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MARKETS

Global stocks saw a modest rise on Thursday as investors continued to bask in the Goldilocks glow of above-trend growth and moderating inflation.

According to the Commerce Department, the U.S. economy expanded in the fourth quarter, with gross domestic product (GDP) growing at an annualized rate of 3.3%, surpassing all estimates, including the highest projection from nearly sixty economists. Additionally, full-year growth stood at 2.5%, and core Personal Consumption Expenditures (PCE) rose by 2%. It's worth noting that the final reading on Q3 GDP saw the core PCE print revised down to 2%, making Q4 the second consecutive quarter of on-target core PCE.

Contrary to expectations at the start of last year, tighter monetary policy and credit conditions did not lead the U.S. economy into recession.

Suffice it to say the Federal Reserve hasn't achieved its goal of fostering growth below the trend, but so long as inflation remains on trend, one could surmise that is a good thing. Still, it will undoubtedly make for an awkward Fed meeting next week as historical modelling suggests what we see across the U.S. economy should not be happening.

The GDP growth in the fourth quarter of 2023 exceeded everyone's expectations. This was due to solid spending by consumers and the government. However, recent business surveys and the Chicago Fed diffusion index indicate that GDP growth in the first quarter could be much weaker. Nevertheless, the Fed is nearly running an inflation victory lap, marked by two consecutive quarterly core inflation readings of 2%. It is an unambiguous positive inflection point for stock investors as it opens the door for H1 rate cuts.

And if you need any more convincing that the inflation dragon has been slayed, the GDP price index rose just 1.5%, far below the 2.2% economists expected and less than half of Q3’s 3.3%.

Overall, it's challenging to interpret the GDP release in any other way than a Goldilocks scenario, which succinctly captures the GDP update's essence, especially considering the balanced economic indicators.

OIL MARKETS

Oil futures surged over 2% on Thursday following claims by Iran-aligned Houthi militants in Yemen that they had targeted a U.S. warship in the Bab el-Mandeb Strait.

In the United States, the ongoing deep freeze continues to disrupt operations at Midwest and Gulf Coast refineries. Nationwide refinery throughput decreased by nearly 1.4 million barrels per day (bpd) or 8.2% from the previous week to 15.2 million bpd. Gulf Coast refinery crude throughput dropped by 1.1 million bpd, while Midwest runs fell by 300,000 bpd. Although there have been no reports of damage to refineries in these regions, some Gulf Coast refiners have initiated planned maintenance earlier than usual.

There appears to be a discrepancy between the valuation of geopolitical risks in the Middle East in futures and physical markets. Quantifying "geopolitical risk" conclusively presents challenges despite the Fed's provision of a news-based measure of adverse geopolitical events.

The complexity of oil market volatility often dissuades cross-asset investors and hedgers from adopting long positions in oil futures. Additionally, the high trading costs associated with managing geopolitical risk through options markets make energy shares an appealing hedge for many investors.

Still, this week's price action is significant, potentially signalling that the oil price bottom is either within sight or imminent. Suppose this perception gains momentum, especially in anticipation of Fed rate cuts amid easing inflation even with above-trend growth. In that case, more investors may re-enter the futures market, further supporting oil prices.

FOREX MARKETS

The optimistic US economic performance could theoretically favour the US dollar. Still, the overall impact on the market, at least through the active lens of the USDJPY, is somewhat muted as FX traders are tongued tied by strong US growth, yet the prospects of US mechanical rate cuts as inflation falls.

How much any of this week’s data will ultimately move the needle for March Fed cut odds is debatable. Jerome Powell’s messaging at the press conference on January 31 is the next major event with the potential to make or break bets on a Q1 rate reduction. But importantly, there are a lot of event risks to navigate before traders embark on a significant dollar bias, starting with today's PCE deflator and the January Jobs and CPI report released in early February. The Fed will have many more current data points by March that’ll easily outweigh anything the market will take away from this week’s docket.

In other Forex news, The European Central Bank (ECB) maintained its interest rates unchanged for the third consecutive meeting on Thursday.

The outcome of the January policy meeting was widely anticipated, with few expecting any significant changes. The primary question revolves around when Christine Lagarde, the ECB President, will shift towards considering rate cuts. The answer to this question remains unclear. Economic growth in the eurozone is stagnant, and inflation has notably decreased, posing challenges for the ECB in providing support to the euro. Despite considerations such as higher energy and freight costs, the ECB's stance hasn't significantly altered market expectations. Traders are currently anticipating a rate cut at the April meeting, with market pricing indicating an 80% likelihood of such a move.

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