- The two-day FOMC meeting ended with the expected 25 bp hike; cracks in the hawkish façade came in the Q&A; Powell did not push back at all against the current looseness in financial conditions nor did Powell push back against dovish market expectations of Fed policy; ADP came in lower than expected ahead of January jobs data tomorrow; the labor market picture will be rounded out by a bunch of data today
- The ECB is expected to hike rates by 50 bp; Germany reported very weak December trade data; the BOE hiked rates by 50 bp, as expected; Czech Republic is expected to keep rates steady at 7.0%
- BOJ Deputy Governor Wakatabe signaled no near-term policy changes; Korea reported higher January CPI
The dollar is soft in the wake of the FOMC decision. DXY is down for the third straight day and trading near 101.094, the weakest since last April. The late April low near 99.818 is the next target and after that is the late March low near 97.685. The euro traded as high at $1.1035 earlier today but is back near $1.10 ahead of the ECB decision (see below). The euro tends to weaken on ECB decision days. In 2022, it weakened against USD on six of the eight decision days. It is trading flat ahead of the decision and the March 1 high near $1.1185 is the next target. After a brief spike higher, sterling is trading back below $1.23 after the BOE decision (see below) and it is likely to continue underperforming due to the negative fundamental backdrop. USD/JPY is trading lower near128.70 despite BOJ signal of no near-term policy changes (see below). Given Powell’s rather uninspiring message yesterday (see below), dollar weakness looks set to continue. We had been hoping for a more hawkish message from the Fed that would help the dollar get more traction but we got the exact opposite.
The two-day FOMC meeting ended with the expected 25 bp hike. In its statement, the Fed said that ongoing rate hikes will be appropriate as inflation has eased somewhat but remain elevated. It added that it will consider the extent of future rate hikes, meaning that this downshift to 25 bp means the Fed is still trying to figure out how high it needs to go. The Fed said job gains have been robust and unemployment remains low, but added that recent data suggest modest growth in spending and production. So far, so good.
Chair Powell initially echoed these views at the press conference. In his opening statement, he said the Fed will need to stay restrict for some time as the labor market remains extremely tight. He added that the Fed will need substantially more evidence of weaker inflation and that it will “stay the course” until its job is done. Powell noted that shifting to a slower pace allows the Fed to better assess its progress.
The cracks in the hawkish façade came in the Q&A. He said the Fed will move rates beyond the December projections if needed, adding that policy is not yet sufficiently restrictive whilst stressing that the Fed has no incentive nor desire to overtighten. This sounded quite equivocal. Powell also played up recent disinflation, noting that it was “gratifying” to see the process under way and seeing progress on lowering inflation without any weakening in the labor market. He seems confident that the Fed can get inflation back to target without causing a deep recession, which seems to us like he’s declaring victory a bit early. Indeed, we get the sense that the Fed is getting a bit too cocky and is drinking the same Kool-Aid as the market is. We just don’t think it’s going to be this easy.
When asked, Powell did not push back at all against the current looseness in financial conditions. He spoke about the Fed focusing on sustained changes in financial conditions but did not use the opportunity to say that the current loosening was unwarranted. We note that through last Friday, financial conditions as measured by the Chicago Fed were the loosest since mid-April, with its adjusted measure the loosest since mid-February. Given the market reaction to the FOMC decision, that means conditions will loosen even more.
Nor did Powell push back against dovish market expectations of Fed policy. When asked about the divergence between the Fed view (Dot Plots) and the market view, Powell simply shrugged it off and said this was due to differences in the inflation forecasts. He said if inflation deviates from its forecasts and moves closer to market expectations, the Fed will adjust policy accordingly. Powell presented such a muddled message that the markets are hearing what they want to hear. And we know that markets were totally positioned for a less hawkish Fed. If one reads between the lines, Powell seems to be putting a lot of weight on the recent disinflation and as we've pointed out before, getting inflation from 8% to 4% is the easy part. The hard part is getting it from 4% to 2% and if inflation proves stickier, will the Fed keep hiking? The jury seems to be out on this. WIRP suggests only 80% odds of a 25 bp hike at the next meeting March 21-22 and less than 25% odds of one last 25 bp hike June 13-14. Not surprisingly, the swaps market is still pricing in an easing cycle in H2.
Yields have fallen sharply as a result. The 2-year yield is trading near 4.11%, barely above the January low near 4.03%, while the 10-year yield is trading near 3.41%, barely above the January low near 3.32%. The S&P 500 is trading at the highest since August, while DXY is trading at the lowest since April. Whether or not he planned it, Powell is single-handedly responsible for another leg in these market moves that will ultimately lead to even looser financial conditions.
ADP came in lower than expected ahead of January jobs data tomorrow. ADP came in at 106k vs. 180k expected and a revised 253k (was 235k) in December. Consensus for NFP sees 190k jobs added vs. 223k in December, with the unemployment rate seen up a tick to 3.6% and average hourly earnings at 4.3% y/y vs. 4.6% in December.
