Drivers for the Week of January 23, 2022

• The two-day FOMC meeting ends with a decision Wednesday; anyone looking for some sort of Powell Put this week will be sorely disappointed; we get our first look at Q1 GDP Thursday; Fed manufacturing surveys for January will continue to roll out; December core PCE reading Friday will hold some interest; BOC meets Wednesday
  
• Eurozone has a busy week; with Germany already likely contracting and the other major economies slowing, the ECB is facing a dilemma; Italian political intrigue isn't helping matters; U.K. has a fairly quiet week; firm U.K. data have fed into BOE tightening expectations
  
• Japan reports some key data; with unemployment approaching the area that the RBA views as inflationary, markets are looking for liftoff sooner rather than later; RBNZ is likely to continue hiking rates aggressively this year
  

AMERICAS

Markets ended last week on a decidedly risk-off note. As we posited on Friday, the risk-off impulses are coming from a variety of factors that perhaps make up a perfect storm ahead of the FOMC meeting this week. We have been warning for some time now that markets still need to reprice the new Fed hawkishness. First it was the rates markets, now it seems that the equity markets are finally getting the message. That said, we need to keep things in perspective. The U.S. is not going into recession this year; indeed, far from it. However, equities had been priced for perfection (modest tightening cycle and strong growth and earnings). Now, two of those pillars are in question, as the Fed removes accommodation at a record pace and Q4 earnings come in mixed. We remain constructive on the U.S. economic outlook but acknowledge that the Fed tightening cycle will be a growing headwind.

The two-day FOMC meeting ends with a decision Wednesday. A hawkish hold is widely expected as the Fed sets the market up for liftoff at the next meeting March 15-16. WIRP suggests a hike then is fully price d in, as are three more quarterly hikes this year. There won't be any updated macro forecasts or Dot Plots at this week's meeting, but we expect Chair Powell to send a very clear signal. Markets will be keen to see any clues on how soon the Fed will allow balance sheet runoff. We had thought this would be a 2023 story, but given recent official comments and the accelerated timeline, we believe runoff will begin in Q3.

Anyone looking for some sort of Powell Put this week will be sorely disappointed. The Fed's number one priority is containing inflation, full stop. The economy is nearing full employment and inflation is stubbornly high, and so the Fed simply cannot target the equity market as well. Stock market valuations will take care of themselves eventually when things settle down, but there is a new narrative shaping up that will make equity upside a bit more difficult.

It is becoming clearer and clearer just how big a factor Fed QE was for markets during the pandemic recovery. As we move through the Fed's toolbox of tapering, rate hikes, and Quantitative Tightening (QT), there will undoubtedly be more casualties ahead. That is why we believe it is important for investors to do their homework and differentiate, whether its amongst companies, industries, countries, or regions. The days of FOMO and BTD are gone. Meme stocks and crypto have recently come under greater pressure but there is still more pain to come for the weaker credits. The tide is going out and we will quickly see who is wearing a bathing suit and who is not.

We get our first look at Q4 GDP Thursday. Consensus sees growth of 5.8% SAAR vs. 2.3% in Q3. The Atlanta Fed's GDPNow model is currently tracking 5.1% SAAR, up from 5.0% previously. With the Fed likely to tighten in March and Build Back Better dead in the water, there are clearly downside risks to the U.S. growth outlook. Bloomberg consensus sees SAAR growth slowing to 2.9% in Q1 before recovering to 3.7% in Q2, 3.2% in Q3, and 2.6% in Q4. All of these forecasts are subject to the vagaries of forecasting, but we remain confident that the U.S. economy will outperform Europe and Japan this year.

Fed manufacturing surveys for January will continue to roll out. Richmond Fed reports Tuesday and is expected at 14 vs. 16 in December. Kansas City Fed reports Thursday and is expected at 19 vs. 24 in December. Last week, Philly Fed came in at 23.2 vs. 19.0 expected and 15.4 in December, while Empire survey came in at -0.7 vs. 25.0 expected and 31.9 in December. Markit reports its preliminary January PMI readings Monday, with manufacturing expected at 56.7 vs. 57.7 in December and services expected at 54.8 vs. 57.6 in December. If so, the composite would probably drop several points from 57.0 in December.

