Dollar Firm Ahead of Core PCE Data

January 27, 2023
  • December core PCE will be the data highlight; U.S. rates are creeping higher ahead of the data; Q4 GDP data are worth discussing; December CFNAI shows the economy is growing below trend; Colombia is expected to hike rates 100 bp to 13.0%
  • Spain reported Q4 GDP; Brexit talks are reportedly progressing well; Scottish politics are heating up
  • January Tokyo CPI ran hot; it is becoming harder and harder for the BOJ to justify current accommodation; Australia reported Q4 PPI

The dollar is up modestly ahead of core PCE data. DXY is up modestly for the second straight day and trading just below 102. After making a new cycle low yesterday near 101.504, DXY is on track to test the May low near 101.297. The euro traded at a marginal new cycle high yesterday near $1.0930, just shy of the April high near $1.0935. It is currently trading back below $1.19 but a break above that April high would set up a test of the March high near $1.1185. Sterling is trading lower $1.2365 and is likely to continue underperforming due to the negative fundamental backdrop. USD/JPY is trading lower just below 130 as moves above that level have been hard to sustain. As such, last week’s high near 131.60 remains out of reach for now. China is closed all week for the Lunar New Year holiday. While we believe that the current dollar weakness is overdone, we continue to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain vulnerable.


December core PCE will be the data highlight. Consensus sees 4.4% y/y vs. 4.7% in November. If so, it would be the lowest since October 2021 but still more than double the Fed’s 2% target. Personal income and spending will be reported at the same time and are expected at 0.2% m/m and -0.1% m/m, respectively. December retail sales data came in very weak and so it will be interesting to see if overall spending that includes services also weakened.

U.S. rates are creeping higher ahead of the data. The 2-year yield is trading near 4.22%, up from the low last week near 4.03%, while the 10-year yield is trading near 3.56%, up from the low last week near 3.32%. As a result, the dollar is trading slightly firmer. That said, we see risks of an asymmetrical reaction to the core PCE data; another soft reading would fit into the Fed pivot narrative but a higher than expected reading probably wouldn’t be enough to derail that narrative.

Q4 GDP data are worth discussing. Headline growth came in at 2.9% SAAR vs. 2.6% expected and 3.2% in Q3. Looking at the components, personal consumption came in at 2.1% vs. 2.9% expected and 2.3% in Q3. This isn't too surprising given the weak November and December retail sales. Investment came in at 1.4% SAAR vs. -9.6% in Q3, while government spending came in steady at 3.7% SAAR. Of note, all four major components of GDP contributed to growth, something we haven’t seen since 2019. Atlanta Fed GDPNow model gives us a first look at Q1 today. It does appear that the U.S. economy lost some momentum as we moved into the new year, as evidenced by weakness in the retail sales and IP data reported last week. However, Bloomberg consensus for Q1 growth of 0.1% SAAR seems too low.

December Chicago Fed National Activity Index shows the economy is growing below trend. This series has taken on greater significance now that the 3-month to 10-year curve has inverted deeply. The headline came in at -0.49 vs. -0.51 in November. November was never released and so both months were reported at the same time. A zero reading means the economy is growing at trend and so there have been two straight months of significant below trend growth. The 3-month moving average came in at -0.33 vs. -0.14 in November and is the lowest since March 2020, when the pandemic hit. Recall that when this 3-month average moves below -0.7, it signals imminent recession and we are still above that threshold. That said, it's only a matter of when, not if, the recession hits.

Other minor data will be reported. Pending home sales (-1.0% m/m expected) will be reported along with final January University of Michigan consumer sentiment. Yesterday, new home sales came in at 2.3% m/m vs. -4.4% expected and a revised 0.7% (was 5.8%) in November, while Kansas City Fed manufacturing index came in at -1 vs. -8 expected and -9 in December. The Kansas City Fed reports its services index today, which stood at -5 in December.

Colombia central bank is expected to hike rates 100 bp to 13.0%. However, nearly half of the analysts polled by Bloomberg look for smaller hikes of 50 or 75 bp. At the last meeting December 16, the bank hiked rates 100 bp to 12.0% in a split 4-1-1 vote. The two dissents favored hikes of 25 and 125 bp. Governor Villar warned then that it was nearing the end of its tightening cycle. Of note, the swaps market is pricing in a peak policy rate near 13.0% but much will depend on how inflation evolves in early 2023.


