Trading insights: The calm before the storm

China’s reportedly targeting high GDP growth while the US economy is picking up steam again. In response, central banks are promising to hike even further and hold rates at high levels as they do battle with sticky inflation. Is this the calm before the storm?

Let’s revisit a chart that we highlighted a couple of weeks ago in CPI, FedSpeak Raise Odds Of Higher For Longer Policy

It looks complicated. Really it’s just the futures implied pricing of US cash interest rates. Things have drastically changed over the past 30 days. Contrast the green line (30th January pricing) with the blue/yellow line (current pricing).

The market is becoming more comfortable with the higher for longer view. Recent data has come in stronger than expected, especially in the US (and China’s big PMI beat on Wednesday), reinforcing the view that although the economy is strong, rates will continue to rise, and stay there.

Obviously, this interest rate repricing is a representation of the best guess. Rate traders could be just as wrong about this path as they were a month ago. Markets are constantly parsing probabilities. That’s (at least in part) why they move.

Is the higher rates regime weighing on stocks? A couple of weeks ago we pondered if this change could see the next leg lower for the S&P 500, especially as Goldman Sachs highlighted how positioning data had evolved to a more neutral stance.

If Goldman Sachs is correct, this imbalance has likely been corrected now, possibly leaving markets with a neutral or long positioning bias.

Which opens the door to a question… How will the S&P 500 respond to more hawkish central bank rhetoric and the inflation picture?

If we’re to believe that ‘non-macro’ flows have perhaps pinned price around current levels, then will the macro start to impact markets again, perhaps pushing the stock index down to the 200 day moving average and a retest of the trendline in the 3950 area?

The market gave a resounding answer.

Before:

After:

So, can the global economy outgrow this monetary tightening?

That’s a key question going forward. China remains out of sync with the West. The Chinese economy is just reopening after Covid lockdowns and further stimulus is expected.

After the strong PMI data on Wednesday, ING analysts expect a high growth target:

We believe that the government will set a GDP growth target of 5.5% to 6% at the Two Sessions on 5 March. This set of PMI data gives the government a very good reason to set a high growth target. Even though the recovery is on track, this year will not be easy with the central government requiring local governments to grow their economies with high-quality growth prospects in mind.

The effect on the global economy is unknowable. Some will argue that the full return of production will aid the disinflationary path, while others believe the increased demand for raw materials and services will prove inflationary.

It looks as if the fight between inflation and growth could have a few rounds left in the tank yet…