US Inflation: Markets
After a light week last week because of the holidays, the economic calendar will go dark again the week of February 1 in preparation for the Federal Open Market Committee meeting.
At the forthcoming meeting, it will be interesting to see how Fed officials have factored in the CPI data from last week into their predictions for a possible slowing of the tightening pace to 25 bps. And it may serve as a wake-up call for those who are “risk-on” or “low-volatility.”
To recap, annual inflation rates for both headline and core CPI came in at 6.5% and 5.7%, respectively, exactly as predicted by economists.
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Reduced US inflation calls for a slower pace of rate hikes but not a cut in the target rate. Nonetheless, the trend following last year’s front-loaded rises lends credence to the idea that we are returning to a more “traditional monetary policy” environment with reduced rate volatility.
As economic prospects in Europe and China improve, inflation slows in the United States, and the Federal Reserve may slow the rate rise rate in the coming months, markets may stay upbeat. At least in the short term, however, the equities markets of Asia and Europe may continue to take the lead.
Even if there will be a quorum of Fedspeak and a plethora of corporate earnings reports from the United States this week, the market may chase equities higher elsewhere.
Investors have been caught off guard by the positive activity reports from outside the US in recent months. As a result of calmer weather across Europe, worries of a recession have subsided, and GDP forecasts for the region have improved. The market may be able to continue relaxing its concerns about US inflation and non-US economic threats if oil prices don’t go on another surge and if US inflation and wage trends continue to show moderation.
When high and growing inflation leads to disinflation, it has generally been good for equities and bonds.
A mountain descent is still a good thing at an inflation rate of above 3%.
While the precise timing of interest rate hikes and cuts is likely to be complex, the fact that inflation seems to have peaked is good news for bond and stock investors both.
US markets are closed on Monday in observance of Martin Luther King Jr. Day. Still, investors will have plenty of opportunities to focus on earnings season during the rest of the week. Many financial institutions, such as banks and credit card firms, are expected to continue reporting, along with many non-financial institutions.
Forex
In contrast to the more hawkish stances taken by the European Central Bank and the Bank of Japan, the US Federal Reserve has seen only moderate inflation in the short term. It would be hard to pray for a more poisonous mixture for the US dollar in the face of strengthening global economic impulses. It’s also worth noting that, for the time being, there aren’t that many roadblocks to the route of least resistance.
As speculation on whether or not the Bank of Japan would continue yield curve control (YCC) at its forthcoming monetary policy meeting, the central bank is at a crossroads. Despite the BOJ’s best efforts, the JGB market became more skeptical about YCC after a media story, leading to higher rates throughout the curve.
Investors believe the BOJ may eliminate YCC, like the RBA, or raise the influential band. When the Bank of Japan eliminates YCC, yields on JGBs will soar. Since the BoJ’s readiness to toe the YCC line leading into the MPM may be the deciding factor, the Yen’s movements leading up to the Tokyo fixings early this week will be closely watched.
The large hoard of offshore dollars that Japanese institutional investors are resting on will soon re-shore if JGB yields become unanchored, causing the USD/JPY exchange rate to plunge.
Asia Forex
The enormous reversal of Q2 2022’s USD liquidity hoarding by Asia’s exporters, led by Malaysia, should occur in Q1 2023.
Thanks to a more attractive interest rate difference between the US dollar and the Malaysian ringgit, a USD rally in 2022, and a higher political risk premium, the share of deposits held in foreign currency inside the financial system increased from 5% to 16% in 2022.
The belief that they have seen the pinnacle of the US dollar and rates is a crucial reason that would motivate exporters to sell their USDs.
Further, rising FDI inflows are expected to coincide with rising political stability.
In addition, the MYR has a strong positive correlation with CNY, so if the Yuan rises, the ringgit will likely gain strength. The reopening of China’s markets should also stimulate the economy by selling products and services.
Oil Market
In keeping with China’s much-improved economic forecast, oil prices rose as the trading week concluded on Friday. Key heavily populated cities shuttered for maintenance or repairs slowly show signs of activity and movement. Market participants continue to look to mobility patterns as a sign of rising Mainland oil demand in the lack of official statistics on COVID case numbers.
While we anticipate a deflation of the rise during the Chinese Lunar New Year as a result of less mobility as another anticipated COVID increase keeps people inside, we still believe the backdrop is quite positive for oil for the following reasons:
- Lower inventory levels are where we’re at the outset.
- The tide is changing for China’s mobility, and the country’s domestic supply has been reduced.
- In 2023, 2 mm bpd of new refining capacity will be available (S&P Global article).
- Positioning among speculators and CTAs seems short. Our data suggest a significant asymmetry in purchasing activity around the current price.
There is a chance that US shale businesses would report lower capital expenditures in their fourth-quarter earnings reports because of the price changes. The substantial pricing power of OPEC would allow it to maintain stable oil prices even if the oil market turned out to be weaker.
OPEC’s production might remain low after its June 4 meeting, or the organization could even reduce output further. Another factor that likely restrains OPEC’s desire to increase output is the group’s acknowledged unhappiness with Western energy policy, such as the price limitation on Russian oil (and the danger it establishes precedents).
Featured Image: Freepik @ atlascompany
Author Shariq Khan 
