by Marc Chandler
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The US January CPI and PPI came in stronger than expected and this extended the recovery in US interest rates. In turn that helped underpin the dollar. We do not think the data itself changes the Fed’s stance. At least seven Fed officials speaking in the coming days will test this hypothesis. There are still several key reports before the data dependent FOMC meets again in about four weeks. Owing to the different weights and methodology, the PCE deflator, which the Fed targets, is likely to be better behaved. Still, the two-year Treasury yield popped above 4.70% at the end of last week, a new three-month high. The dollar has risen against most of the major currencies for six of the seven weeks to start the year. There are a couple of exceptions to note. The yen has fallen for seven consecutive weeks and the threat of intervention by MOF officials had little sustained impact. The other exception is the Australian dollar and the Scandis. They have moved higher for two weeks in a row. This may be a function of risk-appetites that have driven the S&P 500 and NASDAQ to new record highs. Europe’s Stoxx 600 and the Nikkei near record highs.
The largest publicly traded US commercial real estate company reported better than expect earnings and offered a positive outlook on the beleaguered sector. The KBW index of regional banks rose around 3.5% on the news and snapped a two-week, 8.5% drop. The Federal Reserve’s vice chair for supervision Barr confirmed that regulators are monitoring the commercial real estate loans closely and have increased the downgrades to some lenders’ supervisory ratings. In addition to these developments that need to be monitored, the data highlight in the week ahead is the preliminary February PMI. It will take a significant surprise to shake-off the sense of US-positive divergence after Japan and UK reported contractions in Q4 23. China returns from its long holiday. Estimates of strong domestic travel fanned optimism of a recovery in consumption. Chinese officials seem committed to providing more stimulus and they could begin by cutting the one-year benchmark rate early Monday. However, we note that the last cut (August 2023) has not been fully transmitted to the prime rates.
United States: The monthly cycle of important data is behind us for January. Existing home sales are due, but they tend not to be a market-mover. But for the record, existing home sales have fallen in 20 of the past 24 months through the end of 2023. They were at 2010 levels (3.8 mln SAAR) in December and are expected to have risen by almost 5% last month. The hope is that lower mortgage rates will help boost activity. Housing starts rose 7.6% last year after plummeting 24% in 2022. The preliminary February PMI will be reported. The PMI is part of the narrative about the re-acceleration of the economy. The manufacturing PMI rose to 50.7 in January. That is the highest since September 2022. The service PMI rose four consecutive months through January, and at 52.5, the highest since last June. The composite reading stood at 52.0 in January, matching the high from H2 23. It was at 50.1 in February 2023.
Lastly, on February 21, the minutes from last month’s FOMC meeting will be released. At the meeting, Fed Chair Powell pushed as explicitly as possible against market speculation of a March rate cut. Since the FOMC meeting, most Fed officials seemed to echo Powell’s sentiment that while confidence is increasing that inflation is on a sustainable path to the 2% target. Right now, it does not look like there will be dissents from a Fed decision in March to stand pat. The impact from the slightly higher than expected January CPI was not offset by the weakness in retail sales and industrial production. After the firmer PPI, the futures market downgraded the probability of a cut in May to about 37%, or half of what is was a week ago. As we saw a few times last year, the market is also converging with the Fed’s view. Recall that in December’s dot plot, the median official saw three cuts would likely be appropriate this year. As recently as a month ago, the market was pricing in six quarter-point cuts and nearly 70% chance of a seventh cut. Now, it is discounting three cuts fully and almost a 60% chance of a fourth.
The Dollar Index has rallied from almost 102.75 before the January jobs data to nearly 105.00 after the January CPI last week. It consolidated back to around 104.20 before the PPI lifted to about 104.65. The Dollar Index has advanced in six of the first seven weeks of the year, and the one down week was for a loss of 0.1%. The momentum indicators are stretched but they have been overextended for the better part of the past four weeks. We are looking for a sign that the advance, or this leg of it, is over. We do not see it on the charts yet, but the it was unable to sustain the gains scored on the back of the PPI and finished softly ahead of the weekend, setting new three-day lows. Initial support is seen in the 103.70-85 area.
China: Mainland market re-open after the long Lunar New Year celebration. We expect new measures to support the economy, which may entail more efforts to stabilize the equity market. In terms of data, the Q4 23 current account and new house prices, and the yuan’s share on SWIFT are not market movers. Chinese data has long been regarded as suspect. It has often not seemed internally consistent. Many observers attribute political motivations and selectively take some data points, disregard others, and depict on consistent narrative, though rarely generate testable hypothesis. We agree with those who suggest that a significant difficulty arises out of Beijing’s reluctance to fully jettison the old Soviet-era Material Product System and adopt the UN’s System of National Accounts.