Spain reported Q4 GDP. Growth came in a tick higher than expected at 0.2% q/q vs. a revised 0.2% (was 0.1%), while the y/y rate came in 2.7% vs. 2.2% expected and a revised 4.8% (was 4.4%) in Q3. Q4 GPD data for Germany (flat q/q expected), France (flat q/q expected), Italy (-0.5% q/q expected), and eurozone (-0.1% q/q expected) will all be reported early next week. Let’s see if Germany’s recent optimism about avoiding a recession is warranted. We note that the impact of the 250 bp of ECB tightening so far has yet to be felt, while another 150 bp is in the pipeline.

ECB tightening expectations are little changed. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by nearly 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is about 85% priced in, while a last 25 bp hike in Q3 is about 75% priced in that would see the deposit rate peak near 3.5%. If inflation continues to slow, we think the expected peak rate is likely to move back down to 3.25% as it did last week and perhaps even down to 3.0%, which is where it stood back in mid-December. December M3 data was reported and came in at 4.1% y/y vs. 4.6% expected and 4.8% in November. This was the lowest since January 2019 and bodes ill for economic activity ahead.

Brexit talks are reportedly progressing well. After his first meeting with U.K. Chancellor Hunt, Irish Finance Minister McGrath said the two nations are both determined to secure final agreement on post-Brexit trading arrangements. McGrath noted that negotiations on the Northern Ireland Protocol have reached a new level and added “We discussed at a high level our objective of what we’d like to see by way of an outcome and a need for an agreement.” Lastly, McGrath said European Commissioner Sefcovic and his team are “very anxious to secure agreement to bring a final settlement to this issue.” The tone of the talks have changed completely under Prime Minister Sunak and so we remain optimistic that a deal is reached. However, a deal will by no means mitigate the overall negative impact that Brexit has had on the U.K. economy and so we remain negative sterling from a long-term standpoint.

BOE tightening expectations have fallen. WIRP suggest only 55% odds of a 50 bp hike February 2, down from 85% at the start of this week, while odds of a 25 bp hike March 23 are no longer fully priced in. After that, odds of a final 25 bp hike in June or August top out near 55% that would see the bank rate peak near 4.5%. Last week, Governor Bailey said inflation has peaked and will fall “quite rapidly” in late spring due to largely energy prices.

Scottish politics are heating up. Last week, the U.K. overruled Scotland’s parliament for the first time when it rejected a gender bill that had been passed in Edinburgh. The Sunak government argued that the Scottish bill was in conflict with equality laws that apply across Britain. First Minister and leader of the Scottish National Party Sturgeon warned that this was “a full-frontal attack on our democratically elected Scottish Parliament and its ability to make its own decisions.” However, the impact of the U.K. decision is hard to gauge near-term, as many observers are skeptical that the rejection of the gender bill is enough of an issue to boost pro-independence support within Scotland. Stay tuned.


January Tokyo CPI ran hot. Headline came in at 4.4% y/y vs. 4.0% expected and a revised 3.9% (was 4.0%) in December, core (ex-fresh food) came in at 4.3% y/y vs. 4.2% expected and a revised 3.9% (was 4.0%) in December, and core ex-energy came in at 3.0% y/y vs. 2.9% expected and 2.7% in December. Of note, the core reading is the highest since 1981. This points to upside risks to the national CPI readings, which won’t be released until February 24. Last week, Governor Kuroda remained dovish and said the bank will maintain current policy as he expects inflation to decline starting in February. While some relief may be seen next month due to high base effects and energy subsidies, it’s clear that underlying price pressures remain high.

It is becoming harder and harder for the BOJ to justify current accommodation. WIRP suggests 15% odds of liftoff at the next meeting March 9-10, rising to nearly 50% for the April 27-28 meeting and nearly priced in for the June 15-16 meeting. If markets resume testing the BOJ’s commitment to YCC, we still think it’s possible that it abandons YCC at the March meeting in order to set up liftoff at the April or June meetings.

Australia reported Q4 PPI. Headline came in at 5.8% y/y vs. 6.4% in Q3 and suggests some inflation relief ahead after Q4 CPI data ran hot. Headline CPI inflation came in at 7.8% y/y in Q4 vs. 7.6% expected and 7.3% in Q3, while trimmed mean came in at 6.9% y/y vs. 6.5% expected and 6.1% in Q3. For December alone, headline came in at 8.4% y/y vs. 7.7% expected and 7.3% in November. All these inflation readings are new cycle highs. At the last policy meeting December 6, the Reserve Bank of Australia hiked rates 25 bp to 3.10%. The next policy meeting is February 7 and WIRP suggests 80% odds of a 25 bp hike, while the swaps market is pricing in a peak policy rate near 3.85%, up from 3.55% at the start of this 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 the February meeting.

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