Written by Convera’s Market Insights Team
Markets choosing PPI over CPI
Boris Kovacevic – Global Macro Strategist
Most of last week has been about waiting on an event that didn’t cause any volatility in the end. US inflation remained hot in December but had not risen enough to change neither markets, nor the Fed’s perspective on monetary policy. However, the PPI report on Friday took on the role of giving investors the confirmation they had been seeking from the CPI print on Wednesday. Producer prices unexpectedly fell by 0.1% on the month, putting the year-on-year growth rate at just 1%.
Incorporating these two inflation reports into the forecast for the Federal Reserve’s favored price measure gives us a core PCE inflation of 3% in December. If confirmed, this would constitute the lowest growth rate since March 2021 and would strengthen the argument for a policy easing as early as March. Current market pricing puts this scenario at a 77% probability with seven rate cuts being reflected by fed funds futures for the whole of 2024.
US equities benefited from two-year government bond yields falling to the lowest level since May (4.15%) as the disinflationary narrative gained traction. The S&P 500 and Nasdaq are both closing in on their all-time highs and are just a couple of basis points shy of reaching their previous record. Markets have been presented by a hotter CPI and cooler PPI report and have chosen to follow the lead of the latter, signaling their bias for inflation to continue falling in the coming months. The US dollar ended the week flat, as geopolitically driven safe-haven flows got canceled out by investors reinforcing their bets on Fed easing.
Today’s price action will be driven by Asia and Europe as most US markets will remain closed due to Marting Luther King Jr. Day. This week’s US macro data will come in the form of retail sales, industrial production, and the Fed’s Beige Book. In addition to economic releases, at least five Fed speakers are scheduled to give comments on various events. Chicago Fed President Goolsbee set the stage for his colleagues on Friday as the policy maker pushed back against the markets notion of aggressive rate cuts starting in March.
Pounds stellar start to be tested by data?
Boris Kovacevic – Global Macro Strategist
Investors and market participants are gearing up for the first important macro week of the year for the United Kingdom. The British pound has been driven by the risk-on sentiment created by falling US yields and UK data somewhat outperforming expectations over the past few weeks. The latter developments of the two could be tested in the coming days with the release of labor market, inflation, and retail sales data.
Data misses could hurt the pound, which has risen against all but one G10 currency (USD) for two consecutive weeks now. GBP/EUR, GBP/AUD and GBP/JPY recorded their best starts to any year since 2019, 2016 and 2011, with the pound rising by around 1%, 2% and 3% versus the euro, aussie and yen in the first two trading weeks of 2024. The most important pound-related currency pair, GBP/USD, has seen more muted trading but remains sensitive to incoming data, currently sitting around $1.2750.
One of them being UK inflation, which is expected to have come down from 3.9% in November to 3.8% in December. The 10 basis point fall as predicted by the consensus would not be enough to put a dent the pounds outperformance, especially as price growth is expected to rebound in January due to base effects. However, we continue to see inflation trending significantly lower over the first of the year, resulting in a high probability of CPI hitting the Bank of England’s target sooner than later.
The inflation print on Wednesday will be preceded by jobs data on Tuesday, where average earnings growth is expected to slow from 7.3% to 6.6%. Retail sales due Friday will round off the week with an expected drop in volumes. The deviation of the actual numbers from economists forecasts will set the tone for the pound.
ECB faces dilemma
Boris Kovacevic – Global Macro Strategist
The ECB is facing a tough dilemma during the January meeting in two weeks’ time over how early to start cutting rates when the economic outlook is fragile, and inflation remains above its 2% target. In parallel, Isabel Schnabel last week reinforced the message that the central bank remains data dependent and further evidence is needed before rate cuts can be discussed. Subsequently, markets downgraded their policy easing expectations are no longer pricing in a rate cut in the first quarter of 2024. Markets now see 145 basis points of rate cuts in 2024 with the first move coming in April, to be followed by a 25 basis point cuts at most if not all meetings this year.
Contraction in German industrial production accelerated for a record sixth consecutive month in November by -0.7% m/m, missing market expectations of a 0.2% growth. The continued sharp drop-in activity in the construction sector is especially worrying. For the year, industrial production was down by close 5% in 2023 and is more than 9% below pre-pandemic levels. While the historically tight labour market will continue to support consumption, it complicates the matters for the European Central Bank (ECB) which is trying to gauge what impact continued tightness in the labour market will have on inflation. Several members of the Governing Council have stated that the ECB will first want to have a good view of the wage agreements in H1 of 2024 before it can kickstart policy easing.
The euro continues to benefit from expectations that the ECB will keep interest rates at record highs for some time, bolstered by the expected jump in Eurozone inflation last month and historically tight labour market conditions. Several Governing Council policymakers continue to push back against market’s aggressive policy rate cut expectations, highlighting that any talk of a rate cut before crucial first quarter wage data due in May would be premature
Key global risk events
Calendar: January 15 – 19
Dollar flat on the week, US yields fall
Table: 7-day currency trends and trading ranges
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
