ALB Limited 25.01.2023

FED is nearing the end, ECB still has way to go.

Last week we’ve seen heavy sales in the US stock markets. US market was closed on Monday due to holidays. However, the New York Empire State Manufacturing Index for January, which came well below expectations on Tuesday, ignited the “recessiom concerns” on the part of investors, causing them to spread thoughout the week. On Wednesday, we’ve witnessed a pricing contrary to expectations. We’ve also received the PPI data in the US, where both headline and core inflation values came in well below expectations. In fact, while there was a decrease in headline inflation on a monthly basis, we also saw a decrease in the rate of increase in core PPI compared to the previous month. Although PPI came below expectations, indices closed with sales on Wednesday. The reason for this was the economic growth data released on Wednesday, which came also below expectations. Retail sales announced on Wednesday, industrial production and manufacturing data showed even more downturn, igniting recession concerns that began on Tuesday, and even negated the positive effect of the below-expectations PPI. In fact, with the economic growth leading indicators coming in worse than expected on Wednesday, the market was expected to make a “bad data good market” pricing, but instead, we saw “bad data bad market” with sharp sales on the indices.

So why did we see pricing contrary to market expectations in the US last week? Undoubtedly, the most important reason for this was the Fed members who spoke quite hawkish last week. This week, especially after the verbal guidance of Bullard, one of the most hawkish member of FED said that we should quickly move above 5% in interest rate hikes, talk began to emerge that the ceiling interest rate in the US in 2023 could rise to 5,25-5,50%. After the hawkish Fed members, the market made a “I think the Fed is determined to go tight, despite the recession” pricing on Wednesday and even on Thursday with “bad data good market” pricing. On Thursday, weekly unemployment benefit applicatins also came in below expectations at 190.000 (expectations was 214K) further undermining market morale, with a “FED may be more aggressive to cool the labor market” pricing leading to pressure on the indices on Thursday.

On Friday, the indices closed positively. So what happened that the 3-day sales turned positive on Friday? In fact, we can say that there are two reasons for this. Firstly, as we know, it’s the the fourth quarter earnings season. The number of subscribers in the fourth quarter exceeded expectations on Netflix’s earnings report last week, and also on Friday, Google’s parent company, Alphabet, announced that they will lay off employees (with expectations layoffs would reduce costs and increase profitability), which brought purchases to indices. Especially om Nasdaq, on the last day of the week. Of course, the absence of a critical economic data in the US on Friday also prevented this positive atmosphere from being disturbed. Another contributing factor for the positive atmosphere on Friday was the speech by Christopher Waller, a member of Fed. Despite the overall hawkish tone of the speech, Wallers statement that the point at which the Fed said that interest rates could be “sufficiently restrictive” to lower inflation is “quite close”, increased the positive atmosphere in the market in my opinion. With all there developments, looking at expectations for the Fed meeting to be held in the US on February 1st, the possibility of a 50 bps interest rate increase in February and March after Waller completely disappeared, and the possibility of a 25 bps increase in February rose to 99,3%.

Probabilities of Interest Rate Hikes for the February 1st Federal Reserve Meeting

Source: CME Group (https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html)

With these developments together the market is pricing the interest rate rise by 25bps in February and March, bringing the ceiling rate to between 4,75-5,00% and then decrease it by 25bps in November and December, resulting in a policy rate of 4,25-4,50 by the end of 2023. In other words, the market and the Fed are diverging in two ways. In the first place, during first half of 2023, the Fed is indicating a policy rate above 5%, while the market is pricing a rate below 5%. In my opinion, the divergence in the second half of the year is much more important. In the second half, the market is pricing in that the Fed is saying that they will not decrease interest rates this year. Naturally, depending on who is right, there will be significant changes in the main pricing.

Next week, we will be receiving manufacturing and services PMI data from the US on Tuesday. On Thursday, the US’s third quarter growth data will be released. In case these upcoming data come out worse than expectations, taking into account that Fed members are in a period of silence and cannot speak, I sense a high possibility that the bad data will create a “bad data, good market” situation. In this case, if data come out bad, the possibility of an upward trend in the indices and precious metals ahead of the Fed’s February meeting may come to the forefront. Additionally, on Friday, we will be receiving the headline and core personal consumption expenditure price index (PCE) datum, which is a leading indicator for inflation in the US. Honestly, there is a high possibility that we will see an easing effect on inflation on this side as well. In this case, if this happens, the market may gain an important advantage in this sense of “more dove Fed expecatitions” before the FED meeting on the 1st of February.

On the European side, this week the ZEW expectations index for Germany and the Eurozone as a whole was announced positive for the first time since February 2022. This positive sentiment affected European stock markets this week. There were also inflation figures from the Eurozone last week. The headline inflation rate fell to 9,2% and core inflation fell to 5,2%. In Germany, the unemployment rate also fell from 28,2% to 21,6% in December. Despite recent hawkish comments from members of the European Central Bank (ECB), following these expectations of low inflation figures especially this week, there has been a discussion regrading the ECB will lower the rate of interest hikes to 25bps in March due to the decrease in inflation. The current policy rate for the Eurozone is 2%. The market is pricing in an increase of the ECB’s policy rate to 3,46% in 2023, which means an expected 150bps increase from the ECB this year. On the futures side, there is an expectation of a 50bps increase in February, but it seems that the possibility of a 25bps increase will also be on the agenda in meetings after the meeting in February. In addition to a slowdown in the rate of interest hikes, it is also possible that the ECB will consider 75-100bps increase in 2023 instead of 150.

On the Asian side, there were also important outcomes last week. At first, we welcomed the interest rate decision of the Bank of Japan (BOJ) last Wednesday. The market thought that the BOJ would tighten its policy by raising the yield curve control band or completely abolishing the yield curve control policy this month. Some even thought that there would be an interest rate hike decision from BOJ this month. The main reason for these expectations was the fact that the weak yen was increasing inflation against the dollar. However, despite all these market pressures, the BOJ did not abandon its ultra-loose monetary policy, and kept interest rates steady and did not make any changes to the yield curve control. Instead, they sent a message that they would continue with a large amount of bond purchases and loose monetary policy if necessary. With this decision made by the BOJ, while the yen against the dollar suffered a very fast 2,5% loss, there was a 23% decline and a retreat to 0,36 level in Japanese 10-year bonds. This Friday, the People’s Bank of China also did not take an expansionary step contrary market expectations; it left the main 1 and 5 year benchmark lending rates unchanged.

Could the Central Bank of Turkey start lowering interest rates?

The most important agenda item this week domestically was the Central Bank of Turkey’s January interest rate decision. The Central Bank kept the policy rate at 9% in line with market expectations. Of course, eyes were on the text of the interest rate decisions for clues about what the monetary policy would be in 2023. In other words, the market was curious about when possible interest rate cuts might come. In this context, there was no verbal guidance in this month’s text about when new interest rate cuts might come. However, the fact that the Central Bank removed the phrase “The Board has evaluated that the current policy rate is at an adequate level taking into account the increasing risks related to global demand” from the text in the past two months, raised some scenarios. The removal of this phrase from the text has led to the idea that a new interest rate cut may come in the pre-election period. At this point, it is also being said that the Central Bank will wait and see in the next 2 months and then, approximately 2 months before the election, it may again lower interest rates. I also think that the possibility of a new interest rate cut cycle starting in the pre-election period is quite strong if economic growth does not go well.

It seems that we don’t have heavy data flow in this week. January consumer confidence data will be announced on Monday, while January capacity utilization as well as real sector confidence index datum will be released on Wednesday.

Tags: FED, ECB

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