Subjective market review (17-Jan-2023)

... or what recently caught my attention:

1) Speech by FED's Governor Waller (voter) cooled the markets' enthusiasm for rate cuts, but not by much:

(i) March implied cut probability was down to 68% (before Waller spoke at 16:00ET, a March cut was at 76%),

(ii) and 157bps of cuts priced across 2024 vs 165bps of cuts before Waller’s speech.

Waller's speech (link) is a very precise and insightful analysis of economic activity (GDP), PCE inflation, financial conditions, demand in the labor market, revision of inflation data in February 2024, etc.

Based on this analysis, Waller indicates what monetary policy should/will be in 2024... fair enough, yet to this day neither Waller nor the other FOMC members have explained what happened to the Fed's policy between December 1 and December 13, 2023? In other words, based on what data, certainly not economic, was the Fed's pivot made? So why should policy in 2024 be based "solely" on economic data, as in Waller's speech?

Of course, this is nothing new in the FED's policy, since 2008 there has not been a particularly strong correlation between the FED’s rate and economic variables, or even the Taylor’s rule. Therefore, markets must also look at other data, such as the falling level of liquidity in the financial system (I wrote about reserve repo here: link), or political conditions. After winning the Iowa primaries, Trump's odds of winning the election are now at the highest and with 3 ppts above Biden (source PredictIt).

All-in-all, historically, if the market gives more than 70% chance of a rate cut, we usually get it. At the time of writing, the market says the chances of a cut on March 20 are 65%.

2) Risk-off on markets and a strong dollar.

Since December 28, the dollar has strengthened almost to pre-FED pivot levels (December 13, 2023). And one of the most sensitive sentiment measures are Polish shares expressed in U.S. dollars … WIG20USD Index. After yesterday's session, the decline in WIG20USD is already 10.1%. Additionally, yesterday the dollar strengthened against the PLN by over 1.1%.

Figure 1 shows the declines in the stock index and the increase in USDPLN, highlighting the days when such an increase was greater than 1.0% and greater than 1.5%. As you can see in the chart, an increase in USD of over 1% is not yet a "big deal".

3) US New York Fed Manufacturing PMI for January dropped like a rock and amounted to -43.7. In December 2023, the New York PMI was -14.5, and the market expected an increase to -5.0 in January 2024.

Figure 2 shows the volatility of the New York PMI, which is particularly high from 2022 onwards. A strong rebound can be expected in February 2024. Additionally, the New York PMI shows the lowest correlation with the ISM Manufacturing PMI among the other 4 regional PMIs (Dallas, Richmond, Chicago, Philadelphia).