Dollar Soft Ahead of CPI Data

January 12, 2023

The dollar is soft ahead of the CPI data. DXY is down for the second straight day and trading near 103, just above the new cycle low from Monday near 102.944. Next target is the May low near 101.297. The euro is trading flat near $1.0765 after trading at a marginal new cycle high yesterday near $1.0775. Break above the May high near $1.0785 sets up a test of the late April high near $1.0935. Sterling is trading little changed near $1.2160 despite positive Brexit news (see below) and a break above $1.2215 is needed to set up a test of the December high near $1.2445. USD/JPY is trading back below 131 on reports that the BOJ will review its policy next week and will tweak as needed (see below). 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. yields remain subdued ahead of the CPI data. The 10-year yield is trading near 3.53% and traded as low as 3.51% Monday, while the 2-year yield is trading near 4.23% and traded as low as 4.18% Monday. While we continue to disagree with the market’s dovish take on the Fed, we have to respect the price action and acknowledge that this narrative is taking a toll on the dollar. However, as we warned yesterday, developments abroad suggest the fight against inflation is far from over and that markets are underestimating the “higher for longer” story for global monetary policy.

December CPI will be key. Headline is expected at 6.5% y/y vs. 7.1% in November, while core is expected at 5.7% y/y vs. 6.0% in November. If so, this would continue headline inflation’s steady decline from the 9.1% peak in June and core inflation’s more recent decline from the 6.6% peak in September. However, core PCE has largely been in a 4.5-5.5% range since November 2021 and we think the Fed needs to see further improvement before even contemplating any sort of pivot.

We continue to believe markets are underestimating the Fed. WIRP suggests a 25 bp hike February 1 is fully priced in, with nearly 30% odds of a larger 50 bp move. Another 25 bp hike March 22 is fully priced in, while one last 25 bp hike in Q2 is nearly 45% priced in that would take the Fed Funds rate ceiling up to 5.25%. However, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. Harker and Bullard speak today and are likely to maintain a hawkish stance.

Weekly jobless claims and December budget statement (-$65.0 bln expected) will also be reported. Initial claims are expected at 215k vs. 204k last week. This was the lowest since late September and dragged the 4-week moving average down to 214k, the lowest since mid-October. Of note, next week’s initial claims data will be for the BLS survey week containing the 12th of the month. If claims remain low, we can expect another solid NFP reading to follow December’s 223k. Until the labor market softens, we see little downside for wage growth and this should keep the Fed on heightened alert.

Peru central bank is expected to hike rates 25 bp to 7.75%. CPI rose 8.46% y/y in December. While inflation has fallen from the 8.81% peak in June, the process has been uneven and inflation remains well above the 1-3% target range. Since September, the bank has been hiking at a 25 bp clip every month. At the last meeting December 7, the bank hiked rates 25 bp even as the nation was reeling from Castillo’s attempted coup attempt. Bloomberg consensus sees the policy rate peaking at 7.75% but we think much will depend on how the data evolve.


ECB survey shows eurozone inflation expectations falling. The drop is the first since May 2022. According to the survey, inflation expectations for the next 12 months fell to 5.0% from 5.4% in October. Looking further out, inflation expectations in three years also fell to 2.9% from 3.0%. While this is welcome news, we know from recent comments that the ECB remains focused on the continued rise in core inflation and so ECB tightening expectations were little changed. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by 70% 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 70% priced in that would see the deposit rate peak near 3.5% vs. 3.75% last week. If inflation continues to slow, the expected peak rate is likely to move closer to 3.25% and perhaps even to 3.0%, which is where it stood back in mid-December.

