Sweet Emotion
- US economy is in a very good place as the economy is strong and disinflation is underway.
- UK economy barely grows in November. BOE has room to ease further.
- Australia’s December labor force report was good but does not shift the dial on near-term RBA rate expectations.
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USD recovered its losses triggered by yesterday’s softer US core CPI inflation. 10-year Treasury yields are holding near yesterday’s lows and US equity futures point to further stock market gains. The US economy is in a very good place as the economy is strong and disinflation is underway. In contrast, other major economies face sluggish growth prospects. The more favorable US economic outlook relative to other major economies continue to support the fundamental USD uptrend.
The US economy is tracking well above long-run annual trend growth of 1.8%. The Atlanta Fed GDPNow model estimates Q4 growth at 2.7% SAAR. The next GDPNow update is released today.
The US December CPI data was soft but continues to show that progress on inflation is stalling well above 2%, which supports the case for a shallow Fed easing cycle. Headline CPI inflation rose in line with consensus to 2.9% y/y vs. 2.7% in November, while measures of core inflation unexpectedly eased. Core CPI ex. food & energy dipped 0.1pts to 3.2% (consensus: 3.3%) and super core CPI (core services less housing) fell to a one year low at 4.1% vs. 4.3% in November.
The latest Fed Beige Book adds to evidence that upside risks to the inflation outlook had increased. The Beige Book notes that “contacts expected prices to continue to rise in 2025, with some noting the potential for higher tariffs to contribute to price increases.”
The US December retail sales report is today’s data highlight (1:30pm London). Consensus sees headline up 0.6% m/m vs. 0.7% in November. More importantly, the retail sales control group used for GDP calculations and which excludes volatile items like car sales, is projected to rise 0.4% m/m vs. 0.4% in November. Overall, consumer spending is supported by positive real wage growth, healthy labor market and strong household balance sheet.
US December business inventories, January NAHB housing market index, January Philadelphia Fed business outlook and January New York Fed services business activity are also due today. There are no Fed speakers due to the media blackout ahead of the FOMC’s January 29 rate decision.
Scott Bessent, President-elect Donald Trump's pick for US Treasury secretary, will face a Senate Finance Committee hearing today (from 10:30am New York/3:30pm London). Bessent is expected to be questioned on currency policy and the fiscal outlook. In his prepared remarks, Bessent wrote “we must ensure that the US dollar remains the world’s reserve currency.”
Stephen Miran’s 41-page essay “A User’s Guide to Restructuring the Global Trading System” offers a good framework to understand the range of possible tariff/currency driven policies that might be implemented by the incoming Trump administration. Miran was nominated in late December to chair Trump’s Council of Economic Advisers.
GBP is underperforming on subdued UK economic activity. Monthly real GDP grew by just 0.1% m/m in November (consensus: 0.2%) following a fall of -0.1% in October. The services sector was the main growth contributor, rising by 0.1%. Construction also grew, by 0.4%, while production fell by -0.4%.
Encouragingly, the BOE has room to ease further and support economic activity as UK inflation is cooling. BOE MPC member Alan Taylor noted yesterday that “with the economy weakening, it’s time to get interest rates back toward normal to sustain a soft landing.” Market is pricing almost 90% odds of a 25bps BOE rate cut in February and a total of 50bps of cuts over the next 12 months. Reduced risk the UK enters a period of stagflation should cushion the decline in GBP.
EUR/USD is trading sideways around 1.0300. The ECB’s Account of the December 11-12 meeting is up next (12:30pm London). At that meeting, the ECB reduced the policy rate 25bps to 3.00% as was widely expected. However, the ECB signaled more easing was in the pipeline which is an ongoing drag for EUR. The ECB tweaked lower its macro projections, and scrapped reference that it “will keep policy rates sufficiently restrictive for as long as necessary.” ECB President Christine Lagarde acknowledged there were some discussions around the proposal for a 50bps cut.
USD/JPY dropped briefly to near a one month low around 155.20 on rising odds (80% vs. 70% yesterday) of a Bank of Japan (BOJ) rate hike next week. BOJ Governor Kazuo Ueda noted again that there seems to be some positive views on wage hikes gathering momentum since the start of the year. Meanwhile, a news report highlighted that the BOJ sees a good chance of a January rate hike. We are sticking to our view that the BOJ will wait until March to resume normalizing rates as wage trend will be clearer by then. Japan’s December CPI print, due a few hours before the BOJ policy rate announcement, will serve as a key factor influencing policymakers’ decision.
AUD/USD is holding above technical support at 0.6200. Australia’s December labor force report was good but does not shift the dial on near-term RBA rate expectations. The economy added 56.k jobs (consensus: 15k) vs. 28.2k (revised down from 35.6k) in November. All the job gains were in part-time positions (80k) while full-time employment fell by -23.7k, marking its first decline since August 2024. The unemployment rate rose 0.1pts to 4.0%, in line with consensus and lower than the RBA’s 4.3% end of year forecast.
Nonetheless, the RBA signaled in December it may start cutting the policy rate at its next February 18 meeting. First, the RBA scrapped its previous neutral policy guidance that “the Board is not ruling anything in or out”. Second, the RBA noted “the Board is gaining some confidence that inflation is moving sustainably towards target”, adding that “some of the upside risks to inflation appear to have eased.” Previously, the RBA warned of “the need to remain vigilant to upside risks to inflation.” As such, Australia’s Q4 CPI (due January 29) will either lock-in a February RBA rate cut or give the RBA space to delay the start of easing a bit longer. Markets continue to price in roughly 70% probability of a 25bps RBA cash rate cut in February. We agree.
National Bank of Poland meets today and is expected to keep the policy rate at 5.75%. At the last policy meeting December 4, the central bank kept rates steady at 5.75%. However, Governor 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.