The central bank can maintain flexibility and regain some credibility with a larger-than-expected increase next week. Having oscillated between anticipating another 50-basis-point interest-rate increase by the Federal Reserve next week or a downshift to 25 basis points, traders have settled solidly on the latter, guided both by Fed officials’ comments and by media reports. Some economic and market indicators support such a policy action, but it’s far from uniform. Indeed, my broader analysis of economic and financial conditions would favor the Fed raising rates by 50 points, also on account of risk management, credibility and the persistent misalignment between market pricing and the central bank’s forward policy guidance for 2023. Through the details of the Fed’s December policy meeting and numerous speeches since, policymakers have guided the markets to expect the central bank to increase rates by 25 basis points, establish a peak rate of just more than 5% for this hiking cycle and keep it there for the rest of 2023. Despite what has been an unusually uniform and consistent message from Fed officials, the markets continue to refuse to fully price in this policy guidance. Instead, traders expect the Fed to cut rates in the second half of the year and are backing that up with their bets. This leaves the Fed with three policy priorities for next week’s policy meeting: Convince the markets of its policy outlook for the year; implement a policy action consistent with this; and, therefore, partially repair its credibility, which was damaged by its gross mischaracterization of inflation for almost all of 2021 and, after that, too modest an initial policy response. The Fed seems to believe that a 25-basis-point increase is consistent with this goal, down from 50 points in December and, before that, a record-breaking four consecutive 75-point increases. The case made for such a downshift goes beyond the expectation that an already declining inflation rate will continue to fall in the months ahead. It also appears consistent with the significant level of economic fluidity, domestically and internationally — or, as framed by Fed Chair Jerome Powell, the notion of walking slowly in a dark room to better feel one’s way through it. This consideration takes added importance in the context of forward-looking indicators suggesting a still-high probability of recession, including deeply inverted segments of the US Treasury yield curve. Yet these arguments are not without notable counters. Consider the following four as starters:  

• While inflation will indeed continue to come down in the immediate future, its main drivers have been shifting to the service sector, thereby increasing the risk of more embedded price pressures when the labor market remains solid.
• With global growth surprising on the upside, the window for more orderly rate increases has been opened wider.
• Financial conditions have loosened significantly in recent months and, by some measures, are around levels that prevailed last March when the Fed initiated this hiking cycle.
• A faster journey to the peak rate that has already been signaled, and reiterated by Fed officials several times, reduces the complexities of linking the path to a variable destination.

There are also strong risk-management arguments in favor of another 50-point increase before downshifting to 25 basis points. Such a policy action reduces the risk of having to increase rates later this year when the global economy has weakened. It may help reverse some of the damage to the Fed’s inflation-fighting credentials, starting with a better alignment between the central bank’s policy guidance and market pricing. Also, in an inherently fluid world in which the probability of yet another policy mistake is uncomfortably high, it allows for an easier recovery in the event of such an error.

This was in line with market expectations and marked the slowest pace in over a year. Markets have reacted positively, interpreting the disinflation trend as grounds for the Fed to decrease the pace of rate hikes to 25bps from 50bps at the next FOMC meeting on February 1.  For its part, the Bank of Canada hiked by 25bps this week (as expected) and explicitly signaled a pause to assess the impact of tightening thus far, fueling optimism that most major central banks are getting closer to ending their rate hiking cycles. Meanwhile, following a string of soft U.S. data releases, concerns about a potential recession by mid-year in the world’s largest economy appeared to be on the rise. Nevertheless, oil and the broader commodities complex traded well, supported by continuing optimism around China’s reopening. The week was busy for emerging market central banks with a number of policy rate decisions: Nigeria surprised markets with a higher-than-expected 100bps hike, while South Africa sharply slowed the pace of monetary tightening to 25bps from 75bps amid revising its 2023 growth forecast materially lower. Elsewhere, Pakistan is preparing for an IMF visit to unlock critically important disbursements, Ghana moved closer to reaching a deal on domestic debt restructuring, and El Salvador repaid its bulky sovereign bond maturity, clearing the first major emerging markets debt repayment hurdle for this year. For the week ahead, another week when central bank meetings will be in focus, dominated by the Federal Reserve’s decision due on Wednesday, February 1. Market expectations for a slower pace of 25bps have been firmed by this week’s inflation data. As for the European Central Bank (ECB), a 50bps hike appears to be a near certainty and consensus expects a move of similar proportion by the Bank of England (BoE). In Turkey, January inflation data will likely show another large YoY drop of CPI from elevated levels, driven by strongly favorable base effect. In Asia, markets will get PMI data from China and India and look for further signs that economic activity in China is set to pick up as re-opening takes hold.

