by Marc Chandler
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There are several macro highlights in the week ahead, during which Chinese markets are closed for the Lunar New Year celebration. The preliminary January purchasing managers surveys pose headline risk. However, the survey data, for example, had the US composite below the 50 boom/bust level every month in H2 22, which likely overstates the case, as the first look at Q4 22 US GDP will probably show. While some improvement is expected, composite PMI readings are expected to have remained below 50. Still, the pendulum of market sentiment has swung, and it has begun looking at the glass as half full rather than half empty.
By that, we mean market participants have been flirting with the possibility of a soft(ish) landing. The easing of supply chain disruptions, the anticipated re-opening of China after it abandoned its zero-Covid policy, and the softening of price pressures in the US and Europe, coupled with the resilience of labor markets, are encouraging a less pessimistic outlook. This has helped send equities and risk assets higher to start the year and seen benchmark 10-year yields move lower. Yet, the weakness in US data, which includes a sharp decline in retail sales and manufacturing output in November and December, coupled with a host of corporate warnings, caution against complacency and reliance on hope. Another bear market bounce in US equities appeared over, with gap lower moves on Thursday before falling ahead of the weekend. The US dollar has remained mainly within recent ranges, though it finished last week on a soft note amid the risk-on mood.
Canada: The Bank of Canada is the only G10 central bank that meets in the week ahead (January 25). The economy appears to have expanded faster in Q4 22 than the central bank had projected, and with a strong labor market and firm core price pressures, a 25 bp rate hike is expected. It will take the overnight target rate to 4.50%. What makes this hike special is that it is thought to be the last in the cycle. The central bank is unlikely to confirm it, and to maintain its credibility, may frame it as a pause given that it seems prudent given the impact of policy with a lag. The Bank of Canada forecasts growth to slow this year to 0.9% from around 3.3% in 2022. The median forecast in Bloomberg's survey projects growth at 0.5%. Also, for the first time, starting with this meeting, the Bank of Canada will report a record of the meeting. The IMF has suggested as much in last year's review of the central bank's communication. Insight into the deliberations of this largely consensus body can help businesses, investors, and households make more informed decisions. In turn, this may help boost the effectiveness of monetary policy. At the same time, as we can often recognize from other central banks, the minutes/record is not simply a passive god's eye view but a communication channel. It may help fine tune the central bank's message. The record of the Bank of Canada's meeting will be made public with a two-week lag.
With its recent recovery, the US dollar has recouped half of this month's loss against the Canadian dollar (around CAD1.35). The momentum indicators have turned up from oversold. The next upside target is around CAD1.3550 and then CAD1.3600. Note that the five-day moving average is set to exceed the 20-day moving average in the coming days. This simple cross-over has caught the big moves in recent months. Still, the risk-on move ahead of the weekend took the greenback to three-day lows slightly below CAD1.3380. The low this month was set on January 13 near CAD1.3320.
United States: At the end of the week ahead (January 27), the US reports the December PCE deflator, which the Fed targets, as part of the personal income and consumption report. One would expect this to be the focus, given the sensitivity to inflation. However, its thunder has been stolen by the CPI, which provides economists with a good sense of the PCE deflator, and preliminary Q4 22 GDP estimate. The Atlanta Fed's GDPNow tracker sees fourth-quarter growth at 3.5%, while the median forecast in Bloomberg's survey has crept up to 2.9%. The Federal Reserve (median projection) sees the speed limit for the economy, which is the non-inflationary growth at 1.8%. That said, the quarter ended on a decidedly poor note. Retail sales and industrial production figures reported fell in both November and December. Last year, US CPI rose at an annualized rate of more than 10% in Q1 and Q2. The base effect favors a sharp decline in the CPI in the coming months. The risk is that improvement stalls are the second half when recession fears are elevated.
The 102.00 area in the Dollar Index corresponds to the halfway mark of the rally from the post-Covid low on January 6, 2021. It has overshot it on an intraday basis and finally settled below it for the first time before the weekend. The key issue technically is whether the sideways movement in the trough around 102 is a base being formed or a nesting before the next leg lower. With the momentum indicators turning higher and interest rates also seeming to stabilize, we are more inclined to see this as a near-term base. Last week's high was set on January 18 near 102.90.
Japan: The battle between the market and the Bank of Japan will likely continue following last week's decision to maintain the current policy settings, including the 0.50% cap on the 10-year bond. In the four sessions before the BOJ's meeting concluded on January 18, the central bank bought around $100 bln (JPY13 trillion) in government bonds. In addition, the BOJ adjusted its facility for lending money to commercial banks to buy government bonds. Going forward, the interest rate (recently zero) can be adjusted for each loan provision operation, allowing the central bank to fine-tune it for specific maturities. Governor Kuroda said a negative rate could be considered. The new week begins with the preliminary January PMI. The composite was below the 50 boom/bust level in November and December last year. At the end of the week, Japan reports Tokyo's January CPI. The headline and core (excludes fresh food) reached new cyclical highs of 4% in December. While the BOJ tweaked its forecast for this fiscal year's inflation to 3.0% from 2.9%, it kept its forecast for the new fiscal year (starting April 1) at 1.6%, reinforcing its message that the current price pressures are unlikely to be sustained. Government subsidies (energy and wheat) may push prices lower, and the 13% appreciation of the yen on a trade-weighted basis since late October may help dampen imported inflation.
