• Market sentiment has reversed lower after a brief recovery yesterday; price action in the FX market is worth discussing; the omicron variant has weighed a bit on Fed tightening expectations and that’s hurting the dollar; Fed Chair Powell said yesterday that the omicron variant poses risks on both sides of the Fed’s mandate; November Chicago PMI will be the data highlight; Canada reports Q3 GDP data
  
• Eurozone November CPI data surprised to the upside; this will get the ECB hawks riled up, of course; Poland preliminary November CPI surprised to the upside at an impressive 7.7% y/y
• Japan reported mixed October IP and labor market data; China’s official PMI figures for November surprised slightly to the upside; energy prices remain on the backfoot with omicron uncertainty and incoming crude supply from the U.S.
  

The dollar is weaker today despite the return of risk-off impulses. DXY is trading near 95.673, the lowest since November 19. Yen and Swiss franc are outperforming, as one would expect. USD/JPY traded at the lowest level since October 11 near 112.70 and break below 112.60 would set up a test of the October 4 low near 110.80. Elsewhere, EUR/CHF is trading near yesterday’s low for this move near 1.04. The euro is also outperforming and traded as high as $1.1375, while sterling is lagging and is trading near $1.3340.

AMERICAS

Market sentiment has reversed lower after a brief recovery yesterday. The CEO of Moderna warned that it could take months before pharmaceutical companies can make variant-specific vaccines on a large scale, while predicting a “material drop” in the efficacy of the existing ones. This coupled with warnings from Fed Chair Powell that omicron threatens both sides of the Fed’s mandate (see below) saw risk appetite sink in Asia overnight. The Nikkei fell -1.6% and the Hang Seng fell -1.8%, while the Shanghai Composite managed to remain largely flat. This risk-off vibe has carried over into the European morning, with the DAX down -1.4% on the day and the FTSE 100 -1.1%. S&P futures are down -1.1%, while Dow Jones futures are -1.4%. UST yields are down across the board on the flight to safety.

Price action in the FX market is worth discussing. Outperformance of the yen and Swiss franc today is easily explainable. The gains in the euro, not so much. We saw this last Friday as well and remain puzzled that the euro would gain during risk off episodes. As we’ve noted several times before, the U.S. is much better positioned for a potential omicron wave than Europe. Even before the new variant was discovered, several eurozone countries were already in lockdown and the economic outlook is tipping towards potential contraction in Q4. Contrast that with the U.S., where the Atlanta Fed’s GDPNow model is currently tracking growth of 8.6% SAAR in Q4.

The omicron variant has weighed a bit on Fed tightening expectations and that’s hurting the dollar. Liftoff in Q3 22 is no longer fully priced in by Fed Funds futures but is still running near 90% odds. However, odds of a follow up 25 bp hike in Q4 22 have fallen to around 65% after being fully priced in pre-omicron. Odds of Q2 liftoff have fallen to about 40% from 50-50. 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 omicron will also push out their tightening paths further into dovish territory. Market pricing for ECB, BOJ, and SNB lagged the aggressive pricing we saw for the dollar bloc and BOE. Perhaps that is why the recalibration in Fed expectations is leading to outsized moves in those currencies now. Eventually, the interest rate outlook should become clearer and move back in the dollar’s favor.

Fed Chair Powell said yesterday that the omicron variant poses risks on both sides of the Fed’s mandate. Powell and Yellen testify before the Senate today but his prepare remarks were released yesterday. In brief, he noted downside risks to growth and employment as well as added uncertainty for inflation, noting that “Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.” He did not discuss any specific monetary policy responses to the variant but we expect Powell to come under further questioning about Omicron by the Senate. Elsewhere, Williams and Clarida speak. 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.

November Chicago PMI will be the data highlight. It is expected at 67.0 vs. 68.4 in October. Yesterday, Dallas Fed manufacturing survey came in at 11.8 vs. 15.0 expected and 14.6 in October. All told, Empire and Philly Fed came in stronger than expected, Kansas City and Dallas came in weaker than expected, and Richmond came in as expected. Overall, the US manufacturing sector remains quite firm despite the supply chain issues. We get ISM manufacturing PMI tomorrow. September S&P CoreLogic home prices and November Conference Board consumer confidence (111.0 expected) will also be reported today.

