The majors were mostly softer last week after being whip-sawed by large swings in Fed tightening expectations. AUD, CAD, and GBP outperformed while NOK, SEK, and JPY underperformed. We continue to believe markets are putting too much weight on a potential Fed pivot and underestimating the Fed’s capacity to tighten in 2023. As a result, we view last Friday’s setback for the dollar as temporary.

AMERICAS

Markets are still digesting Friday’s data. The jobs report was strong overall as unemployment dropped back to the cycle low of 3.5%, supporting the view that the labor market remains red hot. However, markets focused on the bigger than expected drop in average hourly earnings to 4.6% y/y, the lowest since . We would warn that if the labor market remains as tight as it seems, wages are unlikely to fall much further in the coming months. Later Friday morning, we got an unequivocally bad ISM services report. The 49.6 headline was the lowest since May 2020 and the details were just as bad, with employment falling to 49.8 and activity falling ten full points to 54.7.

The notion of a Fed pivot continues to gain credence. We wholeheartedly disagree. Minutes released last week from the December FOMC meeting made it clear that the Fed is concerned about a premature loosening of financial conditions. According to the Chicago Fed’s measure, financial conditions have loosened steadily from mid-October through yearend. Fed speakers this week should continue to push back against this. Bostic and Daly speak Monday. Powell speaks Tuesday. Harker and Bullard speak Thursday.

We continue to believe markets are underestimating the Fed. WIRP suggests a 25 bp hike February 1 is fully priced in, with nearly 30% odds of a larger 50 bp move. Another 25 bp hike March 22 is fully priced in, while one last 25 bp hike in Q2 is nearly 50% priced in that would take the Fed Funds rate ceiling up to 5.25%. However, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. Barkin, Cook, George, and Bostic all speak today.

December CPI Thursday will be the highlight. Headline is expected at 6.6% y/y vs. 7.1% in November, while core is expected at 5.7% y/y vs. 6.0% in November. If so, this would continue headline inflation’s steady decline from the 9.1% peak in June and core inflation’s more recent decline from the 6.6% peak in September. However, core PCE has largely been in a 4.5-5.5% range since November 2021 and we think the Fed needs to see further improvement before even contemplating any sort of pivot.

Preliminary January University of Michigan consumer sentiment Friday will be closely watched. Headline is expected at 60.5 vs. 59.7 in December. If so, this would be the third straight improvement to the highest since April 2022. Consumption has held up relatively well as the strong labor market continues to boost sentiment and incomes. Both 1- and 5-year inflation expectations are seen steady at 4.4% and 2.9%, respectively.

Otherwise, the U.S. data reports are minor. November consumer credit will be reported Monday and is expected at $25.0 bln vs. $27.1 bln in October. November wholesale trade sales and inventories will be reported Tuesday. Weekly jobless claims and December budget statement (-$65.0 bln expected) will be reported Thursday. We note that initial claims last week came in at 204k vs. 225k expected and a revised 223k (was 225k) the previous week. This was the lowest since late September and dragged the 4-week moving average down to 214k, the lowest since mid-October. December import/export prices will be reported Friday.

EUROPE/MIDDLE EAST/AFRICA

Eurozone has a quiet data week. Germany reports November IP Monday and is expected at 0.3% m/m vs. -0.1% in October. France and Spain report Tuesday and are expected at -1.0% m/m and -0.5% m/m, respectively. Italy reports November retail sales Wednesday, followed by IP Friday that is expected at 0.3% m/m vs. -1.0% in October. Eurozone-wide IP and trade data will also be reported Friday and is expected at 0.5% m/m vs. -2.0% in October.

ECB tightening expectations have fallen. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is nearly priced in, while a last 25 bp hike in Q3 is about 75% priced in that would see the deposit rate peak near 3.5% vs. 3.75% last week. If inflation continues to slow, the expected peak rate is likely to move closer to 3.25% and perhaps even to 3.0%, which is where it stood back in mid-December. Schnabel, de Cos, and Knot speak Tuesday. Holzmann, Vujcic, Villeroy, and de Cos speak Wednesday.

The monthly U.K. data dump begins Friday. November GDP, IP, services, construction output, and trade will all be reported. GDP is expected at -0.3% m/m vs. 0.5% in October, IP is expected at -0.3% m/m vs. flat in October, services index is expected at -0.1% m/m vs. 0.6% in October, and construction is expected at -0.3% m/m vs. 0.8% I October. Clearly, the October bounce is seen as a temporary outlier. The trade deficit is expected at -GBP2.3 bln vs. -GBP1.8 bln in October.

