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The first week of 2023 came with the usual slew of major economic data points, which on net point to the curious post-pandemic era combination of a resilient labor market set against eroding business confidence across the US economy. And if this trend keeps up, it will likely make for a highly bumpy trading landscape in the months ahead, with investors getting yanked in multiple directions.

Still, investors could continue to embrace weak data, especially if signs of descending wage inflation continue. Any indications in the data that the Fed could tap the brakes on its monetary tightening cycle could boost calls for a softer landing that may be optimal for equities.

However, as inflation and rates volatility apex, growth and recession risk will likely be the principal risk factors in 2023. Against that backdrop, if central banks continue tightening, real rates may move higher, choking both corporate profits and the economy more forcefully

Hence equity risk premia look too low considering recession risks, uncertainty over the growth/inflation mix and relatively weak expected profit growth. 

On the other side of the pond, traders remain bullish on STOXX 600 from a valuation perspective amid China tailwinds. Still, based on local updrafts, markets could refrain from doing a victory lap and turn cautious about taking too much comfort in the latest series of inflation prints which primarily reflected declines in energy prices or government price interventions, whereas core inflation firmed modestly. Not to mention the headline inflation decline is unlikely to stem ECB hawkishness.

The focus will be on the start of the 4Q22 earnings season, which unofficially begins on Friday with results from America's biggest banks and other industry bellwethers, including JPM, BAC, C, and others,

Turning back to macro, the focus is squarely on the December CPI reading on Thursday. Also, keep an eye on the December NFIB Small Business survey and the November Consumer Credit Survey.

US Rates & The Dollar

Mixed US economic data helped fuel a large rally in USTs last week. Both employment measures—nonfarm payrolls and the household survey—were robust, though average hourly earnings rose by less than expected, with October and November readings revised lower. By itself, the jobs report suggested a potential cooling of wage pressures without a significant increase in unemployment. From a market perspective, it supported further downshift at the front end of the curve on the idea that the Fed would be able to ease policy by more than previously priced.

Both ISM surveys, however, were in contractionary territory, implying a bleaker outlook. While this also raises the possibility of more cuts priced in sooner, it would impart more of a bull steepening bias to the yield curve if realized and typically a strong signal to sell the US dollar. 

The Fed still drives currency sentiment, however. The minutes of the December FOMC meeting released last week suggested that no FOMC member saw the need to cut rates this year, even alongside forecasts for a material increase in the unemployment rate. Admittedly, this was within the context of an inflation projection well above target. Still, it indicates a high bar to cutting rates this year absent a rapid inflation normalization.

As such, the focus switches to Thursday's CPI report. Markets are currently split on whether the Fed will raise rates by 25bp or 50bp at the February Federal Open Market Committee meeting. Given the softer wage bias in the NFP  data, and if we get another cool core CPI print, we should have more folks pitching tents in the 25 bp camp and thus selling US dollars.

And supporting the currency challenger side of the equation, ECB's hawkish rhetoric continues, pointing to further rate hikes over the first half of 2023

Commodities

Short-Term Pain Longer-Term Gain?

The focus on China's "reopening" and relaxation of COVID-related restrictions has intensified in recent weeks. Although infection rates have risen sharply, hurting the near-term growth picture, optimism about the growth outlook beyond the very near term has been growing.

Oil and Commodity markets have underperformed even as Chinese equities have risen sharply as current growth weakness in China may matter more for commodity assets than it does for equities. If that is the case, then the prospect of commodity (OIL) upside should enhance as we approach the point where China's growth turns more meaningfully positive again.

One possible explanation is that spot growth weakness is a higher hurdle for oil markets to clear as stocks can look more easily through recent weakness to price forward growth prospects. 

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