Equities at highs and bottoms. Looking at global equity markets, one wouldn’t be able to tell how volatile the monetary policy and macroeconomic regime have been in recent months. US stock markets have risen in 13 out of the last 14 weeks and are continuing to build on their upward trend that started in November. Equities have even withstood the rebound of government bond yields and the US dollar in January, which has started fading out a bit during the first two trading days of February. As the S&P 500 found a new record high this week, the European STOXX 50 reached a new 23-year top. At the same time, the Chinese CSI 300 benchmark fell for a sixth consecutive month and is now down 46% from its 2021 peak.
US outperformance. The US dollar has given up some of its Fed-induced gains from Wednesday and is looking to close the week lower, on track to record its first weekly fall this year. The outperformance of the US economy continued into 2024 and the Atlanta Fed Nowcast sees GDP expanding by 4.2% in Q1, an acceleration of the 3.3% seen in Q4. At the same time, inflation continued to moderate in most parts of the developed world (US, Europe) in January, fueling bets of postponed (from Q1 to Q2) but still significant policy easing from the Federal Reserve, European Central Bank and Bank of England for 2024.
Rates cuts as reflation looms? These speculations will have to stand the test of time as momentum in the procyclical and interest rates sensitive part of the global economy (property market, trade, manufacturing) is starting to turn positive as leading indicators of inflation continue ticking up. The rise in shipping costs is still not spilling over into goods inflation but geopolitical developments will remain crucial to gauge how likely policy makers are to turn dovish in Q2. With all major central banks having met over the past two weeks and tier 1 macro data having been released, speeches of policy makers, secondary releases and political events will play a bigger role in the weeks to come.
Global Macro
Policy makers preparing to shift in Q2
Fed shifts into neutral. The Federal Reserve held interest rates steady at a 23-year high at 5.25% – 5.50% for the fourth consecutive time, in line with expectations. Policymakers have finally switched into a neutral stance as they removed the reference to further rate hikes from their statement. However, investors were surprised by the pushback from Fed Chair Jerome Powell against a potential rate cut in March, which he regarded as unlikely. Policymakers acknowledged the rise in consumer confidence and the recent string of stronger macro data but continue to expect a moderation of momentum. The inflation picture has improved in recent months but the goal of getting price growth to 2% on a sustainable level is still not achieved.
What now? There is still plenty of time till the next meeting on the 20th of March for markets to move back and forth on pricing. However, both the labour and inflation data will have to disappoint expectations significantly for the FOMC to consider cutting at the end of Q1. The May meeting continues to be our base case with markets pricing in a cut with near certainty 90%. We will be closely watching the annual CPI revisions on the 9th of February and the next CPI report on the 13th of February to gauge how likely the Fed is to move in March.
The Fed’s problem. Investors have still not given up some hopes of a Q1 cut, which is currently priced at a 35% probability. The only thing that could move the dial here next week will be the ISM services report on Monday. The employment sub-index dropped to its lowest point since the pandemic at 43.8 and suggested negative momentum is hiring. However, the January print will be needed to confirm this bias. The Federal Reserve will need to be attentive to the leading indicators to avoid a hard landing and will most likely have to cut preemptively before growth deteriorates. However, what complicates the picture is the risk of inflation starting to accelerate as wages remain robust.
Rebound in US activity. On the US macro front, a stronger than expected ISM manufacturing report showed industrial activity contracted by less than expected. The purchasing manager index improved from 47.1 to 49.1, reaching the highest level since October. The softening of the manufacturing recession will be a welcomed sign of the pro cyclical parts of the economy bottoming out as the effect of the interest rate increases fade. The recent outperformance of the data has pushed the Atlanta Fed Nowcast for US Q1 GDP to 4.2%, well past the last quarters 3.3% growth rate.
Job openings rose in December. The first data patch this week in the form of the JOLTs report was ambiguous enough to not be market moving. US job openings rose more than expected in December, beating the 8.75 million estimate by a large margin as vacancies increased to 9.02 million. Positive sentiment surrounding the continued resilience of the labor market was dampened by other data points showing some cooling on the demand side. The number of Americans voluntarily quitting their jobs fell to just 3.4 million, reaching the lowest point in nearly three years.
