Dec 15, 2022 Market Briefing ( FOMC Rate Decision)

Hi, good morning !!

"It is by logic that we prove. It is by intuition that we discover" - Henri Poincare'

We had the FOMC rate decision last night where the FOMC raised benchmark interest rates by 50 bps to 4.25% - 4.50%. The Statement of Economic projections is what caught my attention. Real GDP growth for 2023 has been revised lower by a full 70 bps to 0.50%, core PCE inflation has been revised higher by 40 bps to 3.5%, headline PCE has been revised higher by 30 bps to 2.1% and unemployment rate has been revised higher by 20 bps to 4.6%. So between now and 2023, U/R will increase by 90 bps. The projected path of Fed fund rates is for a terminal rate to reach 5.10% in 2023 (up 50 bps) w/o any interest rate cuts and then 100 bps of rate cut in 2024 and 2025 to take the FFTR to 3.10%.

The Fed Chair in his press conference also stated “There’s an expectation really that the services inflation will not move down so quickly so that we’ll have to stay at it”. “So we may have to raise rates higher to get to where we want to go and that’s really why we’re writing down those high rates and why we’re expecting that they will have to remain high for a time.”

It was also highlighted that inflation could be bracketed into 3 segments:

1. Goods inflation ( in my previous post I have highlighted the downtrend in goods inflation)

2. Housing services inflations ( as the property lease gets renewed, inflation is likely to ease)

3. Non housing related services inflation ( this contributes to 50% to the PCE index. Robustness of the labor market - job gains of 277k average for last 4 months, U/R at 3.7% and average hourly earnings (AHE) growing at 5.10% - will contribute to the stickiness of inflation)

Post the FOMC, market appears to be at odds with the Federal Reserve. The market pricing did not materially shift higher post the hawkish policy which suggests that market is pricing in a durable trend lower in inflation and expects the Fed to err on the side of caution. Market pricing suggests rate cuts of 50 bps in the second half of 2023 as opposed to no cuts according to Fed projections. Market May 23 pricing is at 4.8750%. 2x10 curve inversion widened to 75 bps from 72.5 bps earlier.

Market participants have been talking for sometime around the revision to Fed's inflation target of 2% as structural changes across economies as a result of the pandemic, de-globalization and weather related uncertainties could see inflation plateau at a level higher than the 2% target. Or the Fed could overtighten to see the economic growth accelerate the downhill path, cause tremendous hardships to achieve 2% inflation. One option is losing credibility and the second option is causing economic pain - the devil and the deep sea.

I prefer being long USDs at the 103.50 support zone. The divergence in view could see consolidation before a fresh catalyst triggers conviction for long or short.

Thank you v much for reading!!

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