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Dollar Rally Pauses, but Fuel from Interest Rate Adjustment may not be Complete

Dollar Rally Pauses, but Fuel from Interest Rate Adjustment may not be Complete

Overview: This week's dollar surge is consolidating today. Interest rates have steadied, but the adjustment, which involves pushing the first rate from March toward June does not appear complete. This suggests the dollar's recovery from last November-December's sell-off may not be complete either. Today, though, it is a little firmer against all the G10 currencies but the Swiss franc. Most emerging market currencies are also trading with a slightly higher bias, led by the South African rand, South Korean won, and the Mexican peso. Gold has steadied too after approaching $2000 yesterday, a one-month low. It is hovering around $2010 in Europe.

Chinese and Hong Kong stocks traded higher, apparently helping to lift South Korea and Taiwan shares, but most of the other large markets in the region traded heavily. However, Europe's Stoxx 600 is snapping a three-day, 2% drop, but is hardly more than steadying so far today. US index futures are also slightly firmer, seemingly without much conviction. Benchmark 10-year yields are mostly 1-3 bp lower in Europe and the 10-year US Treasury yield is off a couple basis points to around 4.08%. February WTI is recovering from the push to $70.50 yesterday and is trading above $73 today. Iran's proxies are keeping tensions high in the Red Sea, while tensions with Pakistan have increased. 

Asia Pacific

The Australian labor market is slowing, but the December figures were simply awful. It lost 65.1k jobs last month, defying expectations for an increase of 15k. Full-time positions plunged by 106.6k, the most since May 2020 and sufficient to wipe out gains in H2 23 completed. The unemployment rate was steady at 3.9% as the participation rate fell to 66.8% from 67.3%. The market's reaction, however, seems dismissive. The odds of a rate cut in August fell for the third consecutive session to about 73% from nearly 90% yesterday. It was fully discounted plus some as of Monday. And the Australian dollar is snapping a six-day decline. Next week's highlight is the flash January PMI. The composite spent Q4 23 below the 50 boom/bust level.

Japan confirmed that industrial output fell by 0.9% in November, leaving it down 1.4% year-over-year. Ironically, in November 2022, it has also fallen by 1.4% year-over-year. The Japanese economy continues to struggle, despite a negative interest rate target and a currency that is more than 50% undervalued according to the OECD model of purchasing power parity. Tomorrow, Japan reports December CPI, but the Tokyo figures released a couple of weeks ago contained the new information. The headline and core rates are expected to slip to 2.5% and 2.3% from 2.8% and 2.5%, respectively. The measure that excludes fresh food and energy has proven stickier. It is seen easing to 3.7%, a 10-month low, from 3.8%. 

The dollar reached JPY148.50 yesterday, its best level since late November, bolstered by rising US rates and the paring of Fed rate cuts this year. It settled above the Bollinger Band for the second consecutive session for the first time since last September. The greenback is trading quietly today inside yesterday's range and is consolidating between JPY147.65 and JPY148.25. Initial support in North America may be around JPY147.50. The pace of the yen's descent may soon begin to draw official Japanese attention, but one-month implied volatility is still relatively subdued near 9.4%, which is a little below the 200-day moving average (~9.5%) and well off the highs seen last month (~12%). The Australian dollar's sell-off extended to $0.6525 in early North American dealings yesterday. It barely got above $0.6540 afterwards. Like the yen, the Aussie settled outside of its Bollinger Band for the second consecutive session, which it has not done since September 2022. It retested the $0.6525 low today and recording new session highs in the European morning near $0.6570. The $0.6580-$0.6600 area offers nearby resistance. The greenback's consolidative tone helped steady the Chinese yuan today, where yesterday's range has largely confined the price action. The PBOC set the dollar's reference rate at CNY7.1174 (CNY7.1168 yesterday). It has been set higher every day this week. The average in Bloomberg's survey was CNY7.1961 (CNY7.1953 yesterday). 


