Fed Chair Jerome Powell's Testimony

Do not attribute your success / failure to other people. Take responsibility for your actions and cultivate a sense of willingness to improve the quality of your actions. And that my friend shall put you on the path to success.

Fed Chair Jerome Powell's semimanual monetary policy testimony to the Congress and the NFP are 2 major events this week.

In prepared remarks, on day 1 of the 2 day testimony, Fed Chair said a lot of ground has been covered on monetary tightening but the full effects are yet to be felt. He said the declining trends in economic data seen in December reversed in January which could partially be on account of warmer weather. The breadth of reversal suggests inflationary pressures are running higher than expected.

PCE 5.38% yoy (Recent peak 6.98% June 2022)

Core PCE 4.70% yoy ( Recent Peak 5.42% Feb 22)

He attributed the recent decline in inflation prints to falling energy prices, easing supply chain bottlenecks and tighter monetary policy. Even though housing services inflation remains too high, the flattening out in rents evident in recently signed leases points to a deceleration in this component of inflation over the year ahead. He said to restore price stability, Fed would need to see lower inflation in core excluding housing services and softening in labor market conditions.

The most important take away from the day 1 testimony was the Fed Chair's suggestion that the ultimate level of interest rate is likely to be higher than previously anticipated and if the totality of data shows strength and points towards faster tightening , Fed would be prepared to increase the pace of hikes.

Following the testimony, the market has shifted the probability of a 25 bps hike from 68.60% as on 6th March 23 to 36.90% which means that the markets are increasingly leaning towards a 50 bps hike in the next FOMC meeting on 21 - 22 March 23. The market is now assigning a 32% probability to peak terminal rate of 5.75% - 6.00% in the July policy which was nil as early as a month back. USD index has strengthened and SPX is down 1.50%. The 2x10 spread has further tightened to 104 bps.

Bear in mind, we have a host of data between now and the next policy meeting which hold the potential to swing the market - NFP, Unemployment Rates, JOLTS Job Openings, US Inflation and Retail Sales. If we are to see a reversal and repricing of interest rate expectations, we will need multiple data points to corroborate the same and hence a reversal in the USD index on a single data print could be short lived which suggest quick in an out trades. However, a reversal trade for a larger move should be a function of breadth.

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