Fabian Estevez

After December inflation accelerated to 3.4% annually, where shelter costs, which have a significant weight, continue to look at a very gradual pace; and after knowing the first revision of the 4Q23 GDP, which showed a robust annualized growth of 3. 3% (beating expectations of 2%), the Federal Reserve (FED) made the unanimous and widely anticipated market decision to again leave the target range for the federal funds rate unchanged (for the fourth consecutive occasion) at 5.25% – 5.50% (the highest level in the last 22 years).

In this context, the statement noted that recent indicators suggest that economic activity has been expanding at a solid pace, with employment prevailing strong, while inflation, although it has declined over the past year, still remains elevated. Therefore, and as part of a modification from previous statements, the Committee emphasized that it believes the risks to achieving its employment and inflation targets are moving toward a better balance.

Another important change in the statement was that it modified the following wording: “to determine the degree of additional monetary policy tightening that might be appropriate to eventually return inflation to 2%”, replacing it with “in considering any adjustment to the target range for the federal funds rate”. This could be interpreted to mean that the hiking cycle may have come to an end, while the Committee will continue to take into consideration all incoming information, the developing environment and the balance of risks when making future decisions.

Finally, among other changes in language, and no less relevant, is the Committee’s strong message that it is in no hurry to start reducing the federal funds rate range, stating that “the Committee does not expect it to be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%”.

In his press conference, Jerome Powell considered that rates are at the peak of this tightening cycle and did not rule out the possibility that they could remain elevated if necessary. The overall message focused on the FED needing further evidence that inflation is consistently heading towards its target, and he was positive about the results achieved over the last year, reaffirming the importance of carefully assessing economic developments before making future decisions.

Expectation for Federal Funds Rate

Source: AllianceBernstein 

In recent days, Taiwan concluded its presidential election, with Vice President Lai Ching-Te emerging as the winner, securing another four years for the Democratic Progressive Party (DPP). Notably, this marks the first time in Taiwan’s electoral history that a ruling party has clinched a presidential election for a third term. Lai’s inauguration is scheduled for May 20th, 2024.

The elections witnessed a high turnout of around 70%, and it’s worth mentioning that Lai’s 40% share of the presidential vote was lower than his predecessor Tsai Ing-wen’s 57% in the 2020 election. Additionally, the DPP lost its absolute majority in the Legislative Assembly, decreasing its share from 54% in 2020 to 45.1%. Both opposition parties increased their share of seats: the Kuomintang (KMT) from 33.6% to 46%, and the Taiwan People’s Party (TPP) from 4.4% to 7.1%. Consequently, no party holds a majority position. Historically, the KMT has been considered more open to the idea of closer relations with mainland China.

It’s important to note that this scenario aligns with market expectations and, generally, is not anticipated to alter the current course of events in the region. While the outcome is considered unlikely to significantly impact Taiwan’s economic growth in 2024, there will be a continuity of policies implemented by previous DPP-led governments. Regarding relations with mainland China, Lai expressed his interest in maintaining “healthy and orderly” exchanges, reiterating his openness to talks based on more equitable terms.

In conclusion, the positive outcome of this event may bring some calm to the geopolitical sphere in Asia and the world in the short term. However, it’s challenging to rule out the possibility of continued tension in relations with mainland China in the coming years, especially given the close interaction between Taiwan and the United States in the evolving economic landscape, heavily influenced by the semiconductor supercycle and Artificial Intelligence (AI) development.

Global semiconductor wafer capacity installed by region (market share). 

In electronics, a wafer refers to a thin, circular slice of semiconductor material from which microchips/semiconductors are produced.

Source:  UBS 

The December consumer price index (CPI) accelerated by 0.3%, slightly higher than expected, bringing the annual rate of inflation to 3.4% from 3.1% in November. Also, core CPI inflation, which excludes food and energy, increased by 0.3%, although in line with expectations. However, in its annual variation, it decelerated to 3.9% (versus 4.0% in November and October). Therefore, the overall trend shows that core CPI continues to moderate gradually. According to these data, analysts believe that the FED’s preferred price index, known as the “Core Personal Consumption Expenditures Price Index (Core PCE)”, would have increased by 0.2% last month, which would bring the annual variation from 3.2% to 3.0% (vs. 2.4% expected for the end of this year).

Within the report, the monthly performance in the energy component came as a surprise, higher than expected, with an increase of 0.4% (-2% annually), driven by a 1.3% increase in electricity prices (+3.3% annually). Meanwhile, food CPI rose 0.2% (+2.7% annually), in line with recent increases. Food away from home increased 0.3% (+5.2%), which implied a slight improvement over what was seen in previous months.

In other categories of interest, new vehicle prices advanced 0.3% in the month (+1% annually), while used vehicle prices climbed 0.5% (-1.3% annually), although used vehicle prices are expected to moderate again in the coming months. Basic services prices (excluding energy services) advanced 0.4% last month (+5.3% annually). That said, shelter-related increases, which have a significant weight, continue to moderate at a very gradual pace. In this sense, rents increased 0.5% (+6.2% annually), a similar performance to the previous month. Finally, prices for health care services rebounded 0.7% last month (-0.5% annually), pressured by another increase in the cost of insurance.

With all key data now available (inflation and employment), we believe that the Fed would not be in a hurry to accelerate cutbacks to the reference rate, as there is still room for improvements, especially concerning Core CPI. Moreover, it is challenging to think that the upcoming FOMC meeting at the end of January can provide further clues about how the Fed might act in the very near term. What can be anticipated is that the talk of higher rates for a while should prevail until a more pronounced cooling within the economy is observed. Finally, it is worth noting that, despite all of the above, the consensus assigns a 56% probability of seeing a 25-basis point (bp) cutback at the subsequent meeting on March 20th.

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics