Dollar Soft Ahead of Core PCE

December 23, 2022
  • November core PCE will be the highlight; markets still don’t believe the Fed; weekly jobless claims suggest the labor market remains robust; we got the final revision to Q3 GDP; housing data are likely to show continued weakening; Canada reports October GDP
  • We think markets are overestimating BOE and ECB tightening; U.K. surveys suggest trouble for U.K. households; BOE tightening expectations may need to adjust lower
  • Japan reported November national CPI; markets are starting to price in possible BOJ liftoff in 2023; China Covid cases appear to be exploding

The dollar is slightly softer ahead of core PCE data. DXY remains stuck near 104.20 as markets start to go into holiday mode. USD/JPY has edged higher to trade near 133 after trading as low as 130.60 Tuesday. Break below the August low near 130.40 is needed to set up a test of the May low near 126.35. Elsewhere, the euro is stuck near $1.06 while sterling is trading just below $1.21 and on track to test the November 30 low near $1.19. We continue to believe that the fundamental outlook still favors the dollar but acknowledge that we need to see some repricing of Fed tightening expectations (see below). We remain negative on the euro and sterling but our 2023 forecasts for USD/JPY will have to be marked lower as the timetable for BOJ liftoff has been moved forward (see below) and suggests the yen will remain relatively firm.


November core PCE will be the highlight. Consensus sees 4.6% y/y vs. 5.0% in October. If so, it would be the second straight deceleration to the lowest since October 2021. That said, this drop is due in large part to high base effects from 2021 and the Fed’s 2% target still seems a long way off. Indeed, we have always felt that getting core PCE from nearly 6% down to 4% is the easy part; getting it from 4% to the 2% target is the hard part and that is where the pain comes in. Personal income and spending will be reported at the same time and are expected at 0.3% m/m and 0.2% m/m, respectively. November durable goods orders will also be reported and are expected at -1.0% m/m vs. 1.1% in October.

Markets still don’t believe the Fed. After rising as high as 5.5% after the most recent FOMC meeting, the terminal rate as seen by the swaps market has fallen back to around 5.0%. Similarly, WIRP suggests a 50 bp hike February 1 is only 33% priced in, followed by a final 25 bp hike March 22. We cannot understand why the markets continue to fight the Fed. With the exception of some communications missteps here and there, Powell and company have been resolute about the need to take rates higher for longer. Recent U.S. data (see below) confirm that the labor market remains strong and that the Fed will have to do more.

Weekly jobless claims suggest the labor market remains robust. Initial claims for the BLS survey week containing the 12th of the month came in at 216k vs. a revised 214k (was 211k) the previous week. Continuing claims are reported with a 1-week lag and so next week’s number will be for the BLS survey week. This week, they are expected at 1.685 mln vs. 1.671 mln the previous week. Current consensus for NFP stands at 210k vs. 263k in November, with the unemployment rate seen steady at 3.7% and average hourly earnings falling two ticks to 4.9% y/y. Of note, the unemployment rate is derived from the household survey and it will be interesting to see if last month’s -328k reading was an outlier or a harbinger of things to come.

We got the final revision to Q3 GDP. Growth was revised up to 3.2% SAAR vs. 2.9% previously. Personal consumption was revised to 2.3% vs. 1.7% previously, while core PCE was revised up a tick to 4.7%. Of course, this is old news. Looking ahead, the Atlanta Fed’s GDPNow model is currently tracking 2.7% SAAR growth in Q4, down from the previous estimate of 2.8% SAAR. The next model update will be seen later today.

Housing data are likely to show continued weakening. November new home sales (-5.1% m/m expected) will be reported. On Wednesday, existing home sales came in at -7.7% m/m vs. -5.2% expected, while the y/y rate came in at -35.4% vs. -28.4% in October, a new cycle low. On Tuesday, building permits came in at -11.2% m/m vs. -2.1% expected while housing starts came in at -0.5% m/m vs. -1.8% expected. Both y/y rates fell to new cycle lows. On Monday, December NAHB housing market index came in at 31 vs. 34 expected and 33 in November and was the lowest since April 2020. This suggests little relief ahead for this beleaguered sector.

