The dollar mounted a major rebound last week on the back of strong U.S. data and hawkish Fed comments. EUR and SEK outperformed while JPY and NOK underperformed. We continue to believe that risk assets remain vulnerable given the fundamental backdrop of tighter global liquidity and rising risks to global growth. As a result, the dollar should continue to gain.
Markets are still digesting last week’s key developments. The main takeaways are: 1) inflation is proving to be much sticker than many expected; 2) the U.S. economy remains robust in Q1 so far, and 3) the Fed will have to go higher for longer. Markets are repricing Fed expectations and the key investment themes remain higher yields, lower equity markets, and a stronger dollar.
FOMC minutes Wednesday will be very important. At the last meeting, the Fed downshifted to 25 bp and in its statement that ongoing rate hikes will be appropriate as inflation has eased somewhat but remain elevated. It added that it will consider the extent of future rate hikes, meaning that this downshift to 25 bp means the Fed is still trying to figure out how high it needs to go. The Fed said job gains have been robust and unemployment remains low, but added that recent data suggest modest growth in spending and production. Recall that in his press conference, Powell did not push back at all against the current looseness in financial conditions. He spoke about the Fed focusing on sustained changes in financial conditions but did not use the opportunity to say that the current loosening was unwarranted. Nor did Powell push back against dovish market expectations of Fed policy. When asked about the divergence between the Fed view (Dot Plots) and the market view, Powell simply shrugged it off and said this was due to differences in the inflation forecasts. He said if inflation deviates from its forecasts and moves closer to market expectations, the Fed will adjust policy accordingly.
As we wrote last week, we don't think a 50 bp is likely at the March 15-16 FOMC. That said, we can't totally rule it out yet either. We get one more set of premium data (jobs, CPI, PPI) before that decision and so let's see how the economy is faring then. At the very least, the Fed will extend the 25 bp hikes for a longer period of time as we see nothing on the horizon that justifies a pause anytime soon. At a minimum, we look for 25 bp hikes in March, May, and June that takes Fed Funds to 5.25-5.50%, with growing risks of 25 bp in July that takes us to 5.50-5.75%. WIRP is largely in line with this rate path except that there are no odds priced in yet of that fourth 25 bp hike. This should eventually change. Strangely enough, an easing cycle is still expected to begin in Q4 but at much lower odds. Eventually, it should be totally priced out into 2024 in the next stage of Fed repricing. Williams speaks Wednesday. Bostic and Daly speak Thursday. Jefferson, Mester, Bullard, Collins, and Waller all speak Friday.
Financial conditions continue to loosen. As of February 10, conditions as measured by the Chicago Fed are the loosest since late February 2022. Its adjusted measure is the loosest since early February. This must be frustrating for the Fed but all it can do is to continue hiking rates and giving hawkish forward guidance. At some point soon, we think conditions will have to tighten as interest rates continue to rise. Credit spreads have also started to widen out this month and so perhaps we are at the beginning of this adjustment process. Now, if only the equity markets would get the message……
January PCE data Friday will be the data highlight. Headline is expected to remain steady at 5.0% y/y, while core is expected to fall a tick to 4.3% y/y. Given the CPI and PPI data last week, we see upside risks to PCE. Personal income and spending will be reported at the same time and are expected at 1.1% m/m and 1.3% m/m, respectively.
Weekly jobless claims Thursday will be closely watched. That is because the initial claims data will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for NFP but if claims remain low, we’ll get another solid number (though obviously down from the whopping 517k in January). Initial claims are expected at 199k vs. 194k last week. Continuing claims are expected at 1.701 mln vs. 1.696 mln last week.
January Chicago Fed National Activity Index will be reported Thursday. It is expected at 0.00 vs. -0.49 in December. If so, the 3-month moving average would remain steady at -0.33. A zero reading means the economy is growing at around trend. Recall that when that 3-month average moves below -0.7, that signals imminent recession and we are still well above that threshold. This series has taken on greater significance now that the 3-month to 10-year curve has inverted deeply. The continued resilience in the economy is noteworthy and suggests the Fed still has a lot more work to do in getting to the desired sub-trend growth.
