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Financial Conditions Tighten on Still-Robust US Consumer Demand

The three trading rules which have dominated for decades apparently remain intact: don’t fight the Fed, don’t bet against the dollar, and never, ever underestimate the US consumer.

Retail sales rose at the fastest pace in two years in January, providing more evidence that aggregate demand in the American economy isn’t slowing as much as the Federal Reserve might prefer. Overall retail receipts climbed a seasonally adjusted 3 percent in January, snapping back from declines in November and December as consumers spent more on cars, clothing, and eating out. This comes after earlier reports showing that more than half a million jobs were created in the month, pushing the unemployment rate to a 53-year low, inflation cooled only modestly, and manufacturing volumes climbed.

Markets expect policymakers at the world’s most powerful central bank to respond by raising rates more aggressively – just as they said they would do in December. Current market pricing suggests the Fed will deliver quarter-point hikes at the March and May meetings, bringing the terminal rate close to levels projected in the December Statement of Economic Projections (colloquially known as the “dot plot”). Odds on a rate cut by year end are only slightly better than a coin toss, and overall financial conditions are tightening, helping to reverse the ebullience that underpinned markets in early January.

Treasury yields are slightly lower and the dollar is essentially flat against most of its major counterparts as investors push farther out on the risk curve. Equity futures are setting up for a subdued open.

The Canadian dollar is holding near levels that prevailed ahead of yesterday’s retail sales print, with traders expecting the economy—and the Bank of Canada—to move in lockstep with the US in months to come. Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers will appear in front of Parliament later today, with heated criticism from both ends of the political spectrum unlikely to translate into any meaningful action. That’s how Canadians do things.

The Australian dollar tumbled last night after the unemployment rate jumped by more than expected, suggesting that the economy is beginning to cool in response to ever-tighter monetary policy settings. According to data published by the Australian Bureau of Statistics, the jobless rate rose to 3.7 percent in January, up from 3.5 percent in the prior month as 11,000 roles were cut. Labour markets remain historically tight—and inflation remains well above the Reserve Bank’s target—but more evidence of deceleration could lower terminal rate expectations and tilt interest differentials even further against the Aussie.

Initial claims for jobless benefits are expected to climb back above 200,000 for the week ended February 11, normalizing after January’s unusual decline. Prior to the pandemic – in an already-hot jobs market, weekly claims averaged around the 218,000 mark, but we note that a warmer-than-normal winter is playing havoc with employment figures in general, making it difficult to discern the signal beneath the noise.

Economists think producer prices climbed 0.4 percent in January from the prior month, decelerating slightly on a year-over-year basis. China’s reopening has thus far failed to strain the global factory sector, and price growth remains subdued relative to dynamics that unfolded over the last two years.

Today’s Fed speakers include Cleveland’s Loretta Mester, St. Louis’ James Bullard, and Governor Lisa Cook.

The threat of a US debt default is growing more tangible. The Congressional Budget Office released its latest calculations yesterday, showing that if the government’s spending trajectory remains stable and tax receipts come in as projected, the Treasury’s “ability to borrow using extraordinary measures will be exhausted between July and September”. In previous iterations of one of the US political system’s most embarrassing and hypocritical rituals, markets failed to recognize the risk of a liquidity event until they were staring into the abyss – but with a compromise solution looking less likely under today’s uniquely-fractured Republican majority, this time could be different. We expect political risks to increase in importance as the summer approaches.

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