• The Fed is widely expected to deliver a hold this afternoon; new macro forecasts and Dot Plots will be released; ahead of the decision, November inflation data will remain focus; U.S. yields are lower after the 30-year auction yesterday saw solid demand; Brazil is expected to cut rates 50 bp to 11.75%
  
• Eurozone reported soft October IP data; U.K. reported soft October GDP, IP, services, and construction data; BOE and ECB easing expectations have picked up ahead of tomorrow’s decisions
  
• Japan Q4 Tankan survey was solid; the new government has moved the RBNZ back to a single mandate of price stability; New Zealand reported Q3 current account data; China reported soft November money and new loan data

The dollar is trading firm ahead of the FOMC decision. DXY is trading modestly higher near 103.968. The euro is trading lower near $1.0785 and sterling is trading lower near $1.2525, as weak economic data fed into ECB and BOE easing expectations (see below). USD/JPY is trading higher near 145.65 despite a firm Tankan survey (see below). We expect a hawkish hold from the Fed today but at this point, it will likely take a string of firm U.S. data to truly challenge the current dovish Fed narrative. Last Friday’s jobs data is a good start, while elevated core CPI readings yesterday helped move the message along. We continue to stress that the U.S. economy continues to grow at or above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon and by as much as the markets think. The dollar should see another leg higher when market expectations for the Fed finally shift, though that may be a 2024 story.

AMERICAS

The Fed is widely expected to deliver a hold this afternoon. However, we expect the Fed to push firmly back against the elevated rate cut expectations. WIRP suggests no change either this week or in January but after that, it’s all about the cuts. There are nearly 50% odds of a cut March 20 and becomes fully priced in May 1. Four cuts are fully priced in by end-2024, with nearly 50% odds of a fifth one. While we disagree with this market pricing, it will take a hawkish Fed message and a string of stronger data to shift the narrative.

New macro forecasts and Dot Plots will be released. Of note, the extra hike in 2023 that was seen in September will be taken out so the 2023 Dot will fall to 5.375%. Will the 2024 Dot stay at 5.125% (one cut implied) or move down to 4.875% (two cuts)? Either one would suggest limited scope for rate cuts next year. We certainly don’t expect a more dovish 2024 Dot of 4.625% (three cuts), as this would simply feed into the dovish Fed narrative. The 2025 and 2026 Dots have little meaning right now and are unlikely to shift much. Growth forecasts are likely to be revised marginally higher while inflation and unemployment forecasts are likely to be revised marginally lower.

Chair Powell’s press conference is typically important. However, the markets didn’t respond to his hawkish comments right before the blackout period. Recall that Powell said that the Fed was prepared to tighten more if it becomes appropriate and stress that it was premature to speculate on when the Fed might ease. He said policy is “well into restrictive territory” and that the Fed is committed to staying restrictive until inflation is on a path to the 2% target. If he wants to get a hawkish message across, Powell should stress that there has been no discussion of easing policy yet.

Ahead of the decision, November inflation data will remain focus. PPI will be reported today. Headline is expected to fall two ticks to 1.1% y/y while core is expected to fall two ticks to 2.2% y/y. Yesterday’s CPI report is worth discussing. Headline came in a tick higher than expected at 0.1% m/m vs. 0.0% in October, while core came in as expected at 0.3% m/m vs. 0.2% in October. The y/y rates came in as expected at 3.1% and 4.0%, respectively. Headline CPI was depressed by energy, as gasoline fell -6.0% m/m after a -5.0% m/m drop in October. This will be hard to sustain. Services rose 0.5% m/m while housing rose 0.4% m/m, and these are the areas where price pressures remain stubbornly high. Of note, CPI super core rose 0.4% m/m vs. 0.2% in October, while the y/y rate picked up to 3.93% y/y vs. 3.75% in October and is the highest since August. At this point, the Fed can only cross its fingers and hope that core inflation will fall further but given the solid labor market and loose financial conditions, it won't be easy.

U.S. yields are lower after the 30-year auction yesterday saw solid demand. Treasury sold $21 bln at a yield of 4.344% vs. 4.769% at the previous auction. Indirect bidders took 68.5% vs. 60.1% previously and the bid/cover ratio was 2.43 vs. 2.24 previously. Next week, coupon issuance continues with 20-year bonds and 5-year TIPS to be sold.

Brazil COPOM is expected to cut rates 50 bp to 11.75%. Yesterday, November IPCA inflation came in at 4.68% y/y vs. 4.70% expected and 4.82% in October. It was the second straight month of deceleration to the lowest since August and back within the 1.75-4.75% target range. The swaps market is pricing in 200 bp of total easing over the next six months.

Argentina’s shock therapy has begun. The official exchange rate was devalued by 54% and huge spending cuts were announced as President Javier Milei made good on his pledges to reform the economy. Economy Minister Luis Caputo announced after markets closed yesterday that the official exchange rate is now ARS800 vs. ARS366.5 previously. Caputo added that the central bank will now target a monthly devaluation of 2%. The government will also slash spending by 2.9% of GDP. The IMF supported the government’s “bold initial actions” and added that “Their decisive implementation will help stabilize the economy and set the basis for more sustainable and private-sector led growth.” We have seen too many false dawns in Argentina during our long career to go all in on Milei, but we acknowledge that this is a good start. The last time we were optimistic on Argentina was when President Mauricio Macro was elected in 2015, only to see the nation continue to struggle.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported soft October IP data. IP came in at -0.7% m/m vs. -0.3% expected and a revised -1.0% (was -1.1%) in September. The y/y WDA came in at -6.6% vs.-4.5% expected and a revised -6.8% (was -6.9%) in September. Q4 has gotten off to a weak start and markets have noticed. Bloomberg consensus sees Q4 GDP shrinking -0.1% q/q, same as in Q3. However, with headwinds building, we see clear downside risks ahead.