Weekly jobless claims Thursday will be of interest. Continuing claims will be for the BLS survey week and are expected at 1.65 mln vs. 1.635 mln the previous week. Last week's initial claims were for the BLS survey and came in at 286k and are expected at 260k this week. The recent churn claims is making it harder to get a clean read of the labor market. Current Bloomberg consensus for January NFP is 238k vs. 199k in December. The unemployment rate is seen steady at 3.9% but it really won't take more than a few more solid jobs reports to move this back to pre-pandemic lows near 3.5%.

December core PCE reading Friday will hold some interest. It is expected to rise a tick to 4.8% y/y. If so, it would be the highest since September 1983 and further above the Fed's 2% target. Personal income and spending will also be reported and are expected at 0.5% m/m and -0.6% m/m, respectively. We know retail sales and consumption slowed in December as the omicron variant spread. Can consumption recover in Q1? Stay tuned.

Other minor data round out the week. December Chicago National Activity Index will be reported Monday. November S&P Core Logic House prices and January Conference Board consumer confidence (111.8 expected) will be reported Tuesday. December advance goods trade balance (-$96.0 bln expected), wholesale/retail inventories, and new home sales (2.8% m/m expected) will be reported Wednesday. Durable goods orders (-0.5% m/m expected) and pending homes sales (0.5% m/m expected) will be reported Thursday. Final University of Michigan consumer sentiment (68.8 expected) will be reported Friday.

Bank of Canada meets Wednesday. A hawkish hold is expected and the BOC may need to update its forward guidance to prepare markets for potential liftoff. Currently, the BOC has flagged Q2 for likely liftoff. However, recent Canadian data have come in strong, leading markets to move up the timetable for likely BOC liftoff. WIRP suggests over 70% odds of liftoff this week, while March 2 is fully priced in and then some. Looking ahead, the market sees 150 bp of total tightening this year followed by 50 bp next year that would take the policy rate up to 2.25%. This BOC outlook has helped CAD outperform as it is the second best performing major at 0.5% YTD, behind only JPY at 1.1% YTD.

EUROPE/MIDDLE EAST/AFRICA

Eurozone has a busy week. Preliminary January PMI readings will be reported Monday. Headline manufacturing is expected at 57.5 vs. 58.0 in December, services is expected at 52.0 vs. 53.1 in December, and composite is expected at 52.6 vs. 53.3 in December. Looking at the country composites, Germany is expected at 49.4 vs. 49.9 in December and France is expected at 54.7 vs. 55.8 in December. While France has been a pleasant surprise recently, the outlook for Germany has worsened and has negative implications for the eurozone as a whole. German IFO business climate for January will be reported Tuesday. Headline is expected to fall a couple of ticks to 94.5, with a drop in current assessment to 96.1 outweighing a rise in expectations to 93.0. German GfK consumer confidence for February will be reported Thursday and is expected at -8.0 vs. -6.8 in January.

Important eurozone data for the other major economies will also be reported. France reports January consumer confidence Wednesday and is expected to drop a tick to 99. France then reports December consumer spending Friday, which is expected flat m/m vs. 0.8% in November. Italy consumer and manufacturing confidence and eurozone-wide confidence for January will be reported Friday. Q4 GDP for France, Germany, and Spain will also be reported Friday. France is expected to grow 0.5% q/q vs. 3.0% in Q3, Germany is expected to contract -0.4% q/q vs. 1.7% in Q3, and Spain is expected to grow 1.4% q/q vs. 2.6% in Q3.

