UPCOMING EVENTS:
Monday: US NAHB Housing Market Index.
Tuesday: PBoC Rate Decision, BoJ Rate Decision.
Friday: Japan CPI, US PCE.
Last week we got two important events: the US CPI and the FOMC Policy Decision. The CPI missed expectations and caused some risk-on in the market that lasted for a very short time as the market started to look forward to the FOMC Policy Decision. In fact, the market was right in being defensive going into the event. The Fed was more hawkish than expected and this hawkishness is depicted in three details:
· Following the miss in the CPI report, Fed members had the chance to revise the Dot Plot until Tuesday evening, so that is after the CPI report, BUT they chose not to do it.
· The Dot Plot showed an overwhelming consensus from the Fed members in hiking rates to 5% or higher and remaining higher for longer as no cuts are expected for 2023 and a 4.1% rate is expected in 2024.
· Fed Chair Powell sounded resolute in keeping at it and pushed back against expectations for rate cuts in 2023.
This resulted in risk-off across the board the day after. The thing is that the Fed cannot be confident in easing their policy until they have a strong view that inflation is indeed falling back to their 2% target. The key here may be the labour market as they continue to repeat that it’s extremely tight. They want to see the unemployment rate to pick up notably. The problem is that they always underestimate the eventual pain in the labour market as you can see in the chart below:
Chart from TS Lombard
So, in the end, this leads us to expect a deep recession coupled with a possible overtightening from the Fed. These two things are the very worst for risk assets and we should therefore see a flight to safety, which in the currencies space results in USD buying.
This week is all about a continuation from the previous one or a choppy price action as we head into Christmas Holidays.
Monday: We will see the latest NAHB Housing Market Index report. This index has fallen for 11 straight months and it’s sitting at the 33 level, which is way below the 50 neutral level that divides expansion from contraction. The housing market is sensitive to interest rates and it’s also a leading indicator for housing starts. This index is pointing to some really ugly things going forward. It’s expected to show a little increase to 36 from the 33 level, but since the fundamentals have not changed and the Fed wants to keep at it, the trend is still heavily skewed to the downside.
Tuesday: The PBoC is expected to hold the rates unchanged for both the 1Y LPR at 3.65% and the 5Y LPR at 4.30%. There’s a chance though that the 5Y LPR could be lowered as the current government policy is to support the economy. That may result in some very short-term risk-on sentiment but ultimately should be a fade as the whole world is heading into a deep recession with central banks still tightening.
The BoJ is expected to leave policy unchanged and maintain its dovish stance. There was also a report over the weekend that “Japan's government is set to revise a decade-old joint statement with the Bank of Japan (BoJ) that commits the central bank to achieve its 2% inflation at the earliest date possible”. With the revision, Prime Minister Fumio Kishida will aim at making the BOJ's 2% inflation target a more flexible goal with room for allowance, Kyodo reported. The new statement could remove the phrase "at the earliest date possible," or change the language to clarify that the 2% inflation target is a medium- to long-term goal rather than one that needs to be achieved quickly, Kyodo said. There’s some speculation in the market that once Governor Kuroda departs in April next year, the BoJ may start to exit its ultra-loose policy.
Friday: Japan CPI is expected to remain unchanged at 3.7% for the Y/Y headlinefigure and to edge up to 2.7% Y/Y from the prior 2.5% for the ex Food and Energy reading. The BoJ has been pretty much ignoring the rising inflation figures but since we are near the Fed peak in tightening and the BoJ may exit its ultra-loose policy as Kuroda departs, the JPY should have bottomed and a “buy on dips” as the global recession deepens.
The US PCE is expected to show a dip to 5.3% from the prior 6% for the headline Y/Y figure and a dip to 4.6% from the prior 5% for the Core Y/Y reading. The M/M figures are expected to show an unchanged reading of 0.3% for the headline reading and an increase of 0.4% for the Core reading. The PCE shouldn’t be a market-mover as we already got to see the CPI report and the FOMC repeated its commitment in keeping at it.
Wish you all a Merry Christmas and a Happy New Year!
This article was written by Giuseppe Dellamotta.
