The week ahead features the first estimate of US Q4 GDP, which will be revised for the next couple of years, and policy meetings by the Bank of Japan, the European Central Bank, the Bank of Canada, and Norges Bank, Norway's central bank.

Although the market anticipates the beginning of an aggressive easing cycle by several central banks, and an exit of the BOJ's negative interest rate policy, the start is not expected until later in the first half. Obviously, this is an unusual business cycle, and while US growth is expected to have slowed, it may have still grown above what the Fed regards as the long-run pace consistent with price stability.

The preliminary University of Michigan's January survey showed rising consumer confidence and easing of one-year inflation expectations. The flash January PMIs will likely underscore that many large countries are struggling, especially the manufacturing sector.

Since the start of the year, the swap and futures market show investors pushing out the first rate cuts and scaling back the magnitude. This has coincided with the dollar recovery after it was sliding in the last two months. Barring a surprise from this week's central bank meetings, we suspect that the next big mover is the FOMC meeting that concludes on Jan. 31 and the nonfarm payroll report two days later (early estimate ~150,000).

While the US S&P 500 and Nasdaq 100 set new record highs ahead of the weekend, it is Japan's stock market that is off to a dramatic start of the year. The Nikkei is up nearly 7.5% in the first three weeks of the year to levels not seen since 1990. In contrast, the index of Chinese companies that trade in Hong Kong have tumbled by slightly more than 11%, and South Korea's Kospi is off nearly 7%.

March WTI continues to chop between $70-$75 a barrel even as the war in the Middle East appears to be widening. And, the so-called "fear gauge," the volatility of the S&P 500 (VIX) is near 13.3%, the lower end of where it traded last year.

United States

The US reports its first estimate of Q2 GDP on Jan. 25. The median forecast in Bloomberg's survey has crept to 2% from 1.5%, while the Atlanta Fed's GDP tracker puts it at 2.4% as of the end of last week. The Federal Reserve's assessment of the non-inflationary pace of growth has been steady at 1.8%. The risk that the economy is continuing to grow above trend contributes to our skepticism of the aggressiveness of rate cuts being discounted.

After the push back from Fed officials and a string of data that prompted economists to revise higher their forecasts for Q4 23 GDP, the market downgraded the odds of a March hike to below 50% for the first time since the November CPI was reported on Dec. 12. The market is pricing in about 132 bp of cuts this year (down from 167 bp at the end of last year). That's five cuts and an almost 30% chance of a sixth cut in the seven meetings after this month's. 

The GDP report will contain an estimate for December's trade balance, rendering the goods report that same day less relevant. It will also incorporate the following day's personal income and consumption data. Nevertheless, the PCE deflator will draw attention. Many observers still talk about the core PCE deflator as the Fed's "preferred measure." 

If it is the "preferred measure," why don't they target it? They target the headline rate, but talk about the core rate. Why? It is not because food and energy are volatile. It is not because food and energy are often driven by supply, and monetary policy impacts demand. It is because, over time, the headline rate converges to the core rate rather than the other way around. The core rate is a cleaner signal while the headline rate tends to be noisier.

After the CPI and PPI reports, economists look for the core PCE deflator to slip below 3% for the first time since March 2021. Moreover, the measure that several Fed officials have emphasized recently is the core rate excluding shelter. It may have slowed to an annual pace of 2.5%-2.6% in the H2 23. A political agreement was struck to extend the federal government's spending authorization until March. The US budget deficit was about 6.5% of GDP in the last fiscal year, and is seen at around 6% in the fiscal year that began Oct. 1. 

The Dollar Index gapped higher on Tuesday (gap is found between 102.67 and 102.75) and rallied to about 103.70. It stalled in front of the (50%) retracement of the losses since early November 2023, found slightly above 103.85. In the subsequent consolidation, the Dollar Index has held above 103.00. The momentum indicators are getting stretched, but have not turned down.

We are not convinced that the interest rate adjustment has been completed, though a good part of it has, but this makes us cautious about picking a top to Dollar Index. The bottom of the gap may offer support. We suspect the two-year yield, which bottomed at the start of last week near 4.11%, can return to the 4.50-4.55% area. It reached almost 4.32% ahead of the weekend. 

Eurozone

The day after the preliminary January PMI is reported on the 24th, the European Central Bank meets. There is practically no chance of a change in policy. Still, ECB President Lagarde's press conference will be important to framing expectations going forward. The swaps market sees about a 15% chance the ECB moves in March, after the staff updates the economic forecasts.

Recall that at the end of last year, the market had priced in a nearly 65% chance of a cut in March. Now, the first cut is fully discounted for in April. Pricing in the swaps market is consistent with five rate cuts (or 125 bp) and almost a 30% chance of a sixth cut.

The base effect (CPI fell by 0.2% in January 2023) makes for a difficult comparison, but the ECB sees the same thing market participants do: CPI rose at an annualized rate of more than 9% in February-April 2023, and as this drops out, the Eurozone's inflation will likely fall sharply.

