by Marc Chandler
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The US dollar and interest rates appear to be at an inflection point. Much of the past several weeks have been about correcting the overshoot that took place in Q4 23, when the derivatives markets were pricing in nearly seven quarter-point rate cuts by the Federal Reserve this year. US two- and 10-year interest rates set new three-month highs last week. With the help of economic data and comments by Fed officials, the market, as it did a few times last year, has converged to the Federal Reserve. That adjustment seems to have run its course. We look for softer US economic data in the coming weeks, which may help cap US rates. At the same time, the technical condition of many of the G10 currencies has improved and momentum indicators are turning higher. Growth impulses from are still faint in most other high-income countries, but the key, as seen in Q4 23, are the developments in the US.
Another developing story is in China. Beijing has taken formal and informal steps to support equities. The CSI 300 rose every day last week, as the mainland markets re-opened from the extended holiday. The last time it did that in five-day week was November 2020. In fairness, the CSI 300 rose in the four sessions before the holiday commenced. During the Great Financial Crisis and again during Covid, many high-income countries moved to support their stock markets and limited short sales. Many see the threat to financial stability posed by dramatic losses in the equity market to be part of the so-called “Fed put.” It may be even more significant in China where the property market has shuttered a key savings vehicle and central government bond yields are too low. Weak stocks encouraged Chinese investors to export savings to the extent possible and purchase gold. Foreign investors, using the Hong Kong Connect were also active buyers in recent days, perhaps as the “fear of missing out” kicks-in.
Another theme that we think has already emerged with Canada’s January CPI last week and will be extended to the preliminary estimate of the eurozone’s February CPI this week, is a sharp deceleration of inflation. The eurozone, UK, and Canada saw dramatic jumps in consumer prices in the Feb-May 2023 period. As these drop out of the year-over-year measure, headline rates will fall more than many may appreciate. Eurozone and UK inflation likely to slow below 2%, assuming a conservative average monthly gain of 0.3%. With the same assumption, Canada’s headline CPI may hold slightly above 2%.
United States: The January CPI and PPI reports saw market expectations again move closer to the Fed’s December dot plot, which anticipated that three rate cuts this year would be appropriate. Fed Chair Powell has warned that as the quarter progresses, the snapshot of views offered by the Summary of Economic Projections (dot plot) may become dated, but thus far, most of the Fed officials who have spoken do not appear to have changed their minds. At the end of last week, the Fed funds futures show three rates’ cuts are now discounted and less than a 30% chance of a fourth cut. This is about half of the easing that was discounted late last year.
Among market participants, there seems to be two key issues. The first is about the strength of the economy here at the start of Q1 24. January jobs growth appeared solid, but retail sales and industrial output were weaker than expected. While all business cycles are unique, during this one, many standard metrics do not seem to be working, including yield-curve inversion, the contraction in M2, and the collapse of leading economic indicators, to name a few. On balance, with the data in hand, we suspect the economy is growing faster than the Fed’s long-term non-inflationary pace of 1.8%. But is slowing and we expect this to be more evident with this month’s data. Weak Boeing orders will weigh on durable goods orders and the early call for nonfarm payrolls is less than half of January’s 353k increase (March 8). The second issue is inflation. The personal consumption deflator, which the Fed targets, has a different methodology and assigns different weights than the CPI. The PCE deflator rose at an annualized rate of 2% in H2 23, while the core measure rose by 1.8%. A 0.3% increase in January would allow the year-over-year rate to ease to 2.3% from 2.6%, given the 0.6% rise in January 2023. The core rate may rise by 0.4%, which would see the year-over-year rate slip to 2.8% from 2.9%.
The Dollar Index peaked with the release of the January CPI on February 13 near 105.00, overshooting the (61.8%) retracement of the losses from Q4 23 decline. It has fallen in seven of the eight sessions since peak. A break now of the 103.30 area could signal a test on 102.80 initially and then 102.30. The five-day moving average crossed below the 20-day moving average at the end of last week for the first time since early January. The momentum indicators have turned lower.
