• FOMC minutes contained no discussion of rate cut timing; Fed officials discussed when to flag a change in balance sheet policy; the data highlight will be ADP private sector jobs estimate; Banco de Mexico releases its minutes
  
• December eurozone CPI readings continue rolling out; eurozone and U.K. reported firm final December services and composite PMIs; BOE DMP inflation expectations continue to fall
  
• Japan reported firm final December manufacturing PMI; Australia reported soft final December services and composite PMIs; Caixin reported firm December services and composite PMIs

The dollar is giving up some of its recent gains ahead of ADP. DXY is trading lower near 102.277 after four straight up days that saw it trade as high as 102.726 yesterday after making a new cycle low near 100.617 on December 28. The euro recovered to trade near $1.0970 after a brief dip under $1.09 yesterday, while sterling edged higher to trade near $1.2730. Both currencies were helped by firmer than expected PMI readings (see below). Japan returned from holiday and promptly took USD/JPY higher to trade at the highest level since December 19 near 144.30. The pair is likely to test that day’s high near 145. Last month’s dovish Fed decision was a game changer for the dollar, but we believe markets are coming to realize that the U.S. economy remains robust in Q4 and likely to remain so in 2024, which certainly wouldn’t require six rate cuts from the Fed this year. That said, a sustained dollar recovery will really come down to the U.S. data. Over the past few weeks, the readings have mostly come in quite firm and so we continue to believe that the current market easing expectations are dead wrong. Until these expectations shift, however, the dollar is likely to remain vulnerable.

AMERICAS

FOMC minutes are worth discussing. According to the minutes, Fed officials “viewed the policy rate as likely at or near its peak for this tightening cycle, though they noted that the actual policy path will depend on how the economy evolves.” However, officials also noted that “circumstances might warrant keeping the target range at its current value for longer than they currently anticipated.” Officials acknowledged that the Dot Plots show cuts by the end of 2024 but added that “it was possible that the economy could evolve in a manner that would make further increases in the target range appropriate.” The minutes are entirely consistent with the FOMC statement.

Most importantly, we saw no discussion of rate cut timing in the minutes. Recall that Chair Powell said at his December 13 press conference that the Fed had discussed the timing of rate cuts. This makes us think that Powell went a bit rogue at the press conference and that's why so many Fed officials pushed back in the days after that FOMC meeting. When Powell said that the timing was discussed, markets reacted as one would expect and moved forward their expected timing. Of note, WIRP suggests 5% odds of a cut January 31 and rises to 75% March 20 vs. nearly priced in at the start of this week.

The one surprise to us was that Fed officials discussed when to flag a change in balance sheet policy. We felt that Quantitative Tightening would remain on autopilot for most of this year and so did not expect any discussions on changing the pace until well into H2. That said, the minutes suggest the Fed is merely “thinking about thinking about” changing its balance sheet policy and so its timing is still indeterminate. Bank reserves have been rising in recent months, suggesting little danger to the current policy of maintaining so-called abundant reserves. We look for further clarification at the January 30-31 FOMC meeting.

Fed officials remain balanced. Barkin said “A soft landing is increasingly conceivable but in no way inevitable. Demand, employment and inflation all surged but now seem to be on a path back toward normal.” When asked about a March rate cut, Barkin said that meeting is still a “long way away” and added that “I try not to prejudge meetings.” He acknowledged that the recent fall in longer-term rates were stimulative and added “While you might think this would be a first-class problem, strong demand isn’t the solution to above-target inflation. That’s why the potential for additional rate hikes remains on the table.”

Financial conditions continue to loosen. The Chicago Fed’s measure has loosened for ten straight weeks through December 22 to the loosest since the week ending January 21, 2022, nearly two months before the Fed started hiking rates. With equities higher, yields lower, spreads narrower, and the dollar weaker last week, we’ll likely get an 11th straight week through December 29 of looser financial conditions when reported today. This loosening is the major factor behind why we now believe the U.S. may avoid recession in 2024. However, this will likely come at a price of elevated inflation that may eventually require tighter policy.

The U.S. economy remains robust. The Atlanta Fed’s GDPNow model now has Q4 growth at 2.5% SAAR vs. 2.0% previously. It will be updated next Tuesday after the data. Elsewhere, the New York Fed’s Nowcast model has Q4 growth at 2.4% SAAR and Q1 growth at 2.2% SAAR and will be updated tomorrow. Bottom line: the US economy is still growing above trend in Q4. Of note, the early Q4 reads were based largely on strike-depressed October data. If November and December data continue to bounce back as we’ve seen already, the Q4 growth estimates should rise accordingly. In turn, this momentum is likely to carry over into Q1.

The data highlight will be ADP private sector jobs data. It is expected at 125k vs. 103k in November and will be the last major clue before the December jobs data tomorrow, as ISM services PMI will be reported later tomorrow morning. Bloomberg consensus for NFP stands at 171k vs. 199k in November, while its whisper number stands at 180k. Of note, NFP has outperformed ADP three straight months. The unemployment rate is expected to rise a tick to 3.8% while average hourly earnings are expected to fall a tick to 3.9% y/y.

We get some other labor market readings. December Challenger job cuts and weekly jobless claims will be reported today. Yesterday, November JOLTS data were reported. Job openings came in at 8.79 mln vs. 8.821 mln expected and a revised 8.852 mln (was 8.733 mln) in October. This was the lowest since March 2021 but still high by historical standards. Hires fell to 5.465 mln vs. 5.828 mln in October, quits fell to 3.471 mln vs. 3.628 mln in October, and layoffs fell to 1.527 mln vs. 1.643 mln in October. While there was a drop in hires, we think this was balanced by the drop in layoffs and so overall, the labor market remains in solid shape.

