expected since March 2020) could arrive in June. Members of the Monetary Policy Committee (MPC) voted this way: 7-2 to maintain, with two members favouring a cut. But all that glitters is not gold. The MPC warned that indicators of inflation durability "remain high"; just to be clear, service inflation reached the 6% area in March, and there are (as in all developed economies) further "risks deriving from the geopolitical situation".

What do I get out of it? I found Bailey somewhat submissive; I thought he had memorized Jay's latest speeches. Why do I say this?

Essentially because Bailey expressed this sentence:

"We need to see more evidence that inflation will remain low before we can cut interest rates."

But after all, how can you blame him? Is there anyone in this world who doesn't need proof? We all need it, but how wonderful it would be if we all started looking for it, knowing that we live in a world where evidence (at least the perfect, complete, and impeccable one) does not exist.

The main event of the market week is undoubtedly the publication of the US inflation for April, which will shine upon us today. The goal is to try to understand if inflation has started to fall. In any case, to convince the Fed to use scissors by the summer, further confirmation will be needed from the next macro data, such as the PCE core due out at the end of the month.

Bloomberg's consensus data on the consumer price index for April indicate an expected monthly growth of 0.4%, which is in line with that recorded in March.

Once consumer prices have been made known, attention will shift above all to the PCE core deflator, the inflation indicator preferred by the Fed for its monetary policy decisions, to be released on May 31.

According to Bloomberg analysts, the Core PCE could show a more vigorous reading than the CPI of May 15. The core PCE and the so-called "supercore" index (which excludes the housing component) also consider the calculation of prices for eating out, which are not considered by the core CPI.

What do I expect?

“If I see a swallow appear, I will not think that spring is behind it; in the same way, if I see black clouds appear, I will not think of a return of winter in great style.”

Jay gently invited us to consider two possible scenarios that could convince the FOMC to cut rates: a decline in inflation towards the 2% area regardless of the labour market or, otherwise, an unexpected weakening of the labour market.

We have yet to get the new macro data. Still, a report released by the Federal Reserve Bank of New York indicates that US citizens last month were braced for generally higher inflation pressures for the next few years and an acceleration in rising commodity prices.

Today, an American citizen wakes up in the morning to go shopping, starts the car and is careful not to press the accelerator pedal too hard so as not to consume too much gasoline. How come? Well, she or he already knows that when they enter the “temple of consumerism”, a pound of white bread will cost him 2 dollars; for eggs, they will have to spend no less than three bucks for a dozen, and if they want to go home with milk too, they will have to shell out another USD 3.89 for a gallon of milk.

Yes, these are challenging times. But the easy ones, who has ever seen them?

Let’s now look at what the models tell us.