Fed v.s Market: the fight may last for a while

2023년 4월 11일

After the Non-farm payroll event last week, which saw 236,000 jobs added through March, it is clear that the job market is still creating many jobs compared to pre-COVID levels. However, the market has been experiencing some short-squeezing from yields to the dollar.

The reason for this short-squeezing can be attributed to the mispricing between Fed fund futures, which are giving a dovish perspective beyond May, and the Fed's view from its last meeting, which hinted at least one more rate hike.

However, with two holidays in a row right at NFP last week, the short-squeezing action was impaired after the news, and the market quickly came back to price in the CPI tomorrow, as well as retail sales on Friday. The Fed fund futures dropped a few percentage points for a 0.25% chance of a rate hike in May and the dollar also retreated.

While tomorrow's CPI's headline may slow down and be close to the market forecast with a 0.1-0.2% m/m gain due to some correction from the energy price for the period back then, the service and rental costs are back, and they will continue to haunt the core CPI, which may print a 0.4-0.5% m/m gain for last month.

From this perspective, the market is likely to price in the headline instead of the core, as the media would cover that number more, and it may continue to extend the mispricing between the Fed fund rates and the reality that the Fed may continue to have at least one more hike provided a still-hot labor market and stubborn inflation.

Another reason for expanding the mispricing is retail sales on Friday, which may not meet expectations and give the market another reason to beg for Fed to ease. However, it is unlikely that the Fed will reduce that soon. Remember how eagerly people talked about a 0.5% rate hike for the last meeting before the banking crisis? It has only been a few weeks since the latest news on the bank, and things are calm, and the Fed is confident in containing liquidity issues.

So things will be back on track, along with Fed's hiking. The more mismatching there is between the market's expectations and reality, which the Fed may continue to do, the more significant the opportunity when going against the crowd. In short, the yield will gradually come back, provided that the banking crisis is over and there are no more or fewer deposit drains. Then, the other assets follow the yields then.