All is not calm and all is not bright in financial markets this morning, but price action remains surprisingly restrained after yesterday’s Federal Reserve decision. Equity futures are setting up for a weaker open, yet interest rates are stable, the dollar is soft, and most major currencies are trading within ranges established earlier in the week.

The Fed tried to deliver an overtly-hawkish message: An updated dot plot showed the median member of the Federal Open Market Committee thinks interest rates will climb above 5.1 percent next year – well above market levels – and seven of nineteen said they expect a move above 5.25 percent. In the press conference, Jerome Powell noted that he did not consider financial conditions “sufficiently restrictive”, saying the central bank would require “substantially more evidence that inflation is on a sustained downward path” before considering a pause in its tightening campaign, while repeatedly noting the risk of “prematurely easing” policy.

But it fell on deaf ears: A brief sell-off in financial markets was mostly unwound by day end, leaving equities modestly softer, ten-year yields below 3.5 percent, and the dollar only slightly weaker. Theories abound to explain this – some think Powell failed to aggressively push back against easier financial conditions, some argue that his emphasis on the destination, not the pace of rate hikes helped push expectations lower, and others think his comments weren’t delivered in a convincing tone.

We think markets consider the Fed’s communications performative: Investors believe Powell and his colleagues are engaged in a complex communications effort – trying to bring down price pressures now by talking tough on inflation, while preparing to reverse direction once the threat has passed and the economy is slowing. This is leading to an apparent loss of credibility – interest rate futures currently suggest the central bank will raise rates another half-percentage point in early 2023, only to cut them again by the end of the year.

To update the old market cliche: Don’t fight the Fed – unless you think the Fed really doesn’t mean it.

The Bank of England raised its benchmark lending rate by half a percentage point this morning and warned it would tighten more in coming months – but muddled messaging sent the pound tumbling. According to the official statement, “The majority of the Committee judges that, should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in the Bank Rate may be required for a sustainable return of inflation to target”. Yet the decision was marked by a number of striking dissents – one member voted for a larger, three-quarter-point move, and two opted to leave rates as they were, arguing that policy was already sufficiently tight. Most agreed the economy had already entered a recession. The pound sold off as traders lowered medium-term rate expectations.

Madame Lagarde and her colleagues at the European Central Bank are expected to follow suit in a few minutes, raising rates by another half percentage point while telegraphing a slower pace in the months ahead. Markets expect the deposit rate to hit 2.5 percent in early 2023, with rate cuts coming in the second half of 2024.

US November retail sales are expected to slump -0.3 percent from October’s level as vehicle purchases fall. With autos excluded, sales are seen climbing 0.1 percent. Most observers expect a weaker holiday spending season, but the picture is complicated as easing supply chain issues help drive a softening in goods costs, gasoline prices tumble, and consumer spending begins to shift toward services.

The number of initial claims for jobless benefits is seen rising to 232,000 in the week ended December 10, up from 230,000 in the prior week. This is unlikely to move markets – labour markets remain historically tight, with signs of weakness difficult to discern.

Economists think business inventories for October, out at 10 am, will increase 0.4 percent month over month. Markets probably won’t respond, but we are watching this variable closely – a build in inventories now could foreshadow a sharp drop in goods inflation early next year as retailers discount more aggressively.

Karl Schamotta, Chief Market Strategist