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US equities were stronger Tuesday, S&P up 2.4%, recovering after the steep losses last week. US10yr yields up 5bps to 3.28%
The overnight calm would suggest that investors are giving the benefit of the doubt to the Fed, believing front-loaded monetary policy will be just that – providing scope for the looser policy later in the year if demand conditions subside.
While selling pressures from last week have eased, it is hard for investors to shake the recession obsession vibes and the thought of more front-loaded rate hikes. With oil prices bouncing again, investors become increasingly jittery that the Fed will feel compelled to respond forcefully to high headline inflation and consumer inflation expectations if energy prices rise further.
Even more worryingly from a policy perspective is that virtually every recession in the past three decades has been a function of a demand shock, but this is a supply shock; hence monetary policy is less potent.
Despite the uptick in risk sentiment, it still feels we are eons away from shaking the event-driven bear market blues due to prevailing recession obsession headwinds.
Indeed, with both the market and Fed in data-dependent mode, another slide in US home sales could eventually have the bears beating the recession drum as US housing affordability falls to 15-year lows due to the sharp rise in mortgage rates. Indeed, those higher short-term rates could easily trigger a downward housing market reset and could cause consumer spending power to hit the bedrock.
That the data was slightly better than expected, but also marking the 4th consecutive monthly decline, that downtrend is unsurprising, given that US 30yr mortgage rates have risen ~300bps over the past year. MBA mortgage applications are also down about 20% since the beginning of the year. Hence the market took that data in stride.
The recession is only the beginning.
It is sad when median-income couples or young first-time buyers cannot purchase a home because they do not meet the qualifications. That wealth inequality creates chips on many shoulders, And I think we have only seen the tip of the iceberg as the cost-of-living crisis is not confined to the UK. Nor, it seems, will a “summer of discontent.” UK strikes could be a worldwide spreader choking off the global economy even further. Forget about a recession; the world could easily topple into a full-blown economic crisis.
Because the cost-of-living concerns have driven consumer confidence, the risk is an accelerating decline in business confidence.
Hence the market is dialled in on Friday's University of Michigan consumer sentiment (50.2 final vs. 50.2 preliminary), which is now at the lowest level in the history of the series going back to 1952. The recent plunge in consumer sentiment is all the more remarkable given that unemployment is near a historic post-WWII low. Still, it does make sense when you start factoring in how inflation erodes consumer purchasing power.
Oil
Oil initially traded higher on the prospect of a US administration gas tax holiday which would likely put a smile on US travellers' faces hence increasing demand during the summer driving season. Indeed, this seemed to offset some of the market recession obsession angst, although with broader risk sentiment stabilizing, that also likely helped pull oil prices higher.
Energy flows were much better to buy overnight in hopes for an eventual broadening out of the reopening in China and increased US demand due to the US gas tax moratorium.
I would note that those inflows were during the early part of the New York session. It has been pretty much a slow shift downhill since then.
Even oil traders acknowledged that higher oil prices hence higher gasoline prices would lead to a more aggressive tag team onslaught from the Fed pushing rates higher and the Biden administration getting increasingly more creative on the political and fiscal front to tame the energy inflation beast.
Temporarily suspending the gas tax is one of the few remaining options the federal government has to cut gas prices; another option under consideration is allowing increased ethanol blending for the summer.
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