The data come ahead of the European Central Bank decision tomorrow. A hold is widely expected. Despite efforts to push back against the market, easing expectations have picked up. WIRP suggests 5% odds of a cut tomorrow, rising to 10% January 25, 55% March 7, and fully priced in April 11. Five cuts by the end of next year are fully priced in. The bank will discuss adjusting both its PEPP reinvestments and its Minimum Reserve Requirements. ECB hawks have been pushing for changes to both of these sooner rather than later. While the bank may give some hints of these discussions, we do not think a decision on either will be made until 2024.

Updated macro forecasts will be released. Inflation forecasts are likely to be revised down in light of the recent data. However, the ECB cannot cut the forecasts by too much without running the risk of validating market easing expectations. Growth forecasts should also be cut marginally in light of the recent weak data.

President Lagarde will most likely use her press conference to try to push back against the dovish narrative. However, we note that her October conference was quite downbeat, and the growth outlook has gotten worse since then. Similar to Powell and the Fed, her protestations are likely to fall on deaf ears.

U.K. reported soft October GDP, IP, services, and construction data. GDP came in at -0.3% m/m vs. -0.1% expected and 0.2% in September, IP came in at -0.8% m/m vs. -0.1% expected and 0.0% in September, services came in at -0.2% m/m vs. 0.0% expected and 0.2% in September, and construction came in at -0.5% m/m vs. -0.2% expected and 0.4% in September. The y/y rates all fell sharply and signals that the resilient economy is finally succumbing to the growing headwinds. Q4 has gotten off to a weak start and markets have noticed. Bloomberg consensus sees Q4 GDP flat q/q, same as in Q3. However, with headwinds building, we see clear downside risks ahead. Elsewhere, the trade deficit came in at -GBP4.48 bln vs. -GBP2.15 bln expected and -GBP1.57 bln in September.

The data come ahead of the Bank of England decision tomorrow. A hold is widely expected. Here too, the bank is likely to push back against market easing expectations. WIRP suggests no odds of a hike this week or February 1. After that, rate cuts are priced in. WIRP suggests 30% odds of a cut March 21, rising to 65% May 9 and fully priced in June 20. Four cuts are nearly priced in by the end of 2024 vs. three as the start of this week.

ASIA

The Bank of Japan’s Q4 Tankan survey was solid. Large manufacturing index came in at 12 vs. 10 expected and 9 in Q3, while large non-manufacturing index came in at 30 vs. 27 expected and actual in Q3. However, large manufacturing outlook came in at 8 vs. 9 expected and 10 in Q3, while large non-manufacturing outlook came in at 24 vs. 25 expected and 21 in Q3. Lastly, all industry capex came in at 13.5% vs. 12.7% expected and 13.6% in Q3. Given how weak the PMI readings have been so far in Q4, we were expecting a much weaker Tankan survey.

The Bank of Japan liftoff expectations have eased a bit ahead of its December 18-19 meeting. WIRP suggests no odds of a move next week vs. 35% seen last week, as the soft data have provided a bit of a reality check for the markets. Weak wage growth, lower than expected November Tokyo CPI data, and downward revisions to Q3 GDP data all argue for caution in removing accommodation too soon. Odds of April liftoff have also fallen to 75% after being fully priced in at the start of this week.

The new government has moved the RBNZ back to a single mandate of price stability. After the legislatino was passed, Finance Minister Willis said “Inflation has been out of the Reserve Bank’s target range for two-and-a-half years and New Zealanders are doing it tough. In order to address the cost-of-living crisis, the government is taking a number of early steps to support the Reserve Bank in its fight to beat inflation.” Under the new mandate, the Monetary Policy Committee must “achieve and maintain future annual inflation between 1-3% over the medium term with a focus on keeping inflation near the 2% midpoint.” That wording is unchanged from the previous mandate but the second objective to support maximum sustainable employment was removed. The new mandate also simplified is a section which previously required the MPC to assess “the effects of monetary policy on the government’s objective of supporting sustainable house prices.” Now, the bank must only “be aware of the broader context in which monetary policy is conducted” and also to “seek to understand and communicate material interactions between monetary policy and the government’s economic objectives.”

With the focus purely on inflation, the new mandate implies tighter monetary policy ahead. However, WIRP still suggests only 10% odds of a hike February 26, then shifting to odds of a cut that have risen since the start of this week to 40% May 22, 90% July 10, and fully priced in August 14.

New Zealand reported Q3 current account data. The deficit came in at -7.6% of GDP vs. -7.4% expected and a revised -7.6% (was -7.5%) in Q2. It’s disappointing that the external accounts haven’t improved more given the slowdown in the economy, and this will be another headwind for NZD. Q3 GDP data will be reported tomorrow. Growth is expected at 0.2% q/q vs. 0.9% in Q2, while the y/y rate is expected at 0.5% vs. 1.8% in Q2. However, we see downside risks after weak retail sales and manufacturing activity data were reported.

China reported soft November money and new loan data. New loans came in at CNY1.09 trln vs. CNY1.3 trln expected and CNY738 bln in October, while aggregate financing came in at CNY2.45 trln vs. CNY2.6 trln expected and CNY1.85 trln in October. PBOC will set its key 1-year MLF rate Friday and is expected to remain steady at 2.5%. However, with credit growth sluggish and deflation risks rising, we see some odds of a dovish surprise. Markets are disappointed that the annual Central Economic Work Conference in Beijing has ended without any new pledges for economic stimulus.