by Marc Chandler
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Given the world's turmoil, including the escalation, and broadening of the conflict in the Middle East and China's continued aerial harassment of Taiwan ahead of the election, the capital and commodity markets have remained firm. February WTI fell about 1.7% last week and March Brent slipped around 0.65%. Shipping costs are rising as the Rea Sea is avoided and supply chain disruptions are threatened. Still the MSCI index of developed equity market rose by nearly 1.8% last week after posting snapping a nine-week advance the previous week. The MSCI emerging market equity index is off about 3% to start the year. China alone accounts for about half of the losses.
Neither the slightly firmer than expected US December CPI, that included a 0.4% rise in the core measure excluding housing, which some Fed officials include Chair Powell cite (3.9% year-over-year), or the push back against early rate cut expectations had much impact. On the contrary, the futures market is discounted a greater chance of March cut (~85%) than it did after the jobs report on January 5 (~75%). The market now has about 6 1/2 rate cuts priced into the futures strip and swap market for this year. This continues to strike us as unreasonably aggressive, especially as the real sector data may show the US economy continued to grow above the 1.8% pace in Q4 23, which the Fed estimates is the non-inflationary speed limit. China will be the first large economy to report Q4 GDP in the days ahead and it too is not collapsing. It is growing faster than Japan, eurozone, and the UK combined. Not too bad for a country whose model is claimed to failing according to many western takes. After falling sharply in the last two months of 2023, the greenback has steadied and moved mostly in narrow ranges last week, finishing the week mostly +/- 0.25% against the G10 currencies. We are not convinced that the dollar's upside correction is over.
United States: The first week of the year was about the labor market. Job growth is slowing gradually, and the initial estimates have consistently been revised lower. Still, average hourly pay rose by 4.0%-4.1% in Q4 23, down from 4.2%-4.3% in Q3. It continues to run ahead of inflation, which was the focus last week, the second week of the year. This week the focus shifts to the real economy with retail sales and industrial production featured. Retail sales account for a bit more than a third of consumer spending and auto sales account for roughly a fifth of retail sales. We know that vehicle sales rose more than expected in December to a 15.83 mln unit seasonally adjusted annual pace. It the second-best monthly figure last year, after April's 15.91 mln pace, which itself was the most since May 2021. That should help lift December retail sales. The median in Bloomberg's survey looks for a 0.4% increase after a 0.3% rise in November. Consumption in GDP calculations rose by 3.1% in Q3 and appear to be slowing here in Q4. Industrial output is struggling. The end to the auto strike saw a rebound in November (0.2%) after sliding by 0.9% in October. The manufacturing PMI and ISM point to continued weakness in the sector. Industrial production and manufacturing output are expected to have slipped by 0.1% last month. If true, Q4 would be the first quarterly contraction in manufacturing output since Q4 22. Softer interest rates and mortgage rates are unlikely to have helped the housing market much last month. Instead, after a heady 14.8% jump in November housing starts, a pullback in December is likely. The median forecast in Bloomberg's survey is for a 9.2% decline. On the other hand, existing home sales are seen flat after the 0.8% gain in November. Lastly, recall that on January 19, the first set of bills that temporarily extended the federal government's spending authority will expire unless than is congressional action. This will lead to a partial government shutdown. The remaining spending authorization expires on February 2.
The Dollar Index confined to around 35-40 pips around 102.40 settlement after the employment data on January 5. The sideways movement has begun stalling some momentum measures. We think the market is still too confident of a rate cut as soon as March. The real sector data in the coming days may encourage some paring back of the aggressive wagers. Overcoming the 103 area could spur a test on the 200-day moving average near 103.40, and maybe 103.80-104.00.
China: There are three highlights from China in the coming days. First, at the start of the week, the PBOC will likely cut rate of the one-year Medium-Term Lending Facility from 2.5%. It ostensibly is the benchmark, but the government made loans at the end of last year below that at 2.4%. The MLF was cut by 25 bp in two steps in 2023, with the last move (15 bp) delivered in August. Yet the volume is likely to be slashed from CNY1.45 trillion in November and December to a still strong CNY900 bln. Second, China will be the first large country to report Q4 23 GDP. Growth may have slowed to slightly below 1% quarter-over-quarter from 1.3% in Q3. It would mean that the world's second-largest economy grew by about 5.2% in 2023. Given the ongoing drag from the property sector, 5% growth seems impressive, if true. Admittedly China has some serious economic challenges, but despite the warts, China is growing faster than most of the G10 and many emerging market economies. Third, China reports economic details from last month. Of particular note among calls for China to boost consumption, retail sales are rising double the pace of fixed asset investment (capex). The latter is running at a pace a little below 3%, while the former rose by 7.2% in the first 11 months of last year compared with the same period in 2022.