Hard to interpret the labor market. Headline labor market data like jobs growth, job openings and initial jobless claims have remained strong, suggesting a tight labor market. However, all these data releases have been accompanied by ambiguous sub-indicators. Temporary work demand and the voluntary quits rate have fallen in recent weeks while the average unemployment length has increased. Still, the recent soft data on the labor market has seen a light uptick and does suggest that the picture remains mixed and complicated to interpret.
Consumer still strong, as of January. However, the strong macro backdrop has moved markets a bit into the Fed’s direction 1) as the start of the expected policy easing cycle has been postponed by two months and 2) as investors have slightly pared back their cutting expectation for 2024 from seven to six. The Conference Board’s gauge of the current situation of US consumers rose to the highest level since March 2020, indicating a strong start to the year. Households have profited from falling inflation and equity markets at record highs.
Splitting the difference. Going from the Fed on Wednesday to the Bank of England on Thursday, British policy makers held rates at 5.25% for the fourth successive meeting, but all eyes were on the vote split, which came in at 6-2-1. Two voted for a hike, but one voted for a cut, so the door has been opened for a policy pivot, just not yet. It was a dovish tilt, but short of market expectations, so the pound’s reaction was mixed on the day. It was the first 3-way vote split, including a rate hike and cut, since August 2008 and only the sixth time in the BoE’s 295-meeting history. Historically, after such a voting pattern, the central bank’s next move has mostly been to cut rates.
Cut will be the next move. Markets are still pricing in at least four quarter-point rate cuts this year, with the first coming in June. The chance of an earlier move in May remains at around 50%. Along with the unusually divided vote, the BoE dropped its tightening bias by removing guidance that borrowing costs may have to rise again.
Inflation back at 3%? Governor, Andrew Bailey, reinforced this by acknowledging that keeping rates unchanged would push inflation to its it 2% target by the second quarter – the inflation forecast was thus revised down in the near term. Nevertheless, the BoE forecasts inflation to bounce back towards 3% again from the third quarter due to persistent underlying prices pressures in services and wages and geopolitical factors impacting supply chains and shipping costs.
ECB to lead the doves? At the same time, European central bankers remained split about the near-term policy outlook. ECB policymakers de Guindos, Centeno and Kazimir have signaled that the central bank’s next move will involve an interest rate cut but did not agree on the timing nor the triggers for such action. On the contrary his Dutch counterpart Knot is reluctant to follow through with such a course of action, stating that only once slower wage growth is confirmed will the ECB be able to lower interest rates “a bit”. As has been the case for several weeks, markets chose to align with the ECB doves and have fully priced in a 25bps rate cut as soon as April and yet again increased rate cut bets to 143bps by year end.
2024 begins with disinflation. Preliminary estimates showed that German consumer price inflation dropped to 2.9% y/y in January 2024, down from 3.7% the previous month – the lowest rate since June 2021, driven by a slowdown in energy and food inflation, despite a pickup in services. In tandem with German and French inflation, the flash estimate on Thursday showed a decline in Eurozone HICP index from 2.9% to 2.8% in January, with core inflation declining to 3.3% from 3.4% in December. However, it is too soon to declare victory in the inflation battle just yet.
Still some risks to the inflation picture. The European Central Bank (ECB) pays close attention to the evolution of the core inflation and the index is cooling at a slower pace than expected, despite having reached its lowest level since March 2022, and risks remain tilted to the upside. Higher wage agreements might still filter through to higher selling prices and selling price expectations from both PMI and the European Commission’s economic sentiment surveys have been on the rise for several months. Meanwhile, a historically tight labour market with unemployment at 6.4% gives the ECB some comfort that it can maintain policy rates at current levels until it is convinced that inflation is indeed coming down to the desired 2% target.
Weak growth prospects. Recently, both Ifo and GfK Consumer Indicators unexpectedly worsened for the month of January and the latest Eurozone economic sentiment indicator also marginally weakened from December’s 7-month highs. Meanwhile, yesterday IMF downgraded their growth prospects for the Euro Area for 2024 (0.9% vs 1.2%).
Cuts in Q2 still our base case. In addition, the favourable base effects mask a trend of monthly price increases. In fact, the monthly increase in consumer prices was actually higher than previously in the month of January; the prices for goods and food particularly accelerated. Earlier in the week, ECB policymaker Joachim Nagel, typically perceived as a hawk, mentioned that the central bank had successfully tamed the “greedy beast” of inflation, while his colleagues, de Guindos, Centeno, and Kazimir, suggested that the ECB’s next move would involve an interest rate cut.