Brexit is back in the news and in a good way. Reports suggest the EU and the UK are about to enter an intense phase of negotiations next week that’s aimed at addressing disputes over Northern Ireland protocols. The ultimate aim is to strike a deal before the April 10 anniversary of the so-called Good Friday Agreement that has led to lasting peace in Northern Ireland. The first step would be the establishment of a so-called “negotiating tunnel” after U.K. Foreign Minister Cleverly and European Commission Vice President Sefcovic take stock of the situation when they meet January 16. Cleverly and Sefcovic announced earlier this week that the EU had agreed to use the U.K.’s live database that tracks goods moving from Great Britain to Northern Ireland, the first sign of progress. Much still needs to be done but the tone has become softer on both sides, especially after the ouster of Brexit hard-liner Liz Truss.

The Bank of England has sold off its emergency bond purchases from last fall. The bank said that it has sold all GBP19.3 bln of gilts that it bought during the market turmoil brought on by the failed Truss/Kwarteng supply side experiment. The BOE started unwinding those gilt purchases November 29 and completed the task with minimal market impact. BOE tightening expectations have fallen. WIRP suggests 75% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is almost priced in rather than 50 bp previously. After that, a 25 bp hike is about 60% priced in May 11 that would see the bank rate peak near 4.5% vs. 4.75% earlier this week. MPC member Mann speaks today.


Press reports suggest the Bank of Japan will review the side effects of its ultra-loose monetary policy next week. The bank is reportedly concerned about recent interest rate moves after tweaking YCC at its December meeting. Reports suggest the BOJ will consider adjusting its bond-buying again and making further policy tweaks if necessary. In light of this potential review and the sharp fall in Kishida’s popularity due to high inflation, we continue to believe that the BOJ will begin removing accommodation by Q2 at the latest, with some risks of a Q1 move. Of note, the BOJ spent a record JPY2.8 trln in fixed-rate JGB purchases today defending YCC.

BOJ tightening expectations have risen sharply. WIRP now suggests over 25% odds of liftoff at the January 17-18 meeting, rising to nearly 50% at the March 9-10 meeting and fully priced in for the April 27-28 meeting. Our best guess right now is that the BOJ ends YCC in either January or March and follows up with a rate hike in April. However, given the bank’s penchant for surprises, the timetable could be accelerated so that liftoff comes in Q1. JGB yields and the yen continue to move higher from the hawkish shift in BOJ expectations. For USD/JPY, the break below 131.55 sets up a test of the January low near 129.50.

November current account data are worth discussing. The adjusted surplus came in at JPY1.9 trln vs. JPY658 bln expected and a deficit of -JPY609 bln in October. However, the investment flows will be of most interest. November data showed that Japan investors were net sellers of U.S. bonds for the third straight month (-JPY227 bln) and in twelve of the past thirteen. Japan investors remained net sellers (-JPY280 bln) of Australian bonds for the fifth straight month and Canadian bonds (-JPY193 bln) for the tenth straight month, but remained net buyers of Italian bonds (JPY356 bln) for the second straight month. Japan investors were total net sellers of foreign bonds in November of -JPY1.4 trln. If the BOJ does hike and JGB yields continue rising, we see scope for further selling of foreign bonds (and for a stronger yen) as Japan investors bring more money home.

Australia reported November trade data. Exports came in flat m/m vs. -1% in October, while imports came in at -1% m/m vs. a revised -2% (was -1%) in October. The y/y rates continue to slow as the mainland China slowdown continues to bite. We are not as optimistic on the China reopening story as the market is and believe that the recovery will be very uneven and subject to periodic interruptions. That said, the domestic outlook for Australia remains fairly robust as the labor market remains relatively strong. As we noted yesterday, the “higher for longer” story likely applies to most major central banks, not just the Fed.

China reported December CPI and PPI data. CPI came in as expected at 1.8% y/y vs. 1.6% in November, while PPI came in at -0.7% y/y vs. -0.1% expected and -1.3% in November. For now, policymakers remain focused on boosting growth and so the inflation data is unlikely to have much impact on policy for the next several quarters. The PBOC sets its key 1-year MLF rate next week and while consensus sees no change at 2.75%, a handful of analysts look for a 10 bp cut to 2.65%. Such a move would filter down into cuts in commercial banks’ Loan Prime Rates, also to be set next week.

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