More pain coming

Agustín Carstens, the general manager of the Bank for International Settlements, watched on like an annoyed headmaster. His pupils, seated neatly on the stage next to his ample frame, were up to explain to the class how they’d got it so wrong.  

“We understand better how little we understand about inflation,” said Jay Powell, the Fed chair. You can imagine what everyone, including Carstens, was thinking.

“There’s a clock running here,” added Powell. “The risk is that because of the multiplicity of shocks, you start to transition into a higher-inflation regime.” 

Now that’s better, thought Carstens, who only this week warned that we are on the verge of a “paradigm shift” in the global inflation regime. “We may be reaching a tipping point, beyond which an inflationary psychology spreads and becomes entrenched,” the BIS warned. Just as long as these three don’t pay attention to that troublemaker Krugman, thought Carstens. 

“The process is highly likely to involve some pain, but the worse pain would be in failing to address this high inflation and allowing it to become persistent,” Powell continued, to Carstens’ approval no doubt.

It sounded an awful lot like the way BIS concluded its report: “As historical experience has shown time and again, the long-term costs of allowing inflation to become entrenched far outweigh the short-term ones of bringing it under control.” Or as German economist Karl Otto Pohl put it, inflation is like toothpaste. Once it’s out, you can hardly get it back in again.  

So, is the game up? Christine Lagarde seemed to get carried away: The world “will not return to the low-inflation environment” before the pandemic. What, never? This seems unlikely…at least if not then why not? Will central banks need to accept permanently higher inflation? And it’s a rather trite comment from head of a central bank that has yet to actually raise rates despite inflation running at 8-10% across the bloc. US core PCE inflation is on tap later in the session. Powell remains the star pupil, Lagarde is failing her mocks and no one listens to the class clown Bailey any longer.

Wall Street ended a mixed day flat even as real GDP was revised down to -1.6% in the first quarter, whilst real final sales fell -1.2%. European stocks are much flightier this morning, notching roughly two percent declines in early trade as risk appetite soured across the spectrum on the same old cocktail of inflation and recession worries whizzed up in a blender with tighter financial conditions. The message from the panel event in Sintra was there will be even more pain. Investors would say they’ve endured enough hurt – the first half performance has been shocking with the S&P 500 down 20%, DAX -20%, Nasdaq -28%, Dow Jones -15%. Shares in London have held up much better, down just 2.6% YTD.

Yields, stocks and crypto are all down. The 10yr Treasury yield fell to 3.06%, Bitcoin declined to around $19,300 and the FTSE 100 dropped 1.5% to test the 7,200 level. US futures are pointing to a roughly 1% decline at the cash open on Wall Street later. Month, quarter and half-year end tomorrow raises risks for whipsaws. The S&P 500 is down more than 7% this month and over 15% for the quarter, whilst the DAX is off 11% and FTSE down around 5% for the month, 4% for the quarter. Chinese markets performed well as data improved as the easing of Covid measures led to a strong pickup in services activity. Manufacturing activity rose for the first time in four months. Unless you’d followed JPM advice back in May to pivot back into China tech, it’s been a horrible month for stocks.

FX has also been tough for anyone betting against the dollar. Cable is down 10% YTD, whilst EURUSD is down over 8%. The yen is down by more than 18% and the Swissy has retreated almost 5%. Sterling has caught a little bid this morning following yesterday’s two-week low, but struggling to break out from the 1.2160 resistance area. The euro remains under pressure at a two-week low, while the yen has pared losses, bouncing sharply from a fresh 24-year low yesterday.

After running up through the European morning session yesterday, oil tumbled sharply in the US session before stabilising in Asian trade. SEB analyst Bjarne Schieldrop said oil could go to $200, describing the G7 price cap plan a “recipe for disaster”. With the August contract in the rear view mirror, Brent front month is back to $112 on the September contract.