Global Macro
Not much to budge the trend
Europe watch. The recent macro news flow out of Europe has been mixed, to say the least. Leading indicators like the ZEW and ESI have started turning up again. However, the positive bias has not been confirmed by German consumer and business confidence indicators. The Sentix Index on Monday will give some more insight into the question, how Europe started into 2024. At the same time, Eurozone retail sales and German industrial output will close out the lagging data for 2023.
Taking cues from tier 2 data. The only two things we are watching in the US are ISM services report on Monday and the annual revision of the CPI methodology on Friday. Given the lack of important releases on the macro front, political and geopolitical questions might be more market driving than usual. The government bond auctions on Monday (3-month and 6-month Bills), Tuesday (3-year Note) and Wednesday (10-year Note) might be watched as well due to the highly expansionary fiscal policy of the US government.
Macro risk events.
Monday (05.02) – Chinese services PMI, Eurozone Sentix Index, ISM services PMI
Tuesday (06.02) – RBA rate decision, German industrial production, Eurozone retail sales
Wednesday (07.02) – German industrial production, UK house price index
Thursday (08.02) – Chinese PPI and CPI
Friday (09.02) – US annual CPI revision
All dates GMT
FX Views
Dollar down despite positive backdrop
USD Worst week since late December. The US dollar enjoyed strong demand at the beginning of the year rising against 80% of its peers in January, but momentum has stalled, and the Greenback is on track for its biggest weekly drop since late December. The DXY has failed to sustainably break through its 200-day moving average for 12 consecutive trading days and sharply recoiled on Thursday due to 1) upbeat big tech earnings boosting investors’ appetite for riskier assets, 2) renewed jitters over regional US banks, 3) oil prices plunging amid peace talks in the Middle East. On the monetary front, the Fed’s pushback against a potential rate cut in March supported demand for the buck across the G10 space briefly, but market pricing still shows a 37.5% chance of a Fed cut in March and six in total for 2024, which has weighed on US yields. Lacking any fresh significant upside catalysts, the dollar’s positive run may be coming to end, although we note that seasonal trends could prove supportive as the DXY has risen in 15 of the past 24 Februarys, including the last seven years in a row.
EUR Growth surprises, core HICP disappoints. Euro is looking to break from its weekly losing streak against the US dollar and post the first weekly gain since mid-January amid an improving risk sentiment despite a hawkish FOMC on Wednesday. STOXX 50 reached a new 23-year high earlier this week and German 10-year Bund yield extended the decline to 2.12%, reaching its lowest point since January 15th. EUR/USD gained support as preliminary GDP figures which revealed that the Eurozone economy unexpectedly avoided a technical recession in Q4 of 2023. Several ECB policymakers have signaled that the central bank’s next move will involve an interest rate cut but did not agree on the timing nor the triggers for such action. A historically tight labour market with unemployment at 6.4% and stickier than expected January core inflation give the ECB some comfort that it can maintain policy rates at current levels until it is convinced that inflation is indeed coming down to the desired 2% target. On FX front, EUR/JPY lost the most on weekly basis, depreciating close to 0.8% w/w, and EUR/CAD slipped to a fresh 15-week low as Canada posted strongest PMIs in the past 3 months.
GBP Top of the G10 pack. Thanks to hawkish repricing in BoE rate expectations, helped by stronger-than-expected UK inflation and PMI prints, the first month of the year was a broadly positive one for the pound as it appreciated against almost 80% of 50 global currencies. In fact, it’s now the best performing G10 currency year-to-date. Sterling climbed over 1.5% against the euro in January and hit fresh 5-month highs this week, breaking north of its 100-month moving average for just the second time since May 2016. The story hasn’t particularly changed for GBP/USD though, with the narrow $1.26 – $1.28 range remaining intact. The pair remains supported by its 50-day moving average but restricted by its 200-week moving average, so a decisive break below or above these key barriers could prove significant. We note that although the 12- and 3-month correlation between GBP/USD and the S&P500 index remains a strong positive one, we have seen the 1-month correlation break down since the start of 2024. The currency pair continues to trade sideways, whilst the bellwether US equity index is up over 3%. Will a correction lower in equities close this gap or will GBP/USD stretch higher? The lack of top-tier data next week means geopolitical developments and sentiment will likely drive FX trends.
