Wednesday, 01 February 2023
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•          The build-up to a Fed decision usually brings lackluster trading. This time around, things might be different. For starters because of the January EMU CPI release. Spanish and Belgian data on Monday triggered a market reaction as headline inflation didn’t or didn’t fell as fast as expected while core readings keep setting all-time highs. French CPI printed in line with forecasts, but delayed German numbers (to next week because of technical reasons) imply more uncertainty than usual around the EMU number. Consensus expects headline CPI rising by 0.1% M/M with the Y/Y-reading down to 8.9% from 9.2%. Core CPI is forecast to moderate from 5.2% Y/Y to 5.1% Y/Y. We believe that risks are tilted to the upside of expectations. In such scenario, bonds will sell off with Bunds underperforming. EUR/USD’s performance is more linked to risk sentiment. The US eco calendar contains ADP employment change and manufacturing ISM. Ever since the Fed first indicated the possibility of downshifting from 75 bps rate hikes to a slower pace (early November 2022), (US) markets have been reacting asymmetric to data releases – picking out every argument in favour of downshifting/ending the tightening cycle all together. In the run-up to tonight, we expect this reaction function to hold. Consensus expects again decent job growth (180k) with the manufacturing ISM sliding somewhat further in contractionary territory (48 from 48.4). Over the past decades, such levels often turned out to be bottom levels in case of growth slowdowns/mild recessions. Only in real crisis years (eg dotcom, GFC, Covid) did the manufacturing ISM drop much deeper.
•          The Fed is expected to downshift its tightening pace again from 50 bps to 25 bps, bringing the policy rate at 4.5%-4.75%. Several governors argued in favour of doing so, though some stuck to the view to get to a peak level (5-5.25% as per December dots) as fast as possible, allowing for a pause afterwards. This would suggest a 50 bps hike tonight followed by a (conditional) last one in March when new growth/inflation forecasts and dot plot are available. It would probably need to show in the policy statement which for months now says that “the Committee anticipates that ongoing increases (emphasis added) in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time”. Only dropping this reference while simultaneously delivering only a 25 bps hike could trigger a (bond) rally at the front end of the curve. We don’t believe in that outcome as too many (conflicting) factors remain at play: lower (headline) inflation vs tight labour market & wage pressure, weaker growth dynamics vs looser financial conditions,… . In all other scenarios, we expect the US yield curve to invert further via an underperformance of the front end. This should help the dollar above recent support levels (eg EUR/USD 1.0941) while weighing on risk sentiment as well as the other two scenario’s (50-25-pause) or (25-25-25-pause?) are not discounted in US money markets (peak rate 4.75-5%). Apart from how to get to the peak, we expect Powell to talk markets out of the idea of rate cuts in the second half of the year.

News headlines

•          The British Retail Consortium (BRC) said this morning that UK shop prices in January rose by 0.7% M/M and 8% Y/Y, the fastest pace since at least 2006. The cost of fresh food remains a major contributor (0.7% M/M and 15.7% Y/Y). Broader food prices gained 1.3% M/M and 13.8% Y/Y. The cost of non-food items rose by 0.3% M/M and 5.1%Y/Y. In a comment, BRC Chief Dickinson indicated that price rises might not have peaked yet as retailers still have to cope with the pass through of rising energy bills while facing labour shortages. The data are a final piece of info before the BoE decides on its policy rate tomorrow. A 50 bps rate hike is widely expected.
•          The New Zealand labour market remains tight. The unemployment rate was 3.4% in December, up from 3.3% in September and holding near its historic low. Actual hours worked increased 3.6% last year as the number of people employed rose 1.3%. At 71.7%, the participation remained at the highest level since 1986. Salaries and wages as measures in the labour cost index rose 4.1% Y/Y in December, the highest levels since the series began in 1992. Average hourly earnings were up 7.2%, the second highest on record. The data were slightly softer than the RBNZ forecast in its November policy report. The NZ central bank raised its policy rate by 75 bps in November and signaled further increases. Markets expect a downshift to 50 bps, with the peak priced near 5.2% (vs RBNZ guidance at 5.5%).


The ECB flagged more 50 bps rate hikes in Q1 2023, accompanied by QT. This clear prioritization to combat inflation pushed the 10-y Bund to a new cycle top just north of 2.50% at the end of 2022. A potential depo rate peak at >=3.50% and a further reduction of excess liquidity suggests new upside after the early 2023 correction lower. A sustained break above 2.56% resistance (62% retr. on 2008/2020 decline) needs a high profile trigger.

The December dots confirmed the Fed’s intention to raise the policy rate north of 5% and to keep it above neutral over the policy horizon. US yields rebounded, but markets doubt this guidance as recessionary fears linger. Early January activity/labour/inflation data failed to convince them and triggered a correction lower in yields. A downshift to +25 bps rate hikes from February onwards is expected, but markets remain too complacent on the future rate path.

After a strong performance for most of last year, the dollar lost momentum in Q4 as US inflation started topping out. EUR/USD leaving a downtrend channel improved the technical picture with the euro receiving support from the ECB’s hawkish twist, lower energy prices and a bullish risk sentiment at the start of 2023. Next resistance stands at 1.0942 (50% retracement on 2021-2022 decline).

The BoE raised its policy rate by 50 bps in December, with more to come. Recessionary fears among at least part of the MPC might cause a less aggressive approach on inflation further out. Twin deficits are a structural negative for sterling too. EUR/GBP left the 0.86 area post-ECB, but 0.8867 resistance holds at least for now. A break opens the way to the 0.90 area.

Calendar & Table

Note: All times and dates are CET. More reports are available at which you may sign up to.

This document has been prepared by the KBC Economics Markets desk and has not been produced by the Research department. The desk consists of Mathias Van der Jeugt, Peter Wuyts and Mathias Janssens, analists at KBC Bank N.V., which is regulated by the Financial Services and Markets Authority (FSMA). Read the full disclaimer.

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