• November ISM services PMI was firm; the U.S. economy remains resilient; the Fed narrative continues to shift; Chile is expected to keep rates steady at 11.25%
  
• ECB Chief Economist Lane suggested inflation is near the peak; ECB tightening expectations have solidified; Germany reported October factory orders; U.K. reported soft November construction PMI
  
• Japan reported October cash earnings and household spending; BOJ Governor Kuroda remains dovish; RBA hiked rates 25 bp to 3.10%, as expected; Australia reported Q3 current account data
  

The dollar is slightly weaker in consolidative trade. DXY is trading near 105.15 but has held on to the bulk of yesterday’s gains. The euro is holding near $1.05 after trading at a new cycle high yesterday near $1.0585, while sterling is holding near $1.22 after trading at a new cycle high near $1.2345 yesterday. USD/JPY is trading near 136.40 after this recent bounce took it as high as 137.45 earlier today. While we still believe the fundamental outlook favors the dollar, we acknowledge that near-term dollar weakness is likely to continue after Powell’s unexpected dovish turn. If the U.S. data continue to come in firm like ISM services (see below), that dovish Fed narrative could start to crack. Stay tuned.

AMERICAS

November ISM services PMI was firm. Headline came in at 56.5 vs. 53.5 expected and 54.4 in October. This basically reverses last month’s drop from 56.7 in September. The details were firm as employment rose to 51.5 vs. 49.1 in October and activity jumped to 64.7 vs. 55.7 in October. Prices paid came in at 70.0 vs. 70.7 in October. The key takeaways are that 1) price pressures are much more persistent in services than in manufacturing, 2) services activity remains strong, and 3) services employment is expanding. As we all know, the services sector makes up a much greater share of the US economy than manufacturing and so the strong reading is noteworthy.

The U.S. economy remains resilient. The Atlanta Fed’s GDPNow model is currently tracking 2.8% SAAR growth in Q4, down from 4.3% previously but still quite respectable. With more and more Q4 data being reported, expect this reading to be very volatile in the coming weeks. The next update to the model will come today after the October trade data. The deficit is expected at -$80.0 bln vs. -$73.3 bln in September. Of note, Canada also reports October trade along with November Ivey PMI.

The Fed narrative continues to shift. After Powell’s speech last week, the narrative swung towards dovish. After AHE and services PMI, that narrative is swinging back to hawkish. We imagine there will be some whispers about 75 bp from the Fed next week but we think it will depend in large part on the CPI data out the day before the decision. That said, we think it was a mistake for Powell to take 75 bp off the table last week. WIRP still suggests that a 50 bp hike December 14 is fully priced in, with only 5% odds of a larger 75 bp move. The swaps market is pricing in a peak policy rate of 5.0% but odds of a higher 5.25% peak have crept back in. Both AHE and core PCE have flat-lined near 5% for most of this year despite falling CPI and PPI readings. We believe that getting core PCE back down to the Fed’s target of 2% will be much more difficult than markets are pricing in. We don't think two more 50 bp hikes will do it, not when the labor market remains so firm and consumption is holding up.

Chile central bank is expected to keep rates steady at 11.25%. At the last policy meeting October 12, the central bank hiked rates 50 bp to 11.25% but signaled an end to rate hikes. Chile reports November CPI and trade data tomorrow. Headline is expected at 12.9% y/y vs. 12.8% in October. If so, it would be the first acceleration since August and argues for caution against cutting rates too soon after ending the tightening cycle at the October meeting. The swaps market is pricing in the start of an easing cycle within the next 3 months, which seems too soon.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank Chief Economist Lane suggested inflation is near the peak. Specifically, he said “It’s probably too early to make that judgment but I would be reasonably confident in saying that it is likely we are close to peak inflation. But whether this already is the peak or whether it will arrive at the start of 2023, is still uncertain.” Regarding monetary policy, Lane noted that “We do expect that more rate increases will be necessary, but a lot has been done already. The starting point is different now. We’ve already hiked rates by 200 bp. We should take into account the scale of what we have already done.”

