- Recent developments support our view that market had gotten too optimistic about the two major market drivers; Fed Chair Powell’s speech today will be the highlight
- Germany reported weak December IP; BOE policymakers Ramsden, Pill, and Cunliffe speak
- Japan reported December cash earnings and household spending data; RBA hiked rates 25 bp to 3.35%, as expected; Australia also reported soft December trade data; Taiwan reported weak January trade data
The dollar is firm in the wake of Friday’s jobs report. DXY is up for the fourth straight day and traded near 103.794, the highest since January 9. It has recovered nearly two thirds of this year’s drop and a break above 103.793 would set up a test of the January high near 105.631. The euro is trading at the lowest since January 9 near $1.07 and a break below $1.0695 would set up a test of the January 6 low near $1.0485. Sterling is underperforming again and trading below $1.20 for the first time since January 6. It is on track to test that day’s low near $1.1840. The 200-day moving average near $1.1950 may provide some near-term support. USD/JPY traded yesterday at the highest since January 6 near 132.90 but has fallen back to trade near 132.15 today. The pair remains on track to test the January 6 high near 134.75.
Recent developments support our view that market had gotten too optimistic about the two major market drivers: monetary policy pivots and China reopening. The China reopening story will be address in the sections below, but recent data suggest that it has not had much impact on regional trade and activity. With regards to monetary policy, the RBA hiked 50 bp overnight and is showing no signs of a pause whatsoever. Markets are pricing in “higher for longer” Down Under and that notion is spreading. Recent strong U.S. data confirms our long-standing belief that markets had been underestimating the Fed. WIRP now suggests a 25 bp hike March 22 is nearly priced in, while another 25 bp hike May 3 is nearly 80% priced in, and a third 25 hike in either June or July has odds around 20% and rising. If we get that second hike, which seems very likely, that takes the Fed Funds target range up to 5.0-5.25%, which is where the December Dot Plots put it by year-end. A third hike takes us above the Plots. Yet markets are still pricing in Fed easing in H2. Let that sink in. We still have a ways to go to get to peak Fed Funds rate, and yet folks are still looking for H2 rate cuts in what would be an extremely quick turnaround.
Fed Chair Powell’s speech today will be the highlight. It will be interesting to see if he tries to do any damage control. His press conference last week left a lot to be desired and in the wake of the strong data Friday, Powell may have to change his tone. Indeed, the biggest surprise to us was that Powell did not push back against recent loosening of financial conditions. Will he course-correct or will he simply let the data do the talking for him? Stay tuned. Barr also speaks today. Yesterday, Bostic commented on recent firm data and noted “It’ll probably mean we have to do a little more work. And I would expect that that would translate into us raising interest rates more than I have projected right now.” He reiterated that his base case remains for the Fed Funds rate to reach 5.1%, in line with the December Dot Plots, and stay there through 2024, which is more hawkish than the Dot Plots, which show 100 bp of easing in 2024. December trade (-$68.5 bln expected) and consumer credit ($25.0 bln expected) will be reported.
Germany reported weak December IP. It came in at -3.1% m/m vs. -0.8% expected and a revised 0.4% (was 0.2%) in November. Elsewhere, Spain also reported IP and it came in at 0.8% m/m vs. 0.2% expected and a revised -0.6% (was -0.7%) in November. Italy reports IP Friday and is expected at 0.2% m/m vs. -0.3% in November. Eurozone IP won’t be reported until February 15. Germany remains the weak link in the eurozone. Furthermore, data out of Asia (see below) support our view that China reopening is not the panacea that markets have priced in. As a result, we remain skeptical that China will do much to boost eurozone growth in the coming months.
Markets are still digesting the ECB decision. WIRP suggests a 50 bp hike March 16 is nearly priced in but then that may be it for the super-sized hikes. Looking further ahead, a 25 bp hike May 4 is priced in followed by another one either June 15 or July 27 that would take the deposit rate up to 3.5%. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand. We have already seen the cracks reappear last week. ECB speakers are plentiful this week. Villeroy and Schnabel speak today.
Bank of England policymakers Ramsden, Pill, and Cunliffe speak today. Markets are still digesting the BOE decision. Tightening expectations have fallen sharply, as WIRP suggests odds of a 25 bp hike March 23 are only around 75%. After that, the odds of a final 25 bp hike in Q2 have risen to around 55% vs. 30% at the start of the week and so the expected terminal rate is between 4.25-4.5%, down from 4.5% at the start of last week and 6.25% after the disastrous mini-budget back in September.
Japan reported December cash earnings and household spending data. Nominal earnings came in at 4.8% y/y, nearly double the expected 2.5% y/y and up from 1.9% in November, while real earnings came in at 0.1% y/y vs. -1.5% expected and -2.5% in November. Nominal wages rose the most since 1997, but high inflation kept weighed on real wage growth, though it turned positive for the first time since March 2022. If sustained, real wage growth would be the missing piece of the puzzle in terms of BOJ tightening. However, more needs to be done as household spending came in weak at -1.3% y/y vs. -0.4% expected and -1.2% in November.
Reserve Bank of Australia hiked rates 25 bp to 3.35%, as expected. Governor Lowe sounded hawkish, noting that “The board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target.” He added that “The board recognises that monetary policy operates with a lag. There is uncertainty around the timing and extent of the expected slowdown in household spending.” Clearly, the RBA is nowhere close to pausing. WIRP suggests nearly 70% odds of a 25 bp hike at the next meeting March 7, while the swaps market is pricing in a peak policy rate near 4.25%, up from 3.75% at the start of this week and 3.90% at the start of last week. More importantly, the tightening cycle has been extended out to 12 months instead of 6 previously, highlighting the “higher for longer” theme. The bank releases its Statement on Monetary Policy Friday, which will contain updated macro forecasts.
Australia also reported soft December trade data. Both exports and imports continued to slow as any boost from China reopening probably won’t be felt until beyond January if Korea and Taiwan are any indication (see below).
Taiwan reported weak January trade data. Exports came in at -21.2 % y/y vs. -20.3% expected and -12.1% in December, while imports came in at -16.6% y/y vs. -18.2% expected and -11.4% in December. Exports were the weakest since 2009 and weak export orders suggest little relief for shipments until mid-year at the earliest. The data also confirm our belief that China reopening is not a magic bullet for global growth and exports, as regional exporters like Taiwan and Korea have clearly seen very little relief so far.