Pivot or not Pivot?

What happened?

The last FOMC meeting raised hopes for a more dovish FED policy given the declining inflation figures.

However, market participants may have to temper their optimism as the FED will probably take into account several elements to adjust its monetary policy.

In this newsletter, we will examine different parameters that could influence the FED's future decisions.

Is inflation behind us?

Inflation is obviously one of the main indicators that the FED is currently monitoring, so let's dive into the details:

• We are well above the 2% inflation target, even though Headline Inflation is decreasing, due to lower Energy and Food prices.
• Core CPI remains high, notably due to continued rise in prices for services (+6.7%) and shelter (+6.9%) in October.

This means that conjunctural factors (logistical bottleneck, Russia-Ukraine conflict) have less impact now, but structural forces such as the cost of services and housing are now driving Core Inflation.

Consumer Price Index YoY

What about the job market?

Last Friday, as with every first Friday of the month, the non-farm payrolls were released:

• The US economy created 263,000 jobs in November against a forecast of 200,000. This is the lowest figure since April 2021, and shows a normalization towards the pre-covid levels of around 150-200k.
• Interestingly, the main job providers were food services (62k jobs created) and health care (45k jobs created), while 32k jobs were destroyed in general merchandise stores.
• The average hourly wage increased by 4.7% year-on-year.

This tells us that the labor market is normalizing, but remains tight with high demand for labor, which could lead the FED to run a more hawkish policy than expected.

Non-Farm Payrolls historical levels

Are Real Estate foundations still solid?

Several years of monetary policy easing have fueled the rise in house prices. However, rising interest rates have recently reversed the trend:

• If we compare the Case-Shiller Home Price Index (in yellow) to the yield on 10-year Treasuries (in green), there is a negative correlation, but with a significant delay. The impact of interest rates takes time to be reflected in house prices.
• In its Financial Stability Report published in November, the FED highlighted the risk of a significant drop in real estate prices as valuations remain high if we take the price/rent ratio.
• However, the FED stressed that even if a bubble may have been created, the landing should be softer than in 2008 because household debt remains moderate.

Case-Shiller Home Price Index compared to US 10Y Yields

Conclusion

We have seen that three of the most important factors for the FED are showing signs of normalization towards pre-covid levels.

However, markets remain very volatile after each macro data announcement, as the FED's decisions still depend on the most recent news.

Market participants now expect a 50 basis point hike for the December 14 meeting, with the implied probability rising from 61.5% a month ago to 79.4% now.

The next FED decision will be on 1 February, and whether it will be a 25 or 50 basis point hike is in question. We will see how things evolve,