Tis’ the season to be jolly. Traders are in an ebullient mood after yesterday’s data showed consumer prices rising in November at the slowest 12-month pace since December 2021. Although equity markets have largely retraced their steps, ten-year Treasury yields are holding below the 3.5-percent threshold, the dollar is weaker, and risk appetite looks robust across the currency markets.
It might seem like investors are decking the halls with boughs of folly, but there are good reasons to think inflation is stabilizing at lower levels. Cheaper energy prices are gradually reducing upward pressure on headline indices, and seem unlikely to stage a meaningful rebound in the absence of another geopolitical shock or unexpected surge in demand. Core measures will continue to absorb higher wages and shelter costs for many months to come, but vehicle prices are reverting to pre-pandemic norms and inventory buildups are beginning to depress manufactured product costs.
The Federal Reserve is likely to warn more data is needed to determine whether prices are really easing, but is also expected to acknowledge signs of improvement. In this afternoon’s statement, economic forecast update, and press conference, policymakers are expected to announce plans to raise rates in smaller increments before pausing to assess the longer-term impact of this year’s tightening efforts. Economists expect the “dot plot” summary of economic projections to show rates topping out around 4.9 percent – up from the 4.625 percent expected in September, but well below levels that had been feared in October and November. Forecasts for 2024 should also be revised up, and might land closer to 4.1 percent.
But recession worries appear to be replacing inflation fears. The yield curve remains deeply inverted, and investors are clearly bracing for a slowdown in the US economy. As the calendar flips into the new year, markets could become more convinced that monetary policy doctors have cured a high fever by killing the patient.
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There are no major data releases scheduled for the North American session.
China will release retail sales, industrial output, and fixed asset investment numbers for November this evening, but markets are likely to shrug in response, given that conditions have shifted dramatically in the intervening weeks as “zero-covid” policies have been reversed. Economists expect reopening efforts to translate into higher growth in the year ahead, but fear of contracting the virus is keeping millions of workers home, restraining interprovincial travel, and hurting overall consumer demand. A full recovery could take many months to unfold.
The European Central Bank and Bank of England are each expected to deliver half-percentage point hikes at tomorrow’s meetings. Policymakers at both central banks are likely to sound more hawkish than their American counterparts, but market reaction should be relatively muted – traders are likely well prepared.
Karl Schamotta, Chief Market Strategist