Easy Like Sunday Morning

• Data light day ahead. USD is gaining grounds against all major currencies despite a modest correction in US Treasury yields.

• Strong US retail sales outshines UK’s decline. GBP underperforms across the board.

• China economic activity improves in December. We are skeptical this will last.

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USD is gaining grounds against all major currencies despite a modest correction in US Treasury yields. Treasury yields dipped yesterday after Fed Governor Christopher Waller went full dove ahead of the media blackout. Waller noted that if future inflation figures fall in-line with December’s positive report, the Fed may cut more than investors are currently expecting. According to Waller “3 or 4 rate cuts is possible in 2025 if the data cooperates.” In contrast, Fed funds futures imply between 1 and 2 rate cuts in 2025 while the FOMC has 2 cuts penciled in.

In his speech delivered January 8, Waller was optimistic on the US disinflationary outlook, expecting “a significant step-down in the 12-month inflation numbers through March.” If he’s right, Fed funds futures will likely start pricing-in more easing in 2025 which would be a headwind for USD.

Nevertheless, the fundamental USD uptrend is intact. First, the US economy is in a sweet spot (solid growth and modest disinflation) and outperforming other advanced economies. Second, the prospect for looser fiscal policy under a Trump administration will force the Fed to keep policy restrictive for longer. Third, expectations for a lower US corporate tax rate and a wave of deregulation should boost foreign portfolio and FDI flows to the US. Fourth, the favorable US productivity landscape will lead to low inflationary economic growth which translates to higher real interest rate.

The US December retail sales print was indicative of robust consumer spending activity. The retail sales control group - which strips out volatile components and is used for GDP calculations – overshot expectations rising by 0.7% m/m (consensus: 0.4%) vs. 0.4% in November. Overall, the US economy is still tracking well above long-run annual trend growth of 1.8%. The Atlanta Fed GDPNow model estimates Q4 growth at 3.0% SAAR up from 2.7% on January 9. Second-tier US economic data are due today and unlikely to generate material financial market volatility.

GBP dropped against all major currencies following the poor UK December retail sales report. Retail sales volumes unexpectedly declined -0.3% m/m (consensus: 0.4%) following a small rise of 0.1% in November (revised down from 0.2%). Excluding automotive fuel, retail sales volumes plunged -0.6% m/m after rising 0.1% in November (revised down from 0.3%). Black Friday deals failed to encourage spending which was dragged down by food and non-store sales.

The recent UK debt market sell-off threatens to further curtail consumption spending as more mortgage holders reduce spending in anticipation of paying higher mortgage rates. According to the Bank of England, around 800,000 fixed-rate mortgages currently with an interest rate of 3% or below are expected to be refinanced per year, on average, until the end of 2027.

Bottom line: the Bank of England (BOE) will likely have to step-up the pace of easing. Market has virtually fully priced-in a 25bps rate cut in February and almost 75bps of cuts over the next 12 months (up from 50bps earlier this week). BOE/Fed policy trend remains a drag on GBP/USD.

BOE Governor Andrew Bailey delivers a speech titled “A Central Banker’s view of global challenges and expectations for the Bretton Woods Institutions’ response” (9:00pm London) A text of the speech will be released at 5:00pm London.

EUR/USD is trading on the defensive under 1.0300. The ECB Account of the December 11-12 meeting confirmed that more easing was in the pipeline which is an ongoing drag for EUR. According to the Account “if the baseline projection for inflation was confirmed over the next few months and quarters, a gradual dialling-back of policy restrictiveness was seen as appropriate.”

Still, the ECB is not about to crank up the pace of easing despite the proposal for a 50bps cut in December. The Account point out that “some members noted that a case could be made for a 50 basis point rate cut at the current meeting and would have favoured more consideration being given to the possibility of such a larger cut.” However, “it was remarked that a 50 basis point cut could be perceived as the ECB having a more negative view of the state of the economy than was actually the case.”

Bottom line: the Eurozone’s soggy growth outlook leaves plenty of room for the ECB to bring down the policy rate towards the lower-end of its neutral range - estimated at around 1.50% to 3.00%. Markets price-in 100bps of total ECB easing over next 12 months that should see the policy rate bottom around 2.00%.

USD/CNH remains range-bound around 7.3500. China’s economy improved driven by the government’s stimulus measures. Industrial production and retail sales rose more than expected in December. Over Q4, real GDP increased a tick less than anticipated by 1.6% q/q but the previous quarter’s growth was revised four ticks higher to 1.3%. Unsurprisingly, real GDP growth hit the government’s 5% 2024 target.

We remain skeptical that China’s stimulus measures announced so far will have much lasting impact on the economy. To escape the debt-deflation loop, Chinese policymakers need to ramp up fiscal measures to boost consumption.

National Bank of Poland (NBP) delivered a dovish hold yesterday. As was widely expected, NBP left the policy rate at 5.75% and reiterated that “the current level of the NBP interest rates is conducive to meeting the NBP inflation target in the medium term.” However, the bank scrapped previous reference that “in the coming quarters inflation will remain markedly above the NBP inflation target”, paving the way for a rate cut in the next few months. The swaps market is pricing in 25bps of easing over the next three months followed by 25bps of easing over the subsequent three months.

NBP Governor Glapinski will have an opportunity today to share his policy outlook and address the division within the MPC (2:00pm London). Following the December policy-setting meeting, Glapinski unexpectedly pushed out his outlook for rate cuts to 2026 from mid-2025 because the inflation outlook has become more “complicated.” His updated view exposed a rift on the MPC, as several members said they still expect to start discussing easing in March. According to MPC member Kotecki “the position of the central bank’s governor is not the position of the Monetary Policy Council…Unfortunately, these comments are probably dictated by some political considerations.” The swaps market has fully priced-in a 25bps cut over the next three months.