• The two-day FOMC meeting ends today; financial conditions are the loosest since mid-August; we believe the current Fed narrative remains too dovish; new forecasts will be released; November CPI data were certainly welcome but really shouldn’t impact today’s decision; Brazil President-elect Lula is testing the market’s patience
  
• Reports suggest the ECB’s updated inflation forecasts will remain above target through 2025; U.K. reported softer November CPI data; Sweden November CPI is still running hot
  
• Japan reported weak October core machine orders; the Q4 Tankan survey was mixed; reports suggest the BOJ is open to a policy review next year; New Zealand reported Q3 current account data; the New Zealand government issued new macro forecasts; reports suggest China will proceed with its key economic policy meeting tomorrow

The dollar is modestly lower ahead of the FOMC decision. The dollar tends to weaken on FOMC decision days. DXY has fallen five of the past six decision days and seven of the past nine. Indeed, DXY is down for the second straight day and trading near 103.808 and is on track to test the mid-June low near 103.418. The euro is trading just below yesterday’s new cycle high near $1.0675 and is on track to test the June 9 high near $1.0775, while sterling is trading flat near $1.2375 after soft November CPI data (see below). USD/JPY is trading just below 135 and a clean break of its 200-day moving average near 135.35 today sets up a test of the August 2 low near 130.40. While we still believe the fundamental outlook favors the dollar, we acknowledge that near-term dollar weakness is likely to continue until the Fed narrative shifts again. Today’s FOMC decision will be key.

AMERICAS

The two-day FOMC meeting ends today. WIRP suggests that a 50 bp hike is fully priced in, with only around 5% odds of a larger 75 bp move. The swaps market is still pricing in a peak policy rate near 5.0%, with no longer any odds of a higher 5.25% peak. Looking ahead, WIRP suggests around 33% odds of a 50 bp move February 1 along with one last 25 bp hike on either March 22 or May 3 that would see the target range peak at 4.75-5.0%. As always, Powell’s press conference is key and we expect a more hawkish tone than what he delivered to the Brookings Institution last month. Why?

Financial conditions are the loosest since mid-August. Recall that after the Fed’s July 27 decision to hike rates 75 bp, the markets perceived a dovish tilt and subsequently took risk assets higher, with the S&P 500 gaining nearly 10% to its August 16 peak near 4325. Powell then put the hammer down with his short, sharp, and hawkish Jackson Hole speech August 26, after which the S&P 500 sank nearly 20% to its October 13 low near 3492. Since that low, that index has risen over 15% due to renewed hopes of a Fed pivot, leading to much looser financial conditions. Perhaps it is time for Powell to put the hammer down again.

We believe the current Fed narrative remains too dovish. With both AHE and core PCE flat-lining near 5% for most of this year, we don’t think the market’s expected tightening path will get inflation back to target, not when the labor market remains so firm and consumption is holding up. Furthermore, the swaps market continues to price in an easing cycle in H2 2023. This seems highly unlikely and so the mispricing continues. Markets are absolutely positioned for a dovish pivot today but we think it is too soon for that. As so many Fed policymakers have stressed, they will not react to one or two data points but rather the entirety of the situation.

New forecasts will be released. Updated macro forecasts are likely to move closer to market consensus for higher inflation, slower growth, and higher unemployment. Powell has already confirmed that we will see a hawkish shift the December Dot Plots. How hawkish? We believe the 2023 plot is likely to move up to 5.125% from 4.625% in September, which is more hawkish than market expectations for a move to 4.875%. 2024 is tricky but we would expect a move up to 4.625% from 3.875% in September, signaling some easing from a higher peak but not by a lot, while 2025 should move up to 3.625% from 2.875% in September. These are also more hawkish than market consensus but we think they would underscore the Fed’s ongoing message that rates will stay higher for longer, a message that the markets continue to ignore.

The November CPI data were certainly welcome but really shouldn’t impact today’s decision. Headline came in at 7.1% y/y vs. 7.7% in October, while core came in at 6.0% y/y vs. 6.1% expected and 6.3% in October. Both continue to decelerate from the peaks. However, as we’ve noted countless times, getting inflation from 9% down to 4% is the easy part. Getting it from 4% down to 2% is the hard part and will undoubtedly involve much pain. Stay tuned. November import/export prices are the only data to be reported today.

Brazil President-elect Lula is testing the market’s patience. After naming leftist Haddad as his Finance Minister, Lula has now appointed leftist Mercadante to head up the nation’s development bank BNDES. Both Haddad and Mercadante are heavy hitters in the Workers’ Party and support the growing realization that Lula 2.0 may turn out to be quite different from Lula 1.0. Fiscal policy is becoming a growing concern for investors and policymakers. Minutes from the recent COPOM meeting noted that “The Committee evaluated that changes in parafiscal policies or the reversal of structural reforms that lead to a less efficient allocation of resources might reduce the power of monetary policy,” adding that policymakers discussed “extensively” the impact of “different fiscal scenarios” on asset prices, inflation expectations, and neutral interest rates. Lula inherits a surprisingly solid fiscal position despite outgoing President Bolsonaro’s pre-election spending spree.