ECB tightening expectations have solidified. WIRP suggests a 50 bp hike December 15 is fully priced in, with only 15% odds of a larger 75 bp move vs. 20% at the start of this week, 45% at the start of last week, and fully priced in right after the October decision. Elsewhere, the swaps market is still pricing in a peak policy rate near 3.0% vs. 3.5-3.75% right after the October decision. We think there is still room for ECB tightening expectations to fall further and we stand by our call that the ECB will pivot and cut rates before the Fed does. Panetta also speaks today.

Germany reported October factory orders. Orders came in at 0.8% m/m vs. 0.1% expected and a revised -2.9% (was -4.0%) in September. As a result, the y/y rate came in at -3.2% vs. -4.8% expected and a revised -9.8% (was -10.8%) in September. IP will be reported tomorrow and is expected at -0.6% m/m vs. 0.6% in September, while the y/y rate is expected at -0.7% vs. 2.6% in September.

The U.K. reported soft November construction PMI. It came in at 50.4 vs. 52.0 expected and 53.2 in October, the lowest since August. With interest rates still rising, the housing sector is likely to remain under severe pressure. Bank of England tightening expectations have steadied. WIRP suggests a 50 bp hike December 15 is priced in, with 15% odds of a larger 75 bp hike vs. 25% at the start of this week and 35% at the start of last week. The swaps market is still pricing in a peak policy rate between 4.5-4.75%, down sharply from 6.25% right after the mini-budget in late September.

ASIA

Japan reported October cash earnings and household spending. Nominal earnings came in at 1.8% y/y vs. 2.0% expected and 2.2% in September, while real earnings came in at -2.6% vs. -2.2% expected and -1.2% in September. This was the lowest reading for real earnings since June 2015. Simply put, nominal wages are not keeping up with inflation and the lack of any significant wage pressures is likely to keep the BOJ on hold for the time being. Elsewhere, household spending came in at 1.2% y/y vs. 0.9% expected and 2.3% in September.

No wonder Bank of Japan Governor Kuroda remains dovish. Overnight, he said it’s too early to start a review of the bank’s monetary policy framework as it will still take time to hit its inflation target. This was in response to recent comments from BOJ board member Tamura calling for a review “soon.” Kuroda stressed that the BOJ would discuss and communicate its exit strategy as it becomes appropriate as the inflation target approaches. He stressed that the benefits of monetary easing exceed its costs, and added that he expects inflation to fall back below the 2% target in FY23. Next policy meeting is December 19-20 and no change is expected then.

Reserve Bank of Australia hiked rates 25 bp to 3.10%, as expected. Governor Lowe said “The board expects to increase interest rates further over the period ahead, but it is not on a pre-set course. The size and timing of future interest rate increases will continue to be determined by the incoming data.” While this simply echoes the bank’s recent policy statements, some were looking for a more dovish tone that might suggest the tightening cycle might be nearing an end and we didn’t get that. WIRP suggests 45% odds of a 25 bp hike February 7, while the swaps market is pricing in a peak policy rate near 4.0%, up from 3.55% at the start of this week. Updated forecasts will come at that February meeting.

Australia reported Q3 current account data. A shocking deficit of -AUD2.3 bln was reported vs. an expected surplus of AUD6.0 bln and a revised AUD14.7 bln (was AUD18.3bln) in Q2. This was the first deficit since Q1 2019. The goods balance was AUD38.9 bln, while the services balance was -AUD7.7 bln. The big negative was income at -AUD33.2 bln, with transfers adding a small deficit of -AUD300 mln. The OECD forecasts the current account surplus at 0.9% of GPD this year vs. 3.2% in 2021 but moving into a deficit of -0.2% of GDP in 2023. October trade data will be reported Thursday. Exports are expected to rise 2% m/m vs. 7% in September, while imports are expected at 2% m/m vs. flat in September. If China growth remains sluggish, the external balances for Australia are likely to continue worsening and likely to be a drag on AUD.