UPCOMING EVENTS:

Thursday: US CPI

The last week we finally got the FOMC Policy Decision. The statement leant on the less hawkish side mentioning that “the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”. The market interpreted that as a hint to a slower pace of hikes as the Fedwatcher Nick Timiraos has mentioned in his WSJ article the week prior the FOMC meeting.

The market reacted positively to such development, and we saw risk rally across the board and the USD getting offered. What ended the party was the Press Conference where Powell sounded very hawkish. There are three takeaways that Nick Timiraos highlighted:

1) The Fed could step down to a slower pace in December even if inflation data don't improve much.

2) If there had been new estimates of the terminal funds rate released, they would have moved up.

3) Not ready to talk about a pause.

And then adding some key lines from Powell:

"The question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive."

“The risks are asymmetric. If the Fed does too much, it can cut. If it doesn’t tighten enough, then you’re in real trouble.”

"It is very premature to be thinking about pausing...Very premature."

Maybe the Fed wants to slow the pace of hikes but to counteract the likely easing in financial conditions it can keep on raising the terminal rate. I’d say that considering how the market is forward looking, the Fed here is taking a gamble by slowing the pace of hikes when inflation data has not yet shown meaningful improvement, even though forward-looking indicators are signalling moderation in price pressures. The risk is that the market looks more at the slower pace of hikes than the higher terminal rate and financial conditions ease anyway.

Maybe we already got a taste of that on Friday when, after the NFP report, the market rallied, and we saw a big USD dump. Some say it was because of a higher unemployment rate and some other citing China reopening rumours. The former is said to be a noisier data compared to payrolls figure (which beat expectations), and the latter should be seen as more inflationary rather than being good news.

This week will be all about the US CPI on Thursday. The report is expected to show an increase of 0.7% M/M from the prior 0.4% and a little dip to 8.1% for the Y/Y figure from the prior 8.2%. For the Core figures the expectations are for a 0.5% M/M, down from the prior 0.6% and 6.6% Y/Y which would match the prior reading. The market is currently split on the likely rate increase in December between 50 bps and 75 bps. This report may not be as important as the one coming days before the December FOMC meeting, but another hot report should be negative for risk sentiment and see the USD being bid. On the other hand, a soft report may see risk rally and USD getting offered.

Stanley Druckenmiller, who began his career in financial markets back in the 70s and traded successfully through many cycles, had this to say back in June:

“We’ve never had a soft landing after inflation has got above 4.5%.”

"Once inflation gets above 5%, it’s never come down unless the Fed Funds rate is higher than the CPI."

"Once inflation gets above 5%, it’s never been tamed without a recession."

The market prices a terminal rate of 5.00-5.25% in Q2 2023 and just for context the market priced just 75 bps worth of hikes in 2022 back in 2021, and we are already at 400 bps. The market is not always right.

This article was written by Giuseppe Dellamotta.