The labor market picture will be rounded out by a bunch of data today. January Challenger job cuts, Q4 unit labor costs, and weekly jobless claims that will all be reported. Unit labor costs are expected to slow to 1.5% vs. 2.4% in Q3, with productivity expected to rise to 2.4% vs. 0.8% in Q3. Initial claims are expected at 195k vs. 186k last week, while continuing claims are expected at 1.684 mln vs. 1.675 mln last week. Yesterday, JOLTS data for December came in at 11.01 mln vs. 10.3 mln expected and a revised 10.44 mln (was 10.458 mln) in November. All in all, the labor market remains tight and it’s hard to see how wage pressures can fall that much further given this tightness.
ISM manufacturing PMI came in weaker than expected. Headline came in at 47.4 vs. 48.4 in December. Looking at the components, prices paid came in at 44.5 vs. 39.4 in December, employment came in at 50.6 vs. a revised 50.8 (was 51.4) in December, and new orders came in at 42.5 vs. a revised 45.1 (was 45.2) in December. ISM services will be reported Friday, with headline expected at 50.5 vs. 49.2 in December. January auto sales came in stronger than expected at a 15.74 mln annual pace, up from 13.31 mln in December and the highest since May 2021. December factory orders will also be reported today and are expected at 2.3% m/m vs. -1.8% in November. Of note, the Atlanta Fed’s GDPNow model update for Q1 GDP growth was steady at 0.7% SAAR. The next model update will next Tuesday.
The European Central Bank is expected to hike all rates by 50 bp. Hawkish forward guidance will likely be preserved but the debate over the tone is likely to be more contentious after yesterday’s lower than expected CPI data. Recall that the December decision was reached after the hawks and doves compromised on a smaller 50 bp hike in return for more hawkish forward guidance. We expect President Lagarde to stick with the signal for a 50 bp hike at the March 16 meeting, when update macro forecasts will be released. In return, the doves could extract less hawkish forward guidance beyond Q1. The hawks held the upper hand in December but we think that is shifting back towards the doves now. WIRP suggests nearly 80% odds of another 50 bp hike March 16. A 25 bp hike May 4 is priced in, as is a last 25 bp hike in Q3 that would see the deposit rate peak near 3.5%.
Germany reported very weak December trade data. Exports came in at -6.3% m/m vs. -3.0% expected and a revised 0.1% (was -0.3%), while imports came in at -6.1% m/m vs. -1.8% expected and a revised -3.2% (was -3.3%) in November. The weak trade data comes on top of weak factory orders, IP, and retail sales. It’s very hard for us to square the weak real sector data with the more upbeat survey data in Germany, and believe that German officials have gotten too optimistic about the economic outlook.
The Bank of England hiked rates by 50 bp, as expected. The vote was 7-2, with the two dissents Dhingra and Tenreyro voting again for steady rates. Mann moved from a dissent in favor of 75 bp last time to vote with the majority this time. The bank said inflation risks are “skewed significantly to the upside” and that inflation persistence would require further tightening. However, it dropped the guidance that it will respond “forcefully” if needed. The bank also sees a short and shallower recession than it forecast in November. Given the negative fundamental outlook still in place, we believe the updated forecasts seem too optimistic. Tightening expectations remain steady. WIRP suggests a 25 bp hike March 23 is now priced in. After that, odds of a final 25 bp hike in June or August top out near 70% that would see the bank rate peak near 4.5%.
Czech National Bank is expected to keep rates steady at 7.0%. The bank has kept rates steady since its 125 bp hike in June. At the last meeting December 21, the bank said it preferred steady rates “for some time” but could not rule out further tightening if demand leads to higher price pressures. The swaps market is already pricing in the start of an easing cycle in Q1 but this seems too optimistic.
Bank of Japan Deputy Governor Wakatabe signaled no near-term policy changes. He stressed that “The modification was done with the aim of enhancing the sustainability of monetary easing under Yield Curve Control. The bank’s commitment to continuing with monetary easing has not changed at all.” Wakatabe’s five-year term ends March 19, a few weeks before Governor Kuroda’s ends April 8. Wakatabe has been mentioned as a possible successor to Kuroda but lately, markets have been focusing more on Deputy Governor Amamiya and former Deputy Governor Nakaso as the most likely choices. Next policy meeting is March 9-10 and while liftoff then is highly unlikely, we believe it’s possible that Yield Curve Control will be eliminated then in order to set the table for eventual liftoff in either Q2 or Q3.
Korea reported higher January CPI. Headline was expected to remain steady at 5.0% y/y but instead picked up to 5.2% y/y, while core also picked up two ticks to 5.0% y/y. This was the first acceleration in headline since October and moves further above the 2% target. At the last policy meeting January 13, Bank of Korea hiked rates 25 bp to 3.5%. Governor Rhee said two board members wanted to keep rates steady and added that “I don’t think it’s right to interpret from this decision that the rate will be frozen.” Rhee added that three board members saw 3.5% as the terminal rate while three others saw the terminal rate at 3.75%. The swaps market is pricing in a peak policy rate near 3.5% but we think one more hike to 3.75% is likely at the next policy meeting February 23 after today’s CPI data.