What Energy Prices Mean for the Next Fed Decision

SPEAKER_1 (0:00)

Okay, let's move back to the macro and some of the information we've got this morning and what's happening with the treasury market with Thierry Wizman, global FX rate strategist over at Macquarie Group. Thierry, good morning to you.

Let's just talk about what we got via the way the ISM manufacturing. Obviously, a cooler than expected PC print yesterday, but hot prices paid at the factory gate. I'm just wondering what your read is right now on the story that the markets are telling because it seems to be driven by a sell-off on the long end. We've got the 30 year, the 10 year picking up, the two year edging lower. What does that tell you?

Thierry Wizman (0:41)

Well, I think it tells us that the things that have been causing the long-term bond yields to rise in the last few months are just continuing and the focus could be on inflation. Maybe it should be on inflation, but that's not the only story certainly. The other big story in the bonds world is that there has been a flood of issuance from the government because of a high deficit, but especially from corporations, hyperscalers in particular, that are trying to finance their infrastructure buildout, their AI-driven infrastructure buildout. So as long as you have both the government issuing a lot and corporations issuing a lot, we're going to see higher yields and they may stay high as long as the prospect for rates of return on these AI projects are high.

This is not bad news. This is simply saying that companies are investing, they need to borrow, and they're competing with the government for the private sector saving.

As far as inflation goes, we've had mixed signals. We've had this PCE price index print yesterday that was lower, but mainly because of revisions in methodology and source data. It wasn't necessarily because inflation actually came down in the US relative to where it was before. I would put a little more credence, a little bit more weight in the high frequency indicators that we're getting now, like the prices paid index, because that's telling us what's happening in underlying prices and wholesale prices and materials prices, and eventually that will feed through into final consumer prices. Oil prices have been high, food prices have been rising. Those are the two most prominent spikes that we've seen at the wholesale level.

SPEAKER_1 (2:25)

So what do you suspect the Fed should do next then?

Thierry Wizman (2:29)

Well, it's very possible that Kevin Warsh will show up at the October meeting with the rest of his committee members and say, look, I told you we needed to wait until October before we did anything because we were going to see these big revisions in the PCE price index.

He may do an I told you so and say, you owe me one, so let's just stay on hold in October. That is possible. In fact, the market has now been moving from believing that there will be an October hike to believe that there will not be an October hike. But I want to be very clear here. The October meeting is late in the month. We are still four weeks away from that.

Given the situation in the Persian Gulf, given the situation with El Nino and the prospect for drought situations to continue, especially in the US., we may see further spikes upward in raw material prices. And then they're going to have a conundrum. They're going to say, yes, we have a PCPI that has not been trending as high as we thought, but at the same time, the last few weeks have shown that we need to be cautious about the prospect for higher retail price inflation. And they may again conclude that they need another hike. I would say watch what's happening with energy prices and watch what's happening with food prices. That will be the ultimate determinants of whether or not we go back to thinking that October will see a hike.

SPEAKER_1 (3:48)

Right. I mean, for now, at least, the markets have been backing out their rate hiking expectations. I mean, particularly off the back of what we got yesterday, we got down to what 35 percent probability for October. I know that Goldman pushed their October chance out to December. We are looking at the probability of a hike for that month at almost 90 percent at this stage. So markets still currently pricing at least another one before we see the end of the year. So we've got a little bit more information to come, as you say, before that October meeting, which falls late in the month, that being the jobs tomorrow. And then I believe the CPI falls on the 14th.