We get a revision to Q4 GDP Thursday. Growth is seen steady at 2.9% SAAR. This is of course old news and markets are already looking ahead to Q1. Of note, the Atlanta Fed’s GDPNow model is currently tracking 2.5% SAAR and the next model update will come this Friday. If this rate is maintained, it would be the third straight quarter of above trend growth in the U.S.
We get some more February survey readings. Preliminary S&P Global PMIs will be reported Tuesday. Manufacturing is expected at 47.4 vs. 46.9 in January, services is expected at 47.3 vs. 46.8 in January, and the composite PMI is expected at 47.5 vs. 46.8 in January. Philadelphia non-manufacturing index will also be reported Tuesday. Kansas City Fed manufacturing index will be reported Thursday and is expected at -2 vs. -1 in January. Its services index will be reported Friday.
Housing sector data are expected to show continued weakness. January existing home sales will be reported Tuesday and is expected at 2.0% m/m vs. -1.5% in December. New homes sales will be reported Friday and is expected at 0.7% m/m vs. 2.3% in December.
Canada highlight will be January CPI data Tuesday. Headline is expected at 6.1% y/y vs. 6.3% in December, while core median is expected to fall a tick to 4.9% y/y and core trim is expected to fall a tick to 5.2% y/y. December retail sales data will also be reported Tuesday. Headline is expected at 0.5% m/m vs. -0.1% in November, while ex-autos is expected at -0.1% m/m vs. -0.6% in November.
Bank of Canada expectations have picked up after the second straight blowout jobs report. If data continue to come in firm, the bank will find it harder and harder to justify its pause. No change is expected at the next meeting March 8 but WIRP suggests a final 25 bp hike to 4.75% is mostly priced in for Q3.
Eurozone data highlight will be preliminary February PMI readings Tuesday. Headline manufacturing is expected at 49.3 vs. 48.8 in January, services is expected at 51.0 vs. 50.8 in January, and the composite is expected at 50.6 vs. 50.3 in January. Looking at the country breakdown, the German composite is expected at 50.3 vs. 49.9 in January and the French composite is expected at 49.6 vs. 49.1 in January. Italy and Spain will not be reported until the final PMI readings early next month.
Germany reports some important sentiment indicators. February ZEW readings will be reported Tuesday. Expectations component is expected at 23.0 vs. 16.9 in January and the current situation component is expected at -50.0 vs. -58.6 in January. IFO business climate will be reported Wednesday. Headline is expected at 91.1 vs. 90.2 in January, driven by increases in both current assessment and expectations to 94.8 and 88.2, respectively. March GfK consumer confidence will be reported Friday and is expected at -30.0 vs. -33.9 in February. While many of the survey indicators appear to have bottomed, we warn against getting too excited about the eurozone outlook as the hard data remain weak.
ECB tightening expectations have picked up. WIRP suggests a 50 bp hike March 16 is nearly priced in. Looking further ahead, a 50 bp hike May 4 is nearly 70% priced. Another 25 bp hike June 15 is priced in, followed by one last 25 bp hike July 27 that would result in a peak policy rate near 3.75%, up from 3.5% at the start of last week. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand again.
U.K. reports some key data this week. Preliminary February PMI readings and January public sector net borrowing will be reported Tuesday. Headline manufacturing is expected at 47.5 vs. 47.0 in January, services is expected at 49.2 vs. 48.7 in January, and the composite is expected at 49.1 vs. 48.5 in January. CBI will release the results of its February surveys. Industrial trends will be released Tuesday, with total orders expected at -15 vs. -17 in January and selling prices expected at 35 vs. 41 in January. Distributive trades will be released Thursday. February GfK consumer confidence will also be reported Thursday and is expected at -43 vs. -45 in January. Here too, we cannot get excited about the modest recovery in the sentiment indicators as the hard data remain weak.
