Dollar Firms as U.S. Returns from Holiday

January 17, 2023
  • U.S. financial conditions continue to loosen; we continue to believe markets are underestimating the Fed; regional Fed manufacturing surveys for January start rolling out; Canada highlight will be December CPI; BOC Q4 business outlook survey was released yesterday and came in weak
  • Germany reported firm January ZEW readings; ECB officials remain hawkish; the U.K. reported mixed labor market data; BOE tightening expectations remain steady
  • The two-day BOJ started today and ends tomorrow; new forecasts will be released in the Outlook Report; Japan reported firm December PPI and machine tool orders; China reported firmer December IP and retail sales and Q4 GDP data

The dollar is getting some traction as the U.S. returns from holiday. DXY is up slightly and trading near 102.35 after making a new cycle low yesterday near 101.773. With dollar sentiment remaining negative, the next target is the May low near 101.297. The euro is trading flat near $1.0830 after trading at a marginal new cycle high yesterday near $1.0875. Break above the May high near $1.0785 sets up a test of the late April high near $1.0935. Sterling is trading flat near $1.2255 after making a marginal new high near $1.2290 yesterday. Break above $1.2215 sets up a test of the December high near $1.2445. USD/JPY is trading higher near 128.65 after making a new cycle low yesterday near 127.25. Tonight’s BOJ decision will be key (see below) for the yen’s near-erm direction but the break below the January low near 129.50 sets up a test of the May low near 126.35. While we believe that the current dollar weakness is overdone, we have to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain under pressure.


U.S. financial conditions continue to loosen. While the Chicago Fed’s measure hasn’t been released yet for last week, we note that bond yields fell, equity markets rallied, and the dollar weakened and so the loosening trend likely continued despite hawkish Fed-speak. The market continues to position for a Fed pivot and eventual easing this year but the Fed should continue to push back against these notions forcefully. Williams speaks today.

We continue to believe markets are underestimating the Fed. WIRP suggests a 25 bp hike February 1 is fully priced in, with only 10% odds of a larger 50 bp move. Another 25 bp hike March 22 is almost priced in, while one last 25 bp hike in Q2 is around 40% priced in. We think these odds are too low. Furthermore, the swaps market continues to price in an easing cycle in H2 and we just don’t see that happening.

The regional Fed manufacturing surveys for January start rolling out. Empire survey will be reported and is expected at -8.6 vs. -11.2 in December. Philly Fed reports Thursday and is expected at -10.0 vs. -13.8 in December. In between, December IP will be reported tomorrow and is expected at -0.1% m/m vs. -0.2% in November. There can be no doubt that the manufacturing sector is also slowing along with the housing sector. However, this is exactly what the Fed wants to see.

Canada highlight will be December CPI. Headline is expected at 6.4% y/y vs. 6.8% in November. If so, it would continue the deceleration from the 8.1% peak in June to the lowest since February 2021. Bank of Canada tightening expectations remain steady. WIRP suggests nearly 80% odds of a 25 bp hike to 4.5% January 25. Looking ahead, odds of another 25 bp hike in Q2 top out at around 15%. Recent data have come in firm and so we see risks of a peak policy rate that’s higher than what markets are pricing in. Today’s CPI data will be key.

BOC Q4 business outlook survey was released yesterday and came in at 0.1 vs. 1.7 in Q3. This was the lowest reading since Q3 2020 and appears likely to tip into negative territory this year. November manufacturing sales and December existing home sales were also reported yesterday. December housing starts will be reported today.


Germany reported firm January ZEW readings. Both expectations and current situation improved sharply from December to 16.9 and -58.6, respectively. The positive reading for expectations was the first since February 2022, when the war in Ukraine began. Many of the survey indicators in the eurozone countries have improved recently but we think it’s way too early to say it’s all clear.