CHF Two-week winning streak. After hitting a 9-year low in December, USD/CHF recovered over 2% in January amid a sharp rebound in the US dollar as bets of imminent rate cuts by the Fed eased. However, the franc has battled back, notching two consecutively weekly gains as data over the last week revealed Swiss retail sales falling at a softer pace and Swiss business morale and investors’ sentiment rising to the highest in a year in a sign that pessimism around the Swiss economy is slowly abating. Moreover, the Swiss National Bank has maintained a somewhat hawkish stance, despite growing concerns about the franc’s recent appreciation. This has helped drag EUR/CHF to just 0.5% away from fresh 9-year lows. The SNB has kept the benchmark rate at 1.75% since June last year, and is scheduled to meet on March 21st, with markets not expecting a rate cut until June this year.
CNY PMI reinforces need for more stimulus. China’s manufacturing PMI lingering in contraction territory for the fourth straight month in January reinforces the need for more stimulus to support the struggling economy. Despite some improvement in new orders and exports, overall activity remains soft amid weak demand. The lackluster PMI adds to disappointing data and negative news around property, COVID and confidence. More policy support is likely needed to bolster demand as China enters a politically sensitive year. USD/CNH nears initial targets after reversing its November-January consolidation. Tactical support is at 7.09. While consolidation is likely, the path of least resistance appears higher. Next week’s data will be monitored for growth and policy clues.
JPY Wage growth key for BoJ policy. Japan’s mixed December employment data keeps the focus on much-needed wage growth for the BoJ’s policy outlook. While the jobless rate fell to 2.4%, the jobs-to-applicant ratio slipped to 1.27, below expectations. The data underscores the need for tighter labor conditions to drive the sustainable wage increases required to achieve the wage-inflation spiral the BoJ wants before considering exiting negative interest rates. Markets will look to March’s key wage negotiations for evidence of meaningful pay hikes. On the technical side, USD/JPY stalled its recovery below 149.44 resistance and the 150.15 trendline. While overbought conditions suggest consolidation near-term, we don’t see clear signs of a bearish reversal yet and the broader uptrend may resume. Tactical support is at 145.65-146.97. Next week’s data includes services PMI, household spending, leading index and trade, which could provide more clues on the growth-inflation backdrop.
CAD Worst January since 2021. The Canadian dollar depreciated 1.5% against the US dollar in January thanks to Powell’s hawkish pushback against March rate cuts. However, USD/CAD is looking to close at a 3-week low benefiting from a rebound in stocks and a better-than-expected domestic growth backdrop. The preliminary figures showed that the Canadian economy expanded in both December and November months and manufacturing ISM recovered to a 3-month high. This is good news for the BoC as it gives the Bank more breathing space to decide when to cut rates. Markets have pushed back their expectations of early rate cuts, pricing out an April cut, but they continue to anticipate 4 rate cuts over the course of 2024. The assumption that Fed will cut earlier and more aggressively than the BoC over the course of the year should support the Canadian dollar going forward and we could see USD/CAD breach below the resistance level of $1.3372. However, given that CAD has been tracking quite closely the dynamics in US data and the supercharged importance of US labour market data going forward, the Loonie remains vulnerable to deviations in Fed rate expectations due to their strong correlation since the beginning of November.
AUD Snaps 4-week losing streak. After four weekly losses amounting to a 3% decline in AUD/USD, the Aussie dollar is on track for a much-needed weekly gain ahead of next week’s RBA decision. On balance, there still holds a positive medium-term bias for AUD amidst narrower Australia-US short-dated yield differentials given markets pricing in just 60 basis points of cuts compared to the Fed’s 140bps expected this year. Still, Australia’s worse than-expected 2.7% monthly plunge in December retail sales highlights continued weakness in underlying retail spending despite rapid population growth. Household goods, department stores and clothing drove broad-based declines, conflicting with the RBA’s narrative of resilient consumption. Markets will look for more evidence of slowing consumption denting inflation ahead of the RBA meeting. Technically, AUD/USD remains pressured below the January breakdown and key moving averages. While consolidation is expected, the overall downtrend is likely to continue after rejecting resistance. RBA decision and data will draw focus next week.
