Dollar Firm as U.S. Returns from Holiday

January 16, 2024

Win Thin

U.S. yields are on the rise and yet Fed easing expectations remain too aggressive; regional Fed surveys for January will start rolling out; Canada highlight will be December CPI
ECB officials continue to push back against market easing expectations; ECB November inflation expectations plunged; German January ZEW survey was mixed; U.K. reported soft wage data
Japan reported December PPI; China Premier Li Qiang said the economy grew about 5.2% in 2023

The dollar is trading higher as the U.S. returns from holiday. DXY is trading at the highest since December 13 near 103.158 and is on track to test the December 8 high near 104.263. However, the 200- day moving average near 103.445 may provide some resistance. The euro is trading lower near $1.0895 and is nearing a test of the 200-day moving average near $1.0850, while sterling is trading lower near $1.2645 after weaker than expected wage data (see below). USD/JPY is trading higher today near 146.65 and is on track to test the December 6 high near 147.50. AUD is the worst performing major on lower iron ore prices. All indications are that the U.S. economy remains robust in Q4 and likely to remain so in early 2024, which certainly wouldn’t require 175 bp of easing from the Fed this year. Over the past few weeks, the readings have mostly come in on the firm side and so we continue to believe that the current market easing expectations still need to adjust significantly. These expectations have started to shift but more needs to be seen. Perhaps this week’s U.S. retail sales data will help the adjustment process.

AMERICAS

U.S. yields are on the rise. The 10-year yield traded as low as 3.91% Friday but is trading near 4.01% today, while the 30-year yield traded as low as 4.15% Friday but is trading near 4.24% today. The short end is also taking part in this move, as the 2-year yield traded as low as 4.12% Friday but is trading near 4.21% today. If the data remains firm as we expect, yields should continue to edge higher and lend the dollar some support.

Yet Fed easing expectations remain too aggressive. WIRP suggests nearly 85% odds of a cut March 20 vs. 75% at the start of last week. Furthermore, the swaps market is now pricing in nearly 175 bps of Fed easing this year vs. less than 150 bp at the start of last week. This week’s U.S. economic data will either curtail money market expectations of aggressive Fed funds rate cut or validate them. Given extreme market positioning, we believe the dollar’s downside is limited with the risks skewed to the upside. We are observing those upside risks today. Waller speaks today.

The U.S. economy remains robust. The New York Fed’s Nowcast model has Q4 growth at 2.4% SAAR and Q1 growth at 2.5% SAAR and will be updated Friday. The Atlanta Fed’s GDPNow model has Q4 growth at 2.2% SAAR vs. 2.5% previously and will be updated tomorrow after the retail sales data. Bottom line: the US economy is still growing above trend in Q4 and quite possibly Q1.

Regional Fed surveys for January will start rolling out. Empire manufacturing kicks things off today and is expected at -5.0 vs. -14.5 in December. New York Fed services survey will be reported tomorrow and stood at -14.6 in December. Philly Fed manufacturing survey will be reported Thursday and is expected at -7.0 vs. -12.8 in December.

Canada highlight will be December CPI. Headline is expected at 3.4% y/y vs. 3.1% in November. If so, this would be the first acceleration since August to the highest since September and further above the 2% target. Core trim is expected to fall a tick to 3.4% y/y while core median is expected to fall a tick to 3.3% y/y. Of note, the BOC’s Business Outlook Survey for Q4 reported yesterday showed that fewer firms plan greater than normal price increases and that the average expected wage rise that firms plan to give their staff in the next 12 months continues to edge lower. WIRP suggests a rate cut is fully priced in April 10, with 125 bp of total easing priced in for this year. December housing starts will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

ECB officials continue to push back against market easing expectations. Holzmann warned “We should not bank on the rate cut at all for 2024.” Nagel said “Maybe we can wait for the summer break or whatever, but I don’t want to speculate. I think it’s too early to talk about cuts.” Elsewhere, Villeroy said “Expect very probably a rate cut this year but the question of a season is a premature one,” adding that the ECB will “probably be a bit more patient” than current market pricing. WIRP suggests the first cut will come April 11, with 150 bp of total easing this year.

ECB November inflation expectations plunged. This survey continues to show that medium-term inflation expectations are returning to the 2% target. 1-year expectations fell to 3.2% vs. 4.0% in both September and October, while 3-year inflation expectations fell to 2,2% vs. 2.4% expected and 2.5% from August through October. Both readings were the lowest since February 2022.

German January ZEW survey was mixed. Expectations of economic growth came in at 15.2 vs. 11.7 expected and vs. 12.8 in December, while the current situation came in at -77.3 vs. -77.0 expected and -77.1 in December. Of note, the ZEW expectations of economic growth for the eurozone came in at 22.7 vs. 23.0 in December.

U.K. reported soft wage data. Average weekly earnings rose 6.5% y/y for the three months ending in November vs. 6.8% expected and 7.2% previously. This was the lowest reading since August 2022. Elsewhere, earnings excluding bonuses rose the expected 6.6% y/y for the three months ending in November 2023 vs. 7.2% previously. Slowing wage growth should give the BOE more confidence that underlying inflation is on a firmly downward trend and validates money market pricing of BOE rate cuts totaling 125 bp this year and beginning in May. Governor Bailey speaks to the House of Lords Economic Affairs Committee later today. Of note, the ONS continues to estimate a new experimental unemployment rate, which remained steady at 4.2% for the three months ending in November.

ASIA

Japan reported December PPI. It came in at 0.0% y/y vs. -0.3% expected and 0.3% in November. This was the lowest reading since February 2021 and support the general disinflation trend. December national CPI will be reported Friday. Headline is expected at 2.5% y/y vs. 2.8% in November, core (ex-fresh food) is expected at 2.3% y/y vs. 2.5% in November, and core ex-energy is expected at 3.7% y/y vs. 3.8% in November. If so, core would be the lowest since June 2022 and nearing the 2% target. WIRP suggests liftoff is now priced in September 20 as the timing continues to get pushed out by the soft data.

China Premier Li Qiang said the economy grew about 5.2% in 2023. This is no surprise and in line with the official target of “around 5%.” Q4 GDP data will be reported tomorrow. Growth is expected at 1.1% q/q vs. 1.3% in Q3, while the y/y rate is expected at 5.3% y/y vs. 4.9% in Q3 and full year growth is expected at 5.2%. We note that the improvement would largely be due to low base effects, as China did not fully reopen until December 2022. Policymakers are expected to maintain the same target for 2024 but it will be much harder to meet without low base effects.

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