Given the hawkish tone to last week’s Fedspeak, all eyes will be on Tuesday’s report for January. Traders will think a more robust CPI print would look less like a one-off and more like part of a trend, which could have a more pronounced impact on the market’s view of the terminal.
Indeed, this week’s US inflation data has the potential to move like a wrecking ball through a market with a more relaxed inflation outlook that investors have been enjoying in recent months. Even more so, with the market turning its attention to the risk of a longer cycle, inflation and all economic data inputs will be digested as critical information about how ” higher for longer” the FED needs to go.
But interestingly, last week, the was driven more by micro factors (company specific) and less yield curve inversion macro factors. At 4100, the S&P500 is not listening to the doom and gloom recessionistas.
Instead, index investors possibly think the FOMC is keeping an open mind to more disinflation, and they could be right. But given the dispersion under the surface, energy up tech down, it has turned into a stock picker rather than an index investor market, given that a handful of stocks are generating the bulk of the alpha.
According to GS,
“Despite what still appears to be a robust labor market, it will be hard to materially dislodge the easing bias priced in the near term, irrespective of the inflation outcome. Instead, shorts in this part of the curve are more likely to behave as a carry trade—i.e., the cuts get pushed out in time rather than being unwound.”
US yields have sold off significantly in the week following the strong January jobs report. At the front end, markets have moved the terminal fed funds rate higher and modestly unwound a portion of the rate cut pricing.
Although this week’s CPI report will be critical—markets have already priced roughly a 40 % chance of the Fed hiking above the Fed 5-5.25% terminal rate projection, which limits the scope for much additional repricing unless the delta is broad enough.
However, a more considerable upside surprise could result in markets increasing additional hike odds to about 75%. In contrast, a lower-than-expected number may lead to a modest 10-15bp decline in the peak rate. The strong has been a game-changer.
In Forex, the market is trading data surprises very symmetrical, so if the CPI print fails to print above grade, an improving macro backdrop could cheapen the .
But overall, I can’t help but think investors are hopelessly confused as things are very different in a post-pandemic environment, mainly how we live and do business — possibly rendering a host of one-time reliable market indicators potentially less reliable today.
Both rates and inflation have been elevated, yet growth has been reasonably robust — especially in nominal terms.
But after the strong NFP, a 6 % bet on the SOFR contract, and the 3-month signal on the inverted yield curve suggesting recession imminent, its the first time we have skewed our US recession odds to 50:50 (from 35 % chance), not because of the indicators but because we are unsure which way we are headed.