The markets paid little mind to the eurozone's November current account, which at 24.6 bln euros is above the November 2021 surplus (before Russia invaded Ukraine) and November 2019 (before Covid). Nor did the November construction figures impress. The 1.0% decline follows a revised 0.6% decline in October (initially -1.0%). Despite ECB President Lagarde's push against speculation for an early rate cut, the swaps market has about an 80% chance of a cut in April. Still, this is the least since late November. The market has about 138 bp of easing this year discounted. That is five cuts fully priced in and about a 50% chance of a sixth cut. 

The UK reported slower wage growth amid a softening of the labor market on Tuesday, but higher than expected CPI on Wednesday. The net effect has been to see the odds of a May cut, which was fully discounted at the end of last week, pared to about 60%. The swaps market anticipates about 110 bp of rate cuts this year (four fully discounted and about 40% chance of a fifth quarter-point cut), down from 170 bp at the end of last year. 

According to Bloomberg, the euro slipped 3/100 of a cent below the 200-day moving average to $1.0845 before recovering back to session highs in late North American dealings. It may be a bullish hammer candlestick formation. Still, with the US rate adjustment maybe not complete, the euro may find sellers into the first bounce. The euro poked slightly above $1.0905 in the Asia Pacific session and looks poised to extend its gains in North America. but look for the $1.0920 area to cap the upside on this first bounce. Sterling recovered smartly from the brief shallow penetration of the lower end of its $1.26-$1.28 trading range. It nearly reached the range's midpoint and edged slightly above $1.27 today before backing off to about $1.2675 in Europe. It may extend its gains in North America with initial resistance likely in the $1.2715-35 area. Recall that end of last week, sterling was rebuffed from the upper end of the range (~$1.2785-$1.2800). 


The US economy finished last year with somewhat more momentum than expected. December retail sales rose by 0.6%, the most in Q4 23. The measure that feeds into some GDP models, which excludes autos, gasoline, building materials, and food services, rose by an impressive 0.8%, the most since last July, and well above the 0.2% gain the median forecast in Bloomberg's survey. Moreover, the November series was revised to 0.5% from 0.4%. To be sure, the US consumer is pulling back but is not going into hibernation. Retail sales in Q4 23 were the slowest since Q4 22 when they declined. A back-of-the-envelope calculation suggests December personal consumption expenditures may have increased around 0.4%. If true, that would be a 2.8% annualized increase in Q4 23 after a 6.4% pace in Q3. Separately, December industrial production eked out a 0.1% gain, while economists were looking for a contraction of that same magnitude. Still, November's gain of 0.2% was revised away. The Atlanta Fed GDP tracker ticked up to 2.4% from 2.2% a week ago. The initial estimate of Q4 23 GDP is due next week. The odds of a March cut were shaved to about 55% from a bit more than 80% at the end of last week and 100% at the end of last year. 

After surging 14.8% in November, housing starts likely weakened in December. The median in Bloomberg's survey calls for an 8.7% drop. It would be the first decline in four months and would bring the housing starts back to the average of the Jan-Nov period of 1.41 mln. The lower mortgage rates may help the existing home sales (December figures due tomorrow) and help the activity in the housing market more generally. However, the Philadelphia Fed survey may be the highlight today. The collapse of the Empire State manufacturing survey earlier this week (-43.7 from -14.5) draw much attention and would seem to suggest a horrible start of the New Year. However, we suggest it is exaggerated and will look for support in the Philly Fed survey. The median forecast in Bloomberg's survey projects an improvement to -6.5 from -12.8. That would be the best reading in five months. 

The greenback closed above CAD1.35 for the first time since mid-December. It was the fifth consecutive advance, and with yesterday's gains to around CAD1.3540, it retraced half of the losses from the year's high set early last November near CAD1.39. The next retracement (61.8%) is around CAD1.3625. Although the momentum indicators are getting stretched, the price action itself gives no sign a top. The US dollar tested support around the 200-day moving average near CAD1.3480 today and it held. A break of that area or some kind of reversal pattern would be more suggestive that that top may be in place. That is what the Mexican peso did. The US dollar initially extended its gains a MXN17.3860, a little through the 200-day moving average, and then reversed lower. A bearish shooting star candlestick may have been formed. If that signals the end of the dollar's surge, it could see a pullback toward MXN17.00. The greenback has slipped back to MXN7.16 today so far. Initial support may be near MXN17.10. 

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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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