Dollar Drifts Lower Ahead of CPI

January 11, 2024

Win Thin

December CPI data take center stage; financial conditions continue to loosen; Fed officials remain cautious; Peru is expected to cut rates 25 bp to 6.5%
Italy and Spain reported mixed November IP data; Riksbank Deputy Governor Jansson speaks today; Norges Bank released its Q4 2023 survey of bank lending
BOJ sees uncertainty in wage growth; Australia reported mixed November trade data; Korea kept rates steady at 3.5%, as expected

The dollar continues to drift ahead of CPI data. DXY is trading lower for the second straight day near 102.236. The euro is trading higher near $1.0980 while sterling is trading higher near $1.2765. USD/JPY is trading lower despite the soft wage outlook that has pushed BOJ lift off expectations out to September (see below). While U.S. economic data have mostly come in on the firm side, current market easing expectations for the Fed still need to adjust significantly. Until that happens, the dollar remains vulnerable. Perhaps today’s U.S. CPI data will provide some impetus.

AMERICAS

December CPI data take center stage. Headline is expected to pick up a tick to 3.2% y/y while core is expected to fall two ticks to 3.8% y/y. The Cleveland Fed’s inflation Nowcast model estimates the December headline and core y/y rates at 3.3% and 3.9%, respectively. For January, it sees 3.0% and 3.8%, respectively. However, this model has consistently overstated inflation in recent months. PPI will be reported tomorrow. Headline is expected to pick up four ticks to 1.3% y/y while core is expected to remain steady at 2.0% y/y.

Financial conditions continue to loosen. The Chicago Fed’s weekly measure of financial conditions loosened last week for the 12th straight week and are the loosest since the first week of February 2022. So far this week, equities are up, bond yields are down, high yield spreads have narrowed, and the dollar has softened. If these trends continue after the inflation data, we are likely to get a 13th straight week of looser financial conditions. This trend should keep the economy humming along in Q1 and in turn, this may limit the improvement in inflation in the coming months.

Fed officials remain cautious. Williams reiterated that “I expect that we will need to maintain a restrictive stance of policy for some time to fully achieve our goals, and it will only be appropriate to dial back the degree of policy restraint when we are confident that inflation is moving toward 2% on a sustained basis.” He added that “my expectation is interest rates will also come down over time.” Of note, Williams pushed back against expectations that the Fed will slow and then stop the decline in the size of the balance sheet. Williams pointed out that “In its plans, the FOMC said that to ensure a smooth transition it intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves. So far, we don’t seem to be close to that point.” We concur.

Weekly jobless claims and December budget statement will also be reported. Initial claims are expected at 210k vs. 202k last week. Next week’s initial claims data will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for January NFP, but its whisper number stands at 152k vs. 216k in December. Continuing claims are reported with a one-week lag and are expected at 1.870 mln vs. 1.855 mln last week. Lastly, a deficit of -$87.5 bln is expected vs. -$85.0 bln in November.

Peru central bank is expected to cut rates 25 bp to 6.5%. At the last policy meeting December 14, the central bank cut rates 25 bp for the fourth straight time to 6.75% and said, “We forecast that annual inflation will reach the target band within the coming months, and that annual inflation excluding food and energy will hit the target band at the end of 2023.” This suggests the easing will continue. Bloomberg consensus sees the policy rate falling to 6.25% in Q1, 5.5% in Q2, 5.0% in Q3, and 4.75% in Q4.

EUROPE/MIDDLE EAST/AFRICA

Italy and Spain reported mixed November eurozone IP data. Italy came in at -1.5% m/m vs. -0.2% expected and actual in October, while Spain came in at 1.0% m/m vs. 0.2% expected and a revised -1.4% (was -1.5%) in October. The y/y rate for Italy worsened from October but improved for Spain to -3.1% and 0.8%, respectively. Eurozone-wide IP will be reported Monday,

European Central Bank easing expectations remain elevated. We believe the eurozone disinflationary backdrop and weak economic growth outlook reinforce the case for the ECB to start cutting rates in Q2 and this is a clear headwind for euro. WIRP suggests 5% odds of a cut January 25, rising to 40% March 7 and fully priced in April 11. 125 bp of easing is fully priced in, with some odds of another cut on top of that. Vujcic speaks twice today. Last week, Vujcic highlighted that the eurozone will avoid a recession, inflation will slow gradually, and discussion on ECB policy rate cuts are unlikely before the summer. A

Riksbank Deputy Governor Jansson speaks today. He will discuss the economic situation and current monetary policy. The economy is slowing, and interest rate futures are pricing roughly 125 bp of easing this year. This seems too aggressive considering the potential for domestic demand in Sweden to pick up gradually in 2024. Indeed, consumer confidence has recovered from its October 2022 low and the decline in inflation will lead to an increase in real disposable household income and underpin higher consumption. Deputy Governor Bunge speaks tomorrow.

Norges Bank released its Q4 2023 survey of bank lending. It did not have any material impact on NOK or Norway’s OIS curve. The survey highlighted that households and corporates have ample access to credit as overall credit standards were approximately unchanged in Q4, and banks expect the same for Q1. Still, household credit demand fell somewhat in Q4, and banks expect a further fall in Q1. Regardless, there is room for interest rate futures to curtail expectations for Norges Bank easing totaling 100 bp over the next 12 months). We believe higher real wage growth in 2024 will help soften the expected decline in economic activity this year. The Norges Bank projects real wages to rise by 0.60% in 2024 following -0.03% in 2023 and -1.46% in 2022.

ASIA

Bank of Japan sees uncertainty in wage growth. After its quarterly hearings with its branch managers on wage trends, the bank wrote that “There are many companies that haven’t decided the rate of pay increases at this point. Many reports pointed to high uncertainties over the extent and spread of wage gains, especially among small businesses.” Of note, November nominal earnings came in at 0.2% y/y vs. 1.5% expected and actual in October, while real earnings came in at -3.0% y/y vs. -2.0% expected and -2.3% in October. Nominal earnings rose at the slowest rate since December 2021 while real earnings fell the most since April. The BOJ has been signaling it would like to see how the spring wage deals go before shifting policy. Liftoff keeps getting pushed out and is now fully priced in for September vs. July at the start of this month and June at the start of December. This is likely to keep upward pressure on USD/JPY.

Australia reported mixed November trade data. Exports rose 1.7% m/m vs. a revised 0.8% (was 0.4%) in October, while imports plunged -7.9% m/m vs. a revised -2.9% (was -1.9%) in October. In y/y terms, exports improved to -8.2% vs. -12.0% in October while imports weakened to -4.8% vs. 1.4% in October. The drop in imports was surprising given the 2.0% m/m gain in retail sales that month. WIRP suggests 10% odds of a cut February 6, rising to 33% March 19, 45% May 7, 75% June 18, and priced in August 6. Two cuts are priced in for 2024 vs. three at the start of last week.

Bank of Korea kept rates steady at 3.5%, as expected. It appears rates have peaked, as the bank removed the phrase “need to raise base rate further” from the policy statement. Governor Rhee said the bank finds it premature to even talk about rate cuts. He added that the bank sees the rate staying high for a “considerable period” and stressed that it would be hard to cut rates for at least the next six months. However, the swaps market is pricing in steady rates over the next three months followed by 25 bp of easing over the subsequent three months.

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