EM Market Report

Fed and IMF suggest US inflation is not on the turn

Thanim Islam
Thanim Islam 05 January 2023

- Data from Europe continues to support the EUR

- Mortgage approvals drop further in UK, adding to woes for GBP

- Fed says market pricing on rate policy is wrong


  • Europe's S&P eurozone services and composite figures came in better than expected for the month of December at 49.8 and 49.3 respectively. Still lower than the 50 that marks whether a sector is in contraction/expansion, but nonetheless this adds to the narrative that perhaps the economy is in better shape than once thought during the peak of the energy crisis. As a result EUR continues to be well supported.
  • Cracks continue to show in the UK housing market, with the number of mortgage approvals in November plunging to 46,100, down 40% since August.
  • Data from the US supported the notion that the job market still remains strong, with the number of job openings in November increasing to 10,458,000 from 10,334,000 in October. We wait for Friday’s nonfarm payroll figures for further information on how strong the US jobs market is, and thus whether this supports the Fed’s bullish narrative on rate hikes.
  • Ahead of the evening’s minutes from the December Fed meeting, we had Neel Kashkari comment that he favours raising interest rates to 5.4% before pausing – higher than recent projections by the Fed.
  • December’s ISM manufacturing figures, regarded as one of the best indicators of the health of the US economy, came in lower than expected at 48.4 down from 49.
  • The minutes from the December Fed meeting were broadly viewed as moderately hawkish, with a continued reiteration that markets were under-pricing the Fed’s interest rate expectations, and pushed back against market bets of rate cuts this year. Markets are currently pricing in the terminal Fed rate just under 5%, with the Fed’s dot plot projection, the terminal rate, between 5.25-5.50%. We saw equities drop following this, erasing the gains yesterday morning, and early this morning we’re slowly starting to see the USD gain.


Market rates

* Daily move - against G10 rates at 17:00pm, 04.01.23

** Indicative rates - interbank rates at 17:00pm, 04.01.23

Frame 23 (3)-2

Data points

Frame 16 (3)-1


  • USD: Fed Harker, Bostic, and Bullard.

Our thoughts

The EUR is still being supported by markets based on the ECB remaining hawkish on interest rate hikes, as well as data suggesting better output in economic activity. Drops in energy prices are also being cheered in Europe, adding to the positive EUR story. However, let's not get ahead of ourselves - the ECB has only just started to hike interest rates, so the effects of this are yet to be felt in the economy, and on peoples incomes.

The negative story on GBP keeps building following that sharp drop in mortgage approvals yesterday. The economy is likely to take a hit from the recent transport and NHS strikes, so it wouldn’t be too surprising if we saw worse than expected GDP figures for the last quarter of 2022 and the first quarter of 2023. Market pricing for additional interest rates hikes have eased off the top-end following the dovish Bank of England meeting in December, but with a weaker economic outlook the Bank of England will likely err on the side of caution, and it seems for now it will unlikely hike interest rates to the market expectations of peak BoE rates at 4.5%. Currently the base rate is 3.5%.

USD trading has been relatively choppy since the Fed meeting in December. As mentioned yesterday the USD sell-off since the peak in September has stalled, and perhaps a turnaround is due considering that markets, according to the Fed, are under-pricing interest rate expectation in the US. Should they catch up, expect markets to strengthen the USD. This morning the IMF’s Deputy Manager Gita Gopinath commented in an interview with the FT that US inflation has not “turned the corner yet”, and supported the notion that the Fed should continue to press ahead with rate hikes. So, another USD supportive narrative. Ahead of job numbers this Friday and US inflation numbers next week, it seems markets are waiting to see these data points before acting.

Additional comments from the IMF suggest that China’s economy is likely to deteriorate in the near-term following rising hospitalisation and death rates, following the easing of its zero-Covid policy, and as a result this would dampen global growth.

Chart of the day

The view on the downside on GBPUSD continues to build based on the reasons mentioned above. One of the narratives that seems to have underlined GBPUSD moves of late has been the difference/spread between the Fed and BoE’s terminal rate policy. As the spread narrowed between the Fed and BoE’s terminal rate, we saw GBPUSD climb. However, we can see that spread is starting to widen again causing GBPUSD to weaken. We need to remember the Fed remains hawkish on interest rate hikes whereas the BoE remain dovish, and should markets catch up with the Fed’s rate expectation we can assume that the spread will widen and GBPUSD will decline further.

05012022 cotd

Source: Bloomberg Finance L.P.