Canada reports October GDP. It is expected to remain steady at 0.1% m/m, while the y/y rate is expected at 3.1% vs. 3.9% in September. Bank of Canada tightening expectations remain subdued. WIRP suggests odds of a 25 bp hike January 25 are around 65%, which is consistent with swaps market pricing in a peak policy rate near 4.5%.

Brazil reports mid-December IPCA inflation. Headline is expected at 5.93% y/y vs. 6.17% in mid-November. At the last policy meeting December 7, COPOM left rates steady at 13.75%, as expected. However, the minutes were very hawkish in noting that “The Committee evaluated that changes in parafiscal policies or the reversal of structural reforms that lead to a less efficient allocation of resources might reduce the power of monetary policy,” adding that policymakers discussed “extensively” the impact of “different fiscal scenarios” on asset prices, inflation expectations, and neutral interest rates. The swaps market is pricing in 25 bp of tightening in 2023 that would see the policy rate peak near 14.0%, but much will depend on incoming President Lula’s fiscal stance.


Just as the market is underestimating Fed tightening, we think it is also overestimating BOE and ECB tightening. The swaps market had priced in a 4% peak ECB rate earlier this week but it's come back down to a more realistic 3.5%. Let's see if they can hike even that much when Italy comes under pressure again. Elsewhere, WIRP suggests a 50 bp hike February 2 is priced in, with minimal odds of a larger 75 bp move. Another 50 bp hike is 75% priced in for March 16, followed by a 25 bp hike May 4. A final 25 bp hike June 15 or July 27 would take the deposit rate to 3.5%, up from 3.0% at the start of last week.

U.K. surveys suggest trouble for U.K. households. The Office for National Statistics reported that 6 out of 10 surveyed are planning to cut spending during the holiday period by buying fewer and less expensive presents as well as by eating out less. The ONS survey ran through mid-December and also showed 18% had no savings to cushion the rising cost of living and 7% had missed a payment on a bill in the past month. Almost half have had difficulty heating their homes and a third have struggled with rising rents or mortgages. With little relief expected on the fiscal front, it’s shaping up to be a very difficult winter for U.K. households. In related news, a separate consumer survey showed nearly 2 mln U.K. households had failed to make at least one mortgage, rent, loan, credit card, or any other bill payment over the last month.

Bank of England tightening expectations may need to adjust lower. WIRP suggests a 50 bp hike February 2 is about 75% priced in, with no odds of a larger 75 bp hike. The swaps market back to pricing in a peak policy rate near 4.75% vs. 4.5% right after last week’s BOE decision but still down sharply from 6.25% right after the mini-budget in late September. Can the BOE really continue hiking aggressively with the deteriorating economic outlook?


Japan reported November national CPI. Headline came in a tick lower than expected at 3.8% y/y vs. 3.7% in October, while core (ex-fresh food) came in as expected at 3.7% y/y vs. 3.6% in October. Still, core inflation is running at the highest since 1981 and is nearly double the 2% target. Of note, core ex-energy also came in as expected at 2.8% y/y vs. 2.5% in October and shows that price pressures have spread well beyond just energy. With inflation running hot, we expect the BOJ’s forecasts will be revised higher in next month’s Outlook Report for the January 17-18 meeting, perhaps by enough to signal liftoff in FY23. Department store sales were also reported and came in at 4.5% y/y vs. 11.4% in October.

Markets are starting to price in possible BOJ liftoff in 2023. WIRP suggests slight odds for January 18 but those odds rise significantly for March 10 and April 28. The swaps market is pricing in nearly 25 bp of tightening over the next six months and nearly 50 bp over the next twelve. While we had long expected liftoff in H2 2023, the recent tweak to Yield Curve Control has moved up the timetable to H1 and perhaps even Q1. Despite the accelerating inflation story, markets have yet to test the new upper limit for the 10-year JGB yield at 0.50%

China Covid cases appear to be exploding. While officially reported numbers have become meaningless, minutes from an internal meeting of China’s National Health Commission Wednesday suggest nearly 37 mln may have been infected on a single day this week. If so, daily infections would be well above the previous record high around 4 mln back in January 2022. Furthermore, the report suggests that as many as 248 mln likely contracted Covid in the first 20 days of December. Expect the economy to come to a grinding halt this month. How long the slowdown is will depend on how the virus spreads but early indications are not good. Stay tuned.

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