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There are more and more signs of the market pricing the no landing scenario where the economy remains strong, and inflation remains sticky and persistent.
Not only are short rates increasing, but one-year breakeven inflation expectations are rising and approaching 3%, driven higher by the strong January employment report and yesterday’s CPI report.
In other words, the market is saying that inflation will be significantly higher in a year’s time than the Fed’s 2% inflation target. Put differently, instead of expecting a recession and lower inflation, short-term inflation expectations are rising and becoming unanchored.
In response to this, the Fed will have to be more hawkish to ensure that inflation expectations do not drift too far away from the FOMC’s 2% inflation target.
The bottom line is that high inflation and associated Fed hawkishness continue to be a downside risk to credit markets and equity markets.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Fed measures of financial conditions show that Fed hikes since March 2022 have been offset by a rising S&P500, tighter IG spreads, and tighter HY spreads, and overall financial conditions are now as easy as they were before the Fed started raising interest rates, see charts below.
With inflation still in the 4% to 6% range, the risks are rising that easy financial conditions will boost consumer spending, capex spending, and ultimately inflation. In other words, it looks like more Fed hikes are needed to get inflation all the way back to the Fed’s 2% inflation target.
Source: Federal Reserve bank of Kansas City, Bloomberg, Apollo Chief Economist. Note: A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Variables included are Treasury REPO Spread (spread between GCF REPO rate and three-month Treasury bill rate), Two-year swap spread (spread between two-year US interest rate swap rate and two-year Treasury yield), Spread between off-the-run 10-year Treasury yield and on-the-run 10-year constant maturity Treasury yield, Spread between Aaa corporate bond yield and 10-year constant maturity Treasury yield, Spread between Baa and Aaa corporate bond yields, Spread between High-yield Bond and Baa spread, Spread between fixed-rate credit card ABS yield and five-year constant maturity Treasury yield, Negative value or correlation between total return on S&P500 and total return on two-year Treasury bonds, Implied volatility of overall stock prices, Idiosyncratic volatility of bank stock prices, Cross-sectional dispersion of bank stock returns. 
Source: Federal Reserve bank of Chicago, Bloomberg, Apollo Chief Economist. Note: The NFCI provides a comprehensive weekly update on US financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems. The National Financial Conditions Index (NFCI) is a weighted average of a large number of variables (105 measures of financial activity) each expressed relative to their sample averages and scaled by their sample standard deviations. 
Source: Federal Reserve bank of St. Louis, Bloomberg, Apollo Chief Economist. Note: The index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. 
Source: FRB of New York, Apollo Chief Economist (Note: Corporate bonds are a key source of funding for US non-financial corporations and a key investment security for insurance companies, pension funds, and mutual funds). Distress in the corporate bond market can thus both impair access to credit for corporate borrowers and reduce investment opportunities for key financial sub-sectors. CMDI offers a single measure to quantify joint dislocations in the primary and secondary corporate bond markets. Ranging from 0 to 1, a higher level of CMDI corresponds with historically extreme levels of dislocation. CMDI links bond market functioning to future economic activity through a new measure. 
Source: Bloomberg, Apollo Chief Economist. Note: The Bloomberg Financial Conditions Index includes Ted Spread, Commercial Paper/T-Bill Spread, Libor-OIS Spread, Baa Corporate/Treasury Spread, Muni/Treasury Spread, High Yield/Treasury Spread, Swaption Volatility Index, S&P500 Share Prices, VIX Index. See important disclaimers at the bottom of the page.
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Weekly data for global air traffic is at the highest level in five years, see chart below.
Source: Flightradar24.com, Apollo Chief Economist See important disclaimers at the bottom of the page.
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BoJ purchases of JGBs to keep yields low are now bigger than Fed QT, and the result is that central banks are once again adding liquidity to global financial markets, which was likely contributing to the rally in equities and credit in January, see chart below. With YCC still in place in Japan, QE will continue to support global financial markets.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The charts below show that homebuilder confidence is starting to improve, traffic of prospective homebuyers has bottomed, and the number of homeowners going into foreclosure has peaked.
Consumer sentiment has bottomed, CEO confidence has bottomed, and car buying confidence is turning more positive.
The Fed’s own measure of the true Fed funds rate has peaked, and, perhaps most importantly, inflation expectations are rising again.
Combined with strong nonfarm payrolls, very low jobless claims, and the lowest unemployment rate in more than 50 years, the bottom line is that the US economy is starting to reaccelerate.
This is a problem for the Fed with inflation at 6.5%. The risks are rising that inflation will be sticky at levels well above the Fed’s 2% inflation target.
In short, the Fed will be raising rates more than the market is currently pricing and keeping rates higher for longer than the market is currently pricing.
Our daily and weekly indicators for the US economy are available here.
