Market Searching for Clues on Pace of Fed Hikes

Bonds rise on eve of rate hike decision. Treasury yields fell across the curve today, the 2-year and 10-year yields falling by ~3bps to 4.20% and 3.51%, respectively. The move comes ahead of the Fed’s rate hike announcement tomorrow, with a miss in the employment cost index a main contributor. Labor costs in the U.S. increased 1% quarter-over-quarter, which was lower than the forecast of 1.1% and simultaneously marked the third consecutive period of declines. Elsewhere, equities flourished today, as the S&P 500 rose 1.46% while NASDAQ gained 1.67%.

With the Fed largely expected to hike 25bps, the question is how it will respond to recent inflation data. The market has priced in a 25bp hike at the February FOMC meeting for some time now, following last month’s 50bp hike. A key takeaway from this meeting will be how the Fed plans to adjust its stance given recent deflationary data points – core PCE rose 3.7% over the last 6 months, a slowdown from the 4.4% increase on the year. Though promising, central bankers have expressed that despite this positive data, more may be needed before a policy reversal can be considered. In addition, Chair Powell has expressed concerns with persistent inflation outside of the housing and energy sectors, which are largely driven by elevated wages. Labor cost increases did moderate to 1.0% in 4Q22, down from 1.2% in 3Q22 and below the 1.1% estimate, but more data will likely be needed to convince the Fed that labor costs are indeed declining. Fedspeak offered some early clues on how much data will be needed: in his comments before the Blackout period, Governor Wallace, a notable hawk, said that he will need 6 months of deflationary data before deciding on pausing hikes.     

Day ahead. The Fed will announce their rate hike decision at 2 PM ET, and will follow with a press conference at 2:30. There will be a few data releases in the morning, including ADP employment change at 9:45 AM and ISM PMI and JOLTs job openings at 10 AM.