Saturday, February 4, 2023

A risk of transitory disinflation

The main event last week for US investors was the FOMC decision. As expected, the Fed raised rates by a quarter-point and underlined that "ongoing increases in the target range will be appropriate". Powell went on to clarify that "ongoing increases" translated to a "couple" of rate hikes, which would put the terminal rate at 5.00% to 5.25%, a level that was just above market expectations. He went on to signal that the Fed does not expect to cut rates this year. Moreover, he stressed, "We will stay the course until the job is done".

Those statements appeared hawkish, until he allowed, "We can now say for the first time that the disinflationary process has started". In addition, he characterized financial conditions as tight when it was obvious that markets had been taking on a risk-on tone since October. 

As a consequence, the Fed's hawkish warnings fell on deaf ears. Asset prices went into a risk-on mode in response to Powell's statements during the press conference. The market consensus terminal rate stayed at just below 5% and expectations of rate cuts at the end of 2023 changed from one to two. It took a strong surprise from the January Jobs Report to push the terminal rate above 5%, though easing expectations was pushed forward into mid-year.

To be sure, inflationary pressures are softening in a constructive way, but the risk of transitory disinflation is rising.

The full post can be found here.

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