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Dollar and Rates Soften a Little Ahead of US CPI

Overview: The focus is on the US CPI report today, but the price action is anything but intuitive. Although the revisions of the basket and methodological changes reinforce expectations for the largest rise in three months, the US dollar continues to trade heavily after rallying last week. The dollar-bloc currencies are underperforming today. And US rates are softer. The US 2- and 10-year yields are 1-2 bp lower.

Most of the large bourses in the Asia Pacific rallied. Hong Kong was a notable exception and the HKMA intervened to support the Hong Kong dollar for the first time since last November. Europe’s Stoxx 600 is up 0.5% and is at its best level in a year. Benchmark 10-year yields are mixed, with the core yields mostly softer. Japan reported weaker than expected Q4 22 GDP, underscoring the challenge of the new team to run the BOJ, which the media had leaked last week. The UK’s labor market remained strong despite the economy looking recession bound. March WTI has come back offered after closing above $80 yesterday for the first time since January 26. The US confirmed it will sell 26 mln barrels out of its SPR in Q2, honoring a budget agreement struck in 2015. Currently, the SPR holds about 370 mln barrels.

Asia Pacific

In Q4 22, the Japanese economy recovered from the contraction in Q3, but the contraction was deeper than initially estimated and the recovery was weaker than expected. At an annualized pace, the world’s third-largest economy expanded by 0.6%, well off the 2% median projection in Bloomberg’s survey. Economic output shrank by a revised 1.0% in Q3 rather than 0.8% contraction originally reported. The disappointment in Q4 stemmed from weaker business investment and a larger drag by inventories. Net exports also contributed slightly less than expected. Private consumption recovered, growing by 0.5% quarter-over-quarter after being flat in Q3 (initially estimated to have grown by 0.1%).

Japan’s GDP price deflator rose by 1.1% (year-over-year). The deflator has been negative for five of the past eight quarters and in one of the remaining three, was zero. This underscores our sense that sometimes hawk/dove labels are not particularly helpful. Even with a large budget deficit (~6.7% of GDP in 2022), mind-bending extent of monetary stimulus, a yen, which the on the OECD’s PPP model is 28% undervalued, and the Japanese economy can barely sustain upward momentum. The economy contracted in two of last year’s four quarters. At the same time, with a shrinking population, positive growth means a per capita increase. As had been leaked by the press, Ueda was formally nominated to replace BOJ Governor Kuroda, and Uchida and Himino have been nominated as deputies. Note that Kuroda will chair the March 10 BOJ meeting, making the April 28 meeting the first for Ueda.

China set the details for its benchmark one-year medium-term lending facility tomorrow. CNY300 bln fall due and the PBOC is expected to make a net injection. Still, the PBOC does not seem to be in a hurry to ease cut rates, though core inflation is subdued, and mortgage lending remains weak. A steady rate tomorrow means that the one- and five-year loan prime rate (February 19) are also not going to fall. New home prices will be released on Thursday for last month Prices have been falling uninterrupted beginning in September 2021 and is anticipated to continue. The cumulative decline has been modest at around 3.5%.

The US dollar reached JPY132.90 yesterday as it extended its recover from the dip below JPY130 before the weekend. It is consolidating mostly below where it had settled yesterday (~JPY132.40). A move above JPY132.50 is needed to re-target JPY133.00. The Australian dollar recorded an outside up day by trading on both sides of the pre-weekend range and closing above its high. Yet follow-through buying has been limited to a few hundredths of a cent. It has been confined to a narrow range of about a quarter of cent above $0.6950. It needs to push above $0.7000 to be anything of note. Last week’s high was about $0.7010 and the 20-day moving average is slightly above $0.7000. The greenback gapped higher against the Chinese yuan yesterday and filled the gap today. The gap extended to last Friday’s high near CNY6.8145, and today’s low was CNY6.8120. It is also in a narrow range today, peaking a little above CNY6.82. The dollar’s reference rate was set at CNY6.8136 compared with CNY6.8155, median projection in Bloomberg’s survey.


