Soft Landing into a Ditch

Signals are screaming as Powell continues to hike. Although Fed Chair Jerome Powell reiterated rates will remain “higher for longer” at yesterday’s FOMC, this morning’s job report is here to crush his New Year’s high.

Yields have stopped rising and unemployment is not slowing quickly enough. Let’s dive in.

Hike Until it Breaks

The December jobs report released on January 6 came in modestly stronger than expected, with 223,000 jobs created (compared to Kalshi’s projection of 209,000) and an unemployment rate tumbling to 3.5% (compared to Kalshi’s projection of 3.7%). Kalshi’s projections were broadly in line with other forecasts–such as Bloomberg’s 203,000 and Reuter’s 200,000.

The stock market in particular rejoiced at the weakening wage data, with the S&P 500 jumping 1.5% in part based on wages rising only 0.3% and previous month’s wage gains being revised downwards, thereby lowering the Fed’s odds of hiking 50 bps at their February meeting from 50% to 33%.

Looking onwards to next week, Kalshi markets anticipate a negative CPI inflation print (-0.1% month-over-month) for December 2022, and the lowest inflation print since April 2020, with a 40% chance that inflation could even fall to -0.2% or below. Rapidly falling energy prices are a major contributor to this print, as gas prices fell roughly 50 cents over the course of the month.

But gas prices are hardly the only story: core inflation (which strips out volatile energy and food prices, as they are poor predictors for future inflation) is projected to remain stable at 0.2%, well within the Fed’s target range. Moving forward, Kalshi markets expect the inflation cooldown to continue, with a 0.2% headline print in January and a roughly 3% annual inflation rate in 2023. In other words, the modern-day record inflation America experienced in 2021-22 is likely to soon see its end.

These inflation prints will be the basis of the Federal Reserve’s decision whether to continue hiking interest rates. Kalshi traders think that there is a 67% chance that the Fed hikes 25 bps, largely depending on whether the core December print comes in above or below expectations. These numbers substantially changed after the surprisingly positive December jobs report released on the morning of January 6, as the probability of a 50 bps hike tumbled from 50% to 30% on news of softening wage gains.

Market Outlook

If all goes to plan, the rest of 2023 will be far less interesting: markets are expecting a terminal fed funds rate of 5% (representing 50 bps higher than current level) with a 67% chance that the Fed will not cut rates during the year. This behavior is consistent with Powell’s previous statements. He believes that positive forecasts are insufficient to justify a change in course–he needs the prints to consistently come in on target in order to end the hikes. Kalshi numbers differ little from other forecasts–CME’s FedWatch prices a 25 bps hike at a 67% chance and the non-Kalshi Fed funds estimates are more confident in rate cuts at the end of the year than Kalshi.

So what’s the takeaway? Kalshi projects a rapid inflation slowdown to normal levels in early 2023, and the Fed’s rate hikes will likely end by their February meeting and stay constant. The soft landing scenario–which seemed so remote six months ago–now appears most likely.

Strategize for the CPI before it drops

We're hosting a Twitter Space to help you strategize trading on Jerome Powell's favorite markets--inflation and Fed interest rates.

Inflation expectations are tumbling ever since recently low prints, plus the latest jobs report. We're sweeping in to explain why. Set a reminder for our Inflation Twitter Spaces next Thursday at 8AM EST for live coverage and analysis of the CPI print.

The Space begins 30 minutes before the announcement and ends 30 minutes after, in order to best optimize your trading strategies. Set a reminder below.

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