EUROPE/MIDDLE EAST/AFRICA

Reports suggest the ECB’s updated inflation forecasts will remain above target through 2025. Unnamed official said the 2024 forecast will be “comfortably” above 2% while 2025 will be added to the forecast horizon and will be “just” above 2%. No word on the growth forecasts but we suspect they will be modestly downgraded. The bank is expected to hike rates 50 bp to 2.5% tomorrow. WIRP suggests a 50 bp hike is fully priced in, with nearly 15% odds of a larger 75 bp move. Elsewhere, the swaps market is still pricing in a peak policy rate near 3.0%, down from 3.5-3.75% after the October decision. Of course, President Lagarde’s press conference will be key and she is likely to signal another hike at the next meeting February 2. Ahead of the decision, Elderson speaks today. After the decision, Holzmann and Centeno speak Friday.

The U.K. reported softer November CPI data. Headline came in at 10.7% y/y vs. 10.9% expected and 11.1% in October, core came in at 6.3% y/y vs. 6.5% expected and actual in October, and CPIH came in at 9.3% y/y vs. 9.6% expected and actual in October. The data come right before the Bank of England meets tomorrow and we think it cements a 50 bp hike to 3.5%. WIRP suggests a 50 bp hike is fully priced in, with only 15% odds of a larger 75 bp hike, while the swaps market is now pricing in a peak policy rate near 4.5%, down sharply from 6.25% right after the mini-budget in late September. Updated macro forecasts won’t come until the February 2 meeting.

Sweden November CPI is still running hot. Headline came in a tick lower than expected at 11.5% y/y vs. 10.9% in October, CPIF came in a tick lower than expected at 9.5% y/y vs. 9.3% in October, and CPIF ex-energy came in two ticks lower than expected at 8.0% y/y vs. 7.9% in October. Targeted CPIF nearly reversed October’s drop from the 9.7% peak in September and moves it further above the 2% target. At the last policy meeting November 24, the Riksbank hiked rates 75 bp to 2.5%, as expected. The bank noted that “The forecast shows that the policy rate will probably be raised further at the beginning of next year and then be just below 3%.” Minutes from the meeting showed Governor Ingves and Deputy Governor Ohlsson had doubts as to whether planned rate hikes would be enough to tame inflation. Next policy meeting is February 9 and will be led by incoming Governor Erik Thedeen after Ingves’ term ends December 31. WIRP suggests another 50 bp hike to 3.0% is fully priced in along with 75% odds of a larger 75 bp move, while the swaps market is pricing in a peak policy rate near 3.25%.

ASIA

Japan reported weak October core machine orders. Orders came in at 0.4% y/y vs. 1.5% expected and 2.9% in September. This comes just a day after November machine tool orders came in at -7.8% y/y, the weakest since September 2020. The growing weakness in orders suggests IP and exports will weaken in the coming months. November trade data will be reported tomorrow and exports are expected at 19.7% y/y vs. 25.3% in October.

The Q4 Tankan survey was mixed. Large manufacturing index came in at 7 vs. 7 expected and 8 in Q3, while large non-manufacturing index came in at 19 vs. 17 expected and 14 in Q3. Elsewhere, large manufacturing outlook came in as expected at 6 vs. 9 in Q3, while large non-manufacturing outlook came in unchanged at 11 vs. 15 expected. All-industry capex came in at 19.2% vs. 20.7% expected and 21.5% in Q3. Bottom line: manufacturing continues to weaken while non-manufacturing is holding up better. Both remain at risk, however, and so the Bank of Japan remains on hold for the time being. Next policy meeting is December 19-20 and no change is expected then.

Reports suggest the Bank of Japan is open to a policy review next year. However, officials warned that the need to monitor developments in domestic wages and global growth make any review unlikely before the end of Governor Kuroda’s term in April. Specifically, officials said they want to see preliminary results of the annual spring wage negotiations, which typically occur mid-March. Of note, Kuroda’s final policy meeting is set for March 9-10. As we have long felt, any change to the bank’s current policy will most likely be done under Kuroda’s successor and the likely timing of the review reflects that.

New Zealand reported Q3 current account data. The deficit came in a tick better than expected at -7.9% of GDP vs. -7.7% in Q2 but was still the widest on record dating back to 1987. GDP data will be reported tomorrow. Growth is expected at 0.9% q/q vs. 1.7% in Q2, while the y/y rate is expected at 5.5% vs. 0.4% in Q2. For now, the robust economy and ongoing price pressures should keep the RBNZ on its tightening path. WIRP suggests a 50 bp hike to 4.75% February 22 is priced in, with nearly 55% odds of a larger 75 bp move. The swaps market is pricing in a peak policy rate between 5.25-5.5%.

The New Zealand government issued new macro forecasts. The Treasury Department forecast in its Half-Year Economic and Fiscal Update that GDP will contract for three quarters starting from Q2 2023, with an overall contraction of -0.8% seen for all of 2023. Finance Minister Grant Robertson warned that “The global economy is headed for a rough ride over the next year, and New Zealand will not be immune from the impact of that. We face this with a strong starting point. We prepared ourselves for this slowdown with careful fiscal management.” This is a weaker forecast than the RBNZ’s latest from November, which sees the economy growing (barely) in 2023 and 2024. Updated forecasts will come at the bank’s next meeting February 22.

Reports suggest China will proceed with its key economic policy meeting tomorrow. Earlier reports suggested that the Central Economic Work Conference in Beijing would be delayed due to a spike in Covid infections after restrictions were lifted. The conference is held every December so that senior officials can determine the economic outlook, targets, and policies for the upcoming year. November data earlier this week showed a pickup in new loans and aggregate financing but both remain at relatively low levels for the year. We suspect more stimulus will be seen in the coming weeks as the economy struggles with higher infections.