The broad dollar stability last week helped the PBOC keep the steady. The daily dollar fix was little changed (~CNY7.1005-CNY7.1085) over the week. Leaving aside the issue of the mechanisms, besides the fix, by which the PBOC manages the exchange rate, officials seem largely reactionary, tracking the dollar's broad movements. The rolling 60-day correlation of changes in the exchange rate and Dollar Index is near 0.63. Last year's high was near 0.67. The low in 2023 was set in October near 0.25. Given the prospects for a rate cut in China and that the odds of a Fed cut in March may slip, the greenback may edge higher. The CNY7.1880-CNY7.1930 area offers the next upside target.
Japan: Last week's release of Tokyo's December CPI steals the thunder from the national figure due January 19. The year-over-year headline and core rates will likely tick down by 0.1%-0.2%, while the measure that excludes fresh food and energy may be flat. The Bank of Japan meets on January 23, and some speculation of a policy adjustment appears to have been pushed out (until April) after the recent earthquake. Japan also will provide the final estimate for November's industrial production. The preliminary figure showed a 0.9% decline, which unwound the lion's share of the 1.3% gain reported in October. In the first 11 months of last year, Japan's industrial output fell by an average of 0.1% a month. The average in the Jan-Nov 2022 period was flat. More broadly, Japan's economy contracted in Q3 23 but looks to have stabilized in Q4.
The yen is the weakest G10 currency in the first two weeks of the new year, falling about 2.6% against the US dollar. The greenback peaked on Thursday after the US CPI figures near JPY146.40, its best level in a month. It reversed lower and fell to about JPY144.35 ahead the weekend before recovering back to JPY145 Without more support from US yields, the dollar could slip further. The next target may be the JPY143.35-65 area. Yet, we are not convinced that the greenback's upside correction is over. A move above the JPY146.50 area could bring our JPY147.50 target into view.
Eurozone: The aggregate November industrial production and trade figures are due. They are unlikely to impact expectations very much. Investors (and policymakers) already recognize that the regional economy continues to stagnate or contract slightly. Small gains in German and French industrial production likely offset the declines reported by Spain and Italy. The ZEW survey may show that while the worst may be past for Germany, the largest economy in Europe continues to struggle to gain any meaningful traction. On the other hand, shocks from response to Russia's invasion of Ukraine and the de-risking to China appear are being absorbed. The EMU's trade surplus has returned, though it is considerably smaller than pre-Covid. In the first ten months of last year, the eurozone reported a trade surplus of 28.75 bln euros. In the same period in 2022, a 31 bln euro trade deficit was recorded. In the Jan-Oct 2019 period, the eurozone reported at 169.2 bln euro surplus. The ECB publishes the November survey results of one- and three-year inflation expectations. They stood at 4.0% and 2.5%, respectively in October 2023, unchanged from September.
The euro spent last week within the range seen after the US jobs report on January 5 of roughly $1.0875-$1.1000. It has been alternating between advancing and declining sessions for the past eight sessions. The euro is off about 0.5% so far this year. The economic news stream from the eurozone remains poor. Yet, over the past two weeks, the US two-year premium over Germany has narrowed by about 25 bp to about 161 bp, a six-month low. The US two-year yield tumbled from near 4.50% before the CPI to about 4.12% before the weekend. This may have been supportive of the euro, and the sideways movement has broken the downside momentum. A push above $1.10 could see another half-cent move. That said, the approaching ECB meeting (January 25) may limit the upside, though the market is pricing in about a 45% chance of a cut in March. On balance, we think the risk is still for another leg lower that would be signaled by a break of the three-month trendline that is around $1.0915 at the start of the new week and finished closer to $1.0945. The 200-day moving average is around $1.0850, and below there, support may be near $1.08.
United Kingdom: The swaps market does not have the first BOE rate cut fully discounted until June though there is around an 80% chance of a cut in May. With the Fed and ECB seen cutting rates earlier, it may help explain sterling's recent relative resilience. The data in the next several days has the heft to shift expectations and we suspect the risk is for an earlier cut. The UK's labor market is slowing, but and wage pressures are gradually easing. This is still a cause of concern for some BOE officials, even though CPI itself has turned the corner and is poised to fall sharply in the coming months. The December CPI figures are due on January 17. The headline rate may ease slightly from November's 3.9% pace and January's reading could tick up, but recall that in the Feb-May 2023, UK's CPI soared at an annualized pace of almost 11.5%. In the three-month period through November, the annualized rate was about 1.2% and in the previous three months, it was flat. This means, moderating UK inflation will be front-loaded this year after January and improvement may slow, if not stall altogether in the second half. The UK will report December retail sales at the end of the week. UK retail sales, reported on a volume rather than a price basis, averaged a 0.1% gain in the three- and 12-months through November. In 2022, retail sales fell by an average of 0.6% a month.