One of the important developments this year has been downgrading of the left-hand tail risk. Many are talking about “no-landing” in the US economy and that the eurozone could avoid a recession. The EC revised up its outlook for this year’s growth to 0.9%. The ECB ‘s forecast in December was for 0.3% GDP here in 2023. A key part of the optimism stems from the outlook for Germany. Europe’s largest economy is seen growing by a meager 0.2% this year, but considerably better than the 0.6% contraction anticipated late last year. The EC cut its inflation forecasts to 5.6% this year and 2.5% next year, from 6.1% and 2.6% previously. The ECB’s December forecasts anticipated 6.3% CPI this year and 3.4% in 2024. The EC’s forecast may give a hint of the direction, if not the magnitude of updated forecast the ECB’s staff will provide next month.

By most metrics, the UK’s labor market remains strong. As a note for other countries, including the US and Canada, the strong labor market does not prevent an economic contraction. Payrolls in January increased more than expected (102k vs. 15k median in Bloomberg’s survey) and the jobless claims fell by nearly 13k (the 19.7k increase in December was revised to a 3.2k fall). Average weekly earnings excluding bonus payments rose 6.7% in the three-months through December from a year ago. This is the fastest in at least two decades. The Bank of England meets next on March 23 and the swaps market has a quarter-point hike discounted and another quarter point hike in Q2. Those two hikes would bring the base rate to 4.50%.

The euro pushed above $1.07 yesterday and some of the buying seems related to large options. The euro reached slightly above $1.0765 today. Last week’s high was about $1.0805 and the 20-day moving average is closer to $1.0820. The euro’s gains are likely to stall now ahead of the US CPI. It can test support, initially near $1.0720 and then former resistance at $1.07 may acts as support. Sterling posted an outside up day yesterday, and follow-through buying has extended its gains a little through the $1.22 level. This is a six-day high. However, here too, we look for a pullback ahead of the US inflation report. Initial support is seen in the $1.2130-50 band.


The January CPI is the North American highlight. The re-weighting of the basket and methodological changes announced at the end of last week provided more fodder for the shift in market expectations. They have now converged with the Fed’s December dot plot, which anticipated a terminal Fed funds rate above 5%. The market has also retreated from the expectation of a rate cut in Q4. To be sure, that is still the bias, but with considerably less conviction. About a month ago, the implied yield of the December Fed funds futures contract bottomed 34 bp below the implied yield of the September contract. The spread is about 18 bp, the least since the second half of last October and is near 20 bp now. We continue to look for the base effect to drive the year-over-year rate lower in through the H1 23. That said, the Fed is more optimistic than the market on the PCE deflator this year. The December Summary of Economic Projections had the headline deflator at 3.1%. The core deflator is seen at 3.5%. In 2024, when the Fed anticipates being able to cut rates, the median dot was at 2.5% for both the headline and core. The median forecast in Bloomberg’s survey has the headline PCE deflator finishing this year at 3.4% and the core at 3.6%. In 2024, economists see the headline at 2.3% and the core at 2.4%.

News that the vice chair of the Federal Reserve, Brainard, will be named shortly to chair the President Biden’s National Economic Council, has been rumored for the last couple of weeks. It is not clear if it will have substantive impact on the administration’s policies, and in the State of the Union, Biden stressed “buy American” and the export of American jobs. Her departure from the Federal Reserve gives Biden the opportunity to make another appointment and the vice chair. Separately, there was much debate about whether tapping the Strategic Petroleum Reserve given the disruption to the oil market after Russia’s invasion of Ukraine was an emergency or politically expedient. However, the sale of 26 mln barrels in Q2 23 was part of 2015 budget deal. The DOE has tried to rollback related sales.

The US dollar posted an outside down day against the Canadian dollar following Canada’s strong jobs data before the weekend. Follow-through selling took the greenback to about CAD1.3325 yesterday. It is holding above there today but has not been able to get much above CAD1.3350. It would take a move back above CAD1.3380 to signal a near-term low is in place. The Mexican peso remains firm. Portfolio flows and direct investment is helping the peso outperform. The dollar is approaching the three-year low set earlier this month near MXN18.50. The greenback takes three-day loss of almost 2% into today’s activity. Recall that it ended last year near MXN19.50. We suspect it call fall toward MXN18.00 in the medium-term.

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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