The PBOC will return and set the benchmark one-month Medium-Term Lending Facility rate (2.50%). A cut would seem to be in order, but Chinese banks have not fully passed on the last cut (August 2023). These are the same institutions whenever they act in the foreign exchange market are suggested to always be doing the PBOC’s bidding. That said, a cut in the MLF may be done on the condition, understanding, or knowledge that the bank will pass it along this time via the loan prime rates, which are set on Tuesday.
There is some optimism that the reports of increased domestic travel during the long Chinese holiday is an indication of stronger demand. This helped fuel the 2.7% pre-weekend rally in the index of mainland shares that trade in Hong Kong. While this may be supportive of the yuan, the nearly 1% decline of the Japanese yen since the holiday began and the nearly 0.4% rise in the Dollar Index are drags on the yuan, in our understanding of what moves the exchange rate within the band the PBOC set with the daily reference rate. Also, we note that the offshore yuan was fairly stable while the mainland was closed. The dollar settled near CNH7.2150 when the holiday began and ended last week near CNH7.2200.
Japan: Japan’s trade balance always (without fail since at least the early 1970s) deteriorates in January. Japan reported a rare monthly trade surplus in December. In fact, it was the third monthly trade surplus Japan recorded since July 2021. In 1984, Japan’s exports were about 14% of GDP. Some policymakers who helped draft Trump’s tariffs, which the Biden administration has largely left in place, said it was too much and the world could not absorb it. That thinking was part of what led to the Plaza Agreement (1985) that coordinated dollar-selling intervention. In 2023, Japan’s exports were almost 22% of GDP. However, as is the case with the US, exports are not the primary way Japanese companies service foreign demand. Sales by branches and affiliates of Japanese companies outstrip exports by several magnitudes. The historically strong yen and foreign protectionism led to moving large parts of industry (think autos and auto parts) offshore. Japan will also see the preliminary February PMI. Japan’s manufacturing is still under pressure. The manufacturing PMI popped above the 50 boom/bust level last May, but that was a one-month wonder and outside of that exception, has been below 50 since November 2022. On the other hand, with one exception, the service PMI has been above 50 since the end of Q1 22. The composite PMI stood at 51.5 in January, its best reading since last September. Last February, it was at 51.1.
The dollar gained against the Japanese yen for the seventh consecutive week. MOF officials took the first step onto the intervention escalation ladder by warning against rapid moves and threatening action even outside of its time zone. The dollar slipped about half-of-a-yen. The greenback extended its decline on the disappointing US retail sales and industrial production report but closed the week on more solid note after the firm PPI. The dollar approached JPY150.90 at its best last week and the low was slightly above JPY149.55. The weekly settlement was above JPY150 for the first time since last November. Last year’s high was near JPY152, and there appears little on the charts to deter a test. We note that the 15% rally in the Nikkei so far this year is worth about 7.7% to unhedged dollar-based investors, which is better than the return in the S&P 500 or NASDAQ.
Eurozone: The eurozone continues to stagnate or worse and this is in stark contrast with the US. The preliminary February PMI, the main data point of the week is unlikely to change investors’ minds. The composite bottomed last year in October at 46.5. It has not fallen since then but stood at a still lowly 47.9 in January. In February 2023, the composite PMI was at 52. Growth impulses are weak and there is little on the horizon for optimism. The ECB’s forecasts anticipate a second year of less than 1% year-over-year growth.
The euro settled lower for the fifth consecutive week after trading on both sides of the previous week’s range. The euro traded slightly above $1.08 at the start of last week and proceeded to fall below $1.07 for the first time in three months after the US CPI. In the last three sessions, the close was at the upper end of the day’s range, and higher lows were seen on Thursday and Friday. To be anything of note, from a technical perspective, the euro needs to overcome a band of resistance between roughly $1.0810 and $1.0830. Given the extent of the euro’s sell-off this year (after rallying ~4.4% in Q423), and the extent that US rates have backed up, we are looking for some technical sign that a durable low is in place. A move above the band of resistance would qualify.
United Kingdom: The UK economy contracted in Q4 23 for the second consecutive quarter. The strong January retail sales and upcoming preliminary Feb PMI may fuel hope of a better start to 2024. The service PMI rose for the fourth consecutive month in January and at 54.3 was the highest since last May. The manufacturing sector, however, is struggling. The PMI was last above 50 in July 2022. The composite, which is a function of output in manufacturing and services rose every month in Q4 23 and in January. It stands at 52.9, its highest since last May. It was at 53.1 in February 2023.
