Jury Still Out On Fed’s Next Plans

Markets

The jury is still out on the Fed's next plans after payrolls failed to tilt the balance one way or the other. Markets initially erred on the dovish side, but the case wasn't compelling enough to fully endorse Q1 rate cut bets (currently 25% probability for January; 55% for March).

The US 2-yr yield tested the end of November low at 3.45% but a break lower didn't occur. Intraday rebound action higher pulled EUR/USD back from first 1.18+ levels since mid-September to close virtually unchanged at 1.1750. The US yield curve eventually bull flattened with yields ending 1.4 bps (2-yr) to 3.3 bps (30-yr) lower. Calm returned on US stock markets with key indices closing 0.6% lower (Dow) to 0.25% higher (Nasdaq).

Better November payrolls (+64k) failed to make up for a weak October report (-105k; mainly DOGE-impact on government). The US unemployment rate increased from 4.4% in September (BLS unable to conduct October household survey) to a 4-yr high of 4.6% in November (vs 4.5% consensus). Since June (4.1%) it has been one-way traffic higher with alarm bells ringing. Filling the blank October unemployment rate number (eg 4.5%) brings you dangerously close to the 0.50% threshold of the SAHM rule. When the 3-month moving average of the unemployment rate exceeds the lowest 3-month moving average of the past year (currently 4.06%) by that amount, the rule indicates a high likelihood of being in the early stage of a recession.

Last year, it prompted the Fed into a bigger-than-usual 50 bps rate cut at the start of its cutting cycle. Risks of a breach at the next payrolls release early January are high both because of current elevated levels and because the lowest 3-month moving average of the past year will rise to 4.1% with the Dec2024 point dropping out of the equation. We stick with the view that markets currently underestimate the probability of a continuation of the Fed's normalization cycle early next year. October US retail sales and December PMI surveys supported the intraday market rebound. The former because of strength, the latter because of prices spiking higher. Sales in the retail control group increased by 0.8% M/M (vs 0.4% consensus).

The composite PMI set a 6-month low (53 from 54.2) with details showing a second consecutive month of waning momentum. Signs of weakness were broad-based, with a near stalling of inflows of work into the vast services economy accompanied by the first fall in factory orders for a year. A key concern is rising costs, with inflation jumping sharply to its highest since November 2022, which fed through to one of the steepest increases in selling charges for the past three years.

Significantly lower November UK CPI numbers cement the case for more BoE rate cuts and push EUR/GBP from 0.8750 to 0.8780 in a first reaction this morning.

News & Views

The National Bank of Hungary yesterday kept its policy rate unchanged at 6.5%. However, its assessment clearly turned less hawkish, reopening the debate on potential rate cuts next year. The central bank took notice of recent declines both in headline (3.8%) and core (4.1%) inflation in November. This disinflation process was supported by a decrease in global commodity and food prices and the pass-through of a stronger forint into purchase prices.

The MNB also saw more moderate monthly repricings in recent months compared to the first half of the year. Corporate inflation expectations were subdued in November, but consumer inflation expectations were seen as remaining stagnant. In its new forecasts, inflation was downwardly revised both for this year (4.4% from 4.6%) and next year (3.2% from 3.8%). Inflation is expected to average 3.3% in 2027, but is seen reaching the 3% level in H2 of that year. The growth path was slightly downwardly revised to 0.5% this year, 2.4% next year and 3.1% in 2027. MNB still sees positive real rates as necessary. Maintaining tight monetary conditions is warranted, but the MNB shifts to a data-dependent approach. The 2-y HUF swap rate dropped 10 bps to 6.15%. The forint declined to EUR/HUF 386.

The Czech government yesterday approved a plan to reduce electricity bills both for companies and households. From January on, some levies will be transferred to the government. Industry minister Havlicek expects the shift to lower electricity prices by 10%. The move is expected to come at a cost for the budget of CZK17bn, but it is expected to put further downward pressure on inflation. The Czech 2-y swap rate eased 4 bps yesterday. The koruna hardly reacted with EUR/CZK closing the day near 24.32.

Source: KBC Bank