What’s the big deal if the Fed funds rate goes from 0% to 0.8%?

Outlook: The data plate is skimpy today, just jobless claims and PPI. Someone is sure to try to make hay out of jobless claims. PPI is going to undergo the same scrutiny as CPI but we already know its input materials, especially energy and strange stuff like rare earths and specialty ingredients (fertilizer), driving prices. The market is expecting a dip in PPI but even if we get it, it won’t be believed–and rightly so.

After PPI, the important data will be in. But instead of any upcoming data, what we need to care about is sentiment toward risk, and that is in the process of going full withdrawn-head turtle. As Bloomberg editor Joe Wiesenthal puts it, “Now the Fed is raising rates, and the meme stuff and crypto and growth stuff is getting crushed the hardest. But the question is why? What's the big deal if the Fed Funds rate goes from 0% to 0.8% or whatever? How does that change the value of Terra or a digital ape? Of course the Fed Funds rate alone actually doesn't matter. What matters is that the big risk-taking cycle is doing a 180, and the rate hikes while important are only a part of it.”

The current withdrawal from risk-taking can be blamed on youth and inexperience–a whole generation of traders in every market who don’t understand inflation. They have been disrespectful of institutions, especially the Fed, without understanding their true importance. They flail around confusing personal belief (crypto is a viable alternative to sovereign money) with fairy tales. They got snookered on the crypto fable and now their feelings are hurt, like the 4 year-old that figures out fairies don’t really exist and didn’t put that quarter under the pillow. The whole thing has a Peter Pan quality.

It’s not the crypto or even the S&P that should be scaring people, it’s China and its critical place in the supply chain for all those specialty metals and other goods. Those who trade the Australian dollar see it more clearly than anyone else. We always joke that the AUD is the canary in the coal mine for growth. When the AUD is falling as dramatically as we are seeing, we need to look to China. Remember that old phrase “China sneezes and the rest of the world catches cold?” We are there.

Another long-standing quip is that if anyone can snatch defeat from the jaws of victory, it’s Britain. Sure enough, the entire Brexit saga has been mismanaged from the beginning and no government, even the pro-Brexit Boris, has shown the slightest whiff of managerial competence. Everyone likes Sunak because he comes across as competent, but it’s hard to see how he can surmount the latest data batch, which is awful right across the board.

Then there’s Europe. We think EBC chief Lagarde is joining the hawks, but realistically, she is still on the fence. That’s because the universal forecast is for recession later this year and in 2023, and she understandable doesn’t want to have to reverse a “premature” hike.

In an interview with the FT, CIO Mortier of Europe’s largest asset manager Amundi, predicts the euro will fall to parity with the US dollar this year. It’s not just the threat of recession, but also prioritizing keeping the cap on government borrowing costs that itself helps preserve the integrity of the eurozoine. “Such a decision would leave the eurozone central bank even further behind the US Federal Reserve in fighting inflation and knock the euro to $1 for the first time since 2002…”

Exactly as we have been saying for a couple of weeks, Mortier points out that if the ECB raises rates twice in 25 bp tranches from the record low of =0.50, it’s just ack to zero. The market sees three hikes this year and a rise to 1.5% by mid-2024–but that’s too late in contrast to the Fed’s aggressiveness.

“We think they’ll get to zero on the [ECB] deposit rate and that’s it,” Mortier said. “In the meantime the Fed will have done much more. If the ECB were focused only on inflation, then 1.5 per cent would be very likely. But it’s not.”

Here’s the kicker: “Losing sight of the euro-dollar exchange rate is a big mistake when your inflation is mainly coming from imported goods,” Mortier said.

The safe-haven flow to the dollar will ebb and flow, with a retreat inevitable sometime soon as some folks regain their balance. It’s a little funny that the peculiar conduct of the dollar/yen will reverse, too. Absolutely nobosdy can explain why the dollar/yen is on the backfoot and the yen rising so strongly. A safe-haven flow, maybe. Acknowledgement that the economy is actually doing better than expected. Well, nobody knows–but we imagine it can’t last, not when the relative real yield favors the dollar.

Best Tidbit Ever: Readers know we dismiss crypto for many reasons, chief among them that it’s not “money” in any sense of the word. We have Schadenfreude when we read things like this summary from Bloomberg:

“Crypto's current bout of volatility, which saw Bitcoin drop as much as 10.5% this morning before recovering, continues amid uncertainty over the fate of stablecoins. Terra, one of the more exotic offerings, has dropped 99.95% from the 1:1 peg with the dollar in the last week. The much more widely used Tether stablecoin, which claims to be backed by actual assets including the US dollar has also seen its peg come under pressure. The drop in Bitcoin coming amid a much wider global risk-off move again brings into question the cryptocurrency's function as a hedge against inflation.”

Tidbit: The FT has an excellent new feature named a global inflation tracker. You type in the name of a country and up pops its inflation rate and GDP with the global number also shown for comparison. We usually prefer charts that show change over time and comparison like this cannot incorporate historical perspective by definition. A 1% rise in inflation means something very different in Japan than in the US, UK, or Europe. The UK “stagflation” chart is not a bad summary of why sterling is so abnormally weak.

The FT also offers the inflation data in a map where a resized country with a darker color means higher inflation. The biggest and darkest–India and Pakistan. The FT also offers inflation by country by sector, by specific categories (the price of breakfast) and 2022 forecasts in the 5-year breakeven as well as economists’ guesses. On a whole, a tour de force that makes up (Almost) for the FT’s ridiculously high subscription cost.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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