Feb. FOMC QuickTake: The Strengthening Fed Pivot Expectation

In Wednesday's FOMC meeting, Fed acknowledged for the first time in a statement released after the meeting that inflation had eased somewhat. In the press conference, Powell said he was not concerned about the short-term easing of financial conditions (e.g., bond rates down, mortgage rates down, and stocks soaring) that has occurred so far this year, and risk assets went on a binge. As of yesterday, $NASDAQ(.IXIC)$, a poor performer over the last year, has seen a significant catch-up rally.

Source: ForexLive

In fact, there is nothing new in this FOMC Fed's views on inflation and the future direction of monetary policy, as we have analyzed very much in US Recessionary Trade is Brewing; Tight Labor Market Restricts Fed Plans. Despite recent data showing a slowdown in the year-over-year increase in wage inflation, Powell still sees no turn in services inflation other than housing, which is closely related to the job market. He notes that the ratio of job openings to unemployment is back to a high of 1.9. Fed has apparently been telling the market about its concerns over sticky inflation.

However, based on the fact that the Fed did not give negative expressions on the short-term financial conditions, the market further clarified its expectations after the meeting that "current rate hike cycle is nearing its end, with a pause in March and a turnaround at the end of the year". Market positive expectations were reflected in the Fed futures pricing of the benchmark rate in the chart below.

CME FedWatch

So, as we mentioned in the chart in Market review: How long can mild recession trades last?, the probability of Fed turning to a strong reality has improved in the short term. Therefore a large amount of money flowed into $ARK Innovation ETF(ARKK)$ $Gold - main 2304(GCmain)$.

However, after the frenzy, we have to think about whether the strong expectation that "current rate hike cycle is nearing its end, with a pause in March and a turn at the end of the year" will really become a strong reality.

Nomura trader Charlie McElligott pointed out in a recent trading note that

the most mispriced market risk in 2023 is that "after the Fed pauses interest rate hikes, the economic overheating brought about by the shift to accommodative financial conditions will possibly lead to a pick-up of inflation and cause the Fed to restart rate hikes".

Charlie noted that the U.S. 30-year mortgage rate has fallen 90 basis points in the last two months, boosting US pending home sales again. According to Redfin, the number of mortgage applications rose 28% in January compared to early November, and some real estate agents believe the number of home purchase contracts signed in the last month has been more than the entire Q4 last year.

In terms of commodity raw material prices, Lumber Futures rose by upwards of 36% in January this year. Industrial metals like Copper and Aluminum Futures prices, driven by strong expectations of a recovery in China, also rose by 10%. The average US gasoline price rose from $3.159 per gallon a month ago to $3.509 per gallon, a 4.4% price increase compared to a year ago. This means that the continued negative contribution of commodities to inflation since last year's Q4 is likely to reverse in the future, hindering further downward movement of inflation.

Source: Bloomberg

Finally, our judgment last year in Panning for gold: 2023's outlook for major assets that China is recovering and the US is not going into recession for now underpins the forecast that global equity markets will rise in the first month or so of this year. With the market's growing expectations for China's recovery and the Fed's pivot, we need to pay closer attention to the coming Chinese economic data, Non-farm payrolls on this Friday and Fed minutes in three weeks to follow whether the two strong expectations supporting this round of rallies are loosening.

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