China: China reports February PMI and the Caixin manufacturing PMI in the coming days. Many western economists argue that the China’s developmental model has failed. As we have noted before, Nobel prize-winning economy Paul Krugman argued before Xi’s claim to life-time rule, Beijing’s “wolf diplomacy, and harassment of its neighbors, and the unwinding of economic and political reforms since the death of Mao, that Chinese model hit a “great wall.” Many of the architects of Trump’s tariffs, which have been continued and extended by the Biden administration, cut their teeth on confronting Japan in the 1980s. We have suggested China was on a path set into place by Deng Xiaoping and Xi has taken China off that path. The idea of “peaceful rise” or “peaceful development,” which minimized the friction with the US has been replaced by that notion that “you can’t hide an elephant behind a tree.” What makes the current situation exceptionally fraught with risk is that Beijing seems to think that US is in some inexorable decline. In this sense both sides conclude the other is in decline and that would seem to boost the risk of underestimating one’s adversary. Beijing is not content with the current pace and composition of growth and regardless of the latest PMI print, we expect additional stimulus. Last week, it moved to deter institutional investors from selling at the open or close and put a stigma on selling short. In the Great Financial Crisis and during Covid, some market economies banned short selling in some sectors. That ought not be the issue. However, China’s approach seems clumsier and less transparent.
Through formal and informal mechanisms, Beijing appears to have put a floor under Chinese stocks. The CSI 300 has strung together back-to-back weekly gains for the first time in three months. It rose 3.7% last week after rallying 5.8% in the week before the Lunar New Year holiday. It is now higher on the year. This may take some pressure off the yuan. However, the continued weakness of the Japanese yen warns that the CNY7.20 area that has capped the dollar last month and this month could come under further pressure. Assuming the fix continues to be steady, the dollar could rise toward CNY7.24, though we suspect it won’t.
Eurozone: Starting with the preliminary CPI on March 1, headline inflation is set to fall sharply in the EMU. This will likely encourage speculation that the ECB can cut rates sooner, especially in the context of the recent cuts in the growth outlook. In February-April 2023, eurozone CPI rose at an annualized rate of 9.2%. With a conservative assumption of an average monthly increase of 0.3% in the February-April period this year, the headline rate will fall below 2%. It will likely be near 2% by the time the ECB meets on April 11. The core rate is firmer at 3.3% year-over-year in January. It was at 5.5% as recently at the middle of last year. The swaps market has about a 33% chance of a cut in April discounted. It had been fully discounted as recently as the end of January. For the first two weeks of the year, the US two-year rate rose less than Germany’s and the US premium over Germany narrowed to about 155 bp from about 190 bp at the end of 2023. It has since recovered fully and approached 190 bp in mid-February. Eurostat will also report the region’s January unemployment rate. It seems like an underappreciated story. The eurozone has withstood not only the ECB’s tightening but also a stagnant or worse economy without a pick-up in the unemployment rate, which finished last year at 6.4%. Before the pandemic struck, the unemployment rate was at 7.5%, which was lowest since 2008. It reached the EMU-area low of 7.4% in late 2007. It has not been above there since July 2021.
The euro spiked to three-week high in Asia on February 22 near $1.0890 but European and North American participants sold it back to almost $1.08. Still, the technical tone is solidifying with the momentum indicators turning up and the five-day moving average crossing above the 20-day moving average for the first time since early January. The euro recorded its first weekly advance in six weeks. We suspect the $1.0900-20 area needs to be surpassed to signify something more than broad consolidation after falling by about 4.5-cents since late last year. A close below the $1.0790-$1.0800 suggests that forging the low will take more time.
