FX Weekly Update – January 16th, 2024

Posted Under: Weekly updates

Nearly all of the major ones ended the week within 0.5% of where they had started, an unusual level of quiescence. The hotter-than-expected consumer inflation report out of the US initially made some waves, and helped the dollar rally modestly. By the end of the week, markets were, however, back assigning an implied 80% chance of a March cut in Federal Reserve rates after a miss in Friday’s producer inflation report. Government bond yields were lower and risk assets rose upwards in response, while the dollar was essentially flat.

This week is relatively quiet in terms of economic data or policy announcements, although there will be an unusual number of ECB and Federal Reserve speeches on tap. The November Eurozone industrial production data on Monday, and December UK inflation on Wednesday, provide the main economic references. Federal Reserve speeches will be particularly critical to see if the central bank continues to push back against market hopes for a March cut in rates and 165 basis points of cuts for the whole of 2024, which still strikes us as way too aggressive.

The modest upward surprise in the December CPI report did not sway markets to revise their expectations of a Federal Reserve cut as early as March. The key monthly increase in core prices seems to have stabilised at a level of just below 4%, which is too high for comfort and seems to confirm that the ‘last mile’ of the fight against inflation will be tougher than markets expect. By the end of the week, markets appeared to have almost completely forgotten about this upside beat, instead placing greater emphasis on the soft PPI inflation report, released on Friday.

High-frequency labour market indicators continue to suggest little or no loosening, and the most reliable indicators suggest that wages are growing at an above 5% rate amid solid growth and very tight labour markets. We continue to expect that hopes of a March rate cut will be dashed, and therefore think the dollar will stay well supported against European currencies in the short-term.

GBP: November GDP surprised to the upside last week, calming concerns over the possibility of a technical recession in Q4. The economy expanded by 0.3% month-on-month, following a contraction of the same magnitude in October. If the latest PMI data is anything to go by, another modest expansion in activity may be on the way in December, which would likely avoid the confirmation of a technical recession once the quarterly data is released in mid-February. The reaction in sterling to the data was subdued, however.

November GDP surprised to the upside last week, calming concerns over the possibility of a technical recession in Q4. The economy expanded by 0.3% month-on-month, following a contraction of the same magnitude in October. If the latest PMI data is anything to go by, another modest expansion in activity may be on the way in December, which would likely avoid the confirmation of a technical recession once the quarterly data is released in mid-February. The reaction in sterling to the data was subdued, however.

EUR: Economic data out of the Eurozone is not improving and continues to tell a tale of a stalling economy, albeit this has not yet translated into layoffs and employment continues to hold up well. Last week’s retail sales report was slightly stronger-than-expected, although we still saw a more than 1% annual contraction and a fourth quarterly downturn in activity in the past five months.

The hawkishness on display at the European Central Bank’s December meeting is being diluted slowly by dovish noises coming from various members of the Council. This week’s industrial production data for November is expected to be dismal, and more clarity on the ECB’s plans should come from a barrage of ECB officials’ speeches, including president Lagarde on Wednesday. The bank’s latest meeting accounts should also shed some light on the December communications when released on Thursday.

JPY: A disappointing set of domestic economic data sent the yen lower against the dollar once again last week, with the Japanese currency opening trading this week around the 145 level. Expectations for the first Bank of Japan interest rate hike have continued to be pushed further into the future amid signs of an easing in wage pressure and a drop in inflation. Last week’s earnings data for November was a massive miss, with wages growing by only 0.2% year-on-year, the lowest rate since December 2021 and well below the +1.5% consensus.

Bank of Japan officials have placed heavy emphasis on earnings data in recent communications. The upcoming annual ‘Shuntō’ salary negotiations, which conclude in March, will be key in determining the timing of the first hike. As things stand, a strong wage negotiation will likely be needed to convince investors that tightening will commence soon, with swaps now assigning only around a one-in-three chance of a first move in April. National inflation data will be the focus this week, with the December data due on Thursday.

CAD: The Canadian dollar has continued to edge lower against its US counterpart since the start of the year, with the USD/CAD pair beginning the week around the 1.34 level, which is around its highest level since the middle of December. We are entering into a highly important couple of weeks for the Canadian dollar. Tuesday’s inflation report will be a highly important one in guiding Bank of Canada interest rate expectations. Economists are pencilling in a monthly contraction in headline consumer prices (-0.3% consensus), which would be only the second negative print in the past year.

Retail sales data on Friday should also give policymakers a decent barometer as to how well consumer spending held up towards the end of last year, as we head into the January BoC meeting next Wednesday. No change in rates is seen, although the tone of the bank’s communications will held investors gauge whether we can expect a first cut as early as April, which is currently more than fully priced in by swaps.

MXN: Today the peso moves upward for the second straight day. Traders are favoring the US Dollar following hawkish remarks made by Atlanta Federal Reserve President Raphael Bostic suggested the possibility of inflation fluctuating if policymakers decide to cut rates prematurely, thereby providing support to the USD/MXN pair. He also cautioned that the deceleration of inflation toward the Fed’s 2.0% target was anticipated to slow down in the coming months.

The recent data from Mexico indicates that the country is grappling with challenges. The annual inflation rate increased from 4.32% to 4.66% in December. Although the headline inflation has eased to 5.0%, it remains elevated. This high inflation rate could potentially dissuade officials of the Bank of Mexico from implementing policy-easing measures in the first quarter of 2024.

CNY: The Chinese yuan remained under pressure last week and ended it slightly lower against the broadly stronger US dollar. Data confirmed that China experienced the longest deflationary period since 2009, registering three months of declining consumer prices in a row. In December, the CPI index fell by 0.3%. The fact that this was a smaller decline than the month previous (-0.5%), and slightly more limited than expected (-0.4%), has not allayed concerns about domestic demand. Most other releases, including PPI inflation and financial data, also failed to provide optimism, although trade activity did, at least, pick up at the end of the year.

Amid concerns about the economy’s weak performance, the PBoC injected CNY 216 billion in fresh medium-term funds into the banking system today, but contrary to expectations it did not lower the 1-year MLF rate. Looking ahead, attention will be on the year-end data package to be released on Wednesday. GDP growth is particularly worth watching, as it could set the tone for sentiment toward China in 2024.