BOE tightening expectations have steadied. WIRP suggests a 25 bp hike March 23 is nearly 75% priced in. After that, a final 25 bp hike is nearly priced in for Q2 and so the expected terminal rate remains near 4.5%. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September. Mann and Cunliffe speak Thursday. Tenreyro speaks Friday.
Sweden reports January CPI data Monday. Headline is expected at 11.8% y/y vs. 12.3% in December and CPIF is expected at 9.5% y/y vs. 10.2% in December. If so, it would be the first deceleration for headline since July and the first deceleration in CPIF since October. Next Riksbank meeting is April 26. WIRP suggests another 50 bp hike to 3.5% is about 60% priced in and the market is pricing in a peak policy rate near 3.75%. At the last meeting February 9, it hiked rates 50 bp to 3.0% and delivered several other hawkish measures and noted “Inflation is far too high and has continued to rise. The policy rate will probably be raised further during the spring.” Starting in April, the Riksbank will accelerate its Quantitative Tightening and sell SEK3.5 bln ($340 mln) per month in government bonds. Furthermore, the bank is putting more emphasis on the exchange rate after a period of benign neglect, noting “If the krona continues to be weak, it will be considerably more difficult for the Riksbank to sustainably return inflation to the target. A stronger krona would be desirable.” Lastly, forward guidance shifted more hawkish, as the policy rate is now seen peaking at 3.33% in Q4 2024 and staying there through Q1 2026. This compares to market pricing of a 3.75% peak policy rate.
Japan data highlight will be January national CPI data Friday. Headline is expected at 4.3% y/y vs. 4.0% in December, core (ex-fresh food) is expected at 4.2% y/y vs. 4.0% in December, and core ex-energy is expected at 3.3% y/y vs. 3.0% in December. All would be new cycle highs. Price pressures continue to rise, though the PPI is showing signs of peaking. January department store sales will also be reported Friday.
Expected BOJ liftoff is not imminent. Next BOJ policy meeting March 9-10 will be the last one under Governor Kuroda and while no change is expected, we simply cannot rule out one last surprise. WIRP suggests nearly 20% odds of liftoff April 28, rising to nearly 55% June 16 and then fully priced in for July 28. That said, the actual tightening path is seen as very mild as the market is pricing in 25 bp of tightening over the next 12 months followed by only 30 bp more over the subsequent 24 months. That is why we expect the knee-jerk drop in USD/JPY after liftoff to be fairly limited.
Japan also reports preliminary February PMI readings Tuesday. The composite PMI has risen two straight months and stands at 50.7 in January, the highest since October.
Reserve Bank of Australia releases its minutes Tuesday. At that February 7 meeting, the bank hiked rates 25 bp to 3.35% and Governor Lowe sounded hawkish, noting that “The board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target.” Clearly, the RBA is nowhere close to pausing. WIRP suggests around 75% odds of a 25 bp hike at the next meeting March 7, while the swaps market is pricing in a peak policy rate near 4.15% over the next 6 months followed by steady rates for the subsequent 6 months. An easing cycle is priced in for the subsequent 12 months, highlighting the “higher for longer” theme.
Australia reports preliminary February PMI readings Tuesday. Q4 wage price index will be reported Wednesday and is expected at 1.0% q/q and 3.5% y/y.
Reserve Bank of New Zealand meets Wednesday and is expected to hike rates 50 bp to 4.75%. The recent floods will certainly complicate the RBNZ’s job. While the impact is obviously a temporary one, the resulting higher inflation coupled with slower growth is never a good situation. That said, market expectations have not changed much in recent weeks. WIRP suggests a 50 bp hike is about 75% priced in. Looking ahead, 25 bp hikes are priced in for April and May that would see the policy rate peak near 5.25% over the next 6 months. However, the market is still pricing the start of an easing cycle in the subsequent 6 months and that seems very unlikely. New Zealand also reports Q4 PPI data Tuesday. January trade data will be reported Wednesday before the RBNZ decision.