The ECB's December forecast saw the economy expanding by 0.8% this year. The market is less sanguine, and the median in Bloomberg's survey sees 0.5% growth. The World Bank's forecast is for 0.7%, while the IMF's forecast looks dated at 1.2%. In contrast, the median Fed dot was for 1.4% growth this year, while the IMF and World Bank are at 1.5% and 1.6%, respectively.

The euro tested the 200-day moving average (~$1.0865) last Wednesday and Thursday. This area is also important because it holds the neckline of a possible head-and-shoulders top. The neckline has slight downward slope and eased to around $1.0855 at the end of next week.

On the topside, the first euro bounce last week stalled in front of $1.0910. A downtrend line drawn off the high from the end of last year (~$1.1140) and catching the mid-January high (~$1.10) may come in near $1.0915 at the start of next week. It will likely fall to around $1.0865 by the end of the week. The momentum indicators are getting stretched, but are still falling. A move above $1.0920-40 would lift the technical tone. 

Japan

The Bank of Japan meeting concludes on Jan. 23. There had been some speculation that the negative overnight rate target (-0.10%) would finally be ended. But a combination of the earthquake, weaker data, and official comments have dissuaded most market participants. The emerging consensus is for an April move. That is after the results of the spring wage round and the expiration of government subsidies for gas and electricity (which depress CPI by ~0.4%-0.5%).

The BOJ's economic forecasts will be updated. The last iteration was for 1.0% growth this year and 2.8% core CPI. The GDP forecast could be shaved a little, but the core CPI projection may be revised more materially. Core CPI, which excludes fresh food, finished 2023 at 2.3%. The Bank of Japan projected it to fall to below the 2% target to 1.7% in 2025.

Two days after the BOJ meeting concludes, Tokyo reports January CPI figures, which is treated like the Eurozone preliminary CPI estimate--a fairly robust indicator of the national or final figures. Tokyo's headline CPI was 2.4% year-over-year in December, down from 4.4% in January 2023. The core rate was at 2.1%, down from 4.3% at the beginning of 2023. The measure that excludes fresh food and energy is more problematic. It was at 3.0% in January 2023 and peaked at 4% around the middle of last year before finishing at 3.5%.

The dollar rose for the third consecutive week against the Japanese yen and reached JPY148.80 at the end of last week. The yen is the weakest currency in the world at the start of the year, off about 4.8%. The greenback has surpassed the (61.8%) retracement of the decline from last November's high, and that area may now offer support (~JPY147.50).

The momentum indicators are stretched but continue to rise, and the Japanese officials do not appear to have commented on the price action, though the pace is around the same that elicited a response last year. This is fanning talk of a move back to JPY150.

Canada

The first Bank of Canada meeting this year is on Jan. 24. Like other G10 central banks, the Bank of Canada is not quite ready to cut rates. The economy contracted by 1.1% (annualized) in Q3 23, and is seen expanding by around 0.4% (annualized in Q4). The central bank forecasts 0.9% growth this year, while the IMF is more optimistic with a 1.6% projection. The median forecast in Bloomberg's survey is for a 0.5% expansion this year.

The Bank of Canada's reluctance to ease monetary policy appears to stem from the still firm price pressures and the strong wage growth. The December headline and underlying rates are near 3.4%. Yet, the three-month annualized pace is negative, and the six-month annualized pace is less than 2%.

Barring the resurrection of the Philipps Curve, with the Bank of Canada acknowledging that the excessive demand has cooled, the 5.7% year-over-year increase in wage growth among permanent employees should not be an insurmountable hurdle. Still, the market expectations for the Bank of Canada were tempered in recent days.

The swaps market downgraded the chances of a March cut to slightly more than 25% from almost 60% at the end of the previous week. Over the past week, the market has reduced the chances of a cut in April to around 66% from 100%. In the middle of January, the swaps market had five quarter-point hikes and around a 50% chance of a sixth hike discounted this year. Now, the pricing is consistent with almost four cuts.

The US dollar reached CAD1.3540 last week, its best level seen since late November. It pulled back for the second consecutive session ahead of the weekend to test the CAD1.3430 area and returned below the 200-day moving average (~CAD1.3480), which it has settled above in the preceding three sessions. In fact, the 0.4% retreat in the US dollar ahead of the weekend was its biggest single day loss since the day after Christmas.

The Canadian dollar was aided by the strong rally in US equities that carried the S&P 500 and the Nasdaq 100 to new record highs. The US dollar's momentum indicators look poised to turn lower. Still, given the impulsive nature of the run-up, the pullback may be more consolidative than necessarily a new downtrend. A break of CAD1.3400, however, would be more persuasive. 

China

The PBOC failed to cut the benchmark one-year Medium-Term Lending Facility rate as many, including ourselves, thought had been signaled by government loans being 10 bp lower last month. When the PBOC last cut the MLF rate by 15 bp last August, banks did not pass it fully through to their loan prime rates.

The one-year rate was cut by 10 bp to 3.45%, while the five-year rate remained unchanged at 4.20%. Still, the banks are unlikely to announce a prime rate cut. Many still expect a cut in reserve requirements later this quarter. The PBOC's setting of the daily reference rate suggests it is moderating, but not attempting to reverse or arrest the yuan's depreciation.

