• Major central banks continue to add to market volatility; the last lone holdout to global monetary tightening just blinked; markets are still digesting last week’s FOMC decision; CFTC positioning data through December 13 came out late last Friday; housing data are likely to show continued weakening; Canada report October retail sales
  
• The EU finally agreed on a deal to cap natural gas prices; ECB officials remain hawkish; Hungary is expected to keep the base rate steady at 13.0%.
  
• The two-day BOJ meeting ended with an unexpected tweak to YCC; markets will surely test the new trading band; so far, the action has been in FX and stocks; RBA released dovish minutes; China commercial banks left LPRs unchanged, as expected; Taiwan reported very weak November export orders
  

The dollar is mostly lower after the BOJ’s surprise move. The yen is of course outperforming and trading at the strongest level since August near 132. The August low near 130.40 is the next target, followed by the May low near 126.35. Yen strength has dragged the other foreign currencies higher and so DXY is trading lower just below 104. The euro is trading higher near $1.0645, while sterling is lagging and trading flat near $1.2160. EM FX is mixed but should come under further pressure as global liquidity tightens further. We continue to believe that the fundamental outlook still favors the dollar but the BOJ has thrown a spanner in the works. Let’s wait a bit to see how this surprise works its way through the markets but it’s clear that at the very least, our 2023 forecasts for USD/JPY will have to be marked lower as the timetable for BOJ liftoff has been moved forward (see below).

AMERICAS

Major central banks continue to add to market volatility. Overnight, the Bank of Japan upended the global macro landscape with a surprise move on Yield Curve Control. Simply put, the combination of faulty forward guidance and quickly changing macro conditions have led to far too many central bank surprises this year. In a perfect world, central banks should be telegraphing their moves to the markets well in advance, with little market reaction. Obviously, that hasn’t been the case in 2022 and we suspect this will continue well into 2023.

A detailed discussion is in our Asian section but suffice to say here that the last lone holdout to global monetary tightening just blinked. Rates were kept steady by the BOJ but monetary conditions are already starting to tighten in Japan from the combination of higher JGB yields at the long end and the stronger yen. As the fourth largest economy in the world, years and years of negative rates and Quantitative Easing had contributed to loose global monetary conditions.   Today’s move by the BOJ simply hastens the end of the easy money that markets had gotten addicted to. To us, this is another nail in the coffin for risk assets near-term. As a sidebar, the amount of negative yielding debt global is the lowest since late 2014, another sign that the tide is quickly going out.

Markets are still digesting last week’s FOMC decision. After rising as high as 5.5% after last week’s FOMC meeting, the terminal rate as seen by the swaps market fell back to just below 5.0%. Similarly, WIRP suggests a 50 bp hike February 1 is only about 35% priced in, followed by a 25 bp hike March 22 and 20% odds of one more 25 bp hike May 3. We cannot understand why the markets continue to fight the Fed. With the exception of some communications missteps here and there, Powell and company have been resolute about the need to take rates higher for longer. Although the media embargo has been lifted, there are no Fed speakers scheduled this week.

The latest CFTC positioning data through December 13 came out late last Friday. We note that 1) net euro longs near 125k contracts remains near the highest since March 2021, when EUR was trading near $1.19; 2) net sterling shorts near -26k contract are the lowest since March 2020, when GBP was trading near $1.30; and 3) net yen shorts near -53k contracts are the lowest since September 2022, when JPY was trading near 140. Bottom line: positioning is no longer so stretched for the dollar and so it could easily post some gains based on the position skew and the still-supportive fundamental story. Indeed, the positioning argues that long euros is a pretty crowded trade in need of a correction. After that March 2021 peak in net euro longs, the euro embarked on a steady decline. Let’s see if history repeats.

Housing data are likely to show continued weakening. November building permits (-2.1% m/m expected) and housing starts (-1.8% m/m expected) will be reported today. Existing home sales (-5.2% m/m expected) will be reported tomorrow and new home sales (-5.1% m/m expected) will be reported Friday. Yesterday, December NAHB housing market index came in at 31 vs. 34 expected and 33 in November and was the lowest since April 2020. This suggests little relief ahead for this beleaguered sector.

Canada report October retail sales. Headline is expected at 1.5% m/m vs. -0.5% in September, while ex-autos is expected at 1.3% m/m vs -0.7% in October. Bank of Canada tightening expectations remain subdued. WIRP suggests odds of a 25 bp hike January 25 are only around 55%, which is consistent with swaps market pricing in a peak policy rate between 4.25-4.5% vs. 4.25% currently.

EUROPE/MIDDLE EAST/AFRICA

The European Union finally agreed on a deal to cap natural gas prices. The so-called gas market correction mechanism will be temporary and runs for one year starting February 15. This is reminder that there are more and more reasons to be negative on the euro. First, this should have been wrapped up months ago; second, disagreements remained as Austria and the Netherlands abstained from voting; and lastly, gas shortages are likely to persist well into 2023 and so the fiscal accounts will only get worse. Indeed, the major eurozone countries are all planning elevated debt sales at a time when the ECB will be conducting Quantitative Tightening even as it continues hiking rates aggressively.

