Dollar Continues to Firm as FOMC Meeting Begins

January 31, 2023

Win Thin

The two-day FOMC meeting begins today and end tomorrow with an expected 25 bp hike; we get lots of labor market data this week; we get more January survey readings today; Canada reports November GDP; Colombia central bank minutes will be released
France reported January CPI data; eurozone reported firm Q4 GDP data; Germany and France reported weak December retail sales; the U.K. news stream is unrelentingly negative
Japan reported December labor market data; Australia reported weak data; China reported firm official January PMI readings; Taiwan reported December export orders

The dollar continues to firm as the FOMC meeting gets under way. DXY is up for the fourth straight day and traded near 102.607, the highest since January 18 and on track to test that day’s high near 102.899. After that is the January 10 high near 103.49. The euro traded as low as $1.08 today before seeing a modest bounce. However, it remains on track to test the January 18 low near $1.0765. Sterling is trading lower and tested the $1.23 area. It is likely to underperform due to the negative fundamental backdrop (see below). USD/JPY is edging higher to trade near 130.50 and is likely to eventually test the January 18 high near 131.60. While we are happy to see the dollar get some traction recently, We believe that until a more hawkish Fed narrative takes hold, the dollar is likely to remain vulnerable to renewed weakness. Perhaps this week’s FOMC will provide the much-needed spark for the next leg higher in this dollar rally.

AMERICAS

The two-day FOMC meeting begins today and end tomorrow with an expected 25 bp hike. That is the safe choice right now and we see no need for the Fed to deviate from its cautious path. However, the hard part for the Fed will be convincing the markets that they are wrong about its perceived pivot. The Fed will leave the door wide open for further rate hikes and Chair Powell will stress that the Fed is prepared to continue hiking rates beyond 5% and keep them there until 2024, as the December Dot Plots showed. As things stand, the Fed is expected to start an easing cycle in H2 and we view that as highly unlikely and the Fed will have to continue pushing back at this notion. New Dot Plots and macro forecasts won’t come until the March 21-22 meeting. We will send out a more detailed FOMC Preview this morning.

We get lots of labor market data this week. Q4 employment cost index will be reported today and is expected at 1.1% q/q vs. 1.2% in Q3. Of course, the January jobs report will be the data highlight. Consensus sees 185k jobs added vs. 223k in December, with the unemployment rate seen up a tick to 3.6% and average hourly earnings at 4.3% y/y vs. 4.6% in December. Ahead of that, ADP reports its private sector jobs estimate tomorrow and is expected at 170k vs. 235k in December. December JOLTS data will also be reported tomorrow and expected at 10.293 mln vs. 10.458 mln in December. The labor market picture will be rounded out by January Challenger job cuts, Q4 unit labor costs, and weekly jobless claims that will all be reported Thursday. All in all, the labor market remains tight and it’s hard to see how wage pressures can fall that much further given this tightness.

We get more January survey readings. Dallas Fed services index and Chicago PMI will be reported today, with the latter expected to remain steady at 45.1. Yesterday, Dallas Fed manufacturing index came in at -8.4 vs. -15.0 expected and a revised -20.0 (was -18.8) in December. ISM manufacturing will be reported tomorrow, with headline expected at 48.0 vs. 48.4 in December. Prices paid component is expected at 41.8 vs. 39.4 in December. ISM services will be reported Friday, with headline expected at 50.5 vs. 49.2 in December. November FHFA and S&P CoreLogic house price indices and January Conference Board consumer confidence (109.0 expected) will also be reported today.

Canada reports November GDP. Growth is expected to remain steady at 0.1% m/m, while the y/y rate is expected at 2.7% vs. 3.1% in October. Bank of Canada tightening expectations have eased after it hiked rates 25 bp to 4.5% last week and signaled a pause. In light of the bank’s pause, the swaps market is now pricing in steady rates in H1 followed by the start of an easing cycle in H2. Recent data have come in firm and so we do not think the tightening cycle is over by any stretch. Indeed, if the economy remains firm, we see risks of a peak policy rate that’s higher than the 4.5% that markets are pricing in now. Of note, Governor Macklem stressed that it’s still “far too early to be talking about cuts.” We concur.

