by Marc Chandler
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Overview: The market's reaction to the firmer than expected January CPI seems exaggerated. We do not think it was the game-changer for the Federal Reserve that the market seemed to think. The dollar was driven higher, and it is stabilizing today, though the euro and sterling extended their losses, most of the other G10 currencies did not. After the yen's six-week slide did not elicit a response from Japanese officials, yesterday's drop did, and this may have helped steady the exchange rate today. However, the dollar's advance against the yen does not seem over. Emerging market currencies are mostly heavier. The Mexican peso, which was the worst performer yesterday is the best today with a minor gain of about 0.20%.
After the sharp US equity losses yesterday, Asia Pacific markets followed suit. However, Europe's Stoxx 600 is up almost 0.5% to recover about half of yesterday's losses, while US index futures are also firmer. Asia Pacific yields were dragged higher by the surge in US rates, but European yields are off 3-4 bp except for UK Gilts, where the softer headline inflation reading has seen the 10-year yield tumble almost 10 bp. The 10-year US Treasury yield is off around three basis points to near 4.28%. The strong dollar and higher interest rates sent gold to a new low for the year yesterday near $1990. Follow-through selling was limited to around $4 today and the yellow metal has recovered back into yesterday's range. April WTI reached about $78.10 yesterday and is consolidating with a firm bias today despite the large rise in inventories according to API.
Asia Pacific
Japan reports Q4 23 GDP first thing tomorrow. It is likely to have returned growth after contracting at an annualized rate of 2.9% in Q3. Consumption and business investment fell in Q2 and Q3 and are expected to have risen in Q4. Exports also appear to have been stronger, but they need to be put into a larger context. On Japan's GDP-chain-weighted real net exports (four-quarter moving average) was a drag in 2022 by an average of 0.1% and has been between -0.1% and 0.1% for the previous five years. For the same reason that US companies embraced a direct investment strategy to address foreign demand, namely protectionism and an over-valued currency, led Japanese companies to embark on a similar strategy. Consider the auto sector. In 2022, Japan exported about 1.3 mln vehicles to the US and built another 2.8 mln in the US. In 1984, amid "voluntary export restrictions," Japan exported almost 1.7 mln vehicles to the US and built about 2.2 mln in the US (figures from Statista).
The Reserve Bank of Australia is seen as a laggard in the monetary easing cycle within the G10 that is expected to start later this year. It did not raise rates as aggressively as most and underlying inflation has been sticky. The market does not have the first cut fully discounted until September, though there is roughly an 80% chance of a cut in August. The futures market anticipates about 45 bp in cut this year. It had reached almost 70 bp late last year. Australia reports its January employment data tomorrow. Another weak report (December saw a loss of a heady 106.6k full-time jobs with the unemployment rate holding steady at 3.9%) could see the market boost the chances of an earlier hike. Australia unemployment rate had been at 3.5 as recently as the middle of last year.
The jump in US rates lifted the greenback to nearly JPY150.90, its highest level since the middle of last November. Stop-loss and option-related buying may have been triggered on the push above JPY150. Between yesterday, today's and Friday's expirations, there were more than $5 bln of options struck there. Comments by Japanese officials may have helped deter additional dollar buying so far today. Both Finance Minister Suzuki and Vice Finance Minister Kanda cautioned the market and warned although the move is partly fundamentally based, there was an undesirable speculative element. A minor pullback saw the greenback slip to JPY150.35, just below the upper Bollinger Band (~JPY150.50). The JPY151.40 area may offer mild resistance, but the big target is last year's high near JPY152. The dollar had a six-week advance coming into this week. The Australian dollar was bowed by the greenback's surge and slipped through $0.6450 and set a new low for the year. It has stabilized today, holding above yesterday's low. It and recovered to about $0.6480 but appears to have run out of steam. The lower Bollinger Band is found near $0.6455 today. Recall that on Monday, it reached a six-day high near $0.6545. The broad strength of the dollar, especially against the Japanese yen saw it trade higher against the offshore yuan. As we have noted, the offshore market more often than not respects the onshore band. The top of that band would be about CNH7.2455. It reached roughly CNH7.2335 yesterday and slightly higher today. The low has been a little below CNH7.2260 and is near CNH7.2275 in the European morning.
Europe
The eurozone gave us another look at Q4 23 GDP today. It confirmed a stagnant quarter, leaving the economy 0.1% larger than in 2022. The odds of a March cut steadily fell in recent weeks. An April cut had been fully discount in the swaps market at the end of January but has been downgraded to about 55%.