ECB officials remain hawkish. Vasle said that the economic slowdown that’s expected “won’t significantly lower eurozone inflation and bring it close to the 2% target soon” and added that “This isn’t the time to let up in our efforts to control inflation.” Kazamir said the question isn’t whether the ECB needs to raise rates to restrictive levels, but rather “how far we should go and how long we should stay there.” The swaps market is now pricing in a policy rate peak just above 3.75% vs. 3.0% at the start of last week. Elsewhere, WIRP suggests a 50 bp hike at the next meeting February 2 is nearly priced in.

National Bank of Hungary is expected to keep the base rate steady at 13.0%. At the last policy meeting November 22, the bank left rates steady at 13.0%, as expected. It noted that "Tight monetary conditions will be maintained over a prolonged period, which will ensure that inflation expectations are anchored, and the inflation target is achieved in a sustainable manner.” It added that monetary policy tightening would continue with the reduction of interbank liquidity and announced a two-month deposit tender and several FX swap tenders. The swaps market is pricing in the start of an easing cycle over the next three months, which seems too soon given how high inflation remains. Q3 current account data will be reported Thursday.

ASIA

The two-day Bank of Japan meeting ended with an unexpected tweak to Yield Curve Control. The 0% target for the 10-year JGB yield was maintained but the tolerance band was widened to +/- 50 bp vs. +/- 25 bp previously. Governor Kuroda stressed that the move did not represent tightening and that it was made to improve market functioning. While the policy rate was kept at -0.10%, speculation will grow for an eventual rate hike next year. We thought it was an H2 prospect but today’s move suggests it could happen as early as H1. Furthermore, given Governor Kuroda’s propensity for surprises, this hike could come under his watch rather than his successor’s. Of note, the swaps market is pricing in the start of a tightening cycle over the next six months, with the policy rate seen at 0.25% in one year and 0.50% in two years. Given the quickly evolving situation, we see upside risks.

Markets will surely test the new trading band. JGB yields rose today but the 10-year stopped at 0.4%, just shy of the new limit. It may not happen today, it may not happen tomorrow, but make no mistake, markets will eventually test the BOJ. This is akin to a currency peg in FX; once policymakers start tweaking the parameters of the peg, the markets smell blood in the water and attack. YCC been tested sporadically this year but the BOJ has so far successfully defended it. It will probably due so again but even a successful defense may hasten the eventual demise of YCC. Simply put, the BOJ has too many targets and not enough instruments.

So far, the action has been in FX and stocks. The Nikkei is down -2.5% on the day on the prospects that monetary tightening in Japan is finally under way. Elsewhere, the yen has gained nearly 3.5% against the dollar as markets front-run an eventual rate hike. We will have to redo our yen forecasts, which were based previously on no tightening until H2 of next year. Near-term targets are the August low near 130.40 and the May low near 126.35. As a reminder of just how far the yen has fallen, we note USD/JPY started 2022 near 115.

November national CPI will be reported Friday. Headline is expected at 3.9% y/y vs. 3.7% in October, while core (ex-fresh food) is expected at 3.7% y/y vs. 3.6% in October. Core ex-energy is expected at 2.8% y/y vs. 2.5% in October. With inflation running hot, we suspect Kuroda’s hand may have been forced by the reality on the ground. Recent polls show Prime Minister Kishida’s popularity at new lows for his tenure, with much of that presumably due to high inflation and falling real wages.

Reserve Bank of Australia released dovish minutes. At the December 6 meeting, the bank hiked rates 25 bp to 3.10%, as expected. However, the minutes revealed that the bank considered pausing rates but decided against it as “Incoming information had not warranted a reassessment of that broad outlook. Moreover, members noted that no other central bank had yet paused. Members also noted the importance of acting consistently, and that shifting to either larger increases or pausing at this point with no clear impetus from the incoming data would create uncertainty about the board’s reaction function.” The bank added that it expects to hike rates further but “are not on a pre-set path” and that the size and timing of future hikes will be determined by incoming data. WIRP still suggests around 50% odds of a 25 bp hike February 7, while the swaps market is pricing in a peak policy rate near 3.70%. Updated macro forecasts will come at that February meeting.

China commercial banks left their Loan Prime rates unchanged, as expected. After the PBOC left its key MLF rates steady last week, the 1- and 5-year LPR were widely expected to also be kept steady at 3.65% and 4.30%, respectively. For now, we suspect policymakers will remain on hold to see how the reopening develops. If weakness continues in the new year, expect more stimulus to come in Q1. At the economic policy forum this past weekend in Beijing, a senior official pledged that existing pro-growth measures will be kept in place and that more policies to boost the economy will be seen.

Taiwan reported very weak November export orders. Orders came in at -23.4% y/y vs. -12.8% expected and -6.3% in October. This was the third straight month of y/y contraction and far weaker than the depths of the pandemic. IP will be reported Friday and is expected at -4.90% y/y vs. -3.56% in October, but there are clear downside risks to that number. Korea reports trade data for the first twenty days of December tomorrow. Regional trade data have weakened considerably in recent months, not just from the mainland slowdown but also from overall global growth slowing.