Dollar Soft Ahead of PCE Data

January 26, 2024

Win Thin

The U.S. economy continues to grow above trend; December PCE data will be the data highlight; personal income and spending will be reported at the same time; Brazil reports mid-January IPCA inflation
ECB meeting ended with the expected hold; Lagarde came across dovish at her press conference; ECB policymakers are engaging in damage control; Germany reported weak consumer confidence; U.K. reported firm consumer confidence
BOJ released minutes of the December meeting; Japan reported soft December national CPI data

The dollar is a bit soft ahead of PCE data. DXY reversed to trade lower near 103.274 after trading as high as 103.729 earlier today. The euro is trading higher near $1.0870 as ECB policymakers engage in damage control after yesterday’s dovish hold (see below). Sterling is also trading higher near $1.2745 after consumer confidence rose (see below). USD/JPY is trading flat near 147.75 as soft Tokyo CPI data suggest no imminent need for BOJ liftoff (see below). All indications are that the U.S. economy continues to grow above trend as Q1 gets under way. Can inflation continue to fall with this backdrop? Recent data have mostly come in on the firm side and so we continue to believe that the current market easing expectations for the Fed still need to adjust significantly. These expectations have started to shift but more needs to be seen.

AMERICAS

The U.S. economy continues to grow above trend. Q4 GDP growth came in at 3.3% SAAR vs. 2.0% expected and 4.9% in Q3, as personal consumption came in 2.8% SAAR vs. 2.5% expected and 3.1% in Q3. What's noteworthy is that the economy is still firing on all cylinders, just as it did in Q2 and Q3. Personal consumption contributed 1.91 ppt to growth, fixed investment 0.31 ppt, government consumption 0.56 ppt, net exports 0.43 ppt, and inventories 0.07 ppt.

There are no obvious sources of potential weakness in Q1. Barring an exogenous shock of some sort, the economy is on a very nice glide path with very little holding it back since financial conditions remain very loose. The Atlanta Fed will begin estimating Q1 growth today, while the New York Fed currently estimates Q1 growth at 2.4% SAAR and will also be updated today.

Can the Fed really cut rates when growth remains above trend? The market sees 50% odds of a March cut and that seems too soon. A cut in May is fully priced in and while that is plausible, a lot can happen between now and then. If the economy continues to grow above trend in Q1, a cut in May could be hard to justify. The same thing goes if core inflation remains close to 3%. Much has been made about the drop in headline but much of that is due to energy. Over the longer term, we know that headline tends to gravitate towards core and not the other way around.

December PCE data will be the data highlight. Headline is expected to remain steady at 2.6% y/y while core is expected to fall two ticks to 3.0%. The Cleveland Fed’s inflation Nowcast model sees headline and core at 2.7% y/y and 3.0% y/y, respectivley. For January, it sees them at 2.30% y/y and 2.75% y/y, respectively. Can inflation continue to fall when consumption and overall activity remains strong? Stay tuned.

Personal income and spending will be reported at the same time. Income is expected at 0.3% m/m vs. 0.4% in November, while spending is expected at 0.5% m/m vs. 0.2% in November. Real personal spending is expected to remain steady at 0.3% m/m. December retail sales accelerated in y/y terms from November and so we expect personal spending (which includes services) to also accelerate. We believe that as long as jobs are being created, those new wages will go right into consumption.

December Chicago Fed National Activity Index was reported. Headline came in at -0.15 vs. 0.06 expected and a revised 0.01 (was 0.03) in November. As a result, the 3-month moving average fell to -0.28 but remains well above the -0.7 threshold that signals imminent recession. Given the stronger than expected Q4 GDP data, we are surprised that that CFNAI came in so weak. Recall that a negative reading suggests growth is below trend. When all is said and done, however, we believe that the odds of a soft landing have risen in recent months.

Weekly jobless claims suggest the labor market remains firm. Initial claims came in at 214k vs. 200k expected and a revised 189k (was 187k) last week. The 4-week moving average fell to 202k. the lowest since late January 2023. Continuing claims were for the BLS survey week containing the 12th of the month and these came in at 1.833 mln vs. 1.823 mln expected and 1.806 mln last week. Bloomberg consensus for January NFP has crept up steadily and now stands at 185k vs. 216k in December, while its whisper number has risen to 179k.