The UK reported a 0.6% decline in headline inflation, twice the decline expected by the median forecast in Bloomberg's survey. This saw the year-over-year rate stay at 4.0% because January 2023's 0.6% decline dropped out of the 12-month comparison. Services are particularly sticky. It ticked up to 6.5% from 6.4% above year ago levels, which was less than expected. The cyclical high was set at 7.4% last May and July. It was 6% in January 2023. We anticipate a sharp drop in UK inflation in the coming months. In February 2023, headline CPI rose by 1.1%, 0.8% in March, 1.2% in April and 0.7% in May. These will be replaced by much lower numbers and will generate a sharp drop in headline CPI. With some conservative estimates (0.3% a month), UK headline CPI around 2%. Separately, producer prices showed continued deflation.
The euro has been pushed below $1.07 after it held albeit barely yesterday. There were about 1.6 bln euros in options that expired there yesterday, 1.7 bln euros expire there today, and another batch for 2.1 bln euros expires at $1.07 on Friday. The euro has been capped in the $1.0720-25 area. The break of $1.07 give the next target of $1.0650, while the measuring objective of the head and shoulders pattern projects toward $1.06. We had looked for a low near $1.0725 and thought the $1.06 was less likely, but the price action must be respected. Still, the intraday momentum indicators are stretched, and short-term operators may be reluctant to sell the euro in the hole before a bounce. Sterling had initially rallied on the resilience of the UK labor market, but the US CPI trumped UK employment and sterling reversed and settled below Monday's low (~$1.2605). It recorded a bearish outside down day, falling to about $1.2575. Follow-through selling after the UK CPI report sent sterling to around $1.2535. Some of the selling may have been spurred by the option for GBP642 mln at $1.2550 that expires today. Sterling has pierced the lower Bollinger Band (~$1.2540). Last week's low was near $1.2520. The intraday momentum indicators are stretched, suggesting limited immediate downside before a bounce.
America
The market had a dramatic reaction to news that US headline CPI slipped to 3.1% year-over-year from 3.4% in December. The core rate was steady at 3.9%. The data was slightly firmer than expected and appeared driven by shelter costs. In particular, owner-equivalent rent rose by 0.6% and lodging costs jumped 2.4%. Other services prices were also firm. Medical service prices rose by 0.7% and transportation prices rose by 1%. The US two-year yield rose by 16 bp at its most before settling up about 13 bp (4.60%). The 10-year yield rose for the fifth consecutive session and seven of the last eight. It reached its highest level in three-months a little above 4.30%. The futures market reduced the odds of a May cut to about 40% from 69% on Monday and 73% at the end of last week. It also scaled back the extent of this year's cuts to about 107 bp from 112 bp on Monday and 168 bp on January 12. Next month's FOMC meeting will update the Summary of Economic Projections. In December, the median forecast was for three cuts this year. Still, on balance, we suspect that economists forecasts are not so significant for the Federal Reserve, and that the January inflation report is consistent with the good data that Fed Chair Powell had said the central bank wanted to see. Moreover, the shelter prices have less weight in the PCE deflator, which the Fed targets. Medical services in the PCE are derived from a different time series than used for CPI calculations.
This is the lightest day of the week for US high-frequency economic reports--caught between the yesterday's CPI and tomorrow's retail sales, industrial production, Philadelphia Fed, business inventories, and jobless claims. Chicago Fed President Goolsbee (non-voter) and Fed Governor Barr speak today (first time this month), followed by Governor Waller (also first time this month) and Atlanta Fed President Bostic tomorrow. At least 13 Fed officials have spoken this month, and none seem to be flagging a March cut. Two regional Fed presidents (Richmond's Barkin, voter this year, and Boston's Collins, non-voter) said they wanted to see not only a decline in inflation, but also a broadening of disinflation forces outside of goods. However, as much as some want to see more dissent/drama, we are not convinced this is really a new benchmark. Rather, it seems to provide more detail on what it will take to keep inflation trending lower.
The US dollar pushed through the triple top against the Canadian dollar near CAD1.3540 and reached almost CAD1.3590. The Canadian economy is nearly stagnant and the divergence with the US is stark. The sharp sell-off in US equities added the weigh on the Loonie, which, after everything was said and done, fared better than the other dollar-bloc currencies and the Scandis. Still, the US dollar's nearly 1.0% gain was the most in nearly a year. It is in a narrow range today (~CAD1.3535-70) below yesterday's high. However, the greenback's drift lower is stretched the intraday momentum indicators, warning of the risk of another thrust higher. The US dollar reached a six-day high near MXN17.2285 and settled strongly. It is consolidating between about MXN17.16 and MXN17.2060. Last week's high was near MXN17.2810 and the 200-day moving average is closer to MXN17.38. The Mexican peso was the worst performer in Latam yesterday and we suspect this reflects market positioning and the use of the peso as a proxy for less accessible emerging market currencies. Given the Brazilian holiday yesterday, Brazil may have such catch-up to do today.
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