Colombia central bank minutes will be released. Last Friday, the bank delivered a dovish surprise and hike rates 75 bp to 12.75% vs. 100 bp expected. The vote was 5-2 with the two dissents in favor of a smaller 25 bp move. Governor Villar signaled that the tightening cycle is nearing an end by noting “With today’s decision, monetary policy is nearing the stance required to cause inflation to slow to its 3% over the medium term.” The swaps market is pricing a peak policy rate between 13.5-13.75% in H1 followed by the start of an easing cycle in H2. January CPI will be reported Saturday. Headline is expected at 13.25% y/y vs. 13.12% in December. If so, it would be the highest since March 1999 and further above the 2-4% target range.

EUROPE/MIDDLE EAST/AFRICA

France reported January CPI data. Its Eu Harmonised inflation came in as expected at 7.0% y/y vs. 6.7% in December. Germany’s CPI report was delayed until next week and its EU Harmonised inflation is expected at 10.1% y/y vs. 9.6% in December. Yesterday, Spain reported EU Harmonised inflation at 5.8% y/y vs. 4.8% expected and 5.5% in December. Italy reports tomorrow and its EU Harmonised inflation is expected at 10.7% y/y vs. 12.3% in December. Eurozone also reports tomorrow, with headline expected at 8.9% y/y vs. 9.2% in December and core expected at 5.1% y/y vs. 5.2% in December. Accelerating inflation in both France and Spain means that the ECB hawks remain in control of the narrative, at least for now.

The European Central Bank meets Thursday and is expected to hike all rates by 50 bp. WIRP suggests over 80% odds of another 50 bp hike March 16. A 25 bp hike May 4 is fully priced in, as is a last 25 bp hike in Q3 that would see the deposit rate peak near 3.5%. In light of upside inflation risks, we expect the ECB to maintain its hawkish stance and for President Lagarde to stick with her existing forward guidance that points to a 50 bp hike at the March 16 meeting as well, when updated macro forecasts will be released.

Eurozone reported firm Q4 GDP data. Bloc-wide GDP came in at 0.1% q/q vs. -0.1% expected and 0.3% in Q3, which led the y/y rate to come in at 1.9% vs. 1.7% expected and 2.3% in Q3. It appears that the optimists are winning the argument and that the eurozone can avoid recession. That said, Q1 is expected to show weakness and we note that much of the ECB’s tightening has not yet been felt, with another 150 bp in the pipeline. Looking at the country breakdown, France came in at 0.1% q/q vs. flat expected and 0.2% in Q3, while Italy came in at -0.1% q/q vs. -0.2% expected and 0.5% in Q3. Spain and Germany already reported Q4 GDP previously. Spain came in a tick higher than expected at 0.2% q/q while Germany came in at -0.2% q/q vs. flat expected.

Eurozone countries reported weak December retail sales. Sales came in at -5.3% m/m vs. -0.2% expected and a revised 1.9% (was 1.1%) in November. As a result, the y/y plunged to -6.4%, the worst since June. Elsewhere, France reported December consumer spending at -1.3% m/m vs. 0.3% expected and a revised 0.6% (was 0.5%) in November, which led the y/y rate to fall to -5.6% vs. a revised -5.1% (was -5.2%) in November. Eurozone retail sales will be reported next Monday and there are clear downside risks after the two largest economies posted disappointing readings. Indeed, it’s hard to see how the eurozone avoided contraction in Q4 given such weak consumption data.

The U.K. news stream is unrelentingly negative. Where to start? First, it slipped seven places to 18 in Transparency International’s Corruption Perceptions Index as the watchdog noted that scandals ranging from lobbying to ministerial misconduct “highlighted woeful inadequacies in the country’s political integrity systems.” Second, the IMF’s updated forecasts suggest the U.K. will be the only G-7 economy to go into recession this year and will see the slowest growth in 2024. Third, reports suggest senior doctors may join the ongoing strikes, further crippling the health care system. Lastly, Bloomberg analysis suggests Brexit is costing the U.K. around GBP100 bln per year in lost output and that GDP is around 4% smaller as a result. All of these stories encapsulate why we remain bearish on sterling. YTD, cable is the second best performer against the dollar but we expect underperformance to pick up as reality bites.

