Wednesday: US ISM Manufacturing PMI, FOMC Minutes.

Friday: US NFP, US ISM Services PMI.

Welcome to 2023 everyone! If 2022 was a nice year in terms of trading opportunities, this year is going to be even better, so get ready. Let’s first start from where we left and continue from there…

Inflation is showing signs of moderating. The last two US CPI reports missed expectations, and since the CPI is a lagging indicator and leading indicators were already pointing to a slowdown in the inflation rate, we can expect the disinflationary trend to continue.

The labour market is one of the most lagging indicators and it kept on showing strength throughout the 2022, which disappointed the Fed as they wanted to see cracks in the data and a pickup in unemployment. In fact, they keep complaining about the “extremely tight labour market” and this isn’t giving them much confidence in letting go from their tightening process.

There were expectations that the Fed would be less hawkish in its last FOMC meeting in December as the CPI data missed expectations two times in a row, BUT the Fed was more hawkish than expected in 3 key things:

· Following the miss in the CPI report, Fed members had the chance to revise the Dot Plot until Tuesday evening, so that is after the CPI report, BUT they chose not to do it.

· The Dot Plot showed an overwhelming consensus from the Fed members in hiking rates to 5% or higher and remaining higher for longer as no cuts are expected for 2023 and a 4.1% rate is expected in 2024.

· Fed Chair Powell sounded resolute in keeping at it and pushed back against expectations for rate cuts in 2023.

As mentioned earlier, the Fed won’t have the confidence in letting go until they see unemployment picking up. The issue here is that they forecast unemployment to rise to 4.6% in 2023 with no cuts expected.

This means that they will pause hikes somewhere in the 5% area and likely stay there unless unemployment deviates from their forecasts in which case it would be too late as the domino effect takes hold. In the chart below you can see how the Fed always underestimated the pain in the labour market.

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Chart from TS Lombard

This points to a deep recession coupled with a possible overtightening from the Fed. So, the 2023 playbook, in my opinion, would be again to stay defensive as I expect the safe haven currencies (USD, CHF and this time also JPY) to be preferred, the stock market and commodities to fall further and the bond market to switch into a bull market.

On a side note, the long US Dollar was the most crowded trade in 2022 and in such instances, we can generally see huge unwinding once the narrative shifts. This happened in the past months as the market looked forward to slowing inflation and earlier than expected “Fed pivot”.

The Fed ended this narrative, and the US Dollar should come back. In fact, the US Dollar positioning went to the highest net short since July 2021 and lately specs trimmed their net short positions. The long US Dollar trade is no longer overcrowded, which is something you want to see if you want to go long again.

Technically, in the DXY (US Dollar Index) chart below you can see a falling wedge pattern forming (or an ending diagonal if you’re an elliottician). This is a reversal pattern and signals a loss of momentum. Generally, the first target is the top of the pattern, which would be in the 108 area, but all else being equal, we should see it going even higher. This week we may see another spike downwards if the market takes bad data as good news, but I expect that to be faded eventually.

fx majors

Wednesday: The US ISM Manufacturing PMI is expected to dip further into the contractionary territory from 49 to 48.5. The trend is expected to continue as the Fed keeps on tightening monetary conditions and the recession worsens. Prices paid sub-index is something to keep an eye on as it generally a leading indicator for inflation.

fx majors

The FOMC Minutes should just be a reminder for the market that the Fed is not on their side, and they just want to get inflation back to their target. They also want to break the market mentality of the “Fed Put”.

Friday: I expect the US NFP to be the main market mover from now on. Even more than the CPI. The report is expected to show 200K jobs added, down from the previous 263K but still a solid number, and the unemployment rate to stay unchanged at 3.7%. Good data should be bad for risk assets, but I expect also bad data to be bad for risk assets as the risks shift to the overtightening and a deep recession rather than the Fed pausing earlier or even cutting anytime soon.

The average hourly earnings are expected to come at 5% Y/Y, down from the prior 5.1% and at 0.4% M/M, down from the prior 0.6%. If wages beat expectations again, I expect risk assets to suffer as it will make the Fed even more uncomfortable. A miss would be a welcome news, but the overtightening narrative coupled with the recession should come first in the market’s mind.

The US ISM Services PMI is expected to dip to 55 from the prior 56.5 reading. The services sector has been showing resilience throughout the 2022 and worst part is that the prices paid sub-index hasn’t come down as fast as its manufacturing counterpart.

This is something that keeps the “higher inflation for longer” narrative alive as the inflation rate may come down but not enough for the Fed to achieve their target. Although I expect the NFP to be much more important, keep an eye on this report as well as it may exacerbate or reverse the NFP reaction depending on the outcome.

This article was written by Giuseppe Dellamotta.