Source: NAR, Haver Analytics, Apollo Chief Economist 
Source: National Association of Homebuilders, Bloomberg, Apollo Chief Economist 
Source: FRBNY Consumer Credit Panel, Equifax, Haver Analytics, Apollo Chief Economist 
Source: University of Michigan, Haver Analytics, Apollo Chief Economist 
Source: The Conference Board, Haver, Apollo Chief Economist 
Source: Bloomberg, Apollo Chief Economist 
Source: Bloomberg, Apollo Chief Economist. Note: Source: Monthly series of the proxy funds rate, from Doh and Choi (2016) and Choi, Doh, Foerster, and Martinez (2022). This measure uses public and private borrowing rates and spreads to infer the broader stance of monetary policy. When the Federal Open Market Committee uses additional tools, such as forward guidance or changes in the balance sheet, these policy actions affect financial conditions, which the proxy rate translates into an analogous level of the federal funds rate. The proxy rate can be interpreted as indicating what the federal funds rate would typically be associated with prevailing financial market conditions if these conditions were driven solely by the funds rate. 
Source: University of Michigan, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The most important feature of the no landing scenario is that inflation continues to be a problem, and the evidence is accumulating that inflation will indeed remain more persistent for the following ten reasons:
1) Fed measures of inflation persistence have stopped declining, and are moving sideways at levels around 4% to 6%, see the first chart below.
2) The housing market is starting to bottom and we are entering the spring selling season, and this will boost the shelter component of the CPI, see the second and third chart below.
3) The labor market is not showing any signs of slowing down, nonfarm payrolls is strong, the work week is increasing, the participation rate is rising, jobless claims are very low, job openings are near all-time highs, and the unemployment rate is at the lowest level in more than 50 years.
4) Used car prices have bottomed and are starting to move higher.
5) With a strong labor market and auto demand coming back, motor vehicle insurance inflation will stay strong.
6) Revenge travel continues to drive airline ticket prices higher, and travel demand remains very strong, see also here.
7) China reopening will boost prices of energy, food, iron, steel, and copper over the coming quarters, putting upward pressure on US inflation.
8) We will continue to see strong inflation in food and food away from home driven by strong restaurant demand, high wage inflation, and higher commodity prices.
9) There are capacity issues in the food and energy sectors, which will put upward pressure on inflation.
10) Financial conditions are easier than when the Fed began to raise rates, and capital markets are starting to reopen, boosting consumer spending, hiring, and ultimately inflation.
The bottom line is that the risks are rising that inflation will be sticky at the 4% to 6% level and may even reaccelerate over the coming months.
The next data point is the CPI release next Tuesday, where the consensus expects January core inflation to come in at 5.5%, down from 5.7% in December. The Cleveland Fed expects core inflation to come in at 5.6%, see also here. All these numbers are significantly above the Fed’s 2% inflation target, and the slow speed with which they are moving down toward the Fed’s 2% inflation target also points to inflation being sticky at higher levels.
If inflation stays high, it will bring back the trading environment we had in 2022 because equity and credit markets will conclude that the Fed has not succeeded yet with getting inflation down to 2%, and rates therefore need to go higher to generate more demand destruction.
In short, it is too early for the Fed to declare victory over inflation, and markets should be paying attention.
Source: FRBNY, Atlanta Fed, Haver Analytics, Apollo Chief Economist 
Source: NAR, Haver Analytics, Apollo Chief Economist 
: Source: National Association of Homebuilders, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Central banks buy gold to diversify their reserves, for example when some currencies in their portfolios have appreciated significantly, and investors buy gold when uncertainty is high to protect themselves against falling asset prices, high inflation, or geopolitical risks, see charts below.
Source: Bloomberg, Apollo Chief Economist 
Source: IMF, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Investors have been underperforming their benchmarks because they entered 2023 underweight equities, expecting a slowdown that still hasn’t happened, see chart below.
Source: Federal Reserve Bank of Philadelphia, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Subprime credit quality is starting to deteriorate, but the big picture is that wage growth is high, and job growth is strong, particularly in service sector jobs in leisure and hospitality. Combined with a high level of savings in the household sector, this continues to support consumer spending, see charts below. These strong tailwinds to consumer spending increase the risk that inflation will become more persistent. Expect Fed Chair Powell’s speech today at noon to be very hawkish.
Source: Bloomberg, Apollo Chief Economist 
Source: FRB, Haver Analytics, Apollo Chief Economist 
Source: Transunion Monthly Industry Snapshot December 2022 
Source: BLS, Haver, Apollo Chief Economist See important disclaimers at the bottom of the page.
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With the risk of a no landing scenario rising, the Fed will remain hawkish for longer, and that will keep credit markets volatile over the coming quarters, see also our credit market outlook available here.
See important disclaimers at the bottom of the page.
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