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Markets Rally on Soft Landing Confirmation

The American economy expanded far more than expected in the fourth quarter, smashing market forecasts and delivering booming growth even as the lagging impact of one of history’s most aggressive tightening cycles hit home. Data released by the Bureau of Economic Analysis this morning showed the economy expanding 3.3 percent in the October-through-December period, topping market consensus that had been set closer to 2 percent, and exceeding estimates provided by the Atlanta Federal Reserve’s nowcasting model. On a full-year basis, output rose 2.3 percent, defying longstanding expectations for a slowdown and even a recession.

Personal consumption rose 2.8 percent, slowing from 3.1 percent in the third quarter, but remaining much stronger than anticipated. Non-residential fixed investment – sometimes seen as a way to measure business investment – accelerated to 1.9 percent from 1.4 percent in the previous quarter. And net exports and inventories – which had been expected to drag the headline lower, contributed positively, adding 0.5 percent.

Final sales to private domestic purchasers – a proxy for true underlying demand – climbed 2.6 percent after growing 3.0 percent in the third quarter.

Contributors to real gross domestic product growth, quarter-over-quarter change, annualized rate

Perhaps most importantly for rates traders assessing the Fed’s reaction, underlying core personal consumption expenditures inflation held at a 2-percent year-over-year pace, giving the central bank room to follow canonical policy rules in cutting interest rates.

Separately, new orders for durable goods outside the transportation category climbed 0.6 percent month-over-month in December, suggesting that underlying demand remains strong.

Initial claims for unemployment benefits rose to 214,000 in the week ended January 20, slightly above market consensus, but extremely low by historical standards.

With a 2023 “soft landing” effectively confirmed, Treasury yields are inching lower and the dollar is slipping.

Tomorrow’s personal income and spending data should provide further insight into the handoff into the first quarter of 2024, with most early indicators pointing to a modest softening in overall consumer demand. We think the economy should show greater signs of strain in the coming months, helping reduce the dollar’s outperformance against its major counterparts.

And as expected, the European Central Bank kept all of its main policy settings intact, and left forward guidance unchanged. In the statement setting out the decision, the Bank said “Incoming information has broadly confirmed its previous assessment of the medium-term inflation outlook. Aside from an energy-related upward base effect on headline inflation, the declining trend in underlying inflation has continued, and the past interest rate increases keep being transmitted forcefully into financing conditions. Tight financing conditions are dampening demand, and this is helping to push down inflation”. The euro is exhibiting no meaningful reaction as we go to print, although that could change during the press conference, with President Lagarde expected to repeat recent comments and echo Chief Economist Phillip Lane in pushing back against market hopes for rate cuts in the coming months, doing her best to anchor easing expectations around the June timeframe.

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Dollar Cruises Toward Weekly Gain on Fading Easing Expectations
Twists & turns

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