With Germany already likely contracting and the other major economies slowing, the ECB is facing a dilemma. It has already started tapering significantly even before PEPP expires at the end of March. ECB officials continue to downplay the need for 2022 liftoff but seem comfortable with 2023. Rehn said over the weekend that 2023 is "logical" as long as there aren't any new disruptions to the economic outlook. Next ECB meeting is February 3 and widely expected as a placeholder. New macro forecasts won't come until the March 10 meeting.

Italian political intrigue isn't helping matters. Lawmakers will start the process of choosing the next president Monday, with current Prime Minister Draghi the top contender. There are reports that former Prime Minister Berlusconi may drop out of the race. If Draghi were to decide to take up the largely ceremonial presidency, it would leave a gaping hole in the day-to-day stable leadership that he has provided. 10-year Italian spreads to German remain elevated near 135 bp and are likely to move even higher as political uncertainty picks up even as the ECB tapers its QE.

U.K. has a fairly quiet week. Preliminary January PMI readings will be reported Monday. Headline manufacturing is expected at 57.6 vs. 57.9 in December, services is expected at 54.0 vs. 53.6 in December, and composite is expected at 54.0 vs. 53.6 in December. December public sector net borrowing will be reported Tuesday, with es-banking groups expected at GBP18.5 bln vs. GBP17.4 bln in November. CBI releases its surveys for January. Industrial trends survey will be reported Tuesday, with total orders expected at 22 vs. 24 in December and selling prices expected at 63 vs. 62 in December. This will followed by its distributive trades survey Thursday, with retailing reported sales expected at 10 vs. 8 in December.

Firm U.K. data have fed into BOE tightening expectations. WIRP suggests over 90% odds of a hike February 3. Whilst we can never rule out a head fake from the bank, we believe it will follow through this time with a hike. Three more hikes are priced in for this year that would take the base rates up to 1.25% by year-end. Along the way, reinvestment will stop when the policy rate hits 0.50% and active balance sheet reinvestment will start when the policy rate hits 1.0%.

ASIA

Japan reports some key data. Preliminary January PMI readings will be reported Monday. December department store sales will be reported Wednesday. January Tokyo CPI data will be reported Friday. Headline inflation is expected at 0.5% y/y vs. 0.8% in December, while core (ex-fresh food) is expected at 0.3% y/y vs. 0.5%. If so, the slowdown warns of downside risks to the national CPI reading and underscores just how difficult it has been for the BOJ to escape deflation. Last week, national CPI for December came in lower than expected, with core inflation steady at 0.5% y/y and well below the 2% target. Updated macro forecasts from last week's BOJ meeting see core inflation stuck at 1.1% for both FY22 and FY23. FY24 will be added to the forecast horizon at the April meeting and is likely to show subdued price pressures continuing.

Australia also reports some key data. Preliminary January PMI readings will be reported Monday. Q4 CPI data and December NAB business survey will be reported Tuesday. Headline inflation is expected at 3.2% y/y vs. 3.0% in Q3, while trimmed mean inflation is expected at 2.3% y/y vs. 2.1% in Q3. December leading index and Q4 import/export prices will be reported Thursday. Q4 PPI data will be reported Friday.

With unemployment approaching the area that the RBA views as inflationary, markets are looking for liftoff sooner rather than later. WIRP suggests nearly 50% odds of liftoff May 3, rising to nearly 90% June 7. Four hikes in total are priced in over the next twelve months, with a fifth starting to get priced in. Next RBA meeting is February 1. Updated macro forecasts will be released and an end to QE will likely be announced then. More importantly, the RBA will also have to adjust its forward guidance to acknowledge risks of liftoff in 2022.

RBNZ is likely to continue hiking rates aggressively this year. Q4 CPI data will be reported Thursday. Headline inflation is expected at 5.8% y/y vs. 4.9% in Q3, which would be the highest since Q2 2011. Next meeting is February 23 and another 25 bp hike to 1.0% is fully priced in. Looking further out, six hikes in total are priced in for 2022 that would take the policy rate to 2.25% by year-end. Another 75 bp of tightening is priced in for 2023 that would take the policy rate to a peak of 3.0%.

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