The MMT experiment that central banks embarked upon decades ago has confirmed one thing, the market has completely disconnected from any sort of reality or fundamentals.
A Fed balance sheet close to $9 trillion, $5 trillion of which were only added in the last year and a half, it seems there is no fear in this market as every dip is bought only to find some narrative to suit it afterwards. Given the copious amounts of liquidity pumped into the system, inflation is truly well and alive, and not just transitory. Of course, the word transitory can be used very loosely as over a very long-time frame, anything is transitory.
The start of this year saw S&P 500 markets drop 11% and U.S. bonds collapse as the 10-year moved up to 1.90%+. The rates market moved swiftly to price in about five rate hikes this year with at least a 30% chance of a 50 bps rise in March alone. All eyes were peeled on today's Jan CPI data to see whether the Fed would be given some room to breathe or not.
Earlier, U.S. January Consumer Prices rose 0.6% vs. consensus of 0.4%, with year over year printing at 7.5%, beating consensus of 7.3%. The CPI ex Food and Energy came in at 0.6% vs. expectation of 0.4%. To put it mildly, inflation is not transitory and if one were to look at the components, shelter being the biggest part of CPI (33% of the index), is still being understated with rents up 18% over the last year and home prices up 19%! If one were to back out real inflation, the rate is much higher than 7.5%! Against this backdrop, we still have a U.S. central bank that is buying up to $90B-$100B of Treasury assets per month till March of this year. One really wonders.
That the Fed is clearly behind the curve is putting it mildly, and the bond and rates market are testing their resolve. To start with, they should end their QE, and then perhaps raise rates by at least 25 bps! Judging by their past behavior, we know they play a reactionary role, they only react to emergencies and do not alter their course otherwise. When markets fall 15%+, they are quick to print and turn on the taps to support assets. Today we have inflation averaging close to 5% long term, yet the Fed is not even close to addressing that problem. They are eager to blame supply chain tightness, but refuse to acknowledge the trillions in monetary and fiscal policy that have aided this boom in aggregate demand, which is leading to much higher prices across the board. In a nut shell, the economy needs to cool down or at least excess liquidity needs to be drained.
The yield curve has inverted in the front and almost about to in the back. The long end of the market is pricing in cuts, perhaps indicative of aggressive Fed policy action in the near term. This perception of "eventual" Fed support is being quoted as one of the reasons to keep buying the market. If there was ever any bizarre logic, this would be it. The Fed is only able to support the market if it can print more. For now, it is unable to do so until inflation comes down. It is in a bit of a Catch-22 situation as something has to give. But the economy cannot be run on blind hope.
After the bounce over the last week, we are now back to retesting the level where the market first broke down. All asset classes are at an inflection point with Bitcoin at top end of its near term resistance, U.S. 10 year yields at 2%, Nasdaq desperately trying to hold onto the key $15k level, all the while oil is resting on its 20-day moving average. Traders who were fighting hand and fist to get their sell orders through 10% lower from here, are now scrambling to cover their shorts. Is this just a dead cat bounce or the start of a new trend to all-time highs? That remains to be seen. So, what will it be market?