ECB officials remain hawkish. Chief Economist Lane said “We need to raise rates more. We need to bring them into restrictive territory. But in terms of deciding where eventually the level is going to be, there will be a feedback loop from experience.” This supports the view that while hikes will continue, the ECB will remain data-dependent. ECB tightening expectations are little changed. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by 65% odds of another 50 bp hike March 16. A 25 bp hike May 4 is about 80% 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% vs. 3.75% last week. If inflation continues to slow, we think the expected peak rate is likely to move down to 3.25% and perhaps even to 3.0%, which is where it stood back in mid-December. Centeno and Muller also speak today.

The U.K. reported mixed labor market data. For the three months ended November, the unemployment rate remained steady at 3.7% while average weekly earnings picked up to 6.4% y/y vs. 6.2% expected. Excluding the pandemic recovery, this was the biggest gain since the data series began in 2001 and suggests wage pressures will remain high, especially with public sector workers going on strike for higher wages. Of note, private sector wages rose 7.2% while public sector wages rose 3.3%, both well below the 10.7% inflation posted in December. Looking ahead, there may be some cracks forming. December payrolled employees came in at are expected at 28k vs. 60k expected and a revised 70k (was 107k) in November, while the claimant count rose a tick to 4.0%. This was the smallest gain in payrolled employees since August.

BOE tightening expectations remain steady. WIRP suggest nearly 85% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is now priced in rather than 50 bp previously. After that, a 25 bp hike in Q2 is priced in that would see the bank rate peak near 4.5% vs. 4.75% last week. There are very low odds of another 25 bp hike in Q3.


The two-day Bank of Japan meeting started today and ends tomorrow. WIRP suggests little chance of liftoff, followed by 45% for the March 9-10 meeting and nearly 85% for the April 27-28 meeting. While a hike this week seems unlikely, we think it’s quite possible that the BOJ abandons YCC in order to set up liftoff at the March or April meeting. This is the basic roadmap for tightening that’s been well-established by the Fed. Of note, the BOJ’s balance sheet has continued to grow as a result of YCC but we do not foresee Quantitative Tightening until 2024 at the earliest.

New forecasts will be released in the Outlook Report. Reports suggest the bank will raise its core inflation forecasts close to its 2% target. Specifically, the bank is expected to raise its FY23 forecast to between 1.6-2.0% and its FY24 forecast to almost 2% vs. 1.6% for both in the October forecasts. If so, the upgrades would support our view that liftoff is likely to come earlier than we previously anticipated, with risks of a move in Q2 or perhaps even Q1 vs. H2 seen previously.

Yesterday, Japan reported December PPI. It came in at 10.2% y/y vs. 9.5% expected and a revised 9.7% (was 9.3%) in November, and nearly matches the cycle high of 10.3% in September. Like other inflation readings in other major economies, this PPI reading suggests that the battle against inflation is far from over in many countries. December national CPI will be reported Friday and is expected to continue accelerating, with both headline and core seen rising 4.0% y/y.

Firm December machine tool orders were reported overnight. Orders rose 1.0% y/y vs. -7.7% in November and was the first positive reading since September. November core machine orders will be reported Wednesday and are expected at -1.0% m/m vs. 5.4% in October, which would boost the y/y rate to 1.6% vs. 0.4% in October. If sustained, this bounce in orders bodes well for IP and exports in the coming months.

China reported firmer December IP and retail sales data. IP came in at 1.3% y/y vs. 0.1% expected and 2.2% in November, while sales came in at -1.8% y/y vs. -9.0% expected and -5.9% in November. Some improvement was expected after China ditched Covid Zero and reopened, but the outsized gains are a bit suspect given that the resulting spikes in infections led many to follow self-imposed lockdowns.

Q4 GDP data also came in firmer. GDP was flat q/q vs. -1.1% expected and 3.9% in Q3, which helped the y/y rate come in at 2.9% vs. 1.6% expected and 3.9% in Q3. For the year as a whole, GDP grew 3.0%, the slowest since the 1970s and well shy of the target of “around 5.5%.” The target for this year remains “around 5.5%” and policymakers have a good shot at meeting. However, it’s worth noting that China’s population shrank in 2022 for the first time since the 1960s and heralding greater demographic headwinds ahead.

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