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Risk Appetite Weakens as Pivot Hopes Fade

A sense of caution is settling over financial markets this morning, with North American equity futures setting up for a weaker open, commodities under pressure, Treasury yields rising, and the dollar in recovery mode.

Markets went on a bit of a drunkard’s walk after yesterday’s print. Risk sensitive assets rallied in the moments after the release as investors found their worst fears had not been realized, but then seemed to fall as stubbornly-strong services prices lowered the likelihood of a meaningful Fed pivot in the months ahead. Oscillations continued throughout the day as position adjustments unfolded and traders struggled to reconcile contradictory elements in the data.

Fed funds futures are now pointing to a “terminal rate” near 5.25 percent in July—implying two more quarter-point hikes—with no full cuts discounted until early next year. This marks a significant change from a few weeks ago, when at least one—and perhaps two—rate reductions were expected by the end of the year. Implied rate forecasts for the end of 2024 have risen almost 75 basis points this month, suggesting that January’s astonishingly-strong non-farm payrolls report fundamentally shifted market narratives, destroying the almost-universal short-dollar consensus that dominated sell-side currency outlooks last month.

Oil prices are lower even after the International Energy Agency lifted its 2023 forecast for global consumption by 2 million barrels a day, with China’s reopening expected to offset continued demand destruction in other areas of the global economy. Markets are expected to remain in surplus through the first half as Russian crude continues to make its way out into the world, and as steadily-rising inventories in North American put pressure on front-month prices. Both the West Texas and Brent benchmarks are down roughly 1 percent on the day, heaping pressure on a still-defensive Canadian dollar.

The pound slumped this morning as inflation slowed by more than expected, easing pressure on the Bank of England. The Office for National Statistics said headline price growth weakened to 10.1 percent in January, down from a high of 11.1 percent in October and below the 10.3 percent consensus forecast. Perhaps more importantly, core inflation, which removes highly-volatile categories like food, energy, alcohol and tobacco, fell to 5.8 percent from 6.3 percent in December, well short of the 6.2 percent expected in markets. The UK’s central bank raised rates last week, and is still expected to deliver another increase in March, but a pause could come soon thereafter if energy prices remain restrained and wage growth continues on its current trajectory.

US retail sales are thought to have risen 1.9 percent in January, bouncing back from a 1.1 percent decline in the prior month. Numbers already released showed auto sales snapping back, and real-time card spending data released by several major banks points to a sharp pickup in consumer purchases – likely driven by continued jobs growth and a modest easing in price pressures. Social security payments also jumped in the month as inflation adjustments kicked in.

Economists think business inventories climbed 0.3 percent in December – a number that, if realized, would help boost expectations for first-quarter gross domestic product. Overall inventory-to-sales ratios continue to fluctuate wildly as “bullwhip effects” play out, but it does appear as if consumer spending on tangible products has reset to higher levels post-pandemic – perhaps as a consequence of lower commuting times.

In what would normally be a snooze-worthy release, the Congressional Budget Office will publish its latest budget projections at 2 pm. The report will provide insight into the expected net impact of fiscal spending on the economy this year, while also telling markets when to expect a government default if Congress fails to raise the debt ceiling by late summer. Rate curves are beginning to look seriously kinky, and liquidity conditions could deteriorate quickly if politicians remain obstinate.

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