Canada reports Q3 GDP data. Annualized growth of 3.3% is expected vs. -1.1% in Q2. Bank of Canada liftoff expectations have also eased in recent days. WIRP now suggests 1 in 3 odds of a hike January 26 vs. 50-50 last week. A hike March 2 is no longer fully priced in, falling instead to around 80%. Elsewhere, the swap market is still pricing in about 125 of tightening over the next twelve months. This seems too aggressive to us, especially given the heightened risks from omicron. Will the BOC push back a bit at its next meeting December 8? Stay tuned.

EUROPE/MIDDLE EAST/AFRICA

Eurozone November CPI data surprised to the upside. Headline was expected at 4.5% y/y but instead rose 4.9% vs. 4.1% in October. Likewise, core was expected at 2.3% y/y but instead rose 2.6% vs. 2.0% in October. Still, this shouldn’t come as too much of a surprise after German and Spanish inflation surprised to the upside yesterday. Eurozone October PPI will be reported Thursday and is expected to rise 19.0% y/y vs. 16.0% in September, which suggest continuing upside risks for CPI. France also reported November CPI (EU Harmonized 3.4% y/y vs. 3.2% expected) and October consumer spending (-0.4% m/m vs. flat expected), while Spain reported October retail sales at -2.5% y/y. Lastly, Germany reported November unemployment at -34.0k vs. -25k expected.

The CPI readings will get the ECB hawks riled up, of course. However, we still believe Lagarde and the doves still have the upper hand, especially in light of rising downside risks. As we've pointed out many times before, much of the inflation right now won't be addressed by rate hikes and so it would be a big mistake to tighten now. Villeroy and de Cos yesterday took a similar view and downplayed the inflation spike. The former said that supply side factors that are pushing up prices are expected to fade in the coming quarters, while the latter said the spike was transitory and warned of premature removal of accommodation. Both speak again 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.

Poland preliminary November CPI surprised to the upside at an impressive 7.7% y/y, putting the central bank on the defensive. Given current headline inflation and a policy rate of 1.25%, the real rate stands at -6.45%. Energy prices rose 13.4% on the month, explaining some of the surprise, but it’s still a massive overshoot from the 1.5-3.5% target range. There is a lot of work to do here, even if some of the headline moves prove to be temporary. Poland has clearly fallen far behind the hiking cycle in the region. The next policy meeting is December 8, where we expect continued frontloading of the tightening cycle.

ASIA

Japan reported mixed October IP and labor market data. IP rose 1.1% m/m vs. 1.9% expected and -5.4% in September, while the unemployment rate fell a tick to 2.7% vs. 2.8% expected. However, the job-to-applicant ratio unexpectedly fell to 1.15 vs. 1.17 expected and 1.16 in September. Data suggest the economy is a bit sluggish so far 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.

China’s official PMI figures for November surprised slightly to the upside. The non-manufacturing component came in at 52.3, the manufacturing moved back into expansionary territory at 50.1, and the composite rose to 52.0 from 50.8 last month. Much of this is due to government policies to support the economy during the new wave of the pandemic, pulling on both monetary and fiscal tools. Investment in the energy sector also helped release some of the bottlenecks bogging down China’s industrial production. We don’t think the numbers change anything in terms of policy direction, which we expect will remain increasingly accommodative. Of note, Caixin reports its November manufacturing PMI tomorrow, and then reports its services and composite PMI readings Friday, with services expected at 51.0 vs. 53.8 in October.

COMMODITIES

Energy prices remain on the backfoot with omicron uncertainty and incoming crude supply from the U.S. On the latter, the recent plunge in oil prices didn’t deter Biden’s plan to release 50 mln barrels from its strategic reserve. In fact, a State Department senior advisor said they could sell more if needed. The next move in the oil supply narrative is for OPEC+ to lean against the new headwinds by possibly deferring its output increase planned for January. This would help prices, of course, but it seems likely that near-term price movements are not back to pandemic dynamics. Perhaps the most dramatic change in oil markets has been the swift removal of the deep backwardation that prevailed since the start of the year.