Markets are beginning to wake from their long slumber. With month-end flows, the Treasury’s Quarterly Rebalancing announcement, the Employment Cost Index, and a Federal Reserve decision in the docket for the day ahead, equity futures are setting up for a softer open, Treasury yields are down, and the dollar is up – classic signs of risk aversion.

China’s manufacturing sector remained mired in a downturn in January, suggesting that half-hearted government stimulus efforts are failing to generate enough domestic demand to offset weaker export markets. The National Bureau of Statistics’ official manufacturing purchasing manager index rose slightly to 49.2 in January, up from 49 in December, but below the 50 threshold that separates expansion from contraction for a fourth month. A similar services-sector measure inched up to 50.7 in January from 50.4 in the prior month. The yuan is trading defensively as equity markets continue their descent.

The Japanese yen is surprisingly unmoved after a summary of opinions from last week’s policy meeting showed officials moving closer to delivering a rate hike. The currency inched only slightly higher last night after one member said there is a “golden opportunity” to move before other major central banks begin easing, suggesting that “conditions for policy revision, including the termination of the negative interest rate policy, are being met”.

Risks seem biased to the hawkish side in this afternoon’s Fed decision, given that a long-expected downturn in the US economy has largely failed to materialize. Although real policy rates have moved further into restrictive territory in recent months, it isn’t clear they’re taking a terribly negative toll on credit growth, consumer spending, or employment.

Data published this week has been strongly supportive of the “soft landing” thesis. On Monday, the Treasury Department reduced its estimate for federal borrowing in the first quarter, reducing the potential for strain in funding markets. The number of job openings surged last month, surprising observers who had expected a slowdown. And the Conference Board’s measure of consumer confidence climbed to a two year high as households cited “slower inflation, anticipation of lower interest rates ahead, and generally favourable employment conditions” in driving the improvement in sentiment.

Policymakers are unlikely to clearly telegraph imminent cuts. Instead, we think a sentence in the statement which previously kept “additional policy firming” on the table could be replaced with more neutral language that refers to the “timing and scale of adjustments” in the Federal Funds rate. In the press conference, Jerome Powell could be more explicit, warning markets that disinflationary pressures will need to be sustained for longer before policy can be ratcheted back into easier territory. An outright announcement on slowing the pace of balance sheet normalization also looks relatively improbable – Mr. Powell could instead outline the technical factors in play as officials seek to promote healthy market functioning.

We could be wrong of course. A far more dovish outcome could unfold if the statement includes a pledge to “act as appropriate to sustain the expansion” and Powell provides more detailed guidance on the conditions that must be met for rate cuts to begin. Although such a move should be considered a plumbing tweak more than an expression of monetary policy direction, an addendum setting out a slower quantitative tightening trajectory could push yields lower.

Good luck, and stay frosty.

 
Still Ahead

WEDNESDAY

The last two quarterly refunding announcements proved to be monumental, market-moving events, but this week’s iteration should come with fewer fireworks. Treasury officials are likely to increase outright issuance of longer-term instruments, but only modestly, continuing to take advantage of rollover opportunities to extend the borrowing portfolio’s tenor over time. A misstep is possible, but looks less likely at this time. (08:30 EDT)

The Canadian economy might have staged a modest rebound at the end of 2023. Statistics Canada is expected to report an incremental 0.1-percent gain in November – according to a preliminary estimate, the manufacturing, transportation, and natural resource industries helped offset softness in the retail sector – and December’s read could look better, with higher-frequency spending data pointing to a bigger gain in household consumption. This isn’t expected to last: consumer and business surveys are pointing to renewed weakness in the early new year, with spending and investment levels likely to resume their descent. (08:30 EDT)

Wage growth may have accelerated slightly in the fourth quarter, with the Federal Reserve’s preferred Employment Cost Index ticking higher to an annualized 4.4 percent pace from 4.3 percent in the prior quarter. This shouldn’t alarm policymakers – evidence of a “wage-price spiral” has proven non-existent in the post-pandemic years, and survey data suggests that most employers expect costs to moderate in coming months. (08:30 EDT)

The Federal Open Market Committee will almost certainly leave its major policy settings unchanged for a fourth consecutive meeting, but December’s growth and inflation data could complicate the picture for forward guidance, impacting market expectations for rate cuts in coming months. With labour markets, wage gains, and overall growth continuing to defy expectations for a slowdown, language in the accompanying statement is likely to signal greater confidence in the economy’s underlying strength – something that would ordinarily indicate an underlying hawkish bias. However, with inflation falling, real rates pushing ever farther into restrictive territory, and some signs of softness emerging in the deeper recesses of the economy, officials could add sentences referring to greater “uncertainties” in the outlook, and expressing a willingness to take measures that “sustain the expansion” – wording likely interpreted by markets as telegraphing imminent policy easing. We don’t expect an announcement on slowing the pace of balance sheet reduction at this meeting, but discussion among committee members about ensuring an “ample” supply of reserves in the system could intensify, putting the conditions in place for a move in March or April – or, perhaps, in an inter-meeting announcement. (14:00 EDT)

THURSDAY

Disinflation in the euro area likely accelerated in January as December’s year-over-year base effects faded. Markets think headline consumer price growth slowed to 2.6 percent in January from 2.9 percent in December, with the core measure slumping from 3.4 percent to 3.1 percent – a level that would put it within shouting distance of the European Central Bank’s target. A downside undershoot could boost wagers on earlier rate cuts, but we think June remains the safer bet – Teutonic influences on the central bank’s policy committee are likely to argue for a cautious approach for now. (05:00 EDT)

Markets expect a distinct dovish shift even as the Bank of England keeps all of its major policy settings unchanged for a fourth meeting. Prompted by a sharp decline in inflation pressures – projections could show price growth returning to target within the next six months, almost a year ahead of schedule – at least one official is expected to vote for a rate cut, and statement language is seen pivoting away from a tightening bias toward providing hints of easing ahead. The pound could experience an upward jolt if this doesn’t pan out however – if policymakers maintain a more hawkish footing, market consensus could shift. (07:00 EDT)

FRIDAY

The US job creation engine probably kept decelerating in an unusually-cold early January, with fewer than 170,000 jobs added – still above population growth, but below the levels reached last year. Downward revisions in the November and December numbers could see the unemployment rate pushing higher to 3.8 percent from 3.7 percent, while putting modest downward pressure on wage growth indicators. (08:30 EDT)