Dollar Soft Ahead of PPI Data

February 16, 2023

Win Thin

January PPI will be today’s highlight; January retail sales data were red hot; U.S. financial conditions continue to loosen; Fed manufacturing surveys for February continue rolling out; CBO warned that the U.S. government could be at risk of a default as soon as July
ECB doves are getting more vocal; top adviser to the EU Court of Justice rendered an opinion on CHF-denominated mortgage loans that is very negative for Polish banks
Japan reported January trade data and December core machine orders; Australia reported soft January jobs data; Philippines hiked rates 50 bp to 6.0%, as expected; Indonesia kept rates steady at 5.75%, as expected

The dollar is soft ahead of PPI data. After trading as high 104.11 yesterday, DXY is back near 103.758 today. Despite the setback, the break above 103.793 sets up an eventual test of the January high near 105.631. The euro is trading back near $1.07 after trading near $1.0660 yesterday. The break below $1.0695 sets up an eventual test of the January 6 low near $1.0485. Sterling is trading near $1.2050 after trading near $1.1990 yesterday. However, it remains on track to test last week’s new cycle low near $1.1960 and then the January 6 low near $1.1840. USD/JPY is trading just below 134 after trading yesterday at a new high for this move near 134.35, the highest since January 6. The pair remains on track to test that day’s high near 134.75. The recent U.S. data have come around to support our more hawkish view on the Fed, which in turn supports our call for a stronger dollar. Market sentiment is swinging back in the dollar’s favor and we remain hopeful that the data continue to encourage this shift. That said, we are disappointed that the greenback has not benefitted more from the CPI and retail sales data. Perhaps today’s PPI data will help.

AMERICAS

January PPI will be today’s highlight. Headline is expected at 5.4% y/y vs. 6.2% in December, while core is expected at 4.9% y/y vs. 5.5% in December. In m/m terms, headline is expected at 0.4% and core is expected at 0.3%. Of note, PPI revisions were reported Tuesday. Similar to what we saw with the CPI revisions last week, the December m/m gain for headline PPI was revised up to -0.4% vs. -0.5% previously, while the gain for core PPI was unchanged at 0.1%. For November, both headline and core PPI m/m gains were revised up to 0.3% m/m vs. 0.2% previously. The y/y rates were unchanged but the m/m readings across both CPI and PPI suggest inflation momentum picked up at year-end and carried over into the new year.

January retail sales data were red hot. Headline came in at 3.0% m/m vs. 2.0% expected and -1.1% in December, while ex-autos came in at 2.3% m/m vs. 0.9% expected and a revised -0.9% (was -1.1%) in December. The so-called control group used for GDP calculations came in at 1.7% m/m vs. 1.0% expected and -0.7% in December. Of note, the Atlanta Fed’s GDPNow model is currently tracking 2.4% SAAR growth in Q1, up from 2.2% previously. Next model update will be today after the housing data. The strong labor market and rising consumer confidence has clearly led consumption to remain robust as 2023 gets under way.

Fed tightening expectations remain high. WIRP suggests 25 bp hikes March 22 and May 3 are nearly priced in, while the odds of a third hike in June or July top out near 60%. Strangely enough, an easing cycle is still expected to begin in Q4 but we believe that will be corrected in the next stage of Fed repricing. Mester, Bullard, and Cook speak today. We expect them to maintain the more hawkish tone that has been established in recent weeks.

Yet U.S. financial conditions continue to loosen. As of last Friday, conditions are the loosest since late February. Its adjusted measure is the loosest since early February. This must be frustrating for the Fed but all it can do is to continue hiking rates and giving hawkish forward guidance. At some point soon, we think conditions will have to tighten as interest rates have continued to rise. Credit spreads have also started to widen out this month and so perhaps we are at the beginning of this adjustment process. Now, if only the equity markets would get the message……

Fed manufacturing surveys for February continue rolling out. Philly Fed reports today and is expected at -7.5 vs. -8.9 in January. The New York Fed services index will also be reported and is expected at -7.5 vs. -8.9 in January. Empire survey was reported yesterday and came in at -5.8 vs. -18.0 expected and -32.9 in January. January IP was also reported yesterday and came in flat m/m vs. 0.5% expected and a revised -1.0% (was -0.7%) in December. Within IP, manufacturing came in strong at 1.0% m/m vs. 0.8% expected and a revised -1.8% (was -1.3%) in December. The manufacturing sector is clearly slowing but so far has not had much impact on the wider economy, which remains resilient.

Other minor data will be reported. January building permits and housing starts and weekly jobless claims will be reported. Permits are expected at 1.0% m/m while starts are expected at -2.0% m/m. Elsewhere, initial claims are expected at 200k vs. 196k last week, while continue claims are expected at 1.695 mln vs. 1.688 mln last week. The four-week moving average fell last week for the ninth straight week to 189k, the lowest since late April.

The Congressional Budget Office warned that the U.S. government could be at risk of a default as soon as July if lawmakers fail to raise the debt ceiling. For now, the Treasury Department is using so-called extraordinary measures to keep meeting its obligations after hitting the debt ceiling in January. The CBO noted “If the debt limit remains unchanged, the government’s ability to borrow using extraordinary measures will be exhausted between July and September 2023.” A more exact drop-dead date remains elusive right now and the CBO warned that “Treasury could run out of funds before July” if tax receipts come in weaker than expected. However, the timeframe may be enough to get all parties moving on an issue that has been put on the back burner in recent weeks.

