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The two-day FOMC meeting commences tomorrow, and a 25-bps increase is expected.  As noted many times, despite consistent messaging from the Fed, there is a massive disconnect between what the Fed is stating and what the market is interpreting.  The Fed has been adamant that it will increase the overnight rate to slightly over 5% and maintain that level throughout 2023.

The market on the other hand is strongly stating the Fed will pivot by mid-year and the terminal rate will be around 4.75% ending the year at around 4.0%.

The Federal Reserve must remain ahead of inflationary expectations.  Is the Central Bank achieving its objective?  According to the influential University of Michigan Sentiment survey, inflationary expectations improved at the end of January.

Respondents said they expect inflation to advance 3.9% over the next year, the lowest since April 2021.  Consumers expect inflation to rise 2.9% over the next five to 10 years, down very slightly from the preliminary reading.

Because it is believed the Fed is ahead of inflationary expectations, as expectations fuel behavior, the Treasury market is flirting with its best start to a new year since 1988.

An argument can be made if the Fed increases the overnight rate by 50 bps, equities may sharply sell off as January’s equity rally is the primarily the result of perhaps a kinder and gentler Fed.  Accordingly, long dated Treasuries may continue to advance as such strong policy response is consistent with muting current pricing pressures.

If Central Bank raises rates by 0.25% and issues a hawkish post meeting statement, downside volatility may also increase.

Some have suggested the markets have already discounted the most favorable outcome of the Fed meeting…a 25-bps increase and less than hawkish statement.  If this is indeed the case, there might be the proverbial buy on rumor and sell on fact response.

The Federal Reserve has consistently stated its objective to increase unemployment by 1 million workers.  As noted many times, the workforce is about 3 million people smaller than January 2020.  Why have these workers not returned to the workforce?

According to the BLS there are approximately 7 million men aged 25-54 who are not working.  This is a key demographic and economic block.  Also, according to the BLS, this cohort spends 7 hours a day on their phones or watching TV.

The ramifications of such data are potentially huge in so many dimensions.  Unfortunately the Fed cannot legislate fiscal policy to encourage workforce participation.  It can only control the monetary levers.

Earnings season continues to accelerate with several of the mega sized technology firms posting results.  Tuesday META releases earnings and on Wednesday, AMZN, AAPL and GOOG all post results.

Because of their massive capitalization, any release that is different than the consensus view can have an outsized impact on the averages and psychology.

The economic calendar is crowded with a number of top tier statistics including the ISM data, the JOLTS Job opening statistics, several regional manufacturing indices, the ADP Employment survey and the BLS Labor report.  How will the information be interpreted?

Last night the foreign markets were down.  London was up 0.03%, Paris down 0.64% and Frankfurt down 0.73%.  China was up 0.14%, Japan up 0.19% and Hang Seng down 2.73%.

Dow and NASDAQ futures are off about 0.50% and 1.5% ahead of big earnings week and the FOMC meeting.  The 10-year is off 13/32 t o yield 3.56%.

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Kent Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.