December ISM manufacturing PMI came in firm. Headline came in at 47.4 vs, 47.1 expected and 46.7 in November. However, the details were mixed. Employment rose to 48.1 vs. 45.8 in November, production rose to 50.3 vs. 48.5 in November, and new order fell to 47.1 vs. 48.3 in November. Elsewhere, supplier deliveries rose to 47.0 vs. 46.2 in November while backlog of orders rose to 45.3 vs. 39.3 in November. The higher these numbers are, the higher the strains in the supply chains. If both these measures continue to rise, this would be a bad sign for inflation going forward. That said, the fall in the prices paid component to 45.2 vs. 49.9 in November is welcome news.

Banco de Mexico releases its minutes. At the December 14 meeting, the bank left rates unchanged at 11.25% and maintained its forward guidance that it will keep rates steady “for some time” after changing that guidance in November from the phrase “for an extended period.” This suggests steady rates at the next meeting February 8. The swaps market is pricing in 25 bp of easing over the next three months followed by another 50 bp of easing over the subsequent three months.

EUROPE/MIDDLE EAST/AFRICA

December eurozone CPI readings continue rolling out. France’s EU Harmonised inflation came in as expected at 4.1% y/y vs. 3.9% in November. Germany reports later today, and its EU Harmonised inflation is expected at 3.9% y/y vs. 2.3% in November. German state CPI data already reported today point to downside risks to the national reading. Italy and eurozone report tomorrow. Italy’s EU Harmonised inflation is expected at 0.5% y/y vs. 0.6% in November. Finally, eurozone headline inflation is expected at 3.0% y/y vs. 2.4% in November, while core is expected at 3.4% y/y vs. 3.6% in November. Last week, Spain’s EU Harmonised inflation came in as expected at 3.3% y/y, steady from November. Spain is one of the few eurozone countries to report core inflation and it came in at 3.8% y/y vs. 4.5% in November.

European Central Bank easing expectations remain elevated. WIRP suggests nearly 10% odds of a cut January 25, rising to 55% March 7 and fully priced in April 11. A total of six cuts are priced in for 2024, with 33% odds of a seventh. Of note, ECB officials warned that inflation would rise temporarily and so markets are looking through this December spike.

Eurozone reported firm final December services and composite PMIs. Headline services came in at 48.8 vs. 48.1 preliminary, which helped push the composite up to 47.6 vs. 47.0 preliminary and kept it at the highest since July. Looking at the country breakdown, Germany’s composite rose to 47.4 vs. 46.7 preliminary and France’s rose to 44.8 vs. 43.7 preliminary. Italy and Spain were reported for the first time and their composite PMIs came in at 48.6 and 50.4, respectively, both up around half a point.

U.K. reported firm final December services and composite PMIs. Services came in at 53.4 vs. 52.7 preliminary, which pushed the composite up to 52.1 vs. 51.7 preliminary. This is the highest composite reading since June as the U.K. continues to defy expectations. Construction PMI will be reported tomorrow.

Bank of England reported its December Decision Maker Panel inflation survey. 1-year expectations fell to 4.0% y/y vs. 4.4% in November, while 3-year expectations fell to 2.9% vs. 3.2% in November. While the decline will be welcomed by the BOE, both measures remain well above the 2% target. Furthermore, the DMP survey showed wage expectations remain sticky, with 1-year wage growth (3-month moving average) rising a tick to 5.2%. Yet BOE easing expectations remain elevated. WIRP suggests nearly 5% odds of a cut February 1, rising to 30% March 21 and fully priced in May 9. Nearly six cuts are priced in for 2024.

ASIA

Japan reported firm final December manufacturing PMI. It came in at 47.9 vs. 47.7 preliminary. Final services and composite PMIs will be reported tomorrow. Of note, the economy continues to flirt with recession as the 50.4 preliminary composite PMI basically reversed the drop to 49.6 in November. Soft economic data and dovish BOJ comments have led markets to push out the timing of expected BOJ liftoff. WIRP suggests 10% odds of liftoff January 23, rising to 25% March 19, 55% April 26, and 85% June 14.

Australia reported soft final December services and composite PMIs. Services came in at 47.1 vs. 47.6 preliminary, which dragged the composite down to 46.9 vs. 47.4 preliminary. The composite PMI has been under 50 for three straight months and five of the past six. No wonder Reserve Bank of Australia easing expectations remain elevated. WIRP suggests 10% odds of a cut February 6, rising to 15% March 19, 50 % May 7, ad 90% June 18. Two cuts are priced in for 2024.

Caixin reported firm December services and composite PMIs. Services came in at 52.9 vs. 51.6 expected and 51.5 in November, which dragged the composite PMI up to 52.6 vs. 51.6 in November and is the highest since May. Over the weekend, official PMI readings came in mixed. Manufacturing came in at 49.0 vs. 49.6 expected and 49.4 in November, while non-manufacturing came in at 50.4 vs. 50.5 expected and 50.2 in November. As a result, the official composite PMI fell a tick to 50.3 and was the third straight drop. It’s clear that there is a divergence between the official and Caixin readings, but we put more weight on the former. We continue to believe that past stimulus measures are having little lasting impact and so further stimulus is likely in the coming weeks.