EUROPE/MIDDLE EAST/AFRICA

ECB doves are getting more vocal. Panetta said that “With rates now moving into restrictive territory, it is the extent and duration of monetary policy restriction that matters. By smoothing our policy rate hikes - that is, moving in small steps - we can ensure that we calibrate both elements more precisely in the light of the incoming information and our reaction function.” This would seem to validate current market expectations, as WIRP suggests a 50 bp hike March 16 is nearly priced in followed by a 25 bp hike May 4, thought there are 30% odds of a larger 50 bp move then. Another 25 bp hike June 15 is priced in, followed by around 60% odds of one last 25 bp hike in Q3. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand. Nagel, Lane, Makhlouf, and Stournaras all speak later today.

Top adviser to the EU Court of Justice rendered an opinion on CHF-denominated mortgage loans that is very negative for Polish banks. Advocate General Anthony Collins said in a non-binding opinion that Polish banks can’t seek extra remuneration beyond the loan principal from thousands of borrowers whose CHF-denominated mortgages were voided by a 2019 ruling from the very same EU Court of Justice. Apparently, the banks have been counter-suing borrowers to recover some funds and to deter any future litigation and a Warsaw court asked the EU to rule on this. To make matters worse for the banks, borrowers can sue lenders for additional compensation above and beyond the cost of capital that was already repaid, opening up the banks to greater liabilities ahead. A final ruling will be issued by the EU Court of Justice in the coming months. While the opinion is not binding, it does raise risks that Polish banks will eventually have to set aside greater loan loss provisioning. Stay tuned.

ASIA

Japan reported January trade data and December core machine orders. Exports came in at 3.5% y/y vs. -1.7% expected and 11.5% in December, while imports came in at 17.8% y/y vs. 20.6% expected and 20.7% in December. The unadjusted deficit hit a record -JPY3.5 trln, while the adjusted deficit came in smaller at -JPY1.8 trln. Of note, exports to China came in at -17.1% y/y, with weakness led by autos, auto parts, and chip machinery. Elsewhere, core machine orders came in at -6.6% y/y vs. -6.1% expected and -3.7% in November. While it’s early still, Japan data has shown no impact from China reopening. Neither have data from Korea and Taiwan and so we remain skeptical that China will boost global growth this year as much as optimists are projecting.

With the economic recovery still quite soft, expected BOJ liftoff is not imminent. Next BOJ policy meeting March 9-10 will be the last one under Governor Kuroda and while no change is expected, we simply cannot rule out one last surprise. WIRP suggests nearly 30% odds of liftoff April 28, rising to nearly 60% June 16 and then around 95% July 28. That said, the actual tightening path is seen as very mild as the market is pricing in 20 bp of tightening over the next 12 months followed by only 35 bp more over the subsequent 24 months. That is why we expect the drop in USD/JPY after liftoff to be fairly limited.

Australia reported soft January jobs data. Employment came in at -11.5k vs. 20.0k expected and a revised -20.0k (was -14.6k) in December, while the unemployment rate rose two ticks to 3.7%. The jobs breakdown was not good, as -43.3k full-time jobs were only partially offset by a 31.8k gain in part-time jobs. The latest RBA forecasts see unemployment rising slightly over the course of this year to 3.8% and then rising to 4.3% by end-2024. Given the magnitude of expected tightening as well as this January reading, this outlook seems too optimistic.

Reserve Bank of Australia Governor Lowe testifies Friday. He will surely be quizzed about the bank’s unexpectedly hawkish stance taken at last week’s meeting when it hiked 25 bp to 3.35% and signaled more tightening ahead, especially given recent softness in the labor market. WIRP suggests a 25 bp hike at the next meeting March 7 is nearly 75% priced in, while the swaps market is pricing in a peak policy rate near 4.15% over the next 6 months. Of note, an easing cycle is priced in over the subsequent 6 months.

Philippine central bank hiked rates 50 bp to 6.0%, as expected. Governor Medalla signaled further hikes ahead, noting that he personally is ruling out steady rates as well as 75 bp hikes. He added that a pause is feasible in H1. The bank raised its inflation forecast for 2023 to 6.1% y/y vs. 4.5% previously and for 2024 to 3.1% y/y vs. 2.8% previously. The bank added “The Monetary Board also reiterates its encouragement and support for timely and more aggressive whole-of-government actions to mitigate the impact of persistent supply-side pressures on food prices.” CPI rose 8.7% y/y in January, the highest since November 2008 and further above the 2-4% target range. Next policy meeting is March 23 and another hike is expected, though the magnitude will depend on the data. The swaps market is pricing in a peak policy rate near 5.75% but this may move higher if inflation continues to rise.

Bank Indonesia kept rates steady at 5.75%, as expected. The bank noted that the strong rupiah is helping to lower inflation and that this strength is due to fundamentals. It sees both headline and core inflation returning to the target range in H2. Of note, headline CPI rose 5.28% y/y in January, the lowest since August 2022 but still above the 2-4% target range. The tightening cycle may have ended, as Governor Warjiyo said that there’s “no need for any more hikes.” He added that both headline and core inflation are falling faster than initially expected. Next policy meeting is March 16. Whether rate hikes have ended will of course depend on the data but as we have seen elsewhere, the global fight against inflation has turned increasingly difficult.

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