The Week Ahead

The week started with Richard Clarida, the Fed’s Vice Chair, announcing that he would be stepping down from his post this coming Friday, two weeks before his term was planned to end, after admitting last month that he had failed to fully disclose financial transactions at the start of the pandemic. He is the third Fed official to quit over a trading scandal linked to the central bank's efforts to save the economy.

Bonds were relatively quiet with no data on the wires. However, equities had a roller coaster day. The S&P 500 had dropped as much as 2% early on in trading before ending the day flat. NASDAQ also finished unchanged, after a 400-point intraday rally.

Mid-week we had Fed Chair Jerome Powell in front of the Senate for his re-nomination hearing, where he said that the US labour market is recovering ‘incredibly rapidly’, along with the strength of the recovery, believing it was time to shift course away from the pandemic support settings. In general, there was not much in the way of new information from Powell at this nomination hearing that wasn’t already discussed at length in the December FOMC minutes and subsequent press conference.

However, one exchange during the hearing did catch the eye. It was a hypothetical question from Senator Mike Crapo. He asked where things might be on the policy front in terms of tools the Fed could use if in three to four months the unemployment rate was still below 4% and inflation was still in the 5% to 7% range.

Powell responded: ‘So I think, to your point, we're at a place where unemployment is now very low, historically low, and inflation is well above target, and the economy no longer needs these - this very highly accommodative stance of policy. And I would expect that this year, 2022, will be a year in which we take steps toward normalisation. That will involve raising the federal funds rate. That will involve ending asset purchases in March, and perhaps later this year, depending on the run of things. We would also see ourselves beginning to allow the balance sheet to shrink. So that's what I think is the broad picture of what I see happening. The committee hasn't made any decisions about the timing of any of that. And it's -- I think we're going to have to be both humble and a bit nimble here’.

Thursday, we had US CPI releases for December, which broadly matched market expectations, at 7.0%yoy, and 5.5%yoy for the Core reading. CPI was driven to its 39-year high by increases in housing and used vehicles prices as well as the unavoidable high food costs, meanwhile, energy prices fell in December. Interestingly, inflation-adjusted average hourly earnings fell 2.4%yoy; clearly the surge in prices is eroding average higher wages.

December PPI figures out of the US showed the smallest monthly gain since November 2020, moving up by just 0.2%, vs a consensus of 0.4%, however, the November reading was revised up to 1.0% from the 0.8% reported previously. The main drivers for the lower number were food, down 0.6%, and energy, 3.3% lower. In contrast, the PPI for trade services, that measures retailers and wholesaler margins, advanced by 0.8% and has now been up for 11 consecutive months, as sellers continue to pass on higher costs to final demand consumers.

On the back of the figures, Treasuries rallied across the entire curve after what has been an almost one-sided sell-off since the start of the year.

After the numbers we had a plethora of Fed speakers on the wires giving their views on the current state of the economy and how they see tapering and rate rises panning out.

Evans said inflation is too high and sees 3-4 hikes this year. Harker said taper is to end in March and then we can probably expect a rate hike. Also, we had Lael Brainard, in the hearing for her nomination to become the US central bank's Vice Chair, mention that the Fed funds are the main policy tool and that she is very concerned about high levels of inflation. She said the Fed is in position to hike as soon as asset buying ends.

Then we had Waller, who agrees with the growing consensus that three rate hikes in 2022 is a ‘good baseline’, but if inflation stays high, the case will be made ‘for four, maybe five, hikes’. However, he did hedge his bets, adding that if inflation subsided as many, including him, expect ‘then you could actually pause and not even go the full three’.

Finally we had figures released on Friday morning showing the UK economy has recovered to its pre-pandemic level, after a surge of growth in November. GDP came in at 0.9%mom vs a consensus of 0.4%mom, and 1.1%yoy vs 0.8%yoy. Industrial production was at 1%mom vs 0.2%mom, and 0.4%yoy vs -0.3%yoy. However, it was construction output that was the real eye opener, 3.5%mom vs 0.6%mom and 6.8%yoy vs 3.1%yoy.

Fixed Income Team