• Fed Chair Powell stuck to his message yesterday; we think Powell took the right tone; we look for a hawkish shift in the March Dot Plots; BOC will release the account of its last policy meeting; Governor Macklem delivered a preview of the account in a speech yesterday
  
• Italy reported soft December retail sales; the U.K. Tories will likely call the next general elections in H2 2024; Poland is expected to keep rates steady at 6.75%; Borsa Istanbul halted trading for the first time in 24 years
  
• There may be a growing consensus in Japan to increase wages; Japan reported December current account data; India hiked the repo rate 25 bp to 6.5%, as expected
  

The dollar is giving up some of its recent gains after Powell spoke. The dollar has been hit by some profit-taking as markets were perhaps disappointed he didn’t take a more hawkish tone (see below). However, the Fed is clearly set to continue tightening, with risks of an even higher terminal rate if the data remain strong. DXY is down for the second straight day and trading near 103.15 after trading at a new cycle high near 104 yesterday. The break above 103.793 sets up an eventual test of the January high near 105.631. The euro is trading near $1.0735 after trading at a new cycle low near $1.0670 yesterday. The break below $1.0695 sets up an eventual test of the January 6 low near $1.0485. Sterling is trading near $1.21 after trading at a new cycle low near $1.1960 yesterday. It remains on track to test that day’s low near $1.1840. USD/JPY is trading just below 131 after trading near 132.90 Monday, the highest since January 6. The pair remains on track to test that day’s high near 134.75.

AMERICAS

Fed Chair Powell stuck to his message yesterday. The interviewer David Rubinstein did his best to try and pin Powell down on the Fed policy outlook, whilst Powell bobbed and weaved with the best of them. Powell said the Fed probably needs to hike rate further as it hasn’t achieved a sufficiently restrictive stance yet, adding that rates would need restrictive policy for a period of time. He stressed that the disinflationary process “has a long way to go” and yet Powell remained flexible by noting that FOMC forecasts are conditional on incoming data. He stated the obvious by noting that if strong data persist, then the peak Fed Funds rate may be higher. Bottom line: the underlying message remained the same as last week in that the Fed will continue hiking, and that the data will dictate just how far it needs to go.

We think Powell took the right tone. In light of recent strength in the economic data, that was pretty much all Powell really needed to say. He acknowledged that the Fed is not yet thinking about pausing but left the door open to changes in forward guidance base on the income data. Powell didn't take the bait on committing to future rate hikes. While this is the correct stance to take in a highly uncertain environment, it seems that this led some to conclude he wasn't hawkish enough. This is the same trap the markets fell into last week when Powell wasn’t deemed sufficiently hawkish. Williams, Cook, Barr, Bostic, Kashkari, and Waller all speak today and are likely to retain a hawkish tone.

Recent developments confirm our long-standing belief that the Fed will have to go higher for longer than what optimistic market scenarios had priced in. WIRP suggests a 25 bp hike March 22 is fully priced in with very low odds of a larger 50 bp move. Another 25 bp hike May 3 is nearly 80% priced in and fully priced in for June 14. If we get that second hike, which seems very likely, that takes the Fed Funds target range up to 5.0-5.25%, which is where the December Dot Plots put it by year-end. There are over 20% odds of a third 25 bp hike in July, which would take the Fed Funds target above the December Dot Plots. Yet markets are still pricing in Fed easing in H2. Let that sink in. We still have a ways to go to get to peak Fed Funds rate, and yet folks are still looking for H2 rate cuts in what would be an extremely quick turnaround.

We look for a hawkish shift in the March Dot Plots. We note that two Fed officials moving their 2023 rate from 5.125% to 5.375% shifts the median to 5.25%. Three moving there shifts the median to 5.375% and either of these is very possible. Similarly, four Fed officials moving their 2024 rate from 4.125% to 4.375% shifts the median up to 4.375% and four moving their rate to 4.625% does the same. Again, both are very possible. Before the March 21-22 FOMC meeting, Fed officials will get to see one more jobs report and two sets each of CPI, PPI, and retail sales. Obviously, it all depends on the data but a 25 bp hike then seems a no-brainer, as does keeping the door open for a May hike. From the Atlanta Fed: “The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2023 is 2.1 percent on February 7, up from 0.7 percent on February 1.” There will be another model update today after the December wholesale trade sales and inventories data. Bloomberg consensus of 0.1% SAAR for Q1 seems too low but of course it's still early days.

Bank of Canada will release the account of its last policy meeting. The bank will publish its so-called “summary of deliberations” for its January 25 meeting, the first time it has ever done so. Governor Macklem said he has been considering this move for a long time but many observers believe it is an attempt to head off criticism of its policy decisions. Of note, the BOC makes its decisions by consensus and so there will be no vote count to reveal. Bank of Canada tightening expectations have collapsed after it announced a pause at the January meeting, with the swaps market pricing in very low odds of another hike from the current 4.5%. Like the Fed, the market is pricing in an easing cycle from the BOC in H2.

Governor Macklem delivered a preview of the account in a speech yesterday. He noted that it can take 18-24 months to see the full effects of rate hikes, adding that BOC policymakers generally want to avoid overtightening. Macklem said “We need to pause rate hikes before we slow the economy and inflation too much. We shouldn't keep raising rates until inflation is back to 2%.” He also laid out some key metrics that need to improve in order for the bank to meet its inflation target: services prices, wage growth, inflation expectations, and business price-setting behavior. Macklem stressed “If those things don't happen, inflation won't come back to our 2% target, and additional monetary tightening will be required.” He expects growth to be “close to zero” in the first three quarters of this year, which will allow the situation to move from one of excess demand to one of modest excess supply. Lastly, he said "It is really far too early to be thinking about cutting rates. The question is really whether we have raised interest rates enough."

