Hot inflation ends March cut hopes
March cut “off the table”. Financial markets have finally accepted that a March rate cut in the US is unlikely to occur. The probability of a Federal Reserve rate cut in March has fallen from near 80% at the start of the year to 10% by mid-February (source: CME FedWatch). After Fed chair Jerome Powell pushed back on expectations earlier this month, this week’s hotter than expected US inflation report was the final nail in the coffin.
Risk assets “shake it off”. Falling expectations for rate cuts this this year have sent the US dollar and global bond yields higher, but global shares – especially US shares – have held up well. Usually, equity markets wilt as rate cuts become less likely, but a strong earnings season – highlighted by technology stocks – saw US equity benchmarks hit new all-time highs again over the last week.
USD dominance remains the theme. The US dollar has been the main beneficiary of the change in Fed expectations with the USD index up 3.6% so far this year. The USD index hit new three-month highs with the greenback’s best performance versus the low-yielding currencies like the Swiss franc and Japanese yen.
Global Macro
US mostly stronger as UK, Japan fall into recession
Inflation bubbles back. The US dollar hit three-month highs after a hotter-than-expected January inflation report ended most hopes for a March rate cut from the US Federal Reserve. Headline annualised CPI was reported at 3.1% — above expectations for 2.9%. Core annualised CPI was 3.9% versus 3.7% expected. Worryingly, short-term inflation measures (i.e one- and three-month annualised) have seen an ongoing shift higher since mid-2023.
US data stays strong. Most other US data was stronger over the last week with the weekly unemployment claims and Philly Fed better than forecast. Retail sales was one notable miss – January retail sales saw a 0.8% fall (versus expectations for a 0.2% fall) while the core series dropped 0.6%. The retail sales result was the first miss for this series since the July 2023 report. However, poor weather might to be to blame.
Fed makes stance clear. Federal Reserve officials continued to make the case for patience this week with Fed vice chair Michael Barr saying it was “too early” to be confident on inflation reaching target while Atlanta Fed president Raphael Bostic said he wasn’t yet “comfortable” in the trajectory of price pressures.
UK data drives volatility. The British pound was initially supported by a better result from Tuesday’s unemployment result (at 3.8% in January versus 4.0% forecast) and stronger wages growth (at 5.8% versus 5.6% expected). However, on Wednesday, a weaker inflation result weighed on the GBP followed by confirmation on Thursday the UK economy had fallen into a recession in the second-half of 2023.
European GDP ends disappointing 2023. The Eurozone managed to avoid a recession – if only narrowly – with GDP flat in December quarter after a 0.1% contraction in the September quarter. The region produced a hardly-stellar 0.1% increase for the 2023 calendar year. Italy and Spain outperformed, while Germany lagged.
European leading indicators improving, however. While 2023 was clearly disappointing, leading indicators in Europe so far this year have seen some improvement. After January manufacturing PMIs (purchasing manager indexes) in Germany and France beat forecasts, the German ZEW economic sentiment index jumped to 25.0 – the highest in almost a year. Also, Eurozone industrial production in January was up 2.6% – the best result since the 2020 pandemic rebound.
Japan slips into recession. A surprise drop in December-quarter GDP in Japan might make any long-awaited rate hike in Japan less likely. The 0.4% drop in the December quarter followed a 3.3% drop in the September quarter and means Japan is now in a technical recession. The fall in economic production also saw Japan lose the mantle of third-largest economy in the world – Germany now takes that spot.
Singapore growth picks up. A surprise jump in export activity in Singapore provided a boost for the region with non-oil domestic exports (NODX) up a massive 16.8% in annual terms in December. The report was rare good news on the trade front in Asia. The series saw strong growth in electronic and non-electronic categories.
Australian jobs disappoint again. The Australian dollar had a reasonable week even after it shook off a disappointing Australian January jobs report that saw only 500 new jobs added in January. The unemployment rate climbed from 3.9% to 4.1%. The latest report followed a big drop in December of 63k.
