by Marc Chandler
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The dollar peaked last September/October and trended lower until the January jobs report and strong service ISM on February 3. These reports and firm inflation readings, owing, at least in part, to benchmark and methodological changes, helped spur the greenback's recovery. However, we learned last week that auto sales and the service ISM prices paid decelerated in February, and this week, we will learn that job growth has slowed considerably. If accurate, the median forecast in Bloomberg's survey of 200k would be the least since the end of 2020. We look for the February employment report to mark a string of softer economic data, including CPI (March 14), which may slip below 6% for the first time since September 2021. This may help stabilize US interest rates and expectations of the terminal Fed funds rate, which is now seen closer to 5.50% than 5.25%.
China reports trade and inflation gauges, but these reports do not often spark much movement in the closely managed exchange rate. That said, China's export growth is slowing, and economists expect this to continue. The other highlights of the week include Bank of Japan Governor Kuroda's last meeting before retiring next month. The local press has played down the likelihood of a surprise move, and Kuroda's successor, Ueda, seems to be in no hurry to alter policy. Next, the Reserve Bank of Australia meets, and the futures market favors (~80%) another 25 bp hike, bringing the target rate to 3.60%. Finally, the Bank of Canada meets, but this is a non-event since it declared a pause at the end of January. Still, another strong employment report (March 10) could support market ideas that there may still be another rate hike cycle.
United States: The February employment report is the most important high-frequency data point in the week ahead. January's 517k increase was likely a one-off statistical quirk. However, the labor market remains strong and too strong for the Federal Reserve to have confidence that inflation will fall fast enough. Still, the softer jobs report and the slower auto sales should set the broad tone for the data in the coming weeks. Fed Chair Powell appears before the Senate Banking Committee to deliver his semi-annual update on March 7. He answers questions from the House Financial Service Committee the following day. The indications suggest that the median dot later this month will likely validate market expectations of a 5.50% terminal rate, up from 5.125% in December. Separately, the US trade deficit narrowed in the second half of last year (~$69 bln average vs. almost $89 bln in H1), but the deficit will likely begin widening again as the new year gets underway. The futures market has stabilized, showing a terminal rate near 5.50%. The next big input into expectations will be the February CPI on February 14, and the pace should resume its trend slowdown. Moreover, the easing of price pressures will be even more notable with the March report. In March 2022, CPI rose 1%. This will be dropped out of the 12-month comparison. Making a conservative assumption, the year-over-year rate may slow to about 5.5% at the end of Q1. It was at 8.5% in March last year.
The Dollar Index snapped a four-week advance with a modest 0.5% pullback last week. It stalled ahead of the early January high near 105.65. The week's low (March 1) held above 104.00 and the 20-day moving average. The momentum indicators suggest it is topping, and a break of 103.80-104.00 lend credence to the view. Still, given the sensitivity to the inflation report, barring a dramatic shock on the jobs report, the 103.25 area may offer support.
Japan: Governor Kuroda's last meeting at the helm of the Bank of Japan will be a few hours before the US jobs data on March 10. Fears of a surprise have lessened, and Kuroda's successor Ueda has signaled continuity until the inflation is judged to be sustainably at the 2% target. Tokyo's February CPI fell to 3.4% from 4.4% in January, likely presaging a similar fall in the national figures (March 23). Ueda's comments in the Diet reinforce our sense that he represents a substantial degree of continuity of Japanese monetary policy. However, he is pragmatic, and policy will be adjusted when the economic assessment changes. The Bank of Japan's forecasts (to be updated at the April 27-28 meeting) has the core CPI (excludes fresh food) at 1.6% at the end of the year from 3.0% in December 2022.
As the impact of December's surprise waned, the correlation between changes in US interest rates and the exchange rate increased. However, the correlation is tighter at the shorter end of the coupon curve rather than the 10-year yield, which appears to reflect the sensitivity of the dollar to the shift in Fed expectations. As US rates peaked last week, so did the dollar a little above JPY137.00 and held below the 200-day moving average (~JPY137.30) and the high from just before the December 20 BOJ surprise (~JPY137.50). A move above this area would bring our JPY140 target into view. That said, the momentum indicators look ready to turn down, with an initial test on the JPY134-JPY135 area.
China: The February trade balance and inflation gauges will be reported in the coming days. Trade, of course, is the more politically sensitive of the high-frequency data. Exports appear set to continue the trend lower than they began last year. Judging from some figures from its regional trading partners, imports also are soft. Still, the trade balance is not a key driver of the exchange rate. Meanwhile, the re-opening of the economy, illustrated by the strong jump in the non-manufacturing PMI (56.3 vs. 54.4, the highest since April 2012), is likely to increase price pressures. That said, core inflation (excluding food and energy) rose 1% year-over-year in January. Producer prices have been falling year-over-year for four months through January. Deflation may not have ended here but should over the next few months. Chinese officials seem content on letting the exchange rate tracks the dollar against the yen (the 30-day correlation of changes is near 0.50, roughly twice the correlation at the end of last year, after peaking in late February near 0.65, the highest since mid-October 2021) and the euro (0.55 correlation for the past 60 sessions, essentially from the end of last year). The yuan rose last week for the first time in five weeks. The yen rose for the first time in seven weeks.