BOE tightening expectations remain steady. WIRP suggests 80% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is now priced in rather than 50 bp previously. After that, a 25 bp hike is nearly priced in May 11 followed by only 50% odds of final 25 bp hike in Q3 that would see the bank rate peak near 4.75% vs. 4.5% early last week. Chief Economist Pill speaks Monday. Governor Bailey speaks Tuesday. MPC member Mann speaks Thursday.

Norway reports some key data. December CPI will be reported Tuesday. Headline is expected at 6.1% y/y vs. 6.5% in November, while underlying is expected to remain steady at 5.7% y/y. if so, headline would decelerate for the second straight month from the 7.5% peak in October but remain well above the 2% target. At the last policy meeting December 15, Norges Bank hiked rates 25 bp to 2.75% and noted that the policy rate “will most likely be raised further in the first quarter of next year.” Governor Bache stressed that “The forecasts for the Norwegian economy are more uncertain than normal, but if the economy evolves as anticipated, the policy rate will be around 3% next year.” Updated macro forecasts and expected rate path were released then and the expected rate path still saw the policy rate peaking near 3.0%, with gradual easing expected in H2 24. Next policy meeting is January 19 and another 25 bp hike to 3.0% is expected. The swaps market is now pricing in a peak policy rate near 3.0% vs. 3.25% right after that meeting. November GDP will be reported Thursday.

Sweden also reports some key data. November GDP, household consumption, IP, and industrial orders will all be reported Tuesday. December CPI will be reported Friday. Headline is expected at 12.0% y/y vs. 11.5% in November, while CPIF is expected at 9.9% y/y vs. 9.5% in November. Both would be new cycle highs and CPIF would move further above the 2% target. At the last policy meeting November 24, the Riksbank hiked rates 75 bp to 2.5% and noted that “The forecast shows that the policy rate will probably be raised further at the beginning of next year and then be just below 3%.” Minutes from the meeting showed Governor Ingves and Deputy Governor Ohlsson had doubts as to whether planned rate hikes would be enough to tame inflation. Next policy meeting is February 9 and will be led by incoming Governor Erik Thedeen after Ingves’ term ended December 31. WIRP suggests another 50 bp hike to 3.0% is fully priced in with 75% odds of a larger 75 bp move, while the swaps market is pricing in a peak policy rate near 3.5%.

ASIA

Japan highlight will be December Tokyo CPI Tuesday. Headline is expected at 4.0% y/y vs. 3.7% in November, while core (ex-fresh food) is expected at 3.8% y/y vs. 3.6% in November. If so, both would be new cycle highs and would suggest further upside in the national CPI too. November household spending will also be reported Tuesday. November leading and coincident indices will be reported Wednesday.

BOJ tightening expectations remain elevated. WIRP suggests nearly 30% odds of liftoff at the March 9-10 meeting and 80% at the April 27-28 meeting. We believe liftoff is likely to come earlier than we previously anticipated, with significant risks of a move in Q2 vs. H2 seen previously. Given Kuroda’s penchant for surprises, we cannot rule anything out right now and even Q1 is possible.

November current account data will be reported Thursday. An adjusted surplus of JPY658 bln is expected vs. a deficit of -JPY609 bln in October. However, the investment flows will be of most interest. October data showed that Japan investors were net sellers of U.S. bonds for the second straight month (-JPY985 bln) and in eleven of the past twelve. Japan investors remained net sellers (-JPY266 bln) of Australian bonds for the fourth straight month and Canadian bonds (-JPY85 bln) for the ninth straight month, but became net buyers of Italian bonds (JPY184 bln) after two straight months of net selling. Overall, Japan investors were total net sellers of foreign bonds in October of over -JPY3 trln. Preliminary MOF data suggest Japanese life insurers continued to sell foreign bonds (mostly U.S.) in November to the tune of nearly -JPY2 trln.

Australia reports some key data. November CPI will be the highlights Wednesday. Headline inflation is expected at 7.3% y/y vs. 6.9% in October, while trimmed mean is expected at 5.5% y/y vs. 5.3% in October. If so, headline would match the cycle high from September and move further above the 2-3% target range. At the last policy meeting December 6, the Reserve Bank of Australia hiked rates 25 bp to 3.10% while 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. Next policy meeting is February 7. WIRP suggests nearly 60% odds of a 25 bp hike, while the swaps market is pricing in a peak policy rate near 3.85%. Updated forecasts will come at that meeting.

Key real sector data will also be reported for Australia. November retail sales will be reported Wednesday and is expected at 0.7% m/m vs. -0.2% in October. Ahead of that, November building approvals will be reported Monday and are expected flat m/m vs. -6.0% in October. Trade data will be reported Thursday. Home loan data will be reported Friday.