Dollar Firm as New Week Begins

February 05, 2024

Win Thin

Fed Chair Powell stuck to his cautious stance; growth remains strong in Q1; Fed’s SLOOS will be reported; ISM services PMI will be the data highlight
Final eurozone January services and composite PMIs were reported; data continue to show Germany as the weak link in the eurozone; BOE Chief Economist Pill speaks today; U.K. labor market may be tighter than we thought; Turkey reported January CPI
BOJ conducted bond buying operations to limit a spike in repo rates; Australia reported some firm data; Caixin reported January services and composite PMIs

The dollar rally is carrying over from last week. DXY is trading higher for the second straight day near 104.298, the highest since November 17. Break above 104.632 is needed to set up a test of the November 1 high near 107.113. The euro is trading lower and testing a key retracement objective near $1.0755. Break below sets up a test of the November 1 low near $1.0515. Sterling is trading lower near $1.2575 and is on track to test the December lows near $1.25. USD/JPY is tested the January high near 148.80 but has since fallen back to trading flat near 148.40. When all is said and done, developments last week support our view that the Fed is unlikely to cut rates anytime soon. Recent data have mostly come in on the firm side and so we continue to believe that the current market easing expectations for the Fed still need to adjust significantly. These expectations have started to shift but more needs to be seen, even after the Fed’s hawkish hold and January jobs data.

AMERICAS

Markets are still digesting last week’s fundamental developments. The Fed’s hawkish hold was completed justified by the blockbuster jobs report. Simply put, the U.S. economy continues to run hot and it’s hard to justify a rate cut anytime soon. Odds of a March cut have fallen just below 20% from being fully priced in at the start of 2024. A May cut is no longer seen as a sure thing either, with odds falling to around 75%. A total 125 bp of easing is still priced in for 2024, however, and so while the repricing process has begun, there is a long way to go still. When markets finally capitulate on the dovish Fed outlook, the dollar should see another leg higher.

Fed Chair Powell stuck to his cautious stance. In a television interview Sunday, he said that the “danger of moving too soon is that the job’s not quite done, and that the really good readings we’ve had for the last six months somehow turn out not to be a true indicator of where inflation’s heading.” Powell added that “We don’t think that’s the case. But the prudent thing to do is to, is to just give it some time and see that the data continue to confirm that inflation is moving down to 2% in a sustainable way.” Interestingly, Powell downplayed the risk of a commercial real estate-led banking crisis. Powell pointed out that while some smaller and regional banks have concentrated exposures in these areas that are challenging, the problem is “manageable”, and the Fed is doing a lot to manage it. Goolsbee and Bostic speak today.

Growth remains strong in Q1. The Atlanta Fed’s GDPNow model’s first update came in at 4.2% SAAR vs. the first estimate of 3.0%. The early estimates are often volatile, and the next update comes Wednesday after the data. Elsewhere, the New York Fed’s Nowcast model’s Q1 estimate stands at 3.3% SAAR vs. 2.8% previously and will be updated Friday. Its estimates for Q2 will begin in early March.

The Fed’s Senior Loan Officer Opinion Survey (SLOOS) will be reported. It will be an interesting read, particularly following the recent concerns over U.S. regional banks’ commercial property loan exposures. The October SLOOS indicated that in Q3, the majority of banks (mostly banks other than the large ones) reported tightening loan standards and weaker demand for all types of commercial real estate (CRE) loans.

ISM services PMI will be the data highlight. Headline is expected at 52.0 vs. 50.5 in December. Keep an eye on employment and prices paid, which stood at 43.8 and 56.7 in December, respectively. The preliminary S&P Global services PMI came in at 52.9 vs. 51.4 in December and is consistent with a solid expansion in services activity.