EUROPE/MIDDLE EAST/AFRICA

Italy reported soft December retail sales. Sales came in at -0.2% m/m vs. -0.7% expected and 0.8% in November, while the y/y rate eased to 3.4% vs. 4.4% in November. While there has been some marginal improvement in the recent data, we simply cannot get too excited about the eurozone outlook. ECB tightening expectations have steadied. WIRP suggests a 50 bp hike March 16 is nearly priced in but that may be it for the super-sized hikes. Looking further ahead, a 25 bp hike May 4 is priced in followed by another one either June 15 or July 27 that would take the deposit rate up to 3.5%. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand. We have already seen the cracks reappear last week. Knot speaks today.

The U.K. Tories will likely call the next general elections in H2 2024. Conservative Party Chair Greg Hands said “The next 18 months will see us win or lose the next general election.” Prime Minister Sunak has to call one by January 2025 at the latest and so many expect the vote to come in November in order to give the ruling Tories the greatest amount of time to regain popularity before colder weather sets in. The road ahead will be difficult, with recent polls showing the Tories trailing opposition Labour by around 20 percentage points. Local elections this May should provide some insight, though Hands admitted that these races would be difficult.

The economic backdrop will be key for the incumbent party. The latest Bank of England forecasts were much more optimistic than the November projections and include a shallower recession, lower inflation, and lower unemployment. However, the path ahead is by no means clear. BOE tightening expectations have fallen sharply, as WIRP suggests odds of a 25 bp hike March 23 are only around 75%. After that, the odds of a final 25 bp hike top out near 50% and so the expected terminal rate is now between 4.25-4.5%, down from 4.5% at the start of last week and 6.25% after the disastrous mini-budget back in September.

National Bank of Poland is expected to keep rates steady at 6.75%. Minutes from the January 4 meeting will be released Friday. At that meeting, the bank also kept rates steady and noted that future decisions will depend on Ukraine and the data. It noted that a strong zloty would help curb inflation and sees inflation returning to target gradually. CPI rose 16.6% y/y in December, the lowest since August but still well above the 1.5-3.5% target range. Prime Minister Morawiecki said that if inflation continues to fall, a rate cut becomes “possible and even likely.” The swaps market is pricing in the start of an easing cycle in H2. While this has been pushed back from H1, it still seems too soon.

Borsa Istanbul halted trading for the first time in 24 years. The announcement to suspend trading in equities, futures, and options was made after two circuit breakers were triggered today as a deep selloff continued in the wake of this week’s devastating earthquakes. There was no word on when trading would resume. Of note, President Erdogan declared a state of emergency for 90 days but reports suggest he is still planning to hold general elections May 14 as previously planned.

ASIA

There may be a growing consensus in Japan to increase wages. Reports suggest Prime Minister Kishida is open to the idea of reviving three-way talks between the government, businesses, and labor unions on setting wages. Those talks have been dormant for almost eight years and opposition DPP leader Yuichiro Tamaki apparently raised the idea of reviving them when he met with Kishida yesterday. Tamaki noted that “To create momentum for pay rises not only among large corporations but among small and medium-sized firms with no labor unions, I proposed that talks among the government, business and labor should be held soon. The prime minister clearly responded that he would work to do that.” Nominal wages jumped 4.8% y/y in December, the most since 1997, but real wages rose only 0.1% y/y and so it’s clear that more needs to be done to boost worker pay in this era of higher inflation. The Bank of Japan has said it wants to see higher wage growth along with 2% inflation before it removes accommodation.

Japan reported December current account data. The adjusted surplus came in close to consensus at JPY1.2 trln vs. JPY1.9 trln in November. However, the investment flows will be of most interest. December data showed that Japan investors were net sellers of U.S. bonds for the fourth straight month (-JPY332 bln) and in thirteen of the past fourteen. Japan investors remained net sellers (-JPY193 bln) of Australian bonds for the sixth straight month but turned net buyers of Canadian bonds (JPY74 bln) for first time after ten straight months of net selling. Investors turned net sellers of Italian bonds (-JPY99 bln) after two straight months of net buying. Japan investors were total net sellers of foreign bonds for the fourth straight month in December (-JPY919 bln). If the BOJ does hike rates this year and JGB yields continue rising, we see scope for further selling of foreign bonds (and for a stronger yen) as Japan investors bring more money home.

Reserve Bank of India hiked the repo rate 25 bp to 6.5%, as expected. The vote was 4-2 and the bank left the door open to further hikes by maintaining its tightening stance and noting “It is imperative to remain alert on inflation so as to ensure that it remains within the tolerance band and progressively aligns with the target.” Governor Das noted that the “global economic outlook does not look as grim now as it was a while ago but added “We need to see a decisive moderation in inflation.” The RBI sees inflation averaging 5.3% in FY23/24 beginning April 1 vs. a revised forecast of 6.5% in FY22/23, and sees growth of 6.4% in FY23/24 vs. 6.8% in FY22/23. The tightening bias surprised some observers who were looking for a softer tone after CPI came in at 5.72% in December, the lowest since December 2021. The swaps market is now pricing in a peak policy rate near 6.75%.