Market Strategist
Summary: Despite some improvement in the growth narrative recently, the Fed has limited new trends of the US economy to take note of at their January 31-February 1 meeting. The recovery in Q4 GDP comes with a weakening consumer spending, and incoming data remains volatile at best. This means there is reason to believe that the Fed will want to lengthen its tightening cycle, and go in smaller steps, in order to buy more time to assess the growth and inflation dynamics.
The expectations of a soft landing have picked up since the start of the year, relative to the rising recession bets seen in H2 of last year. Meanwhile, inflation has been on a steady downtrend in the last six months, which has allowed the Fed to downshift to a 50bps rate hike in December after a spate of rate hikes in 75bps increments before that.
Yesterday’s US economic data, including the Q4 GDP or durable goods, further supported the case for sustained economic activity and eased recession fears. The advance print of Q4 GDP came in at a stronger-than-expected +2.9% YoY (vs. 2.6% YoY exp) for the fourth quarter from 3.2% YoY in Q3. In addition, sustained labor market strength was once again signalled by another sub-200k print in the weekly jobless claims.
The wave of layoffs seen in the tech sector is now even extending to other sectors. But broader US labor market data, including nonfarm payrolls or weekly jobless claims, continues to signal sustained tightness in the US labor market. These divergent data signals are underpinned by several factors:
Overall, most of the layoffs appear to be steps to control costs in the current scenario of margin pressures and an impending slowdown, but do not really signal any fears of a prolonged recession.
Besides the Fed’s most hawkish member, James Bullard, all other FOMC members have broadly hinted at a further slowdown in the pace of rate hikes. Bullard does not vote this year or next, and the overall Fed committee composition for 2023 hints at a slightly more cautious to dovish stance ahead unless inflation shoots up again. Most recently, two of this year’s voters, Waller and Harker, have backed a clear preference for 25bps rate hikes from February onwards.
Economic data recently has been extremely volatile. Moreover, the fourth quarter GDP report may have been above expectations on the headline, but details are still patchy. Consumer spending grew 2.1%, which was below the 2.9% rate expected, suggesting that the consumers may be starting to pullback after using their excess savings last year. The recent activity data in January, from retail sales to ISM surveys, suggests pressure may be building for Q1 growth.
This means there is some reason to believe that Powell and team may be aiming to lengthen the hiking cycle in order to buy more time to assess both the incoming data and the impact of their previous aggressive rate hikes. This warrants a smaller rate hike of 25bps at the February 1 decision.
The key risk factor, favouring another 50bps rate hike, could be the financial conditions which are the easiest since April 2022 or the risks of another shoot higher in inflation due to China’s reopening and the resulting rise in commodity prices.
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