Drivers for the Week of December 19, 2021

December 19, 2021
Here's a look at the main drivers in Developed Markets this week.
  • It was a wild and volatile week for currencies; there are no Fed speakers scheduled for this week; the market still does not believe the Fed in terms of the magnitude of the tightening cycle; November core PCE is the key data point this week; weekly jobless claims will be of interest; fiscal stimulus may be dead in the water; Canada reports some key data; BOC tightening expectations have intensified
  • It’s all about consumer confidence in the eurozone this week; the ECB delivered a hawkish hold last week but market pricing suggests the bank is in no hurry to hike rates; U.K. reports some minor data; markets are still struggling with BOE messaging; U.K. politics remain a mess
  • Japan reports some key data; the BOJ is clearly not concerned about inflation risks; RBA minutes will be released Tuesday; the data have improved and there is a chance that the RBA will end QE altogether in February

AMERICAS

It was a wild and volatile week for currencies. A hawkish Fed led to initial dollar gains, followed by subsequent dollar losses as the ECB and BOE delivered some hawkish signals of their own. On Friday, the dollar recouped its losses and ended higher on the week against all the major currencies. JPY and GBP outperformed, while the dollar bloc and Scandies fared the worst. Looking through all the noise, we remain confident that the true signal is one of further dollar strength. Simply put, the Fed is on a stronger tightening trajectory than most major central banks. EM FX was largely weaker last week, with PHP and ZAR outperforming and TRY and COP underperforming. Of note, the removal of accommodation by many of the major central banks will hit EM hard, along with other risk assets that are dependent on cheap and plentiful liquidity. As such, EM is likely to remain under pressure as we move into 2022.

There are no Fed speakers scheduled for this week. However, Governor Waller closed out last week with a hawkish tilt. Regarding liftoff, he said "We'd like to put March on the table as a possible date to start lifting if we need to." Waller added that the “whole point” of moving to a faster pace of tapering was to allow for a quicker liftoff. WIRP suggests 50-50 odds for March 16 liftoff, while Q2 is fully priced in. A follow-up hike in Q3 is fully priced in, while another Q4 hike is about 66% priced in.

The market still does not believe the Fed in terms of the magnitude of the tightening cycle. Fed Funds futures are pricing in a terminal Fed Funds rate between 1.50-1.75% by end-2024. The swaps market is even more dovish, with a terminal rate priced in of 1.25-1.50%. Contrast this to the updated Dot Plots, where the median Fed Funds rate is 1.625% by end-2023 and 2.125% by end-2024. We saw a similar dynamic during the 2015-2019 tightening and when all was said and done, the Fed moved towards the market’s dovish narrative. Will history repeat? Only time will tell.

November core PCE is the key data point this week. Consensus sees 4.5% y/y vs. 4.1% in October. If so, it would be the highest since March 1989 and further above the Fed’s 2% target. The Fed’s updated core PCE forecasts saw 2021 revised up to 4.4% from 3.7% and 2022 revised up to 2.7% from 2.3%. 2023 was revised up a tick to 2.3% while 2024 was kept steady at 2.1%. We note again that a terminal Fed Funds rate of 1.5% and core PCE at 2% would result in a negative real policy rate at the end of a tightening cycle, which is highly unlikely. Personal income and spending will be reported at the same time, with the former expected at 0.5% m/m and the latter at 0.6% m/m.

Weekly jobless claims will be of interest. That is because the initial claims data are for the BLS survey week containing the 12th of the month. Continuing claims are reported with a 1-week lag and so next week’s reading will be for the survey week. Initial claims are expected at 205k vs. 206k the previous week, while continuing claims are expected at 1.815 mln vs. 1.845 mln the previous week. Both readings would support the view that the labor market continues to heal. Current consensus for December NFP is 419k vs. 210k in November, while the unemployment rate is seen falling a tick to 4.1%. Of note, the Fed’s updated unemployment rate forecasts saw 2021 revised down to 4.3% from 4.8% and 2022 revised down to 3.5% from 3.8%. Both 2023 and 2024 were kept steady at 3.5%.

The rest of the U.S. data releases are minor. November leading index (0.9% m/m expected) will be reported Monday, followed by Q3 current account data (-$206 bln expected) Tuesday. November Chicago Fed National Activity Index (0.40 expected), existing home sales (3.0% m/m expected), and December Conference Board consumer confidence (111.0 expected) will be reported Wednesday. November durable goods orders (2.0% m/m expected), new home sales (3.4% m/m expected), and final December University of Michigan consumer sentiment will be reported Thursday.

We also get another revision to Q3 GDP. Growth is expected to remain steady at 2.1% SAAR, but this is old news. Q4 is looking much stronger, with the Atlanta Fed’s GDPNow model tracking 7.2% SAAR vs. 7.0% previously. Bloomberg consensus sees 6.0% SAAR in Q4, slowing to 4.0% in Q1 and 3.6% in Q2. With Germany tipping into recession, the eurozone growth outlook has worsened and so the U.S. economy is likely to continue outperforming for the time being.
Fiscal stimulus may be dead in the water. Senator Manchin said he would not support President Biden’s Build Back Better program. He said he could not support the nearly $2 trln price tag and so Democratic leaders must decide whether to pare it down again or simply give up altogether. Manchin’s announcement came just days after Senate Democrats pushed back likely passage of the bill to next year, with the implicit understanding that the Senator from West Virginia was still on board.

Canada reports some key data. October retail sales will be reported Tuesday. Headline sales are expected at 1.0% m/m vs. -0.6% in September, while sales ex-autos are expected at 1.5% m/m vs. -0.2% in September. October GDP will be reported Thursday and is expected at 0.8% m/m vs. 0.1% in September. While this is old news, the economic data have been coming in strong in November as well. While the Bank of Canada maintained its forward guidance at this month’s meeting, updated forecasts will come at the next meeting January 26. 2024 will be added to the forecast horizon and will be an important part of its forward guidance.