Global Macro
Searching for clues from Fed and ECB
Fed, ECB minutes in focus. Whichever of the Federal Reserve or European Central Bank are the first to cut could have a seismic impact on FX markets. Therefore, this week’s minutes from each central bank’s most recent meetings will be critical in providing evidence about their respective priorities. That said, the Fed’s path forward is now more uncertain after the recent hot inflation print, while a recent pick-up in some activity data presents a more positive view on the ECB’s recent growth worries. The road to the first cut might be bumpy.
Global PMIs due. The monthly purchasing manager index series is seen as the most up-to-date reading of the global economy so Thursday’s sequence of numbers from Australia, Japan, Europe, UK and US will be critical. In January, manufacturing improved in Australia, France and Germany, while both manufacturing and services saw good improvements in the UK. In the US, manufacturing rebounded, while services stayed strong.
Macro risk events.
Monday (19.02) – Canada producer prices
Tuesday (20.02) – China policy rate, Canda inflation
Wednesday (21.02) – Australian wage price index, Fed minutes
Thursday (22.02) – Global PMIs, ECB minutes
Friday (23.02) – NZ retail sales
All dates GMT
FX Views
Dollar bulls reign, but bears hit back
USD Recoils from 3-month high. The US dollar has been the clear outperformer so far this year as the US economy continues to show underlying strength. The dollar index (DXY) remains 12% above its long-term mean since 2000 and has clocked its longest daily streak above the 95.0 level since 2003. Standout performances for the USD year-to-date include a 6% gain against JPY, and around 5% gains against CHF and AUD. The most recent catalyst for dollar demand was the hotter-than-expected US inflation report, which we warned would trigger some choppy price action. This forced a hawkish repricing in market implied Fed rate expectations. At one point, less than four rate cuts were priced in for 2024 sending US yields to 2-month highs across the curve, supporting the DXY to 3-month highs. Lacking any improving expectations for economic growth outside the US and given the dollar’s ongoing yield advantage, it’s unlikely we’ll see a big shift in sentiment. But further upside potential also looks limited. Dollar sellers hit back towards the end of the week meaning the DXY failed to hold above its 100-week moving average and recoiled from the 105 level in a sign of exhaustion. Perhaps a down spell is in the offing.
EUR Searching for a supporting floor. The euro continues to trade sideways versus the US dollar, holding onto the $1.07 handle – smack in the middle of its 6-month trading range. Although cumulative rate cut bets have fallen to 118 basis points worth of ECB easing by year-end, down from 140 basis points from the beginning of last week, any euro uplift appears capped at $1.08 for now. However, we think EUR/USD is not too far from a supporting floor as well, because despite a sixth weekly drop in seven and potentially more dollar resilience in the near term, the longer-term outlook of USD weakness should play into the hands of the common currency. We also think the markets are still overestimating the size of total ECB easing, therefore expect some hawkish repricing to support European yields and thus the euro too. Against the pound, the euro clocked its best week of the year and its third weekly rise in a row despite falling to a near 18-month low at one point. Flash industry PMIs will be the focus next week, as traders look for more signs that the Eurozone economy has bottomed.
GBP Short-term risks, long-term rewards. The pound suffered its fifth weekly decline out of seven against the US dollar. GBP/USD continues to find much-needed support at its 200-day and 50-week moving averages, but should these key supports give way, we’re eying the 100-day moving average, located at $1.25, as the next downside target in the short-term. Fundamental risks still linger due to growth differentials favouring the still-high-yielding dollar. Meanwhile, mixed UK data saw wage growth stronger than expected, inflation weaker than expected, confirmation the UK entered a technical recession last year, and retail sales rose to a 3-year high in January. Overall, the probability of interest rate cuts by the BoE have been scaled back and around three 25 basis points of cuts are pencilled in for 2024. We think the BoE will probably keep interest rates higher than the Fed and ECB for longer and this will reward the pound over the long-term due to widening yield differentials. The premium of UK government bond yields over those in the rest of the G10 is above 110 basis points at present, compared with an average of just 20 basis points over the last 10 years. It’s no surprise, therefore, that speculators hold one of the largest long-GBP positions in the last 10 years.
