UPCOMING EVENTS:
Wednesday: BoJ Policy Announcement, US Retail Sales, US PPI, US NAHB.
Thursday: US Jobless Claims, Fed’s Brainard.
Last week didn’t offer much in terms of surprises as the Fed Chair Powell didn’t touch on monetary policy or on the latest set of data and the US CPI was basically bang on expectations.
What keeps on beating expectations is the labour market data. The US Jobless Claims keep on showing strength and that’s something that won’t give the Fed much confidence in stopping with their rate hikes plan. Given the recent developments in inflation though, the Fed is expected to deliver a 25 bps hike in February.
The market keeps on showing a positive mood despite the latest PMI data. This looks like a “Suckers Rally”. It may be a combination of falling inflation with a resilient labour market and China reopening, with the latter possibly being a negative if it raises inflationary pressures via commodities.
Even if the Fed downshifted to a 25 bps rate hike pace, it will still hike by another 50/75 bps bringing the terminal rate to 5%. The 2 year Treasury yields rarely trade below the Fed Funds rate, and when it does so it’s because the market expects rate cuts soon.
These rate cuts may come and be bigger than expected because the Fed, despite the big weakening in leading indicators, hikes till their projected terminal rate in the 5% region and stays there for too long because the labour market doesn’t show meaningful cracks.
They projected 4.6% in unemployment rate in 2023 with a terminal rate of 5.1%. They may very well stay at 5% until the unemployment rate converges with their projections, but in that case, it will be too late as the recession will deepen.
Wednesday: The BoJ is expected to keep its policy unchanged with the rate remaining at -0.10% and the YCC to flexibly target 10yr JGB yields at 0%. There is though a risk of a hawkish surprise given the recent developments in Japan. First of all, the BoJ surprised in December by increasing their YCC band to +/- 50% from the previous +/-25%. That caused a huge bid in the JPY.
Then we got reports of a possible adjustment to Abe-era deflation fighting mandate. Finally, persistent reports of BoJ boosting its inflation forecasts at the meeting and a review of the side effects of its easing. In the chart below you can see the major catalysts that led the USD/JPY pair to fall by more than 1900 pips.
US Retail Sales are expected to show again another decline with the Control Group seen at -0.2% and the headline number at -0.8%. High inflation, rising interest rates and recession fears are all big headwinds for the consumer and the worse is yet to come.
US PPI is expected to show another decline across the board with the headline Y/Y number coming at 6.8% from the prior 7.4% and the M/M reading seen at -0.1% from the prior 0.3%. The Core Y/Y number is seen at 5.9% from the prior 6.2% and the M/M reading is expected at 0.1% from the prior 0.4%. Inflation has clearly peaked and the market knows that, but there’s too much complacency on the growth side in my opinion with leading indicators pointing to a bad recession.
The US NAHB is expected to remain unchanged at 31. It’s been falling like a rock since January 2022 as one of the fastest monetary policy tightening impacted heavily the US housing market. This trend is set to continue and it’s very likely that the 2020 trough will be breached soon.
Thursday: US Jobless Claims are seen at 212K and Continuing Jobless Claims at 1655K. As mentioned at the beginning of the year, the labour market data should now be more important for the market than the inflation data. The Fed wants to see a higher unemployment rate, so it won’t ease if the labour market keeps showing strength. Maybe the next big risk off wave will start only when we’ll see weakness in jobless claims or NFP data.
This article was written by Giuseppe Dellamotta.