Analysts hope abandonment of zero Covid policies will unleash flood of consumer spending.  The Chinese government has vowed to make consumption the “main driving force” of the economy as hopes grow that Beijing’s abandonment of zero Covid policies will unleash a flood of spending by Chinese consumers, fuelling a global rebound. “The greatest potential of the Chinese economy lies in the consumption by the 1.4 billion people,” Li Keqiang, China’s premier said during a meeting of China’s cabinet, the state council, according to a statement released late on Saturday. “Boosting consumption is a key step to expand domestic demand. We need to restore the structural role of consumption in the economy.” While China has long sought to boost consumer spending, the comments from its outgoing premier come at a crucial moment as Beijing seeks to rebuild the economy after years of punishing lockdowns. The Chinese economy grew by just 3% in 2022, underscoring the impact of the government’s zero-Covid strategy before it was abandoned last month. Last year’s collapse of the property market, which has contributed around one quarter of GDP over the past decade, has also added to economic stress. Economists hope that China’s pent-up consumer activity will buoy global demand. Multinationals including Unilever have said in recent weeks they were expecting a rebound in demand in the country and banks including Morgan Stanley have increased their Chinese growth forecasts. “We believe the market is underappreciating the far-reaching ramifications of reopening, and the possibility that a robust cyclical recovery can occur despite lingering structural headwinds,” the bank said in a January note. Still doubts remain over the willingness of Chinese consumers to start spending again. Experts have long warned that China’s desire to move away from property-driven growth towards greater consumer spending will be challenging. Household spending accounted for 38% of Chinese gross domestic product in 2021. By comparison, it accounted for nearly 70% of US GDP in 2022. The last few years of Covid has also bred economic caution as incomes and house prices came under pressure in the real estate crash. The country’s already high gross national savings rate swelled during the pandemic. Renminbi deposits held by households nationwide grew in 2022 by a record Rmb17.8tn ($2.6tn), compared with growth of Rmb9.9tn in 2021, according to data from the People’s Bank of China. Chinese citizens celebrated lunar new year last week for the first time since pandemic controls were lifted. While state media say 226m domestic trips were made, 74% more than last year at the height of Covid restrictions, that is still just half the 420m trips made in 2019.

Investors who hoped that 2023 would bring a change in fortunes to America’s tech companies following their walloping in the markets in 2022 were left disappointed by Microsoft’s earnings. The company reported solid revenue and profits for the final quarter of last year, but said the growth in demand for its cloud services, the main driver of its business, had softened as clients curtailed spending. It was the first of America’s tech giants to publish results for the fourth quarter. Markets are nervously awaiting earnings reports from the others. Meanwhile Microsoft confirmed that it had increased its investment in Openai, the startup behind the Chatgpt artificial-intelligence bot. Chatgpt has become an ai sensation since its release on the market last November. Taking direction from just a few commands, it has passed exams in law and medical licensing, and completed the final exam in the Wharton mba programme (which may not surprise anyone who has attended business school). America’s Justice Department sued Google for anticompetitive behaviour in online advertising. The suit alleges that Google tried to limit its rivals’ access to digital-ad technology by acquiring firms that develop it and wielded its dominance in the market to force advertisers and publishers to use its products. The news comes after Alphabet, Google’s parent company, announced 12,000 job cuts, another instance of the tech industry’s great retrenchment. In an indication of shareholder frustration at the strategic direction of some tech firms, Elliott Management, a prolific Wall Street activist hedge fund, has reportedly taken a stake in Salesforce, one of the world’s biggest software companies. Salesforce has also shed jobs to cut costs, but investors’ exasperation goes beyond its hiring spree to its $28bn acquisition of Slack, which critics think was overvalued. Reed Hastings stepped down as chief executive of Netflix, which he helped found in 1997 as a dvd rental firm. He’ll remain at the company as executive chairman. The streaming company, meanwhile, said it was pleased with the progress of its new ad-supported subscription option, and that it would ban the sharing of passwords to its service by the end of March. America’s economy grew by 2.9% in the fourth quarter on an annualised basis, slowing slightly from the 3.2% recorded in the previous three months. GDP expanded by 2.1% for the year as a whole. A German union said that Ford is planning to cut 3,200 jobs and move some activities to America. The carmaker has not confirmed the cuts, saying only that it needs to make structural changes amid the shift to electric vehicles. Press reports suggested that Ford was considering selling one of its German factories to byd, a Chinese maker of evs. Qatar’s investment agency has doubled its stake in Credit Suisse and now owns 6.8% of the Swiss bank, according to a regulatory filing. It is now the second-largest shareholder in Credit Suisse, after Saudi National Bank, which holds a stake of 9.9%.