Central banks are in a holding pattern for now. With rates seemingly having topped out in North America, Europe, and most of Asia, it is widely assumed cuts are the next policy step.
But policymakers have been working overtime to contain expectations for imminent action, fearing the mistake of stepping off the brakes too early. More precisely the next focal point for policymakers will be the US CPI (Tuesday) as market will be looking for direction, even if the March rate cut has been taken off the table and chances for May have slipped to 50-50 given the resilience in the US economy.
The CPI tomorrow shouldn’t change the overall outlook too much, especially now that the markets are seeing the FOMC on hold this quarter, with fewer rate cuts expected this year. The numbers are not expected to be sufficient to sway officials who want to see several more months of data evidencing the downtrend in inflation. Yet the numbers will help formulate the projections for the SEP due with the March 19-20 FOMC. We also expect more signs of Goldilocks with receding inflation and decent growth.
January headline and core CPI should post increases of 0.1% and 0.3%, respectively, after December gains of 0.2% (was 0.3% before annual revisions) and 0.3%. As-expected January results would leave the y/y headline slowing to 2.9% from 3.4% in December, with the core y/y easing to 3.7% from 3.9%. Both y/y gauges benefit from easier comparisons in Q1. We expect dissipating upward pressure on core prices as disruptions subside from global supply chain bottlenecks, though officials are wary of the impacts from the Red Sea dislocations.
Market Sentiment and Monetary Policy
This week, along with the data, Fedspeak will be closely tracked to hear if there are any deviations from recent comments cautioning against moving too soon. The constant Fedspeak downplaying risks for not only a near term easing as soon as March but also against a string of 6 quarter point moves in 2024 as most policymakers appeal to the 3 cuts reflected in the dots as the base-case, are finally having some impact on the market. And of course the resilience in the economy and the labor market have added to the less dovish outlooks too.
Interestingly, this week’s Fed funds Survey Medians also reflect that downshift. The May contract is priced for 18.5 bps in easing, with June at 38 bps, compared to expectations for cuts of 52 bps and 78 bps, respectively, in late December, with a total of 158 bps in 2024. The FOMC is anticipated to begin normalizing rates in June after there is more data confirming the downtrend in inflation. And the forecasts so far are in line with the 3 cuts seen in the FOMC’s dot plot.
Implications for Financial Markets
