Dollar Soft Ahead of CPI Data

January 15, 2025
  • December CPI data will be the highlight; PPI ran cool; Fed Beige Book report for the January meeting will be released; market pricing for the Fed remains hawkish; regional Fed surveys for January will start rolling out
  • ECB doves are pushing back against more hawkish market bets; German GDP shrank for the second straight year; eurozone reported November IP; U.K. December CPI ran cool; market pricing for the BOE remains too hawkish
  • BOJ Governor Ueda hinted at a possible rate hike next week; Indonesia cut rates 25 bp to 5.75% vs. an expected hold

The dollar Is remains soft ahead of CPI data. DXY is trading lower for the second straight day near 109.066 after making a new high for this cycle near 110.176 Monday. We view this dollar dip as a buying opportunity. The yen is outperforming after BOJ Governor Ueda hinted at a hike this month (see below), with USD/JPY trading below 157 for the first time since January 6. Sterling is stabilizing after CPI data ran cool (see below) and is trading flat near $1.2225, while the euro is trading lower near $1.03 after data showed German GDP contracting for the second straight year (see below). More tariff noise is likely in the coming days and weeks but we continue to look through that and focus on the underlying fundamental backdrop, which remains unchanged. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar.

AMERICAS

December CPI data will be the highlight. Headline CPI is expected at 2.9% y/y vs. 2.7% in November and core CPI is expected to remain steady at 3.3% y/y. The Cleveland Fed’s Nowcast model forecasts headline and core at 2.9% y/y and 3.3% y/y, respectively. Looking ahead, the model sees December headline and core at 2.8% y/y and 3.2% y/y, respectively. Recent data have raised the possibility that progress on inflation may be stalling well above 2%, which should keep the Fed in hawkish mode.

December PPI inflation ran cool. Headline came in at 3.3% y/y vs. 3.6% expected and 3.0% in November while core came in at 3.5% y/y vs. 3.8% expected and a revised 3.5% (was 3.4%) in November. PPI services ex-trade, transportation, and warehousing, which feeds into the core PCE calculations, slowed to 4.1% y/y from a revised 4.7% (was 4.6%) in November. This was the slowest since February 2024 and bodes well for December PCE readings. Still, it’s clear that price pressures remain in the pipeline.

The Fed Beige Book report for the January meeting will be released. The previous report for the December meeting was roughly balanced. On overall economic activity: Economic activity rose slightly in most Districts. Three regions exhibited modest or moderate growth that offset flat or slightly declining activity in two others. On labor markets: Employment levels were flat or up only slightly across Districts. Wage growth softened to a modest pace across most Districts, as did expectations for wage growth in coming months. On prices: Prices rose only at a modest pace across Federal Reserve Districts. Contacts indicated they expect the current pace of price growth to persist, but businesses in several Districts indicated tariffs pose a significant upside risk to inflation. With the economic data running a bit hotter, we expect a slightly more hawkish tone in this report.

Market pricing for the Fed remains hawkish. The next cut isn’t priced in until September, with no further cuts seen after that. Much will obviously depend on how the economy evolves in H1 but for now, strong momentum has carried over from 2024 and we see little chance of a cut in H1. Barkin, Kashkari, Williams, and Goolsbee all speak today.

Regional Fed surveys for January will start rolling out. Empire manufacturing survey kicks things off today and is expected at 3.0 vs. 0.2 in December. Philly Fed manufacturing (-5.0 expected) and New York Fed services surveys will be reported tomorrow.

EUROPE/MIDDLE EAST/AFRICA

The ECB doves are pushing back against more hawkish market bets. GC member Guindos said “The policy trajectory is clear, and we expect to continue to further reduce the restrictiveness of monetary policy. The latest information suggests that the economy is losing momentum.” Elsewhere, GC member Villeroy said “If the retreat of inflation is confirmed in the coming quarters as we forecast, it makes sense to go toward this 2% rate by next summer without slowing the pace.” It seems that policymakers aren’t happy with the market pricing in less easing, with the terminal rate now seen between 2.0-2.25% vs. 1.5% back in December.

German GDP shrank for the second straight year. The economy contracted -0.2% in 2024 vs. -0.3% in 2023 and is only the second time since 1950 of back to back contraction. By our calculations, Q4 GDP contracted -0.4% y/y vs. 0.1% in Q3. IFO official noted that “Germany is going through by far the longest phase of stagnation in post-war history. It is also falling behind considerably in an international comparison.” Of note, IFO forecasts “barely perceptible” growth of 0.4% this year while the Bundesbank sees 0.2%.

Eurozone reported November IP. IP came in as expected at 0.2% m/m vs. a revised 0.2% (was flat) in October, while the y/y rate came in as expected at -1.9% vs. a revised -1.1% (was -1.2%) in October.

U.K. December CPI ran cool. Headline came in a tick lower than expected at 2.5% y/y vs. 2.6% in November, core came in two ticks lower than expected at 3.2% y/y vs. 3.5% in November, and CPIH came in a tick lower than expected at 3.5% y/y and was steady from November. The Bank of England will be particularly encouraged by the sharp drop in services inflation to a 33-month low of 4.4% y/y vs. 5.0% in November. The BOE projected services CPI at 4.7% y/y in December while the markets expected 4.8% y/y. Bottom line: the risk that the U.K. enters a period of stagflation has diminished, which should cushion the decline in GBP and ease the sell-off in gilts. We’ll now more tomorrow with the release of real sector data.

Market pricing for the Bank of England remains too hawkish. A 25 bp cut at the next meeting February 6 is about 90% priced in, but then the market is pricing in only one more 25 bp cut over the next 12 months. Given the growing risks to the economy, this seems too little too late. BOE MPC member Taylor speaks today. His speech is titled “Inflation Dynamics and Outlook.” Taylor was one of three MPC members to support a 25 bp rate cut at the December meeting when the majority voted to keep rates steady at 4.75%.

ASIA

Bank of Japan Governor Ueda hinted at a possible rate hike next week. Ueda pointed out that he has heard many encouraging views on pay at the BOJ’s recent branch managers’ meeting. Following his comments, odds of a rate hike at the January 24 meeting increased to over 70% from 60% yesterday and 50% last week. We still expect the BOJ to wait until March to resume normalizing rates as underlying wage trends will be clearer by then.

Bank Indonesia cut rates 25 bp to 5.75% vs. an expected hold. Governor Warjiyo said “We have changed our stance, which is to pro-stability and growth. And we have said that we continue to look at the room for interest rate cuts in line with global and national economic dynamics.” Previously, he said “The focus of monetary policy is directed at strengthening the stability of the rupiah exchange rate from the impact of heightened global economic uncertainty due to U.S. policy direction and escalation of geopolitical tensions in various regions.” Expect further rupiah weakness given this shift in policy.

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