FED expected to close 2022 at 4.50% by increasing 50 bp

With the ISM non-manufacturing PMI data coming from the USA on Monday last week at 56.5 (expected at 53.3 and last month’s data at 54.4) both last month and above expectations, “there is no sign of cooling enough in the real market as a result of the interest rate hikes, so the FED may become more aggressive.” With its pricing, there was a serious decrease in the risk appetite in the market. On Tuesday, we saw that sales continued in the US, this time for a different reason. After the reports and verbal guidance on the recession and layoffs from major US investment banks such as JP Morgan, Bank of America, Morgan Stanley, and Goldman Sachs on Tuesday, the “recession concerns” in the markets were the main selling factor. Tuesday’s sale continued on Wednesday with the same concerns. However, on Thursday, the indices started to rise, as the weekly jobless claims came in above expectations. On Thursday, the market increased risk appetite (even though we do not believe it is rational pricing) by pricing “the labor market is getting cooler, so the FED will not need to raise interest rates more than necessary” as unemployment benefit applications exceeded expectations. With this pricing, we saw a pullback in the dollar index and US 10-year and 2-year bond rates while buying indices and precious metals this time.
On Friday, we received the November PPI data in the United States. While the headline PPI was 0.3% monthly (expected 0.2%) and 7.4% annually (expected 7.2%), the core PPI was announced as 0.4% monthly (expected 0.2%) and 6.2% (expected 5.9%) annually. As soon as the data was released, we saw a serious decrease in the risk appetite in the market. The reason for this was that both the headline and core inflation data were above expectations on both a monthly and annual basis. After the CPI and PPI data, which came below expectations last month, the market did not react positively to the above-expected data, as it expected a very rapid retraction in inflation in the following period. Although the first post-sale indices went up a little bit, we saw that they closed negative on Friday.
We think the following question needs to be answered: What does the US PPI data released on Friday tell us? First, let’s start with the following determination, there are points in the PPI data that we can define as good and bad, the downside, of course, is that both the headline and core numbers have exceeded expectations, as the market has priced them. This is an expected situation for us. Because, according to our base scenario, even if there is a regression in inflation in the USA, this retracement will not occur very quickly due to the permanence effect, However, as I previously stated, the fact that the market – particularly Wall Street Investors – had very optimistic expectations about the inflationary pullback was the main factor that demoralized. We embrace two developments in PPI from 8.1% to 7.2% while the annual core PPI regressed from 6.9% to 6.2%. In other words, the annual PPI decreased compared to the previous month. Thus, the headline PPI has been continuing its downward trend for the last 6 months. Another satisfying point in the announced figures is that although there is no downward acceleration in the monthly momentum of both the headline and core PPI, there is no upward momentum, meaning there is no amplification of inflation. This is an encouraging and reassuring situation for the Fed. As we all know, the Fed closely monitors the monthly inflation dynamics in the inflation figures.
On Friday we also met the short and long-term inflation expectations data from the University of Michigan in the US. While there has been a decrease in short-term inflation expectations, there is no change in long-term inflation expectations compared to the previous month. Especially this retreat in short-term inflation expectations can be seen as a positive development for relief in inflation. However, the fact that the data of the University of Michigan, which was announced on Friday, can be considered as a leading parameter such as economic consumer expenditures, economic growth, and consumer sentiment. Because all these three data that were announced indicate that the economy is still alive and inflation may remain high as well. In short, it can be said that the data from the University of Michigan on Friday indicate mixed pricing.
At the end of these developments, we can say that risk appetite is low at the beginning of this week. As of Monday, it is pricing in a 74.7% probability that the FED will raise the interest rate by 50 bps on Wednesday this week, thereby raising the interest rate to 4.25 – 4.50 for the end of 2022. In addition, after the FED’s 50 bp increase in February 2023 and 25 bp increase in May 2023, the interest rate ceiling rate was raised to 5.00 – 5.25 in 2023, and immediately afterward, with 25 bp reductions in July and September 2023, the interest rate was increased to 2023. It is priced to reduce to 4.50-4.75 at the end of the year.

Target rate probabilities for FED’s 14 December meeting

On the US side, CPI data for November will be released this Tuesday. US headline annual inflation is expected to ease to 7.3% from 7.7% in November and annual core inflation to 6.1% from 6.3% in November. Monthly, both the headlines and the core side are expected to increase by 0.3%. In this situation, we see a strong possibility of buying indices with a serious rise in risk appetite and a fall in the dollar index. On the other side of the coin, if inflation spikes, with a serious drop in risk appetite, index selling may accelerate, At this stage, even if inflation beats expectations, we don’t believe the likelihood of a 50 bps rate hike by the FED in the next meeting will change. We believe that the main elements of pricing will be the economic projections to be announced and Powell’s speech, rather than the Fed’s interest rate decision. At this point, how the interest rate and economic growth expectations for 2023 are revised in economic projections will be very important in terms of risk appetite.
This week, on Thursday, December 15th, the European Central Bank (ECB) will announce its December interest rate decision. Taking into account the latest expected CPI and PPI data as well as verbal guidance from ECB members, we expect the ECB to increase by 50 basis points on Thursday. The main pricing in this case is determined by Lagarde’s statements. With the Eurozone teetering on the brink of recession, it is not anticipated that Lagarde will be too hawkish at this point either. Accordingly, no major effects on market price formation are to be expected after the ECB interest rate decision. However, if the ECB decides to increase 75bps instead of 50bps on Thursday, under the assumption that the Federal Fund Rates increase 50bps, it will be highly likely that we will see a decline in the dollar index drop and prices above 1.0620 in euro/dollar parity.
Also this Thursday, the Bank of England (BOE) will announce its December interest rate decisions. BOE is also expected to hike interest rates from 3% to 3.50% with increasing 50 basis points. One of the developments to watch closely is the bank’s emphasis on the possible risk of a recession in the coming period.
The domestic inflation rate was disclosed at the beginning of this week. The Annual CPI was announced as 84.3%, slightly below expectations, while monthly inflation was announced as 2.8%. Thus, annual inflation fell from its peak of 85.5% last month, albeit to a limited extent due to the base effect. The annual base rate is likely to be much present in December and January in particular. Accordingly, the market is pricing an inflation rate of 70-75% by the end of the year. Due to the base effect, the CPI is expected to fall back to 50% from March 2023. The D-PPI also observed in November a regression from 157% last month to 136.02% this month, due to the recession in energy prices, especially every month, as well as the impact of the stable reversing exchange rate in recent months. This week, October's current account deficit and unemployment data are tracked on Monday. Industrial production and retail sales for October on Tuesday, November household balance sheet data on Thursday, and the CRBT market participant survey on Friday will be on the radar of the market.