Bank of Canada tightening expectations have intensified. WIRP suggests 60% odds of a hike next month and is almost fully priced in for the March 2 meeting. Five hikes in total are nearly fully priced in for 2022, which is consistent with swaps market pricing for an end-2022 rate of 1.5%. Another two hikes are priced in for 2023 that would take the policy rate up to 2.0%. Similar to the Fed, this would imply a real policy rate close to zero at the end of a tightening cycle, assuming inflation returns to target. Since this seems very unlikely, we think the risks are tilted toward a higher terminal policy rate than 2%.

EUROPE/MIDDLE EAST/AFRICA

It’s all about consumer confidence in the eurozone this week. German January GfK consumer confidence will be reported Tuesday and is expected at -2.7 vs. -1.6 in December. If so, it would be the lowest since June 2021. Eurozone December consumer confidence will be reported the same day and is expected at -8.1 vs. -6.8 in November. If so, it would be the lowest since April 2021. Italy December consumer and manufacturing confidence will be reported Thursday. The former is expected at 116.3 vs. 117.5 in November, while the latter is expected at 115.3 vs. 116.0 in November. The spread of omicron is already having an impact on the PMI readings and so we expect deterioration in the consumer surveys as well.

While the ECB delivered a hawkish hold last week, market pricing suggests the bank is in no hurry to hike rates. Swaps market is pricing in no ECB tightening whatsoever over the next twelve months. Madame Lagarde stressed this after the decision and we agree. However, we believe the bank took a risky move to taper its asset purchases just as Germany appears to be tipping into recession. ECB speakers are limited this week. Kazimir speaks Tuesday and Holzmann speaks Wednesday. Last week, Holzmann said the ECB will adjust policy if upside risks to inflation materialize.

U.K. reports some minor data. CBI releases its industrial trend survey for December Monday, with orders expected at 20 vs. 26 in November and selling prices expected at 60 vs. 67 in November. CBI distributive trades survey will be released Tuesday, with retailing reported sales expected at 25 vs. 39 in November. Public sector net borrowing for November will also be reported Tuesday, with ex-banking groups expected at GBP16.0 bln vs. GBP18.8 bln in October. Q3 current account and final GDP data will be reported Wednesday.

Markets are still struggling with Bank of England messaging. After talking up inflation risks in November and then standing pat, the bank seemed to downplay inflation risks in December and then surprised with a rate hike. WIRP suggests 66% odds of a follow-up hike February 3, while a March 17 hike is fully priced in. Swaps market is pricing in a terminal rate of 1.25% by end-2022, which would imply quarterly hikes. As in the case of the Fed, this in turn implies a negative real policy rate at the end of a tightening cycle (assuming inflation returns to target) and that just does not seem right to us.

U.K. politics remain a mess. Brexit Secretary Frost resigned abruptly at a very delicate moment for negotiations with the EU. Foreign Secretary Truss will take over the post, adding to her portfolio as well as to speculation that she will eventually challenge Johnson for leadership of their party. Johnson and his government continue to plunge in the polls, with further downside risks coming from possible movement restrictions ahead of the Christmas holiday. Reports suggest Chancellor Sunak (another possible challenger to Johnson) is considering fresh aid to the hospitality and tourism sectors. An emergency VAT cut or possible cash payments are among the measures being considered by the government.

ASIA

Japan reports some key data. November department store sales will be reported Thursday. November national CPI, PPI services, and housing starts will be reported Friday. Headline inflation is expected at 0.5% y/y vs. 0.1% in October, while core (ex-fresh food) is expected at 0.4% y/y vs. 0.1% in October. If so, headline would be the highest since January 2020 but still well short of the 2% target. That said, base effects are playing a big part and will continue to do so in December and January as well. The BOJ will issue updated macro forecasts at the January 17-18 meeting. In the October forecasts, the BOJ saw targeted core inflation at 0.0% in FY21, 0.9% in FY22, and 1.0% in FY23, suggesting no urgency to tighten. FY24 will be added to the forecast horizon at the April 28 meeting but is unlikely to show a significant rate from FY24.

And that’s why the Bank of Japan is clearly not concerned about inflation risks. The bank just delivered a dovish hold last week, announcing plans to pare back its commercial paper and corporate bond holdings over the next five years whilst extending its loan support program to small- and medium-sized firms for another six months through September. Governor Kuroda acknowledged the slow pace of policy normalization, saying “Each country decides their monetary policy seeking stability in their economy and prices. It’s only natural that there’ll be directional differences.”

Reserve Bank of Australia minutes will be released Tuesday. At that meeting, rates were kept steady at 0.10% and QE was maintained at the current weekly pace of AUD4 bln until the planned review at the next meeting February 1. At that meeting, the bank said it is prepared to be patient and won’t hike rates until inflation is sustainably within its target range. The bank also said it was likely to take some time to meet the conditions for a rate hike, as inflation pressures are lower in Australia compared to other countries. However, the bank felt that omicron is unlikely to derail the recovery.

Since then, the data have improved and there is a chance that the RBA will end QE altogether in February. Governor Orr said as much last week and the jobs data backed him up, with the unemployment rate falling to 4.6% in November. Thus, the labor market has basically recouped its losses stemming from the autumn lockdowns and the unemployment rate is approaching an area (low 4s) where the RBA believes wage pressures will pick up. The swaps market is now pricing in nearly 75 bp of tightening over the next twelve months, which seems too aggressive to us. Updated forecasts will come February 1 and would have to show significant upward revisions to the macro outlook from November to justify this expected tightening cycle.

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