Conventional wisdom sees the PBOC pursuing an aggressive foreign exchange policy, but we see it as reactionary. This is to say that it manages the exchange rate to minimize the fluctuation. And, that knowing the direction of the euro and yen, one can, to a large extent, anticipate the direction of the yuan.

Note that the 100-day rolling correlation of the changes in the Dollar Index and the dollar against the yuan is slightly below 0.65, the tightest it has been in six months. The correlation of changes in the dollar-yuan and yen over the past 100 days is near 0.55, the upper end of where it has been since Q4 22. A near-term cap appears near CNY7.20. In the bigger picture, this could be the middle of a new range (~CNY7.15-CNY7.25).

United Kingdom

After contracting by 0.3% in October, the UK economy expanded by 0.3% in November. The December and Q4 GDP figures are due Feb. 15. The PMI gives some hope that another quarterly contraction could be avoided (-0.1% in Q3), but the unexpectedly poor December retail sales (-3.2% vs median forecast in Bloomberg's survey for -0.5%) undermines it.

The October composite PMI was 48.7. It recovered to 50.7 in November and 52.1 in December, a six-month high. The Bank of England meets on Feb. 1. The swaps market sees practically no chance of a cut and not much more of a chance in March (<15%). The perceived odds of a May cut were reduced to slightly below 60% from 100% the previous week. In addition, the swaps curve is now pricing in about 110 bp of cuts this year, down from 130 bp at the end of the previous week. At the end of last year, the nearly 175 bp of cuts were anticipated.

Sterling continues to chop in the $1.26-$1.28 trading range that has persisted since mid-December. The upper end was frayed on an intraday basis in late December and the lower end was frayed last week, but not on a closing basis. The momentum indicators are somewhat less helpful in this sideways movement. We have favored an eventual downside break, but the persistence of the range while the interest rate adjustment seems well advanced, diminishes our confidence.

Australia

The preliminary January PMI is the data highlight of the week for Australia. The survey points to a weak finish to 2023 and little momentum coming into the year. The manufacturing PMI fell in the last four months of 2023 and slipped to a new cyclical low of 47.6 in December. It has not been above 50 since last February.

The service PMI fell to 47.1 in December from 46.0 in November. It was the third consecutive month below 50. The composite, which combines output measures, edged up to 46.9 from 46.2. It spent Q4 23 below 50. Last January, the composite PMI was at 48.5. The economy grew by 0.2% quarter-over-quarter in Q3 23, and economists expect it to have performed similarly in Q4.

While a contraction may be avoided, the economy is not seen improving until H2 24. Ironically, the futures market does not have the first cut fully discounted until November (though there is a little better than an 80% chance of a hike in September). The market is discounting 1.5 cuts this year (~38 bp). At the end of last year, two quarter-point cuts and nearly a 75% chance of a third cut was priced into the futures strip. 

With the advance ahead of the weekend, the Australian dollar met the (38.2%) retracement objective of the slide from the Jan. 12 high. The Aussie put together its first back-to-back gain this year, though it still lost about 1.3% last week.

It found bids near $0.6525, ahead of the support we cited near $0.6500. The momentum indicators are understandably stretched given the nearly 3.5-cent decline since late last year. The nearby hurdle is the $0.6625-50 area, and a move above it would lift the technical tone.

Mexico

Mexico is to report its bi-weekly CPI and December trade and employment numbers in the week ahead. While headline CPI has been edging higher, the core measure is still falling, and this will likely allow the central bank to cut the overnight target rate from 11.25% later this quarter. The bi-weekly measure of headline CPI rose steadily in the last two months of 2023. It bottomed in the second half of October at 4.25% and finished the year at 4.86%.

The bi-weekly measure of the core rate finished last year at 4.98%. It has been falling without fail since the end of January 2023 and stands at a new cyclical low. Although the economy is slowing, the unemployment rate of 2.71% in November was the lowest since mid-year. After expanding by about 1.1% quarter-over-quarter in Q3, growth is expected to have downshifted to around 0.4% in Q4.

Despite the peso's more than 20% appreciation against the dollar over the past two years, its trade balance has improved. Consider that in the first 11 months of last year, Mexico recorded an average monthly trade shortfall of about $882 million. In the same period in 2022, the average monthly trade deficit was around $2.53 billion. In November, the 2.6% year-over-year increase in manufacturing exports was driven by auto, where exports were up 7.7% year-over-year. Other manufacturing exports were slipped by 0.1%. 

Last week was one of two distinct halves for the Mexican peso. In the first part of the week, it buckled in the face of the dollar's broad rally. The greenback reached about MXN17.3860 (which was near the 200-day moving average) on Wednesday after settling the previous week near MXN16.87. It reversed lower on Wednesday (shooting star?) and traded back down about MXN17.08 before the weekend, recouping a little more than half of the week's losses.

The risk-on mood supported the peso's recovery. Still, its five-week advance, the longest since November 2022, was snapped with a 1.25% loss. Initial support for the dollar may be seen around MXN17.00. This month's low was set on Jan. 8 near MXN16.7850.

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