The narrator of TS Eliot’s “The Wasteland” assumed that April was the cruellest month precisely because it was a time of waking up and waking up after the long, comfortable sleep of winter. You’re not really supposed to agree with that sentiment, although for over a hundred years people have insisted on quoting Eliot’s poem as if the poet himself despised April.
For the stock market, April was indeed the cruelest month, in part because it saw a blossoming realization that inflation is not going to die of exhaustion after hitting 40-year highs. . Evidence of this could be seen in remarks by Fed officials this week.
Let’s start with Mary Daly, one of the more dovish members of the Federal Open Markets Committee. She said she supported a 50 basis point hike at the next meeting and expected a “fast march” towards a neutral rate by the end of the year. Daly even went so far as to say that a “mild recession” would count as a soft landing. His own forecast is that the economy should slow to “something resembling below-trend growth, but that will not tip into negative territory, but could potentially tip into negative territory.”
When doves talk about pushing the economy into below-trend growth or even contraction, we no longer believe we will achieve “perfect disinflation,” or an end to inflation without economic pain.
Remarks by Fed Chairman Jerome Powell on Friday sealed the deal for a 50 basis point hike at the May meeting and likely at the June meeting. Many analysts are now saying we should expect another 50 in July. There is even talk of a “mega-rise” of 75 basis points at one or more of these meetings. It’s still very much in the minority on Wall Street; but we’ve said before that the Fed probably needs to get ahead of market expectations in order to get inflation under control, so we’re not ruling out a bigger hike than expected.
Exactly a month ago, Powell botched his first attempt at a “warmongering turn” in a speech at the annual convention of the National Association of Business Economists. Instead of markets tightening financial conditions — meaning lower stock valuations and higher bond market returns — stocks surged, with the Nasdaq gaining 1.95%. The five-year breakeven rate, which is the rate of inflation implied by the prices of 5-year Treasury bills and Treasury inflation-protected securities, continued to climb to a record high of 3.59 %.
This time it was much more effective. The Dow Jones Industrial Average fell more than 980 points on Friday, down 2.82%. Stocks have now fallen for four straight weeks, and the 10-year Treasury yield is at 2.904 and nearing 3%. The 5-year break-even rate fell to 3.37, which is still very high but heading in the right direction. It is the tightening of financial conditions that Powell needs.
One of the reasons breakevens may not move even further is that, by all indications, inflation continues to rise. The Beige Book was full of talk about companies facing even higher costs and successfully passing them on to their customers. Today’s flash composite Purchasing Managers’ Index (PMI) showed that service sector input inflation is at its highest level since data began to be collected over ten years old. Gasoline, fortunately, is down from a month ago, which could reduce some of the overall month-over-month gain. Used cars are likely headed down as well. But all other indications are that inflation is not peaking but is still gaining ground.
April showers, according to a simpler poem, bring May flowers. Or, for our purposes, the long-awaited jump in interest rates.