Digesting the Fed, BOE Holds Steady, International Conflict

Yesterday, as expected, the Fed held rates steady for the fourth consecutive meeting in a range of 5.25-5.50%.?

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Also as expected, the Fed removed the likelihood of any additional policy firming and further inched open the door to eventual rate cuts. Removing the phrase “In determining the extent of any additional policy firming that may be appropriate…,” the January statement now reads that the “risks to achieving its employment and inflation goals are moving into better balance.”?

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That being said, the statement also clarified that the Fed is not in any hurry to reduce policy firming nor do officials think it will be appropriate to do so anytime soon. Furthermore, any support for a reduction in rates will not come unilaterally, but with the prerequisite of further improvement in inflation. Amid “solid” growth, an upgrade from “strong” in December,?“strong” job gains and “low” unemployment, inflation has come down but remains “elevated.” Given such robust conditions, “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

The central bank also reiterated its focus on reducing the balance sheet by $95 billion per month while removing any mention of a “sound and resilient” banking system, along with a warning of the impact of “tighter financial and credit conditions.”

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The decision was unanimous.?

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Bottom Line: Despite market optimism for a near-term reduction in rates, the Fed has clearly outlined the need for further improvement in inflation before taking the first step to unwind policy firming.?With an economy accelerating beyond earlier expectations, a tight labor market and solid consumer, with inflation still above target levels and sizable risks to the upside, there is no incentive for the Fed to take its foot off the brake, at least not yet. Policy need not remain at the terminal level forever, but the Fed made a mistake on the front end, allowing price pressures to become well established under the misguided assumption of “transitory.” The Fed doesn’t want to risk making a second error on the back end by prematurely removing sufficiently restrictive policy before the goal of price stability has been achieved.?

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Following the rate announcement yesterday, the Dow Jones Industrial Average fell 317 points to close the day at 38,150.30. Yields, meanwhile, moved lower after the announcement with the 10-year falling 12bps, closing the day at 3.91%. This morning, the Dow is up 0.2% at 38,244.91 and the 10-year is down 2bps at 3.89% as of 9:32 a.m. ET.

Earlier today, following the footsteps of the Fed, the Bank of England (BOE) held its key lending rate unchanged at 5.25% as it has been since August.?The BOE, like the Fed, also dropped a reference to the potential for further policy firming in its guidance.?

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Unlike yesterday’s rate announcement here at home, however, the BOE’S decision was not unanimous, with two policy makers voting in favor of higher rates, while one voted for a cut.?According to Bloomberg data, the market is still pricing in roughly 115bps of BOE rate cuts this year with the first potentially as early as May.?

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In international news, according to reports, the U.S. launched two additional strikes on Houthi targets inside Yemen and intercepted a missile fired by the terrorist group. According to President Biden, “These strikes are in direct response to unprecedented Houthi attacks [that] have endangered U.S. personnel, civilian mariners, and our partners, jeopardized trade, and threatened freedom of navigation."

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While expectations for the impact of the attacks and more broadly, the Israel-Hamas war are still relatively muted, according to maritime advisory firm Sea-Intelligence, the disruptions to global shipping could rival that of the global shutdown during COVID. Already reports of massive price increases have been reported with shipping costs on containers traveling from Asia to the North American East Coast specifically up 130% with several routes out of the Middle East Gulf showing double-digit gains.

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Also yesterday, along with the Fed announcement,?MBA mortgage applications fell 7.2% in the week ending January 26. The 30-year mortgage rate, meanwhile, was unchanged at 6.78%.

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Also yesterday, ADP reported that private-sector employment rose by 107k in January, significantly less than the 150k gain expected and down from the 158k rise the month prior.

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The Employment Cost Index rose 0.9% in the fourth quarter, slightly less than the 1.0% gain expected and down from the 1.1% increase the quarter prior.

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Finally, yesterday, the Chicago PMI unexpectedly fell from 47.2 to a reading of 46.0 in January, a three-month low. According to the median forecast, the index was expected to rise to 48.0 at the start of the year. In the details of the report, prices paid and deliveries rose, signaling expansion. On the other hand, new orders, employment, and order backlogs fell, signaling contraction.

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This morning, initial jobless claims unexpectedly rose by 9k from 215k to 224k in the week ending January 27, a two-month high. The four-week average increased from 203k to 208k. Continuing claims, or the total number of Americans claiming ongoing unemployment, gained from 1.828M to 1.898M in the week ending January 20.

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Also this morning, nonfarm productivity rose 3.2% in the fourth quarter, surpassing the 2.5% gain expected, albeit down from the 4.9% gain in Q3. Unit labor costs, meanwhile, rose 0.5% in Q4, less than the 1.2% gain expected, albeit a two-quarter high.

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Later this morning, the ISM Manufacturing Index is expected to decline from 47.4 to 47.2 in January, potentially marking the 16th consecutive month of contraction (a reading below 50).

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Tomorrow, the January employment report will be released. After a larger-than-expected 216k gain in December, nonfarm payrolls are expected to slow to just a 180k rise in January, potentially marking a three-month low.

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The unemployment rate, meanwhile, is expected to tick up from 3.7% to 3.8%, still well below what the Fed designates as the full unemployment range, perpetuating the notion of tight labor market conditions.?

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Finally, average hourly earnings are expected to rise 0.3% in January and 4.1% over the past 12 months, matching the 4.1% gain in December. Wages continue to remain elevated, compounding pressures on businesses while offering a welcome offset to elevated prices and higher borrowing costs on the consumer side.?

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-Lindsey Piegza, Ph.D., Chief Economist