• There has been a significant drop in real yields globally; Fed officials are sounding more cautious even as easing expectations have intensified; financial conditions continue to loosen even as the U.S. economy remains robust; BOC releases its summary of deliberations; Chile cut rates 75 bp to 8.25%; the soft dollar and lower U.S. rates have allowed EM central banks to become more aggressive
  
• Germany reported January GfK consumer confidence; U.K. reported soft November CPI data; BOE easing expectations picked up as a result of the data
  
• Falling JGB yields suggest BOJ liftoff is not imminent; Japan reported soft November trade data; New Zealand released plans to cut spending ahead of pledged tax cuts; China banks set their Loan Prime Rates

The dollar is getting some limited traction. DXY is trading higher near 102.385 as the 102 area is providing support for now. Sterling is the big mover today, trading lower near $1.2650 as lower than expected CPI data ratcheted up BOE easing bets (see below). The euro is being dragged lower and trading near $1.0940 as the $1.10 area is proving tough to crack. USD/JPY is trading lower near 143.40 despite the continued slide in JGB yields (see below). This pair should eventually move higher given the dovish BOJ hold this week. Last week’s dovish Fed decision was a game changer even as Fed officials are still attempting damage control (see below). Despite strong pushback from the ECB and BOE last week, easing expectations continue to spread to virtually every other major central bank and this has likely helped the dollar get some limited traction. However, a sustained dollar recovery will really come down to the U.S. data. Over the past two weeks, the readings have all come in quite firm and so we continue to believe that the current market easing expectations are wrong. Until these expectations shift, however, the dollar is likely to remain vulnerable.

AMERICAS

There has been a significant drop in real yields globally. Real 10-year yields are close to zero in the U.K. and Germany and remain deeply negative in Japan. The U.S. stands head and shoulders above the rest at 1.68%. Though down from the absolute peak near 2.5% this past fall, the gap with the rest of the world is about as wide as it was at the peak this past fall. This is helping the dollar get a little bit of traction.

Fed officials are sounding more cautious. Bostic said, “For me, I’m thinking inflation is going to come down relatively slowly in the next six months, which means there’s not going to be urgency for us to pull off our restrictive stance.” He said he expects the Fed to cut rates twice in 2024, most likely in H2, but stressed “It is not like there has been an active discussion on this.” Elsewhere, Barkin said “If you’re going to assume that inflation comes down nicely, of course we would respond appropriately.” However, he stressed that he’s looking for “consistency and breadth” in inflation data over the next several months. Barkin added that “I don’t assume what the data is going to do. I’ve got a perspective that inflation is a little stubborner than the average person is in there. And I hope I am wrong on that.” Goolsbee and Harker speak today.

Fed easing expectations have intensified. WIRP suggests 10% odds of a cut January 31 and rising to over 90% March 20. A second cut is fully priced in May 1 and six cuts are fully priced in by end-2024 vs. four at the start of last week. While we still strongly disagree with this market pricing, it will now take a much longer string of stronger data to shift the narrative than what was needed before the Fed’s dovish performance last week. It’s clear that the Fed’s damage control efforts are having little impact on the market.

Financial conditions continue to loosen. The weekly Chicago Fed measure for last week will be reported today and is likely to record the ninth straight loosening. Given market movements this week, we can expect even looser conditions ahead. Of note, the New York Fed's FCI-G measure of financial conditions shows monetary policy was basically neutral in November. Given market movements this month, we can only assume that policy has moved to accommodative in December. That is why we remain skeptical that inflation will come down as quickly as the Fed believes.

The U.S. economy remains robust. Atlanta Fed's GDPNow model now estimates Q4 growth at 2.7% SAAR, up from 2.6% previously. Next update comes Friday, same as the NY Fed's Nowcast model that is currently tracking 2.2% SAAR. Both suggest the economy continues to grow above trend. The early reads were based largely on strike-depressed October data. If November data continue to bounce back as we’ve seen already, the Q4 growth estimates should rise accordingly.

Housing sector data will remain in focus. Existing home sales are expected at -0.4% m/m vs. -4.1% in October. New home sales will be reported Friday and are expected at 1.6% m/m vs. -5.6% in October. Yesterday, November building permits and housing starts came in at 14.8% m/m and -2.5%, respectively, while the y/y rates both turned positive and were the strongest since mid-2022. If mortgage rates continue to fall, we should see this sector continue to recover.

December Conference Board consumer confidence will also be reported. Headline is expected at 104.5 vs. 102. 0 in November. Final December University of Michigan consumer sentiment will be reported Friday and preliminary headline was 69.4. Q3 current account data will also be reported today.

Bank of Canada releases its summary of deliberations. At that December 6 meeting, it delivered another dovish hold. Rates were kept steady at 5.0% as the bank saw further signs that its previous rate hikes are cooling spending. The bank added that the economy is no longer in excess demand but stressed that it wants to see further sustained easing in core inflation. This was the bank's second straight dovish hold. WIRP suggests nearly 15% odds of a rate cut January 24, rising to 55% March 6 and fully priced in April 10 vs. June 5 at the start of last week. Five cuts are priced in by the end of 2024 vs. four at the start of last week. However, the market is starting to price in around 50% odds of a sixth cut next year.

