NY Fed inflation expectations and a check in on the bond market

a look ahead in the week

The New York Fed released their monthly consumer inflation expectation survey. The general overview is that consumer inflation expectations continue to be on the rise move up to 6.6% in May versus 6.3% in April. This matches the figure from March which was a record high at that time. Long-term consumer expectations have stayed largely the same at 3.9%.

What you don’t see until you drill down is the wide dispersion and actual median point prediction.

When you eliminate the funky “expected” rate you are able to see that consumers are actually expecting anywhere from 3.6%-10.0% inflation with the median point being 8.4%! Consumers are quickly catching up to the actual CPI.

This should be lighting a fire under the Fed heads. They have always clamored on about how inflation expectations are well anchored. It not longer appears that this is the case. In fact, I would say expectations have gotten largely out-of-hand. This is going to force the hand of the Fed to continue rate hikes in the face of a recession. I think my meme on Friday has a high probability and now all the major banks are starting to get on-board.

Barclays, Jefferies, Nomura, Standard Chartered, and now JPMorgan have all jumped on the 75 basis point hike bandwagon. We’ll have the answer Wednesday.

Also this week:

• Tuesday

  • PPI

• Wednesday

  • Retail sales

  • FOMC interest rate decision, press conference, and economic projections

• Thursday

  • Housing starts and building permits

• Friday

  • Fed Chair Powell Speech

  • Industrial Production

As I have explained before, the stock market is a derivative of the debt market. If the debt market loses it’s footing, the stock market is set to tumble. The debt market thrives on liquidity. There is a lot of money that is loaned and borrowed through the debt markets. Treasuries, corps, munis, and MBS are all trading hands like a big game of musical chairs. However, the Fed is cutting the music. By reducing their balance sheet, they are removing liquidity from the market. This is beginning to cause turmoil in the bond markets. Today saw the 10 year treasury break through to 3.15%.

This is setting up the rare double-secret yield curve inversion.

The spread is down to 9 basis points. One more slip up and we’ll be finished.

I’m always on the lookout for new indicators. I was perusing the selection over at the St Louis Fed’s website and came up with this:

This details the spread between investment grade and junk bonds. As you can see, I found the peaks to be very meaningful. When these spreads blow-out, they shock the stock market into fear mode. When the market is under stress, bond buyers require a larger margin of safety to purchase riskier bonds. This will put extreme stress on those companies that aren’t turning a profit. They rely on the bond market for liquidity. As their bonds slide down the risk scale towards junk, investors will abandon their stock. This will cause a panic as the door to exit is small and the herd is large.

Since this run to the exits is human emotion run amok, it follows a traditional pattern.

I believe we are somewhere between denial and return to “normal” in the Blow off Phase. We haven’t reached fear yet but we could be getting close. We are a long ways from seeing the bottom. After witnessing this kind of market action, I might need to pour myself a drink and buy more puts.