Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Macro Digest: US March CPI release and the complacent market backdrop.
Steen Jakobsen
Chief Investment Officer
Summary: A look at the US March CPI release on Wednesday, the reaction function and the variety of market scenarios that investors are juggling, from an incoming recession to surprisingly stubborn inflation and even an extension of the current expansion cycle. What is absent, however, is any sufficient level of concern on how these scenarios could play out.
The US March CPI is on tap for Wednesday, April 12. Bloomberg consensus expectations for core inflation are +0.4% MoM and +5.6% YoY. SaxoStrats see the reading more likely at 0.4% and +5.7% YoY.
The main drags of late on inflation have come at the core from falling used car prices (down nearly -9% last four months and -13.6% YoY as of February) and in headline inflation from gasoline (down -2.0% YoY in Feb despite Russian invasion just over a year ago) and of late natural gas prices (down -5% over the last five months to Feb. before another large drop in spot natural gas prices in March.) Upside contributors for both core and headline have come from transportation services, electricity, food and the notoriously lagging and heavily weighted Owner Equivalent Rent (OER: up 8.1% YoY in February).
In the consensus view, a decelerating the next few months should continue to see 0.3-0.4% and resulting in an end-of-year 3.7% CPI (Core) in the consensus view.
SaxoStrats don’t share this view as we expected the energy component to swing positive in the second half of this year, meaning that all of the hoped for moderation of inflation would have to come from the OER falling quickly, something we see unfolding more slowly than the market does.
The market is extremely complacent. The Q1 trading range was a modest sub-10% despite the banking turmoil, which may have actually helped the market climb the wall of worry on the sharp drop in yields as Fed hike expectations were quickly reduced after the early March Silicon Valley Bank collapse. This market is a trader’s market with no direction or conviction. Looking at the mere facts: Here using my own 4-Factor model, which makes it pretty clear where the strong Q1 snapback performance came from: Financial conditions are over-easy after the March banking turmoil scare. Bond volatility is back to its long-term average and Dollar and the Fed next 18 months are both hitting YTD lows.
But remember this is due to the majority of market players “betting” that a recession will happen in the second half of this year. We continue to fade both that trade and inflation falling persistently below 4%.
Overall, market participants seem to be weighing three scenarios (Source: Goldman Sachs)
GS surveyed 1000 institutional managers and got the following top three choices for the most prominent regime for now:
- Sticky Inflation: 21%
- Recession: 36%
- US Cycle Extension: 24%
Conclusion: We remain closer to the base case of sticky inflation than the other two scenarios, but don’t really buy into the cycle calls here as we want to be flexible. A sticky inflation outlook in theory means we should remain long commodities (oil and gold), short the US dollar and short equities (we are neutral on equities in SaxoStrats).
Bigger macro piece is coming later this week…
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