PRIMER: Fed Chair Powell to speak at 14:00GMT/09:00EST on Tuesday, January 10th

Analysis details (16:08)

IMPORTANT NOTE: Some calendars suggest Powell's appearance could begin from 13:00GMT/08:00EST. Additionally, it is worth noting that Powell will be speaking at a Riksbank panel on 'central bank independence and the mandate – evolving views', and accordingly, some believe that there is a risk that he disappoints those who are looking for fresh insight on the current monetary policy outlook.

‘PEAK INFLATION’ HAS BEEN DISCOUNTED: The start of 2023 has been characterised by data that continues to allude to cooling inflation pressures combined with softening activity data that alludes to deteriorating growth dynamics. Judging by traders' reactions to last week's ISM reports (weak activity in both manufacturing and services) and nonfarm payrolls (wage growth cooling), there is a feeling that the 'peak inflation' narrative has now been fully discounted, and traders are increasingly fretting about the challenging growth situation. These dynamics will again be put to the test this week, with the release of various inflation reports out of the US. Ahead of Thursday's December US CPI data, the NY Fed's survey of consumer inflation expectations for that month was mixed, with the 1yr ahead expectation easing to 5% from 5.2%, expectations for 3yrs ahead was steady at 3%, while the 5yr rose to 2.4% from 2.3%. Participants will also be eyeing the Preliminary January University of Michigan survey on Friday, particularly the inflation expectations.

WHEN WILL FED PIVOT FOCUS ONTO GROWTH: If these inflation data continue to show a cooling in price pressures, traders will gain confidence in the notion that the Federal Reserve will need to pivot its focus to support the growth side of the equation, which may involve easing up on some of its hawkishness. Fed Chair Powell's remarks on Tuesday will also be eyed in this context, although the Fed is expected to continue its hawkish messaging on inflation until they see substantial evidence that inflation has indeed peaked and that its price target is back within sight.

TERMINAL RATE: Despite the Fed's December Staff Economic Projections pencilling in a peak Federal Funds Rate of 5.1% (5.00-5.25% FFR target), and warnings by some officials that if inflation doesn't behave, then 5.4% could also be seen (5.25-5.50%), money markets continue to see the peak at between 4.75-5.00 from March onwards, and expects rates will stay there until November when markets begin to price rate cuts. Fed officials – burned by their incorrect pandemic view that inflation was transitory – are trying to re-establish their inflation-targeting credentials, so are unlikely to relent on their hawkishness any time soon, out of fear of causing credibility issues. Analysts note that, historically, the Fed has stayed at terminal for between 3-15 months, with the average being around 6.5 months.

LAYING THE GROUNDWORK FOR A PIVOT

While the Fed may not explicitly pivot its policy until it has seen ‘substantial’ evidence that inflation has peaked, there are some elements that officials could introduce that suggests that its focus is moving:

‘SUBSTANTIAL PROGRESS’: At the December FOMC, Powell suggested that the Fed wants to see “substantially more evidence” that gives confidence that inflation is on a “sustained downward path”, and while inflation has been cooling, at around 6% it is still three times the Fed’s 2% inflation target.

‘ONGOING’ RATE HIKES: Although the Fed’s December meeting statement was little changed, it still “anticipates that ongoing increases in the target range will be appropriate”; there were some outside expectations for the Fed to tweak this guidance in December to something to the effect that it sees ‘some further’ rate hikes ahead. Accordingly, if officials begin using language like this, it might hint that the last rate hike of the cycle is in sight.  

GROWTH CONCERNS: Many consider the ISM's reports on business to be a more forward-looking indicator than releases like the jobs report. Last week, the ISM data showed that the headline and new orders components for both the manufacturing and services sectors were sub-50, in contractionary territory. Analysts note that, historically, when this happens, the Fed is usually easing policy to support the economy. However, Fed officials' base case, for now, is only a growth slowdown, and many are not predicting a recession, instead citing the labour market strength. If officials do begin expressing concerns about slowing growth, and backing away from their previous baseline views, traders might use that as part of the case that shows the Fed is realigning its focus onto growth.

FINANCIAL CONDITIONS: Some argue that the Fed’s concerns about loosening financial conditions (read: lower yields, higher stock prices) is second only to inflation, and currently ranks above growth concerns. Powell in December said that the Fed's tightening had engineered tighter financial conditions, but added that these conditions fluctuate in the short term in response to many factors, but it was important that over time these conditions reflect the policy restraint that the central bank is putting in place to return inflation back to the 2%. The latest minutes also revealed that participants were wary of an "unwarranted" easing in financial conditions. If Powell continues to express concerns about easing financial conditions, it would not be a sign that he was preparing us for a policy pivot (and vice versa).

09 Jan 2023 - 16:10- Fixed IncomeData- Source: Newsquawk