The larger-than-expected decline in headline CPI last month saw sterling fall to about $1.2535 on February 14. That was the low for the week. The market took little notice that the Tories lost both of last week’s byelections and will likely lose the one on February 29 too. Sterling settled back in its previous range ($1.26-$1.28) ahead of the weekend. Nearby resistance is seen in the $1.2625-50 area.
Canada: Canada’s CPI fell at an annualized rate in Q4 23. The base effect warns of a significant slowing of Canada’s inflation in the coming months. Recall that in the first four months of last year, Canada’s inflation rose at an annualized rate of slightly more than 6.3%. As these drop out of the 12-month comparison, headline inflation will moderate. However, this may not have happened very much last month. On February 20, Canada reports January CPI. The median forecast in Bloomberg’s survey is for a 0.4% month-over-month increase which would allow the year-over-year rate to slip to 3.6% from 3.7%. The rub for the central bank is that the underlying core measures have stopped improving. The trimmed mean stalled in Q4 at 3.5% and finished the year at 3.7%, which is where it was in June 2023. The weighted median fell to 3.5% in October 2023 but was at 3.6% in November and December. Softer underlying rates of inflation, on the heels of the second consecutive loss of full-time jobs may see expectations for a rate cut brought forward. December retail sales will be reported on February 22. At the end of last month, StatsCan reported that receipts for retailers rose 0.8% in December, which is the largest increase since April. However, this reflects higher prices, with volumes up a more modest 0.2%.
The US dollar rallied from around CAD1.3440 to CAD1.3585, a new high for the year, in response to the US CPI. It spent following three days paring the gains. It recorded a low near CAD1.3460 ahead of the weekend. The greenback managed to eke out a small gain for the week (less than 0.2%), but it was the sixth weekly gain in the past seven. The week that it fell (week ending on February 9), it slipped by less than 0.1%. The US dollar has not taken out a significant technical level or carved out a reversal pattern. Trend line support begins the new week near CAD1.3445 and finishes the week by CAD1.3475. On the upside, the next technical objective is the CAD1.3600-25 area.
Australia: The flash PMI is the Australia’s data highlight in the coming days. It is more promising than the eurozone but not as strong as the US. After spending the preceding 10 months below 50, Australia’s manufacturing PMI popped to 50.1 in January from 47.6 in December. The 2.5-point rise is the largest since September 2021. The service PMI was below 50 in January (49.1) for the fourth consecutive month. Last February, it was at 50.7. The composite PMI finished 2023 at 49.1, a four-month high. Still, the disappointing January employment report (0.2% rise in the unemployment rate to 4.1% and creating 11k full-time jobs after losing 109k in December) may temper enthusiasm.
The Australian dollar was resilient. It dropped to around $0.6440 after the US CPI, which was a new three-month low, but recovery steadily. Ahead of the weekend, it set a marginal new two-week high near $0.6545). The 20-day moving average is near $0.6540, and the Aussie has not closed above it since January 3. The 200-day moving average is around $0.6565. The momentum indicators are encouraging.
Mexico: The second look at Mexico’s Q4 GDP and CPI for the first half of February are the main reports in the week ahead. Recall that the initial estimate was that the Mexican economy expanded by less than 0.1% in Q4 23. The median forecast in Bloomberg’s survey was for 0.3% growth. At its meeting earlier in February, the central bank shifted its forward guidance and signaled a rate cut is coming, as early as next month. The CPI for the first half of February must rise by less than 0.3% (and 0.35% for the core rate) for the year-over-year pace to slow. Even if there is some disappointment, the fact of the matter is that with headline and core inflation near 4.9% and 4.75%, respectively in January, the overnight rate of 11.25% is pinching and seems unnecessarily high.
Latam currencies were three of the top four best performing emerging market currencies last week. Peru, Colombia, and Mexico eked on minor gains against the greenback (and were joined by South Africa). The Mexican peso made a marginal new seven-day high ahead of the weekend. The greenback approached MXN17.03 and the market has shown a reluctance to push it below MXN17.00. It has not traded below there in two months. Three-month implied volatility has slipped to nearly 9.5% at the of last week, a two-and-a-half year low. The low-vol environment is conducive for carry-trade strategies. Trendline resistance is seen a little below MXN17.21 at the start of the new week.
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