Canada reported November CPI. Headline came in at 3.1% y/y vs. 2.9% expected and 3.1% in October, core trim came in at 3.5% y/y vs. 3.4% expected and 3.5% in October, and core median came in at 3.4% y/y vs. 3.3% expected and a revised 3.4% (was 3.6%) in October. Yesterday, BOC Governor Macklem said rates would be cut next year but we think the timing will be pushed out if inflation remains stubbornly high.

Chile central bank cut rates 75 bp to 8.25%, as expected. Some were looking for the bank to cut rates 50 bp again but falling inflation and the strong peso allowed the bank to return to the 75 bp pace. The bank said “The convergence of inflation to the target will require further cuts in the monetary policy rate. Its magnitude and timing will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation.” Next meeting is January 31, and it will likely come down to how the peso is trading. The swaps market is pricing in 150 bp of easing over the next three months, followed by another 150 bp over the subsequent three months.

The soft dollar and lower U.S. rates have allowed EM central banks to become more aggressive in their easing cycles. Colombia just cut yesterday for the first time, with the strong peso being a major factor there as well. Recall that over the summer and into the early fall, EM central banks had to slow their rate cuts due to significant weakness in their currencies. Those pressures may return if the dollar recovers but for now, policymakers are happy to take advantage of this window for larger rate cuts.

EUROPE/MIDDLE EAST/AFRICA

Germany reported January GfK consumer confidence. Headline came in at -25.1 vs. -27.0 expected and a revised -27.6 (was -27.8) in December. This was the highest since August. Eurozone also reported October current account and construction output data.

European Central Bank easing expectations remain elevated despite the hawkish hold last week. WIRP suggests 10% odds of a cut January 25, rising to 50% for March 7 and fully priced in April 11. Six cuts by the end of next year are now priced in vs. five as the start of last week. Officials continue to push back against easing expectations. Nagel said “There’s a high likelihood that the peak in interest rates has been reached. To all those speculating on an imminent rate cut I say: Careful, others have miscalculated before.”

U.K. reported soft November CPI data. Headline came in at 3.9% y/y vs. 4.3% expected and 4.6% in October, core came in at 5.1% y/y vs. 5.6% expected and 5.7% in October, and CPIH came in at 4.2% y/y vs. 4.5% expected and 4.7% in October. Headline is the lowest since September 2021 but still well above the 2% target. Of note, services inflation came in at 6.3% y/y vs. 6.6% in October while food prices rose 9.2% y/y vs. 10.1% in October.

Bank of England easing expectations picked up as a result of the data. WIRP suggest 5% odds of a cut February 1, rising to 45% March 21 and fully priced in May 9 vs. June 20 at the start of this week. Five cuts are now priced in by the end of 2024 vs. four at the start of this week and three at the start of last week. Breeden said yesterday that it is “important for monetary policy to be restrictive for an extended period in order to return inflation sustainably to the 2% target in the medium-term.”

ASIA

Falling JGB yields suggest Bank of Japan liftoff is not imminent. The 10-year yield dropped to 0.55%, the lowest since late July when the bank tweaked Yield Curve Control. This is down sharply from the November 1 peak near 0.97%, as the market never tested the 1.0% ceiling that’s still in place. WIRP suggests 35% odds of a hike then, rising to 60% March 18-19 and nearly 75% April 25-26. Bank of Japan liftoff is now priced in June 13-14 vs. April 25-26 at the start of last week.

Japan reported soft November trade data. Exports came in at -0.2% y/y vs. 1.4% expected and 1.6% in October, while imports came in at -11.9% y/y vs. -8.6% expected and -12.5% in October. With exports shrinking again, the last thing Japan needs is a sharply stronger yen and so we continue to believe that liftoff will come later rather than sooner.

New Zealand released plans to cut spending ahead of pledged tax cuts. Finance Minister Nicola Willis outlined NZD7.5 bln ($4.7 bln) of spending cuts over the next five years in her first mini budget. The Treasury Department also published its half-year economic and fiscal outlook that forecasts the budget returning to surplus in 2027, the same as its previous projection. Willis said “The update shows a worsening economic picture. We have a big job to do to get the books back in surplus by 2027. That remains our intention.” However, Willis said that the government is committed to following through on the tax cuts pledged during the campaign. She stressed that “Tax reduction is coming, but first we have to do the work. We’ve made a significant down payment on tax reduction, $7.5 billion worth of savings already. We’ve committed to the actions needed to find the rest of the money.”

Fiscal tightening is always difficult when the economy is slipping into recession. Revenues fall and outlays rise, making the balanced budget a moving target. With tax cuts already planned, the risks of fiscal slippage rise even further. Fiscal tightening also comes at a time of tight monetary policy, with the RBNZ not expected to cut rates until mid-2024. Bottom line: downside risks to New Zealand growth are rising.

China banks set their Loan Prime Rates. As expected, the 1- and 5-year LPRs were kept steady at 3.45% and 4.20%, respectively. However, with deflation risks rising, we expect further monetary easing in the coming weeks as real interest rates are rising.