Eurozone: Sticky inflation and an economy that appears to have dodged the worst scenarios, coupled with the shift in Fed expectations, have encouraged speculation of higher for longer in the eurozone too. The market has begun warming up to the idea of a 4.0% terminal rate from 3.50% at the end of last year. The ECB meets on March 16, and a half-point hike (from 2.50%) is as done of a deal as these things get. The swaps market sees an 80% chance of another half-point hike (rather than a quarter-point) at the following meeting on May 4. The eurozone reports January retail sales (March 6) but may draw some market interest as only France of the large members, have reported January consumption figures. Germany and Italy report January retail sales on March 8 and Spain on March 10. Separately, the downward revision of Germany's Q4 GDP (to -0.4% from -0.2%) warns of downside risk with the revisions to the aggregate figure. Initially, Eurostat estimated growth of 0.1%.
The euro may be forging a near-term bottom, and the Slow Stochastic has turned higher, while the MACD looks poised to do the same. The euro tested the $1.0535 area to start the week, and we thought if $1.05 gave way, the next target would be near $1.0460. The initial hurdle on the upside is the 20-day moving average ($1.0665), which it has not closed above since February 2, the day before the powerful US employment figures, and the March 1 high a little shy of $1.07.
United Kingdom: Perceptions of the left-hand tail risk in the UK have also eased. The labor market remains strong, January retail sales unexpectedly rose, and the composite February PMI jumped to an eight-month high of 53.0 (from 48.5 in January). Still, we know that the economy contracted in December (-0.5% vs. median forecast in Bloomberg's survey for -0.3%) and will report January GDP on March 10. Growth in January will likely make economists pare estimates of a 0.3% contraction (in Q1 and Q2). Sterling seemed to outperform in recent days as the bulls appeared to be encouraged by the "Windsor Framework," which, if approved, would resolve the problems with the Northern Ireland protocol, would finally give some closure to Brexit, and lay the groundwork for improved relations with the EU.
Sterling bumped against its 200-day moving average (~$1.1915), but it held on a closing basis. However, the bounces off it seemed less pronounced, though it advanced last week for the first time in three weeks. Sterling is encountering resistance around the 20-day moving average (~$1.2045), which, like the euro, has not closed above it since February 2. It tested this area ahead of the weekend. From a slightly different perspective, a new trading range has emerged over the last couple of weeks, roughly $1.1915 on the downside and $1.2150 on the upside. The sideways movement has left the momentum indicators flattish.
Canada: There is little doubt that the Bank of Canada will stand pat at the March 8 meeting. The economic data have been in line with expectations, and the lack of surprises allows the Bank of Canada to make good on the pause it indicated in late January. While the strong January employment data may not have been a game-changer for the Bank of Canada, another one on March 10 would be harder to shrug off. The swaps market shows a bias toward another hike in Q3 and has completely unwound thoughts of a cut this year. Still, the "higher for longer" meme, especially in the US and eurozone, put the Canadian dollar at a disadvantage. The Canadian dollar underperformed last week, falling against the greenback as most G10 currencies rose. Also, the correlation between changes in the exchange rate and the S&P has eased, while the correlation with the 2-year rate differential between Canada and the US has increased. Still, all last week, the greenback was confined to the range set on February 24 (~CAD1.3525-CAD1.3665). The momentum indicators look toppish, but the weekly settlement near CAD1.36 looks constructive. It was the highest weekly close since mid-December.
Australia: Outside of somewhat better trade relations with China, the news stream has not been particularly favorable. The labor market was weak in January, the composite February PMI remains below 50, and the housing market is cracking under the weight of indebtedness amid rising interest rates. At the same time, Q4 22 GDP was robust, and the current account was well above expectations (A$14.1 bln vs. median forecast of A$5.5 bln in Bloomberg's survey), and the Q3 deficit (A$2.3 bln) was revised to small surplus (A$800 mln). The Reserve Bank of Australia meets on March 7, and the futures market shows about an 80% chance of a quarter-point hike has been discounted. If the RBA were to hike by 15 bp (to bring the overnight cash rate 3.50%), many would conclude that it is the last hike before a pause. The Aussie snapped a four-week decline with a gain of about 0.25% last week. The week's range was set Wednesday (~$0.6695-$0.6785). The momentum indicators look poised to turn higher but do not rule out another test probe below $.0.6700. It takes a move above $0.6800 (200-day moving average is around $0.6790) to lift the technical tone, and ahead of the weekend, the Aussie finished near session highs around $0.6770.
Mexico: The dollar broke down afresh last week and traded below our medium target of MXN18.00 and approached the 2018 low (MXN17.94). The pace of was quicker than we anticipated. Tesla's investment plans added fresh fuel to the peso's advance. A break of the MXN17.90 area could spur a move toward the MXN17.50 area, last seen in Q3 17. On the margins, the political backdrop is deteriorating. A fight with the US over Mexico's steel exports, AMLO's efforts to weaken the election watchdog, and AMLO's push to nationalize lithium mines may not set well with some groups of investors. Although Mexico has the ninth largest known lithium deposits, the only mine expected to be operational this year is operated by a Chinese company in Sonora. Still, the substantial carry, and flows into the Bolsa and direct investment (illustrated by Tesla's $5-10 bln project) continue to drive the peso. The peso's 2.5% gain last week was the largest advance in over six months. The momentum indicators are over-extended but do not appear poised to turn higher. Initial resistance may be found in the MXN18.07-MXN18.10 area.
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