Japan: The signal from the January CPI has already been given by the Tokyo estimate several weeks ago. That signal is of disinflationary forces. Due primarily to different weights, the Tokyo CPI is running a couple of tenths of a percent below the national figures. The January Tokyo headline and core CPI tumbled to 1.6% from 2.4% and 2.1%, respectively. In December, the national CPI was 2.6% and the core was 2.3%. Both may have slipped below 2% last month. This, like recent news that showed the Japanese economy unexpectedly contracted in Q4 23, could be seen as hampering what had been expected to be the BOJ’s exit from the negative policy rate. We have argued that rather than an economic issue, the BOJ appears to be approaching it as a technocratic issue. Negative interest rates making it more difficult to conduct monetary policy. While the knee-jerk market reaction may disagree, we do not think the sharp drop in January industrial production will change the BOJ’s drive either. The earthquake in early January was a significant disruption.
Japan also reports retail sales. Japanese consumption on a GDP basis contracted for three consecutive quarters through the end of last year. Consumer spending fell by 0.9% at an annualized rate it Q4 23, which was the least of the three quarters, even though retails fell by an average of 1.1% a month, the most in the early days of Covid. Still, a poor retail sales report could contribute to the negative sentiment after having been surprised by the Q4 23 economic contraction. While consumption in Q4 23 was weak, production was strong. Industrial output rose by an average of 0.6% in Q4 23, the strongest quarterly performance in two years. The January report estimate is due on February 29. At the same time, Japan will report January employment figures. The unemployment rate finished last year at three-year low of 2.4%, despite the back-to-back quarterly contractions. Before the pandemic, at the end of 2019, it was 2.2%.
US yields rose to new highs for the year last week and the dollar closed higher last week, as it has done every week so far this year. As we have noted, implied three-month vol is near a two-year low (~8%). Still, the market looks orderly, and with negative policy rate, Japan probably does not get a sympathetic hearing from its counterparts for material intervention. Nevertheless, the market may turn cautious as the JPY152 area is approached. That capped the greenback in 2022 and 2023. Not to lean too far ahead of our skis, but we look for softer data, including US February jobs data that will help cap US rates and take some pressure off the yen.
United Kingdom: February Nationwide house price index and January consumer credit and mortgage lending is the not the stuff that typically moves sterling. The UK holds its third by-election of the month in Rochdale. The Labour MP passed and hence the byelection. However, what makes it interesting is that both Labour and the Greens have distanced themselves from their respective candidates for comments about the Middle East. Meanwhile a former Labour MP (2010) who was suspended from the party in 2017 (explicit emails to a 17-year-old girl) is running as the Reform Party candidate (led by Nigel Farage). The UK holds local elections in May and a national election is expected to be call later this year.
Sterling rose last week for the first time since mid-January and its nearly 0.55% gain was the most since mid-December. The weekly settlement was the highest since January 26. The momentum indicators have turned up and the five-day moving average pushed above the 20-day moving average for the first time since early January. Sterling has recovered from the breakdown to around $1.2520 earlier this month and it has returned to the middle of the $1.26-$1.28 trading range that dominated from mid-December through early February. The $1.2750-$1.2800 area offers what appears to be formidable resistance.
Australia: The Antipodeans are seen as among the laggards in upcoming easing cycle, ex-Japan. Indeed, the swaps market continues to price odds of another rate hike by the Reserve Bank of New Zealand with around a 60% chance by the end of May, the last meeting of H1 24. That said, the swap market has a cut fully discounted (-90%) by the end of November. The futures market shows a clear easing bias for the Reserve Bank of Australia but does not have the first cut fully discounted until September (though there is around an 85% chance of a cut in August). Australia’s month’s CPI measure (as opposed to the traditional quarterly report) has fallen from 8.4% at the end of 2022 to 3.4% at the end of last year. The Q4 23 CPI fell to 4.1% from 5.4% in Q3 23. The RBA forecast CPI to fall to 3.2% this year. A faster than expected decline in inflation could spur speculation of an earlier rate cut, but the market, like policymakers, seem to put more stock on the quarterly measures. Australia will also report January retail sales. They were dreadful in January, falling 2.7% month-over-month. This overstates the weakness of the Aussie consumer after the recent rate hikes (last one was in November 2023).
