Equi Friday Five - 01/27/23

1/ All eyes were on PCE inflation this week. The metric increased 5% YoY, continuing its downward momentum, and marking the smallest rise since October of 2021. In addition, the Fed’s preferred inflation metric, Core PCE, moderated at 4.4% YoY

2/ When you delve deeper, it appears that the Fed still has some work to do. 3-month PCE inflation growth rates, though having moderated, still haven't registered negative percent changes, suggesting that the Fed Funds Rate will likely need to remain higher for longer

3/ As we count down to the next Fed meeting, the market is anticipating, with a 98% probability, that the Fed will hike rates by 25 basis points. With this policy decision, the Fed Funds Rate would be greater than PCE inflation for the first time since February 2020

4/ With the FFR > Core PCE, restrictive policy is clearly imminent, but will the Fed maintain this or pivot? The former seems more likely when considering the relatively strong economy & labor market, as well as both the recent easing of financial conditions & market rally

5/ Lastly, any future inflation surprise may wreak havoc given the market is conveying it doesn't believe the Fed's plan for rates, how sensitive financial conditions are to this phenomenon, and how underhedged market participants have become as gauged by option skew