1/13/23 – Fed Downshifts Rate Hikes as CPI Softens
The December CPI report released on Thursday was a pleasant surprise for investors. The headline CPI fell -0.1% month-over-month, and the year-over-year measure fell to 6.5% from 7.1% the previous month. Core CPI, the measure that excludes food and energy, rose 0.3% over the previous month, a slight uptick from the 0.2% previously reported. Core CPI has fallen to 5.7% year-over-year from the peak of 6.6% reported last September. The market breathed a sigh of relief as witnessed by the massive rally in the long bond on the day of the release, closing nearly two points above the previous day’s close. We suspect that much of the rally was driven by short covering, driving the yield-to-maturity down below 3.6%. At that yield level it’s hard to justify buying from a fundamental perspective. At the short end of the curve, the yield on the two-year note touched 4.14% which now makes it inverted to Fed Funds. The yield on the 2-year had traded as high as 4.72% in November as investors feared that the Fed would raise rates by 75 basis points at their December meeting. Instead, of course, they only moved 50 basis points as the economy showed signs of slowing.
Also on Thursday, Philadelphia Fed President Harker said the days of 75 basis point hikes are “surely” behind us and that 25 basis point hikes will be appropriate going forward. Those comments and the encouraging CPI release have driven consensus to expect a 25-basis point hike at the February 1st FOMC meeting. He also said that a soft landing was still possible even if it’s bumpy. We assume he means that the economy will avoid recession, but the unemployment rate will rise. Reading the year ahead outlooks that have been published, that view is out of consensus. Pundits are expecting a recession later this year and Fed Fund futures are predicting a rate cut later this year. For their part, no Fed speakers are hinting at a rate cut anytime soon.
Though it wasn’t market moving and not mentioned in the press, the Federal Reserve’s open market portfolio of holdings fell below $8 trillion for the first time since it peaked at nearly $9 trillion last April. As of Wednesday’s reporting, holdings fell to $7.99 trillion. As a reminder, the Fed is letting its portfolio run off to the tune of $120 billion a month.
Next week we’ll get a measure of how the holiday selling seasoned fared when retail sales are released on Wednesday.
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