The Australian dollar has strung together three consecutive weekly gains after falling for first five weeks of the year. It posted its highest settlement since February 1 ahead of the weekend. It will begin the week with an eight-day rally in tow. The five-day moving average crossed above the 20-day moving average for the first time since early January and the momentum indicators are trending higher. The $0.6600-$0.6625 area posted the next technical hurdle. On the downside, a break of the $6520 area would be disappointing.
Canada: Canada is among the last of the G10 countries to estimate Q4 23 GDP. The December monthly and fourth-quarter GDP will be reported on February 29. The economy contracted by 1.1% in Q3 23 but likely returned to growth in Q4. The economy may have grown by around 0.2% in December after expanding by 0.2% in November, which ended a three-month stagnation. The median forecast in Blomberg’s month survey is for 0.3% in each of the first two quarters this year. The swaps market has about a 75% chance of a June cut. It was completely discounted at the start of the month.
The US dollar traced a range on February 13, the day the January CPI was reported, against the Canadian dollar that has remained intact since then: roughly CAD1.3440-CAD1.3585. Another way to think of the range is that it is between the 50- and 100-day moving averages (~CAD1.3410-CAD1.3540).The 200-day moving is in the middle of the range The Canadian dollar continues to be sensitive to the general risk environment. The rolling 30-day correlation of changes in the exchange rate and the S&P 500 is around 0.56, the upper end of where is has been over the past year.
Mexico: The economic diary is jammed in the coming days: January trade figures, the central bank’s new inflation report, unemployment, and worker remittances. Also manufacturing PMI and IMEF February surveys are due. However, the data are unlikely to change the impression that the Mexican economy is slowing down. The central bank has already signaled that it is preparing the first rate cut. Even with a quarter-point cut that may be delivered as soon as next month, Mexico’s rates are attractive. Its external account is solid. Last year, for example, Mexico recorded an average monthly trade deficit of $455 mln (vs. an average monthly deficit of $2.2 bln in 2022). Worker remittances averaged nearly $5.3 bln in 2023 (~$4.9 bln average in 2022).
Since mid-January, the US dollar has recorded lower highs and found support near MXN17.00. We continue to detect a change in sentiment toward the peso. A down trendline off the late January high and early February high comes in near MXN17.1170 at the start of the new week and falls to about MXN17.07 by the end of the week. This month, the greenback has not closed outside of the MXN17.03-MXN17.20 range. Our bias is toward an upside break as overweight positions are trimmed. In the futures market, speculators have the largest net long peso since early 2020. Three-month implied volatility has fallen below 9% for the first time since before the pandemic.
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December 2023 Monthly
2023-12-02
As the
year winds down, the global economy appears to be entering a new phase. While
North American and European central bankers swear that they are prepared to
respond to new threats to price stability, the markets demur. Indicative pricing in the derivatives
markets reflects the general conclusion that the central banks have most likely
completed the post-Covid monetary tightening cycle. Central bankers are pushing
against a premature easing of financial conditions. Last year’s sporadically large jumps in
monthly CPI measures have dropped out of the 12-month comparisons. Still,
inflation remains above targets but has slowed considerably. Japan remains the
notable exception. The Bank of Japan continues to inch its
way toward the exit of its extraordinary monetary policy. Previously,
Week Ahead: Have the Markets Turned?
2023-11-04
An inflection point may have been reached last week. Despite,
Chair Powell’s insistence that the Fed did not adopt an easing bias and
confirmed that there is still no talk of a cut, the market knows better. The
implied yield of December 2024 Fed funds futures contract is about 4.45%, which
is to say, the market is discounting not only the two cuts in the Fed’s
September projections, but a third cut, and the risk again (~60%),
of a fourth cut. The first cut is now fully discounted by the end of Q2 24. The
disappointing employment report pushed on an open door, sending US rates and
the greenback lower. It
fits into the evolving narrative of a dramatic slowing of the US economy after
the heady 4.9% annualized pace in Q3. This is regarded as a forgone conclusion.
It is still early in the data
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