• November CPI will be the data highlight; we see upside risks to CPI and could impact Fed policy expectations further; as it is, short-term rates continue to support the greenback; weekly jobless claims are worth discussing; Peru delivered the expected 50 bp hike yesterday but the communication sounded dovish
  
• Eurozone data came in on the soft side; the ECB is clearly struggling to come up with a consensus for next week’s policy meeting; U.K. October data dump came in soft; recent weakness in the data has led markets to adjust the BOE outlook; Turkey’s expected inflation rose sharply for December, providing yet another leg lower for the lira
• Japan reported higher than expected November PPI; China policymakers are signaling concern with the strong yuan; crypto markets continue to struggle despite no major negative news flows for the sector
  

The dollar is regaining some traction. DXY is up for the second straight day and trading near 96.40. The November cycle high near 96.938 remain in sight as 2-year rate differentials continue to move in the dollar’s favor (see below). The euro bounce ran out of steam near $1.1350 and is back below $1.13 as we continue to look for a test of the November cycle low near $1.1185. Sterling remains under pressure after weak U.K. data dumb (see below) and is trading below $1.32 and on track to test this week’s cycle low near $1.3165. With market sentiment improving, USD/JPY has crept higher but remains below 114 and remains subject to bouts of risk-off selling. We believe the underlying trend for a stronger dollar remains intact.

AMERICAS

November CPI will be the data highlight. Headline inflation is expected at 6.7% y/y vs. 6.2% in October, while core (ex-food and energy) is expected at 4.9% y/y vs. 4.6% in October. If so, headline would be the highest since June 1982 and core the highest since June 1991. Of note, average hourly earnings only rose 4.8% y/y in November vs. 5.0% expected. The Fed Beige Book warned of robust wage gains across most Fed districts and so we expect this series to continue ticking higher, especially with the labor market remaining tight. Preliminary December University of Michigan consumer sentiment (68.0 expected) and November budget statement (-$195.0 bln) will be reported Friday.

We see upside risks to CPI and could impact Fed policy expectations further. The Fed is widely expected to announce a faster pace of tapering next week. The debate surrounding actual liftoff remains unsettled, though, as markets are steadily moving the timetable up. Q2 liftoff is now fully priced in, as are subsequent hikes in Q3 and Q4. What strikes us as odd is that the terminal rate is currently 1.50%. If inflation returns to the 2% target, this will imply a negative real rate at the end of a Fed tightening cycle, which is something unheard of. If the labor market is as tight as we fear, it seems that the risks to the terminal rate are tilted to the upside. When markets realize this, that should give the dollar another leg higher.

As it is, short-term rates continue to support the greenback. The 2-year yield is trading at a new cycle high near 0.72% today. The 2-year differential with Germany is at 141 bp, with Japan at 82 bp, and with the U.K. at -29 bp, all at new highs (lows) for this move. We see this trend continuing, though we remain puzzled why the long end of the U.S. curve remains so depressed. We will explore this in a longer note.

Weekly jobless claims are worth discussing. Initial claims are expected at 225k vs. 222k the previous week and continuing claims are expected at 1.91 mln vs. 1.956 mln the previous week. As we noted last week, the four-week moving average for initial claims is now 239k, the lowest since March 2020. If we get a couple more readings near 200k, that 4-week moving average will be pulled lower to levels we haven't seen since 2019 and 2020, when the U.S. was last at full employment. Bottom line: we are closer to full employment than we thought and that will likely start showing up even more in the wage numbers.

Peru central bank delivered the expected 50 bp hike yesterday but the communication sounded dovish. While the door remains open for further hikes, it will not necessarily happen in consecutive meeting as the outlook still requires an accommodative stance. The bank expects inflation to fall back to the 1-3% target range in H2 of next year but growth will remain below potential. There was little price action following the announcement. Peru’s rate is now on par with Colombia’s, and just under Chile at 2.75%. However, both those central banks are in the midst of aggressive tightening cycles and so Peru may start to lag in terms of policy.

EUROPE/MIDDLE EAST/AFRICA

Eurozone data came in on the soft side. Spanish October IP came in at -0.4% m/m vs. 0.3% expected and a revised flat reading (was 0.3%) in September. Elsewhere, Italian IP came in at -0.6% m/m vs. 0.3% expected and 0.1% in September. Recall German IP surprised to the upside at 2.8% m/m, as did French at 0.9% m/m. The recovery in the eurozone remains uneven and is likely to get worse as the virus numbers rise. Eurozone IP will be reported next Tuesday and is expected at 1.3% m/m vs. -0.2% in September.

