Views are my own. Just my thoughts on macro developments. Not investment advice.
After ignoring the higher than expected dot plot in the December SEP the market is now ignoring the hawkish minutes from that meeting (key paragraph below). The market seems to be more focused on the data and are coming to their own conclusion that inflation has peaked. NFP tomorrow and CPI on 12th Jan will be important for whether we get 25/50bps on 1st Feb FOMC, market currently pricing 35bps.
Overall I still feel the market is underpricing the Fed as they will be forced to keep policy tight even as the economy falls into recession to prevent a re-emergence of inflation. Neel Kashkari warned of this in an essay he published yesterday: “Given the experience of the 1970s, the mistake the FOMC must avoid is to cut rates prematurely and then have inflation flare back up again.” Why We Missed On Inflation, and Implications for Monetary Policy Going Forward | by Neel Kashkari | Jan, 2023 | Medium
This stagflationary environment should be good for USD. I particularly like short AUDUSD after the failed break above the 200dayMA yesterday at 0.6850. 0.68865 high is resistance. Not investment advice.
FOMC minutes:
No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023… A number of participants emphasized that it would be important to clearly communicate that a slowing in the pace of rate increases was not an indication of any weakening of the Committee’s resolve to achieve its price-stability goal or a judgment that inflation was already on a persistent downward path. Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.
Market 2023 outlooks produced so far are mostly calling for USD lower this year and JPY higher. Short USDJPY seems to have developed into a consensus trade by the market. This is based on the assumption that the Fed are nearing the end of their hiking cycle whilst the BOJ could be shifting more hawkish this year. A shift on YCC from the BOJ is likely to come in April after governor Kuroda steps down. For now the rate divergence between the US and Japan is still stark and if US yields start pushing higher again USDJPY is likely to follow and cause pain for these consensus shorts.
My expectation for 2023 is that the global economy is headed into a stagflationary environment. Tighter monetary policy is doing its job of slowing growth but it will need to remain tight to ensure that inflation follows. Western governments will need to keep spending to support consumers against the energy crisis and to support Ukraine so expect EUR and GBP to devalue against the more fiscally conservative CHF and Gold. The USD will benefit from the hawkish Fed and reserve currency status so should also prove a safe haven along with CHF and Gold. US three-month T-bills yield 4.2% so they seem like the safest place to store wealth in this stagflationary environment.
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