Housing data will remain in focus. Pending home sales are expected at 2.0% m/m vs. 0.0% m/m in November. Yesterday, December new home sales came in at 8.0% m/m vs. 10% expected and a revised -9.0% (was -12.2%) in November. The national average for a 30-year mortgage fell from over 8% in late October to just below 7% in late December but has since move sideways around 7%. This drop has helped the housing sector to stabilize but we believe that mortgage rates need to move even lower if this sector is to fully recover. That will likely require the Fed to follow through with its rate cuts.

Brazil reports mid-January IPCA inflation. Headline is expected at 4.63% y/y vs. 4.72% in mid-December. If so, it would be the lowest since mid-August and further within the 1.75-4.75% target range. Next COPOM meeting is January 31 and another 50 bp cut to 11.25% is expected. Looking further ahead, the swaps market sees the policy rate bottoming at 9.25% over the next 12 months.

EUROPE/MIDDLE EAST/AFRICA

The two-day European Central Bank meeting ended with the expected hold. The bank left policy rates steady and reiterated its plan to reduce reinvestment from maturing securities purchased under the PEPP over the second half of the year and discontinue them at the end of 2024. So far, so good.

President Lagarde came across dovish at her press conference. Madame Lagarde emphasized that the debate over rate cuts was premature but reiterated that borrowing costs could be lowered from the summer. Lagarde also cautioned the need for the eurozone “to be further along in the disinflation process before we can be sufficiently confident that inflation will actually hit the target in a timely manner.” Nonetheless, it’s probably what Lagarde did not say rather than what she did say that was the biggest dovish surprise in our view. Lagarde did not push back, as she did in previous talks, against aggressive money market expectations of the ECB’s easing cycle. ECB easing expectations have picked up. The OIS curve implies a 90% probability of a 25 bp policy rate cut in April, up from 65% Wednesday.

ECB policymakers are engaging in damage control. Governing Council member Kazaks warned the ECB should be in no rush to begin the process of cutting interest rates as cutting too early would be the worst mistake. Governing Council member Simkus said that he’s less optimistic than markets are on the prospect of an April reduction in interest rates but will remain open-minded. Governing Council member Vujcic noted he didn’t consider the messaging in Lagarde’s press conference to be dovish. Lastly, Governing Council member Muller cautioned that it was reasonable to expect that borrowing costs will remain on hold at the next “several” meetings.

December eurozone M3 was surprisingly firm. Growth came in at 0.1% y/y vs. -0.7% expected and -0.9% in November. This was the first positive reading since June but when all is said and done, eurozone monetary developments are consistent with sluggish economic activity. The increase in private sector credit growth was muted at 0.5% y/y vs. 0.3% in November.

Germany reported weak February GfK consumer confidence. Headline came in at -29.7 vs. -24.6 expected and a revised -25.4 (was -5.1) in January. This was the first drop since November and is the lowest since March 2023. It also mirrors the recent deterioration in business sentiment seen in other German surveys.

The U.K. reported firm January GfK consumer confidence. Headline came in at -19 vs. -21 expected and -22 in December. This was the third straight increase and is the highest since January 2022. GfK noted that “Despite the cost-of-living crisis still impacting many households across the UK, consumers appear to be encouraged by the positive news about falling inflation.” It added that all of its indicators improved, including those of major purchases, savings, and the general economic situation. On the other hand, the U.K. CBI distributive trades survey for January showed a very weak retailing outlook. We’ll know more when January retail sales are reported February 16.

ASIA

The Bank of Japan released minutes of the December meeting. According to the minutes, “Members shared the recognition that it was important for the bank to continue to deepen discussions on issues such as the timing of the exit from the current monetary policy and the appropriate pace of raising policy interest rates thereafter.” While discussions are progressing, there is no sense of urgency as “Some members said that it seemed that the bank was currently not in a situation where it would fall behind the curve if it did not rush to raise policy interest rate.” Lastly, only one member sounded hawkish and felt that “To avoid the risk of high prices damaging the underlying trend in consumption and undermining the achievement of the target as a result of overly careful assessment, the bank should not miss an opportunity to revise its policy.” The summary of opinions for the January meeting will be released next Wednesday.

Japan reported soft December national CPI data. Headline came in at 1.6% y/y vs. 2.0% expected and 2.4% in December, core came in at 1.6% y/y vs. 1.9% expected and 2.1% in December, and core ex-energy came in at 3.1% y/y vs. 3.4% expected and 3.5% in December. Tokyo core was the lowest since March 2022 and well below the 2% target. The lower readings certainly complicate the BOJ’s decision-making. Markets are now looking at June for liftoff, but much will depend on how prices and wages evolve over the next few months.

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