This week is all about the Federal Reserve and what it communicates to markets about its terminal rate. The last FOMC meeting saw the Fed plays a masterful stroke. In the statement, it sent stocks higher on the acknowledgement that the Fed would be taking monetary policy ‘lag’ into consideration. In other words, the Fed’s hikes are not felt in the wider US economy until around 12 months later. This means it would be possible for the Fed to over-tighten rates, so it assured markets it is considering these effects. Secondly, Jerome Powell told markets that the Fed may actually need to go higher than markets previously expected and that sent stocks lower. So, in summary, the Fed’s current message about rates is, “Slower rates, but not necessarily lower rates.”

Don’t forget the obvious

It’s mainly about inflation and labour data for the Fed. The Fed wants to see inflation fall and signs of slowing growth creeping into the labour market. It wants demand to cool and prices to fall. So, leading up to the Fed meeting the market has been pushed and pulled around on the latest inflation and labour prints as investors and traders try to position themselves for what this will mean for the Fed. The problem is that it has been a mixed bag of data.

Inflation data has shown a firm core PCE print and a strong average weekly hours increase from the NFP print. These data points signalled that the Fed will need to do more and go higher. The Fed watcher from the Wall Street Journal, Nick Timiraos, said that, ‘Elevated wage pressures could ‘muddy the debate over the 50 vs 25bps hike in February and lead officials to pencil in more hikes this year’. However, on the other hand, labour unit costs are down from last Wednesday’s print at 2.4% vs 3.1% expected q/q and continuing jobless claims moved higher. Rents are also showing signs of falling which can be a good sign for inflation peaking.

Before the Fed meeting, we also have US CPI which will set the mood music on Tuesday. The headline is due to fall to 7.6% from 7.7% and the core is due to drop to 6.2% from 6.3%. If we see a bigger drop then the USD will fall into the Fed meeting. However, then it will all depend on the Fed forecasts. A 50 bps hike is now assumed and the question is will the Fed go above 5% next year. So far the Fed has signalled it will go higher than expected, but what will it actually say? If it drops that element of the guidance and hints at a pause around/under 5% then watch for USD lower, stocks higher, and gold to rocket. However, if it signals firmer rates in Fed and a higher terminal rate then expect the opposite reaction, at least as an initial reaction.