Christine Lagarde's Stance Unshaken: European Equities Forge Ahead Despite Monetary Policy Hurdles
But Conditions Remain Challenging
Summary
News broke this week that hedge funds are holding record short Treasury exposure right now.
Central bank president Christine Lagarde said this week that monetary policy “still has a bit of a way to go” to get back to the 2% target.
That hasn’t stopped European equities from enjoying a nice run here.
News broke this week that hedge funds are holding record short Treasury exposure right now. To hold a short position in Treasuries right now, you have to believe to some extent that either a) inflation is still a problem and might be for a while yet or b) the markets are overconfident that rate cuts are coming in the 2nd half of the year, if at all. If there’s a perfect example of the crowd thinking it knows an unknowable future, this might be it. I think it’s likely that the Fed has already overtightened and any further tightening, such as the rate hike we’re almost certain to see at the May meeting, will only extend the impact that has yet to even show up in the economy.At some point soon, the Fed is going to be forced to acknowledge that the U.S. economy is heading towards contraction (lumber, housing, jobless claims and manufacturing are already signaling it) and that should force Powell to loosen. Once Treasuries are free from the impact of the Fed, conditions favor a potentially significant rally in long-dated government bonds. The mood started shifting last week towards Treasuries again and it could be set to continue.
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The one thing perhaps working in favor of the inflation hawks is the latest home price data. For the first time since June 2022, the Case Shiller Home Price Index rose compared to the prior month. The index was up 0.2% compared to expectations for a 0.7% decline. After seven straight months of declines, we need to see if this is a blip or the beginning of a new uptrend. It would seem counterintuitive that prices are rising given that lumber continues to push lower and housing starts have declined in 8 of the past 11 monthly readings. It could get Powell thinking more about sticky inflation again and maybe provide some fuel for the “higher for longer” argument. Given everything we know, I suspect it’s more likely that this is a one-off reading.
I’m going to be very interested to hear what Powell says at next week’s meeting. The market is expecting rate cuts in the 2nd half of the year, but the Fed has been notoriously stubborn about making any dovish connotations. The expected path of rates came way down following the failures of Silicon Valley Bank & Signature Bank. With First Republic now restructuring its balance sheet to remain alive, it’ll be interesting to see if the Fed sees banking sector risks as isolated or still a potential red flag. Risk assets might be in a tough spot here. If Powell remains hawkish because he thinks inflation isn’t finished, risk assets could sell off. If he’s inclined to turn more dovish because he’s worried about the financial sector, risk assets could also sell off like they did in March.
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