The ECB is clearly struggling to come up with a consensus for next week’s policy meeting. By all accounts, the bank is focusing on ending PEPP as planned in March whilst softening the blow by announcing a period of increased purchases under its regular APP. The devil is in the details, however, and we think it’s possible that the ECB defers its decision until the February 3 meeting, when more information will be available about the economy and the impact of omicron. Lagarde, Weidmann, Villeroy, Panetta, and Elderson all speak today and may provide some more hints about what to expect next week.

The U.K. October data dump came in soft. October GDP, IP, construction and services, and trade were all reported. GDP rose 0.1% m/m vs. 0.4% and 0.6% in September, IP fell -0.6% m/m vs. 0.1% expected and -0.4% in September, construction fell -1.8% m/m vs. 0.2% expected and 1.3% in September, and services rose 0.4% m/m as expected vs. 0.7% in September. The trade deficit came in at -GBP2.03 bln vs. -GBP2.42 bln expected. Of note, this data is from before the recent rise in virus numbers and so the economy is going into this winter wave with weakening momentum.

Recent weakness in the data has led markets to adjust the Bank of England tightening outlook. Odds of a December 16 hike are now less than 1 in 5 and slightly less than 90% for a February 3 hike, both well off recent highs. We see no hike next week and believe risks are building for no hike in February, though this will be dictated by upcoming data. Complicating matters for the bank is a steady rise in inflation expectations. Bank of England consumer survey shows the median estimate for inflation over the next twelve months rose to 3.2%, up from 2.7% in August and the highest since 2019. When asked is the BOE was “doing its job to set interest rates to control inflation,” the so-called net satisfaction balance (the proportion satisfied minus the proportion dissatisfied) was 14%, the lowest since 2012.

Turkey’s expected inflation rose sharply for December, providing yet another leg lower for the lira. Forecasts for inflation 12 months forward rose from 15.61% to 21.39%. The survey also showed estimates for the benchmark 1-week repo rate at 14.53% for year-end and USDTRY at 13.77 (up from 9.98), which looks very optimistic. Nothing too surprising here given the magnitude of the inflation pass-through in the pipeline from the weaker currency. USDTRY is just under 14, having weakened almost about 2% this week. Central bank policy meeting next Thursday will likely be the catalyst for the next move lower for the lira, as consensus sees another 100 bp cut to 14% despite the deteriorating conditions.

ASIA

Japan reported higher than expected November PPI. It was expected to rise 8.5% y/y but instead rose 9.0% vs. a revised 8.3% (was 8.0%) in October. However, this tells us nothing about November CPI due out December 24. As we’ve noted before, the PPI pass-through to the CPI remains minimal as firms’ pricing power has been destroyed by decades of deflation. Both headline and targeted core CPI rose only 0.1% y/y in October, well below the 2% target. For now, the Bank of Japan will remain on hold. Next policy meeting is December 16-17 and no change is expected. Reports suggest the bank will announce that its corporate lending programs will expire as scheduled in March, but we think this is more likely at the January 18 meeting due to the potential impact of the omicron variant.

China policymakers are signaling concern with the strong yuan. The PBOC yesterday raised foreign exchange reserve requirements for its commercial banks. Banks will now need to hold 9% of their foreign exchange in reserve starting December 15, up two percentage points and the second increase this year. The move effectively removes dollars and other foreign currency from circulation and should be seen as a signal that the yuan is viewed as getting too strong. The PBOC daily fixing yesterday was much weaker than expected and today’s fix was as well, which is also a signal of concern. We've been puzzled by the recent yuan gains even as broader EM FX continued to weaken and so perhaps the yuan will finally play some catch-up.

ALTERNATIVE INVESTMENTS

Crypto markets continue to struggle despite no major negative news flows for the sector. We suspect that the correlation with tech has been the main near-term driver. Like any financial asset, crypto will suffer from broad market moves. In particular, crypto (proxied by bitcoin) this year seems to do better during periods when tech is outperforming. We can see this using a ratio of Nasdaq/S&P500. This correlation may be driven by a similar investor base, or simply because both assets tend to be higher beta. Whatever the case, we suspect this correlation will loosen eventually, especially for non-BTC cryptocurrencies.