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Volatility Falls Ahead of Central Bank-Packed Trading Week

Trading activity in global financial markets remains muted ahead of the last US inflation print to land before next week’s central bank meetings. With equity futures inching down and Treasury yields holding flat, the dollar is effectively unchanged against its significant counterparts, with the inflation-propelled Australian dollar looking like the only major to eke out serious gains over the week.

The US economy grew substantially faster than forecast in the final quarter of 2022, but odds on a smaller rate increase at next week’s Federal Reserve meeting remained unchanged, and markets continued to brace for a recession later this year. Data released by the Bureau of Economic Analysis showed gross domestic product increasing at a 2.9-percent annualized rate between October and December after a 3.2-percent gain in the third quarter. Accounting identities played a big role, with inventories adding 1.5 percent and net exports contributing 0.6 percent to the headline, while final sales to private domestic purchasers climbed just 0.2 percent on an annualized basis. Treasury yields and the dollar were effectively unmoved in response.

Today’s inflation, income, and spending data might have similarly-weak effects. Markets think the Fed’s preferred inflation indicator—the core personal consumption expenditures index—will climb 0.3 percent month-over-month, up 4.4 percent relative to the prior year, and down from 4.7 percent in November. Personal income gains should continue, with stronger wages and ongoing tax refunds helping to bolster the flow of cash into the household sector. Spending is expected to shrink slightly as both the tangible and services categories post year-end declines.

The University of Michigan’s second consumer sentiment index estimate for January is expected to hold at 64.6, unchanged from the initial reading. Year-ahead inflation expectations, which fell from December’s 4.4 percent to 4 percent should hold steady, suggesting that households—more sensibly than some economists—remain on Team Transitory, seeing the post-pandemic surge in prices as originating in coronavirus-related supply disruptions and excess government stimulus, not a structural shift in the economy’s underpinnings.

In next week’s central bank meetings, the Federal Reserve is almost universally expected to raise rates by a quarter percentage point, while the Bank of England and European Central Bank are likely to deliver a half percentage point each. Surprises, if there are any, could come in the forward guidance provided by policymakers, with the Bank of Canada’s surprising strong commitment to a “conditional pause” paving the way for more explicit acknowledgement that monetary tightening cycles are nearing completion. US and European policymakers are likely to make half-hearted attempts at tilting against easier financial conditions, but dissent among members of the UK’s Monetary Policy Committee could make for a more confusing—and potentially dovish—set of communications.

Non-farm payrolls, due for release next Friday, are seen climbing by 175,000 positions in January, with widespread hiring continuing to offset high-profile layoffs from the likes of Amazon and Meta. The unemployment rate may tick up slightly, but should remain near historic lows. In the absence of a major surprise, these numbers are unlikely to force a reappraisal of the Fed’s monetary tightening trajectory.

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