“I Don’t Get It”

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

One of my favorite movies is “Big” starring Tom Hanks, John Heard, Elizabeth Perkins, and many others. You may recall that Tom Hanks is constantly challenging John Heard’s character (Paul) by stating “I don’t get it” whenever “Paul” is presenting an idea related to a new toy before senior management. As I reflect on last Thursday’s market activity, I feel very much like Tom Hanks’ character Josh. Sure, the CPI declined from 8.2% to 7.7% and Core inflation came in at 6.3%, which was below expectations, but the market’s reaction to this news would have had you believe that the Fed had accomplished its goal of driving inflation to 2%. I don’t get it! The rally in US Treasuries was nearly unprecedented. In fact, the move in the 5-year Treasury Note was the 6th greatest in the last few decades and the only one that didn’t involve central bank action.

The Federal Reserve has raised the Fed Funds Rate to a range of 3.75% to 4.00%. Given the stated objective to get to a point where there are “real rates”, the Fed will have to do more work. Based on yesterday’s inflation news, the probability of a 50bps increase in the FFR in December now stands at just over 80%. That is still a significant increase. Again, you would have thought that market participants had heard the Fed Governors proclaim that the “great pivot” was soon to begin. Yet, that is not what we heard. Dallas Fed President Lorie Logan said, “while I believe it may soon be appropriate to slow the pace of rate increases so we can better assess how financial and economic conditions are evolving, I also believe a slower pace should not be taken to represent easier policy.”

Former Treasury Secretary, Larry Summers, warned last month that “history indicates inflation will be slower to fall than Fed officials anticipate.” The concerted effort to rein inflation comes with the risk of driving the economy into a potential recession. However, based on the current strength in the US labor force and projections of strong 4th quarter GDP growth (Atlanta Fed’s GDPNow forecast of 4%), Fed action in 2022 has not shown much progress.

It was great to see markets rally, but the magnitude of the moves seems truly premature. We’ve seen myriad head fakes in 2022. This market action may prove to be just another in that series.

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