• Market sentiment is recovering today after ending last week on a sour note; the omicron variant has done little to impact Fed tightening expectations so far; Fed manufacturing surveys will continue to roll out
  
• Some key eurozone November CPI data have started to emerge; ECB so far remains unfazed by omicron; U.K. announced tighter travel restrictions and mandatory masking for indoor settings; recent BOE comments have been less hawkish but still suggest a bias to tighten in the coming months
  
• Japan reported solid October retail sales; RBNZ downplayed omicron risks
  

The dollar is clawing back some of its recent losses. After two straight down days, DXY is trading higher near 96.16 after finding support below 96. We look for a test of last week’s high near 97. After that, the June 2020 high near 97.802 is coming into focus. The euro feels heavy as the recent bounce ran out of steam just above $1.13. We believe e it will soon test last week’s cycle low near $1.1185 and then the June 2020 low near $1.1170. Sterling is having trouble making any headway above $1.3350. We expect a test of last week’s cycle low near $1.3280 and a break below would set up a test of the December 2020 low near $1.3135. USD/JPY is recovering after last week’s risk off bout pushed it down to near 113. If market sentiment continues to improve, this pair should test last week's cycle high near 115.50. After that, there are really no major chart points until the December 2016 high near 118.65. We believe the fundamental backdrop continues to favor the dollar.

AMERICAS

Market sentiment is recovering today after ending last week on a sour note. Global equity markets are higher, as are global bond yields, while EM is recovering at the expense of the traditional haven assets. Sentiment was helped by the WHO; while urging caution, the organization noted that symptoms linked to the new strain so far have been mild. Moderna added to the positive sentiment by predicting it would have a modified vaccine ready by early 2022. Still, because it will take some time to determine the likely impact of omicron on health and the global economy, we believe bouts of risk aversion will continue to roil markets in the coming weeks.

The omicron variant has done little to impact Fed tightening expectations so far. This supports our view that the U.S. is well-positioned to deal with the potential fallout from the omicron variant. Liftoff in Q3 22 is still fully priced in by Fed Funds futures, as is a follow up 25 bp hike in Q4 22. Last Friday, Bostic played down the risk of the omicron variant and said he was still open to a faster pace of tapering. While we tend to agree with Bostic, the added uncertainty is likely to keep the bar fairly high to a faster taper. Odds of Q2 liftoff have risen back to nearly two thirds, which we think is way too aggressive. That said, we believe that the monetary policy outlook continues to favor the dollar over the euro, yen, and Swiss franc. None of those central banks are likely to hike rates until 2023 at the earliest and so the 2-year yield differentials should continue to move back in the dollar’s favor this week after plunging last week.

Fed manufacturing surveys will continue to roll out. Dallas Fed manufacturing index will be reported today and is expected at 17.0 vs. 14.6 in October. Chicago PMI will be reported tomorrow and is expected at 67.0 vs. 68.4 in October. ISM November manufacturing PMI (61.1 expected) will be reported Wednesday, followed by final services PMI (65.0 expected) Friday. Of note, virtually all of the survey readings for the U.S. remain at or near record highs. Thus, it should be no surprise that the Atlanta Fed GDPNow model is tracking 8.6% SAAR growth for Q4 currently. October pending home sales (0.8% m/m expected) will also be reported, while the Fed’s Williams, Powell, and Bowman speak. Canada also reports Q3 current account data (CAD5.7 bln expected).

EUROPE/MIDDLE EAST/AFRICA

Some key eurozone November CPI data have started to emerge. Spain reported headline EU harmonized inflation at 5.6% y/y, as expected and up from 5.4% in October. Germany reports CPI later and is expected at 5.5% y/y EU Harmonized vs. 4.6% in October. German state CPI data out so far today suggest some downside risks for the national number. Eurozone reports November CPI data tomorrow, with headline expected at 4.5% y/y vs. 4.1% in October and core expected at 2.3% y/y vs. 2.0% in October. Eurozone October PPI will be reported Thursday and is expected to rise 19.0% y/y vs. 16.0% in September, which suggest upside risks for CPI going forward.

The European Central Bank so far remains unfazed by omicron. Villeroy noted that the economic impact of each successive wave of COVID has been less and less. He stressed that “We must monitor closely the latest Covid developments and the new Omicron strain” but added that it “shouldn’t presumably change the economic outlook too much.” De Cos, Guindos, Centeno, Schnabel, and Lagarde also speak today. Next policy meeting is December 16 and we fully expect some sort of extension for QE to be announced then. Of note, the swap market only sees 3 bp of ECB tightening over the next twelve months, down from nearly 25 bp after the last ECB decision October 28.

The U.K. announced tighter travel restrictions and mandatory masking for indoor settings after three confirmed cased of omicron were detected. Starting tomorrow, all travelers arriving in the U.K. must take a PCR test on or before the second day of their stay and isolate until they receive a negative result. Previously, only travelers from ten southern African nations on the so-called “red list” were required to undergo a 10-day quarantine at a hotel at their own expense. Of note, Health Secretary Javid yesterday stressed that there’s no need yet to impose new work from home or movement restrictions.

Recent BOE comments have been less hawkish but still suggest a bias to tighten in the coming months. Of note, WIRP suggests only about one in three odds for liftoff at the next policy meeting December 16, down from 50-50 at the start of last week. However, liftoff February 3 remains fully priced in. Swap market sees 100 bp of tightening over the next twelve months, down from 125 bp at the start of the month but still striking us as way too aggressive.

ASIA

Japan reported solid October retail sales. Sales rose 1.1% m/m vs. 1.0% expected and 2.8% in September. Data suggest the economy is likely to slow for the second straight quarter in Q4, which makes the recently announced JPY36 trln extra budget all the more important. With significant fiscal stimulus in the pipeline, the Bank of Japan is on hold for the foreseeable future. Next policy meeting is December 16-17 and no change is expected then. However, expect some jawboning if the yen continues to strengthen. Governor Kuroda so far remains optimistic, saying “I’m quite sure that Japanese economy would overcome the impact of Covid-19 in coming months and would be on the recovery- and growing-phase within a couple of months.” Of note, Prime Minister Kishida closed Japan’s borders to all foreign visitors starting tomorrow in an effort to limit exposure to the omicron variant.

Reserve Banks of New Zealand downplayed omicron risks. Chief Economist Ha said that the new variant would have to have a dramatic economic impact to prevent the bank from continuing to hike interest rates. He added that the bank would have hiked last week even if omicron was known then, stressing it’s not the same as August, when RBNZ delayed a hike due to a just announced lockdown. However, he added that the bank will have better information about the variant's economic impact at its next policy meeting February 23. After last week’s 25 bp hike, WIRP suggests 25 bp hikes at each of the February, April, May, and July meetings are fully priced in. Looking further ahead, swap markets sees 150 bp of tightening over the next twelve months.