The Bank of England meets Thursday and is expected to hike rates by 50 bp. However, nearly a third of the analysts polled by Bloomberg see a smaller 25 bp move. WIRP suggest nearly 80% odds of a 50 bp hike, down slightly from 85% at the start of last week, while a 25 bp hike March 23 is now fully priced in. After that, odds of a final 25 bp hike August 3 come in at nearly 90% that would see the bank rate peak near 4.5%. Recall that for the 50 bp hike at the last meeting December 15, , the 6-3 vote was surprising in that Dhingra and Tenreyro voted to keep rates steady and Mann voted for a larger 75 bp move. Updated macro forecasts will be released this week.

ASIA

Japan reported December labor market data. Unemployment remained steady as expected at 2.5%, while the job-to-applicant ratio was steady at 1.35 vs. 1.36 expected. We know that BOJ officials are focused on wage growth and believe that greater wage pressures are needed before the bank can feel comfortable about meeting its 2% inflation target “sustainably.” Despite the relatively tight labor market, wage growth has lagged inflation. We’ll know more after December cash earnings are reported next Tuesday. Next policy meeting is March 9-10 and while liftoff then is unlikely then, we believe it’s possible that Yield Curve Control is eliminated than in order to set the table for eventual liftoff at either the April 27-28 or June 15-16 meetings, where WIRP suggests odds currently stand near 45% and 95%, respectively.

Other real sector data were mixed. December retail sales, housing starts, IP, and January consumer confidence were reported. Sales came in at 1.1% m/m vs. 0.7% expected and -1.3% in November, while IP came in at -0.1% m/m vs. -1.0% expected and 0.2% in November. Housing starts came in at -1.7% y/y vs. 0.4% expected and -1.4% in November, while confidence came in at 31.0 vs. 30.5 expected and 30.3 in December. The data suggest that domestic demand is holding up even as weaker external demand hits IP.

Australia reported weak December retail sales, private sector credit, and January CoreLogic house price index. Sales came in at -3.9% m/m vs. -0.2% expected and a revised 1.7% (was 1.4%) in November, while credit growth came in at 0.3% m/m vs. 0.5% expected and actual in November. Despite the soft data, RBA tightening expectations remain steady. The next policy meeting is February 7 and WIRP suggests nearly 80% odds of a 25 bp hike, while the swaps market is pricing in a peak policy rate near 3.90%, up from 3.55% at the start of last week. Given that inflation is still rising despite the 300 bp of tightening seen so far, we believe there are upside risks to the expected terminal rate. Updated macro forecasts will come at that February meeting.

China reported firm official January PMI readings. Manufacturing came in as expected at 50.1 vs. 47.0 in December, while non-manufacturing came in at 54.4 vs. 52.0 expected and 41.6 in December. As a result, the composite jumped over ten points to 52.9 vs. 42.6 in December. Caixin reports its manufacturing PMI tomorrow and is expected at 49.8 vs. 49.0 in December. Its services and composite PMIs will be reported Friday, with services expected at 51.0 vs. 48.0 in December. The rebound from December is to be expected; the bigger question is whether the rebound can be sustained beyond just a month or two.

Taiwan reported weak December export orders. Orders came in at -23.2% y/y vs. -25.0% expected and -23.4% in November. This was the first acceleration since September but still points to weak shipments in H1. Korea reports January trade data tomorrow. Exports are expected at -11.1% y/y vs. -9.6% in December, while imports are expected at -2.6% y/y vs. -2.5% in December. While China’s reopening should help the regional exporters recover, the nation’s increasingly inward-looking stance suggests that relief for its neighbors may be limited.

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