The dollar bottomed at the start of last week near JPY127.25 and peaked on the BOJ's decision, slightly shy of JPY131.60. However, the momentum indicators are curling higher, and the greenback posted its highest close ahead of the weekend in seven sessions. With the BOJ enjoying some success post-meeting, the dollar appears poised to recover. A move above the JPY131.60 area could see a further recovery toward JPY135.00, which it has not traded above since the December surprise.
Eurozone: The combination of a warmer-than-expected winter and better-than-expected economic data seen market participants reassess their pessimistic outlook toward the eurozone. The German economy appears to have stagnated in Q4 rather than contract, and Chancellor Scholz spoke confidently that a recession would be avoided. The German composite PMI was below 50 consistently in H2 22, but the pace slowed in November and December. As a result, investors have flocked back to the euro area. The Stoxx 600 extended its gains and is now up more than 6% this year, falling almost 13% last year. European bonds have surged this year. The 10-year Italian yield is off nearly 100 bp, and the spread against the German Bund has narrowed by around 70 bp. Italy's 10-year premium is at its lowest since last April (~170 bp), and the two-year tip (~25 bp) is the least since October 2021. Italy's Prime Minister Meloni is expected to appoint several administrative posts, including the Director of the Treasury, which oversees the state-owned businesses. The government will appoint managers for these SOEs in the spring. After snapping a five-quarter slide in Q4 22, appreciating by 9.2%, the euro is up around 1% in January.
Last week, the euro made a marginal new high, slightly above $1.0885. However, appears to have lost its upside momentum since first moving above $1.08 on January 12, though it finished last week on a firm note. The question here is whether this sideways trading is a prelude to another leg up, as turned out to be the case in the second half of December, or whether it marks a near-term top. The momentum indicators suggest the latter. The $1.0730 area remains the key to the downside, and a convincing break could signal another cent pullback. On the upside, a push above $1.0945 would improve the medium-term technical outlook.
United Kingdom: The average weekly earnings and core inflation were reported as firmer than expected last week. These reports, after the recently reported unexpected expansion in November, and the hawkish rhetoric from the Bank of England, underpin market expectation for a 50 bp hike at the central bank's next meeting (February 2). That brings the base rate to 4.0%, and the swaps market looks for a terminal rate between 4.25% and 4.50%. Still, the December retail sales figures were dreadful as the cost-of-living squeeze takes a toll. The UK's composite PMI has not been above 50 since last July. It has not fallen since October, feeding some economic optimism, which does not appear to have been derailed by the strike activity that seems set to continue into next month. The FTSE-350, which represents about 90% of the UK equity market capitalization, is up approximately 4.3% this year after falling 2.7% in 2022. The 10-year Gilt yield has fallen by nearly 30 basis points since the end of last year.
Sterling approached but could not surpass the mid-December high near $1.2450 last week. It has been in a six-cent range since late November. It tested the upper end of the range but remained firm ahead of the weekend as if the market had not given up on last month's cap. Initial support may be seen near $1.2250, while a break of $1.2170 could signal a return to the lower end of the range.
Australia: Encouraged by the market's optimism toward the re-opening of China, higher iron ore and copper prices, and the prospect of better trade relations, the market has taken the Australian dollar up to five-month highs (~$0.7065). It is the second strongest G10 currency this year, behind sterling (~2.6%), and is up almost 2.4%. The Aussie rose nearly 6.5% in Q4 22. The ASX 200 equity benchmark is up almost 6% this month. The yield of the 10-year bond is off about 65 bp, which is the most in the G10 after Italy (-78 bp). Australia reports the preliminary January PMI. The composite spent Q4 22 below 50. The quarterly inflation report (Q4) is due on January 25. The new monthly CPI report showed headline price pressures were sticky at 7.3% in November, the same in Q3. The RBA meets on February 7, and about 15 bp of tightening is priced into the overnight index swaps. Assuming, as many observers do, that the central bank wants to return to quarterly increments, the issue is whether it does so now or waits for what it expects to be the last move in the cycle. We suspect the latter and are more inclined to view the market as discounting a 60% chance of a 25 bp hike. The cash target rate is at 3.10%, and the market sees a peak near 3.75%.
The Australian dollar traded between almost $0.6870 and $0.7060 last Wednesday and Thursday. It may consolidate in the coming days, especially given the absence of China. Still, it closed firm, near session highs before the weekend, and looks poised to attempt again to sustain a foothold above $0.7000. A renewed setback signals a retest on last week's low. Below there, the risk extends toward $0.6820-30 initially.
Mexico: Mexico's stock and bonds have begun the new year with aplomb. After falling 9% last year, the Bolsa is already up around 11.4% this year. Its 10-year dollar-bond yield is off 60 bp this month. In comparison, Brazil's Bovespa is up about 2.25%, while its 10-year dollar bond yield is up a few basis points. Mexico's three-month cetes (T-bill) yields almost 10.9% compared to the US T-bill, which pays about 4.65%. Mexico's inflation has stopped rising, but pressures have not eased significantly, suggesting policy rates may be sticky.
The dollar fell to a new low since March 2020 in the middle of last week near MXN18.5670 before reversing higher. Follow-through buying lifted the greenback to nearly MXN19.11 the next day, a six-day high. This effectively retraced half of the dollar's losses this year. Moreover, the momentum indicators have turned up, reinforcing the importance of the low recorded. Yet the underlying drivers have not changed, and we suspect the peso's setback will be seen as a new buying opportunity by real money. That said, technically, the risk may extend toward MXN19.20. However, initial support is seen in the MXN18.77, and a break could re-target the lows. -MXN18.84 area.
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