The recent bout of interest hikes by central banks across the globe has thrown the markets into turmoil yet again. Whilst nobody ever knows where the markets are headed in the short run, here’s someone who can help us get our heads around what will it take to tame inflation and hence where are interest rates and the global economy headed over the coming year or so. Chen Zhao is the founder and Chief Strategist at Alpine Macro, a Canadian research boutique and previously at the highly regarded macro research firm, BCA research. In this interview with The Market, Zhao simplifies the situation for us:
“First, let’s agree that inflation is the dominant factor right now. We saw that on September 13th when the CPI report came in hotter than expected, causing stocks and bonds to plummet as markets began to price higher rates for longer. The fear of a much more hawkish Federal Reserve is rampant. Now we have kind of a binary situation going forward: If inflation starts to go down faster than people anticipate, then you have to be bullish. If inflation stays stubbornly high and moves even higher, then we have a serious problem both in bonds and in equities.
Based on our research, we have come to the conclusion that inflation has peaked and will move down faster than anticipated. This is not just an assertion. In our analysis, we broke down the core PCE inflation for the US, that’s the inflation gauge that the Fed cares about, and we grouped it into two categories: Supply side driven inflation and demand side inflation. What we found is that demand side inflation has already fallen to 1%, while supply side is still high but falling. Based on this, we see core PCE inflation going down to about 1% by the end of next year. The bond market seems to agree with our forward-looking assessment, as it is anticipating inflation to fall to around 2% one year out, supporting the conclusion of our model forecast. That’s why we think it’s not the right time to be panicking about inflation.”
So, why can’t the Fed see it that way? He points to the contradiction in Powell’s words and actions historically:
“Fed Chair Jerome Powell is super hawkish right now. But if you look at history, you were almost always right by betting against what Powell is saying. In late 2018 he said that the Fed’s quantitative tightening would be on «autopilot», and a month later he flipped by cutting rates. In 2021 he was talking about not thinking about thinking about raising rates – and then in 2022 he has not only raised rates, but did so very aggressively. A little more than a month ago he was talking about an economic soft landing, and now he’s talking about more pain ahead. If you look at his past performance, you basically have to bet against what he says. If you take Powell as a contrarian indictor, his turn towards super hawkishness could be an indication that inflation not only has peaked but will fall fast soon.”
The rest of the interview is a worthwhile read, laced with similar clarity of thought around what the stock and bond markets are pricing in and also insights on Europe, China and Emerging Markets in general.
“First, let’s agree that inflation is the dominant factor right now. We saw that on September 13th when the CPI report came in hotter than expected, causing stocks and bonds to plummet as markets began to price higher rates for longer. The fear of a much more hawkish Federal Reserve is rampant. Now we have kind of a binary situation going forward: If inflation starts to go down faster than people anticipate, then you have to be bullish. If inflation stays stubbornly high and moves even higher, then we have a serious problem both in bonds and in equities.
Based on our research, we have come to the conclusion that inflation has peaked and will move down faster than anticipated. This is not just an assertion. In our analysis, we broke down the core PCE inflation for the US, that’s the inflation gauge that the Fed cares about, and we grouped it into two categories: Supply side driven inflation and demand side inflation. What we found is that demand side inflation has already fallen to 1%, while supply side is still high but falling. Based on this, we see core PCE inflation going down to about 1% by the end of next year. The bond market seems to agree with our forward-looking assessment, as it is anticipating inflation to fall to around 2% one year out, supporting the conclusion of our model forecast. That’s why we think it’s not the right time to be panicking about inflation.”
So, why can’t the Fed see it that way? He points to the contradiction in Powell’s words and actions historically:
“Fed Chair Jerome Powell is super hawkish right now. But if you look at history, you were almost always right by betting against what Powell is saying. In late 2018 he said that the Fed’s quantitative tightening would be on «autopilot», and a month later he flipped by cutting rates. In 2021 he was talking about not thinking about thinking about raising rates – and then in 2022 he has not only raised rates, but did so very aggressively. A little more than a month ago he was talking about an economic soft landing, and now he’s talking about more pain ahead. If you look at his past performance, you basically have to bet against what he says. If you take Powell as a contrarian indictor, his turn towards super hawkishness could be an indication that inflation not only has peaked but will fall fast soon.”
The rest of the interview is a worthwhile read, laced with similar clarity of thought around what the stock and bond markets are pricing in and also insights on Europe, China and Emerging Markets in general.
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