EUROPE/MIDDLE EAST/AFRICA

Final eurozone January services and composite PMIs were reported. Final headline readings were unchanged from the preliminary at 48.4 and 47.9, respectively. Looking at the country breakdown, the German composite fell a tick from the preliminary to 47.0 while the French composite rose four ticks to 44.6. Italy and Spain reported for the first time and their composite PMIs came in at 50.7 and 51.5, respectively. Both showed significant improvement from December.

Data continue to show Germany as the weak link in the eurozone. Germany reported December trade data. Exports came in at -4.6% m/m vs. -2.8% expected and a revised 3.5% (was 3.7%) in November, while imports came in at -6.7% m/m vs. -1.9% expected and a revised 1.5% (was 1.9%) in November. Factory orders will be reported tomorrow and are expected at -0.2% m/m vs. 0.3% in November. IP will be reported Wednesday and is expected at -0.5% m/m vs. -0.7% in November.

Bank of England Chief Economist Pill speaks today. Pill will likely reiterate that the BoE discussion about future policy has shifted from whether monetary policy is restrictive enough to how long to maintain the current restrictive stance. Bank of England easing expectations have fallen slightly after last week’s hold. The market now sees 100 bp of rate cuts this year vs. 125 bp before the decision. In our view, the risk is that the BOE does not deliver this much easing, partly because the projected UK fiscal drag in 2024 will likely be softer as Chancellor Hunt is expected to announce pre-election tax cuts at the March 6 Spring Budget.

The U.K. labor market may be tighter than we thought. The ONS will reinstate the reweighted Labour Force Survey (LFS) starting February 13. According to the ONS, the reweighted estimates suggest that over the last five months, the unemployment rate may have fallen more quickly than the experimental indicator suggested (3.9% versus 4.2%). This suggests that wage pressures may be more persistent, though we note that ongoing challenges with response rates and levels mean that LFS-based labor market statistics will be viewed as still in development until further review. Final January services and composite PMIs rose from the preliminary readings to 54.3 and 52.9, respectively. BRC retail sales will be reported later today.

Turkey reported January CPI. Headline came in at 64.86% y/y vs. 64.56% expected and 64.77% in December, while core came in at 70.48% y/y vs. 68.80% expected and 70.64% in December. The stickiness in core inflation is concerning. So is the abrupt resignation of central bank Governor Erkan, but incoming Governor Karahan said, “We are determined to maintaining the necessary monetary tightness until inflation falls to levels consistent with our target.” The current policy rate of 45% is nowhere near high enough to lower inflation and stabilize the lira, and yet the market is already pricing in 150 bp of easing over the next three months followed by more aggressive cuts over the next three years that see the policy rate bottoming around 16.5%. The central bank releases its quarterly inflation report Thursday.

ASIA

The Bank of Japan conducted bond buying operations to limit a spike in repo rates. The bank offered to purchase JPY5 trln of bonds and bond futures today and JPY4 trln tomorrow at a minimum yield of -0.1%. This was the first time the BOJ has done this since July, but the bank will likely have to conduct more operations as liftoff approaches in order to limit market volatility.

Australia reported some firm data. Final January services and composite PMIs came in at 49.1 and 49.0, respectively. Both were up around a point from December. December trade data were also reported. Exports rose 1.8% m/m vs. 1.7% in November, while imports rose 4.8% m/m vs. a revised -8.4% (was -7.9%) in November. Both y/y rates improved from November. Of note, exports to China rose 14.7% y/y.

Caixin reported January services and composite PMIs. Services came in at 52.7 vs. 53.0 expected and 52.9 in December. As a result, its composite PMI fell a tick to 52.5. Meanwhile, in effort to stabilize the selloff in Chinese stocks, the China Securities Regulatory Commission vowed again on Sunday to guide more medium- and long-term funds into the market and crack down on illegal activities such as malicious short selling and insider trading. Of note, the CSI 300 index is down -6.7% YTD, including over -3% in the last five trading days. Until the underlying fundamentals shift, such support measures are unlikely to have any lasting impact.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.