• Markets are still digesting last week’s FOMC decision
  
• Germany reported a firm December IFO survey; ECB officials remain hawkish; Italian spreads are widening again; U.K. CBI reported its December industrial trends survey
  
• The two-day BOJ meeting began today and should end tomorrow with another dovish hold; China reported two Covid deaths over the weekend, the first since reopening measures were taken; Malaysia Prime Minister Anwar Ibrahim won a confidence vote in parliament
  

The dollar is modestly lower as the new week gets under way. DXY is trading lower near 104.555 after two straight up days and a break above 104.915 is needed to set up a test of the December 7 high near 105.822. The euro is trading near $1.06 despite the very hawkish signals from the ECB (see below), while sterling continues to trade below $1.22 in the aftermath of the BOE’s rather underwhelming 50 bp hike last week. USD/JPY is trading near 136 ahead of the BOJ decision tomorrow (see below). We continue to believe that the fundamental outlook still favors the dollar even as the Fed narrative remains in flux despite the hawkish the FOMC decision (see below).

AMERICAS

Markets are still digesting last week’s FOMC decision. After rising as high as 5.5% after the meeting, the terminal rate as seen by the swaps market has fallen back to just below 5.0%. Similarly, WIRP suggests a 50 bp hike February 1 is only 33% priced in, followed by a final 25 bp hike either March 22 or May 3. We cannot understand why the market continues 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. After the decision, several Fed officials confirmed this message. With regards to the latest Dot Plots, Williams said “it could be higher than what we’ve written down.” Elsewhere, Daly said “We still have a long way to go. We are far away from our price stability goal.” Although the media embargo has been lifted, there are no Fed speakers scheduled this week. December NAHB housing market index is the only data to be reported today.

EUROPE/MIDDLE EAST/AFRICA

Germany reported a firm December IFO survey. Headline business climate came in at 88.6 vs. 87.5 expected and a revised 86.4 (was 86.3) in November, driven by larger than expected gains in both current assessment and expectations to 94.4 and 83.2, respectively. January GfK consumer confidence will be reported Wednesday and is expected at -38.0 vs. -40.2 in December. Improved eurozone readings have come against a backdrop of relative warm weather and lower energy prices. The recent chill, if sustained, will surely challenge this more optimistic outlook.

ECB officials remain hawkish. Guindos said that “We have to take additional measures to increase interest rates at a speed similar to that of this last 50 bp increase.” Simkus said “We’re only coming back to neutral rates. Up until this point we were still at accommodative monetary policy.” Kazimir said “The temporary cooling of the economy won’t be sufficient to calm price growth and gradually return to the desired levels. For us, this means we need to increase the base interest rate significantly higher than today.” These comments are clearly in support of Madame Lagarde’s hawkish performance last week, WIRP suggests a 50 bp hike February 2 is nearly priced in, with no odds of a larger 75 bp move. Another 50 bp hike March 16 is about 75% priced in, followed by a 25 bp hike either May 4 or June 15 that would take the deposit rate to 3.25%, up from 3.0% at the start of last week.

Italian spreads are widening again. After falling to as low as 182 bp on December 7, the 10-yaer spread to Germany is back at 218 bp, the highest since late October. ECB tightening and QT is set to roil local markets. It didn’t help that Italian officials themselves are sounding the alarm over the weekend. Defense Minister Guido Crosetto lamented that “A credit restriction at this time is a very heavy decision,” adding that Italy faces a EUR100 bln credit crunch due to Quantitative Tightening next year. Elsewhere, Foreign Minister Tajani said that “it’s a mistake to raise borrowing costs for businesses and households in this phase.” Politicians should never comment on monetary policy, nor should they call attention to vulnerabilities that persist in the economy. Better to remain silent as there is really no upside. We expect peripheral spreads to widen further as QT bites and will surely test the ECB’s unproven Transmission Protection Instrument. In turn, this should limit any upside for the euro.

The U.K. CBI reported its December industrial trends survey. Total orders came in at -6 vs. -9 expected and -5 in November, while selling prices came in at 52 vs. 47 in November. Its distributive trades survey will be reported Wednesday, with retailing reported sales expected at -24 vs. -19 in November. Bank of England tightening expectations remain subdued after last week’s dovish message. 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 is back to pricing in a peak policy rate near 4.75% vs. 4.5% right after last week’s BOE decision, but this is still down sharply from 6.25% right after the mini-budget in late September.

ASIA

The two-day Bank of Japan meeting began today and should end tomorrow with another dovish hold. Despite the recent chatter about a potential policy review next year, we believe it is way too early for the BOJ to commit to one now. Indeed, we believe such an announcement is unlikely during the remainder of Governor Kuroda’s term, which ends in April. Instead, we think it will be up to his successor to initiate a review that sets up a potential BOJ pivot, most likely in H2 of next year at the earliest. Updated macro forecasts won’t be seen until the January 17-18 meeting.

China reported two Covid deaths over the weekend, the first since reopening measures were taken. Infections have spiked and there have been reports of increased activity at crematoria. Other reports suggest officials are listing the underlying causes of death rather than Covid. Either way, suspicion and lack of credible information have led to self-imposed lockdowns across the nation despite looser Covid restrictions. This will surely take a toll on the economy as we move into 2023.

Malaysia Prime Minister Anwar Ibrahim won a confidence vote in parliament. After winning a narrow majority last month, Anwar appears to have shored up support for his coalition as its members agreed last week to have him serve a full five-year term. Earlier, Anwar’s choice for parliamentary speaker received 147 votes, just one vote shy of a two-thirds majority. Both votes strengthen Anwar’s position and will allow him as Finance Minister to move forward with a budget for next year. After four prime ministers in the past four years, the nation should benefit from a more stable political outlook.