CHF Weak Swiss inflation sends franc tumbling. As we expected, the Swiss franc continued its depreciation and clocked a 3-month low against the USD this week after weak Swiss inflation data. Low levels of cross-asset volatility continued to fuel risk appetite too, which has weighed heavily on the safe haven franc and Japanese yen recently. The main catalyst that triggered increased CHF selling though was data showing Swiss consumer price inflation rose 1.3% in January, below the 1.7% consensus forecast. Headline inflation is now tracking at -0.09% on a three-month annualised basis, whilst core measures fell into outright deflation. This adds further confidence to our view that the Swiss National Bank will be the first G10 central bank to cut interest rates next month. We also note that the franc has been supported by repeated foreign exchange selling by the SNB during this global tightening cycle but expect the SNB to switch back to FX buyers in a bid to weaken the franc to try and bring inflation back to its 2% target.
CNY Chinese data provides Lunar New Year Boost. The Chinese yuan is finding support from encouraging Lunar New Year holiday spending numbers, but remains weak as CNH 21-day EMA is below its 100-day EMA. USD/CNH is nearing initial upside targets (re Weekly Jan 19th publication: targeting 7.239-7.2665 resistance) after consolidating between November-January. Alternative data showed encouraging travel and spending numbers during China’s Lunar New Year holiday. Visitor arrivals at major sites were up 22.8% y/y, while Macau welcomed 167k daily tourists on average, up 226% y/y. Key data to watch next week includes loan prime rates and house prices.
JPY Could 157 be next target? The yen, which is highly sensitive to US rates, is down over 6% against the USD this year as investors pare back their expectations of rate cuts from the Fed. Upbeat US data, especially strong January CPI, cemented a hawkish Fed outlook while the BoJ maintains ultra-loose policy. This boosted USD/JPY above 150 with momentum signals stretched. Japan unexpectedly slipped into recession at the end of last year too, losing its title as the world’s third-biggest economy to Germany and raising doubts about when the BoJ would begin cutting rates. The 5%+ carry trade is thus proving too attractive to resist, giving rise to increased selling of JPY in favour of higher yielders. In fact, GBP/JPY climbed to its highest since 2015 this week. Japanese authorities are attempting verbal intervention to curb excessive volatility, but for USD/JPY, the 157 handle looms as a potential ‘red line’ given past reactions to 5% monthly moves. Core focus next week will be on machinery orders, trade balance and flash PMIs.
CAD Another fresh lower low. Earlier this week, the Canadian dollar hit its weakest intraday level in two months against the US dollar, edging closer to the 1.36 handle as investors reassessed prospects of Fed interest rate cuts over the coming months. The CAD has recorded a new lower low in six out of seven weeks since its December high, remains 2% weaker since then and is flirting with an upward sloping trendline that’s holding for now. The CAD fought back this week though after resistance was met at the 100-day moving average. Hot economic data from Canada has pressed against calls for a rate cut domestically, countering the growing pessimism surrounding the Canadian economy. This sent Canadian yields climbing to 2-month peaks, tracking US yields higher as markets continue to pare back rate cutting wagers.
AUD Aussie struggles on weak data. The Australian dollar is set for momentum decline against its US counterpart, with 21-day EMA below its 100-day EMA, as weak domestic data weighs. YTD performance at -4.3%. Australia’s unemployment rate jumped to a two-year high in January, signalling further labour market weakness and increasing bets on RBA rate cuts. The jobless rate rose to 4.1% from 4%, topping forecasts of 4%. While Australia added 11k full-time and shed 11k part-time roles, hopes were for a 30k jump. The participation rate held at 66.8%, but hours worked fell 2.5%. AUD/USD remains under pressure near 0.65 support. Inability to clear 0.664-0.6657 resistance could trigger declines toward 0.617-0.6296 range support. Focus will be on upcoming flash PMIs and wage price index data.