Sterling is the only G10 currency that has risen against the dollar in the first two weeks of 2024 with about a minor 0.15% gain. It remains mired in a two-cent range: $1.26-$1.28. For the first time since mid-September, the UK two-year yield is at a small premium to the US. Sterling approached the upper end of its range against the dollar ahead of the weekend, when it set a new two week high near $1.2785. Since the upper end was last tested and it held, the rule of alternation warns of possible test on the lower end of the range. A near-term shelf has been forged in the $1.2675-80 area.
Canada: Job growth in Canada slowed to less than 45k in Q4 23, the least since Q3 22. Yet, the stronger wage growth (rightly or wrongly) will likely deter from the central bank from being among the first G7 countries to cut interest rates. The focus in the coming week, ahead of the Bank of Canada meeting on January 24, is on the December CPI print and November retail sales. The base effect warns that the year-over-year rate will likely increase (from 3.1% in October and November) for the first time in four months. In December 2022, Canada's CPI fell by 0.6% (the largest monthly drop since April 2020) and it will likely be replaced with by a 0.2%-0.3% decline last month. That would lift the year-over-year rate toward 3.4%-3.5%. This is only a temporary acceleration, and the base effect suggests a further moderation through the first part of this year. In the first four months of last year, Canada's CPI rose at an annualized rate of around 6.3%. In the three-months through November, Canada's CPI rose at an annualized rate of about 0.3%. The underlying core measures were unchanged in November, 3.4%-3.5%, but may have slipped slightly. Canadian shoppers delivered the best two months of retail sales in September and October (1.2%) last year. They appear to have taken a break in December.
The greenback reached almost CAD1.3465, its highest level since December 14 after the US CPI report. Still, the US dollar was unable to close above CAD1.34 but it did so the following day, ahead of the weekend. The price action lends credence to our suspicion that the US dollar's upside correction is not complete. The risk may extend toward CAD1.3480-CAD1.3500.
Australia: The futures market has the first RBA cut fully discounted in August and has not quite priced in two cuts by the end of the year. The main economic report in the week ahead December employment. The labor market is slowing gradually. In 2022, Australia created an average of 44k jobs a month, of which 46k were full-time posts (lost or turned part-time jobs into full-time). In the first 11 months of 2023, Australia created an average of almost 40k jobs a month and about half were full-time. The unemployment rate bottomed at historic lows of 3.4% in late 2022. It was at 3.5% in mid-2023 and rose to 3.9% in November. The participation rate has risen from 66.7% at the end of 2022 to 67.2% in November, suggesting the workforce (spurred in part by immigration) is increasing faster than jobs.
The Australian dollar spent last week chopping within the range set on January 5, approximately $0.6640 to $0.6750. The low was successfully test, while last week's gains stalled near $0.6735. Recall that the Aussie rose in nine of the last 11 weeks of 2023, appreciating about six cents. It has fallen by about 2.3 cents from the late December high. It settled softly ahead of the weekend, below $0.6700. Our bias is for another leg lower, perhaps toward $0.6575-85. That said, if we are wrong and the Australian dollar pushes higher, there may be scope toward $0.6780 to $0.6820.
Mexico: The economy is slowing, and price pressures are moderating, setting the stage for a rate cut later in the first quarter. The slowing in the economy is evident in consumer demand and factory output. On January 19, Mexico reports November retail sales. Retail sales increased by an average of 0.6% a month in 2022. They have been flat in the three-months through October. The peso's resilience has been impressive. It is the second strongest currency in the world in the first two weeks of the year, rising by about 0.7%. Only the Russian ruble has performed better (1.25%). News that November industrial output fell by a sharp 1% (a 0.2% gain was the median forecast in Bloomberg's survey) was reported the same day as the US CPI.
The greenback posted an outside down day and follow-through selling took it to about MXN16.8330 ahead of the weekend. A four-month low was recorded at the start of last week near MXN16.7850. Last year's low was set in late July near MXN16.62. The market is pricing in the first Banxico rate cut later this quarter, but US rates have fallen faster, leading to a greater Mexican premium, key support for the peso. On the other hand, Chile reported a sharper than expected decline in CPI at the start of last week (-0.5% vs. expectations for a 0.1% decline), which brought the year-over-year rate below 4% for the first time since June 2021. The market now expects for aggressive easing by the central bank. The next meeting is January 31. Chile cut rates by 300 bp in H2 23 to 8.25%. Another 75-100 bp could be delivered this month. The swaps market is discounting 300 bp of cuts here in H1 24. The Chilean peso was the weakest currency in the world here at the start of 2024, off nearly 3.2%.
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