100bps: Shock and Awe | Morning Express 9/21/2022

Posted: Sept. 21, 2022, 3:34 p.m.

E-mini S&P (December) / NQ (December)

S&P, yesterday’s close: Settled at 3872.75, down 44.50

NQ, yesterday’s close: Settled at 11,921.50, down 0.75

Fundamentals: The Federal Reserve concludes its two-day policy meeting at 1:00 pm CT with a rate hike decision and updated economic expectations. The CME FedWatch Tool, driven by Fed Fund futures, is signaling a 75bp hike with an 84% probability. Is a third straight 75bp hike aggressive enough to tame stubborn inflation? Back in April, we coined the ‘Inflation Showdown at Jackson Hole'. This was the idea the Fed’s tightening (tapering, hikes, and balance sheet run-off) would contain the rise of inflation through the summer, but if not, things could get ugly. May’s CPI, released in June, then ran hot and forced more aggressive maneuvers from the bank. Despite added market volatility, front-loading a quicker rise to the neutral rate would have a better shot at derailing rising prices. For a moment in July, it seemed to be working, Core CPI fell back below +6.0% for June, and Gasoline prices were plummeting. Data for July, released in August, furthered that notion as Core CPI YoY stayed at +5.9%, MoM at +0.3% was the smallest rise since March, headline YoY fell from +9.1% to +8.5%, and headline MoM was flat. Although +8.5% was still stubbornly high, there was a light at the end of the tunnel.

As Fed Chair Powell’s Jackson Hole speech neared, something began happening. The Cleveland Fed’s Inflation Nowcast signaled August inflation was tame, but September’s data began re-elevating. During this time, the S&P enjoyed a 19% rally from the June lows to its August 16th peak. The entire summer’s work was dissipating, and Powell had no choice but to cock back and deliver a blow at Jackson Hole. In his speech, he said, “Restoring price stability will take some time and requires using our tools forcefully…higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring pain to households and businesses.” He used the phrase “bring pain” and then went on to say, “We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent.” Furthermore, he called it the bank’s responsibility to deliver low and stable inflation, he quoted former Fed Chair Volcker, and said, “we must keep at it until the job is done.” The narrow and deliberately hawkish speech concluded, and no questions were taken. It took a moment, but the shock settled into markets.

Do not miss our daily Midday Market Minute, from yesterday.

Today is about shock and awe, just like Jackson Hole. Hiking rates the widely anticipated amount has not worked. Core CPI in August rebounded by +0.6% MoM, while +6.3% YoY was the highest since peaking in March. To make matters worse, the Cleveland Fed Inflation Nowcast expects September Core CPI at +0.5% MoM and +6.64% YoY. Gasoline prices may have dropped for nearly 100 straight days, but headline CPI is expected to reemerge MoM at +0.3%. By not shocking markets today, there is a real risk of seeing asset prices rally in the aftermath. Yes, the easy answer is the Fed must hike 100bps. If Powell and the committee only move the expected 75bps, it is imperative the economic expectations and 1:30 pm CT press conference do not merely embody average hawkishness.

By shocking markets again, Fed Chair Powell and the committee give themselves another opening, like this summer. Base comparisons of inflation begin rising in October, and more importantly, the stickiest portion of CPI, Owners’ Equivalent Rent (OER makes up about one-third of CPI), should begin tapering off in no more than six to nine months. If a proper 100bps hike is announced today and the Fed remains vigilant through yearend, a victory over inflation could be had by the end of Q1.

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