FX Weekly Update – January 22nd, 2024

Posted Under: Weekly updates

It has been the view for some time now that traders were getting ahead of themselves pricing in central bank cuts generally, and particularly so in the case of the Federal Reserve.

Last week we saw further vindication of this view, as the strength of US economic data continues to surprise markets, notably the latest retail sales and initial jobless claims figures, and FOMC officials push back against an early start to cuts. The 2024 dollar rally picked up steam, and the greenback rose against every major currency worldwide, as bets on a March Fed cut receded to a year low of 40%.

Economic data will be front and centre this week, together with the ECB’s January meeting on Thursday. Wednesday will see the release of the PMIs of business activity for January in the major economies. These numbers are particularly important in the Eurozone, given the absence of other reliable timely indicators. US PCE inflation for December will be another important reference for markets on Friday, as will the fourth quarter GDP report on Thursday. We think that generally positive data will continue to allow central banks to push back against the notion of early interest rate cuts.

A slew of second-tier data (retail sales, industrial production, housing starts and weekly jobless claims) all came out strong and above economists expectations, underlining the continuing strength of the US economy. The labour market, in particular, continues to perform remarkably well, with last week’s jobless claims data not only coming in well below expectations, but also its lowest level since September 2022. Unsurprisingly, rates continue to rise across the curve and the dollar is reversing last year´s sell-off.

This week´s PMI, GDP and PCE inflation data, the Fed’s preferred measure of price growth, will provide further clarity on the state of the US economy. However, this is unlikely to change the Fed´s apparent view that market expectations for rate cuts are still too aggressive. We would expect the FOMC to dampen expectations for cuts at its upcoming meeting next week, which should take a March start to easing almost entirely off the table.

GBP: December inflation ran significantly hotter than expected in both the headline and core indices. In particular, annual core inflation stayed above the 5% level. The data suggest that the ‘last mile‘ of the inflation fight will be the toughest in the UK, as well as elsewhere, and consequently expectations for Bank of England cuts continue to be pushed back.

A nagging concern for investors remains the rather fragile state of Britain’s economy. Friday’s retail sales report was particularly soft, with sales posting their largest monthly downturn since 2021, i.e. when the pandemic restrictions were still in place. It remains a coin toss as to whether a technical recession will be confirmed for Q4 when the official GDP data will be released in mid-February. If last week’s data is anything to go by, a mild recession appears more likely than not. This week’s PMI data is expected to be far more upbeat, and remain well above the level of 50 that denotes expansion, which should support sterling.

EUR: Eurozone industrial production data remains bleak, partially attributable to disappointing Chinese growth. Last week’s November report showed an annual contraction of nearly 7%, and the sector is dragging the economy into a technical recession. However, ECB officials have continued to push back against market expectations of aggressive and early cuts in rates, suggesting that inflation is not beaten and that cuts in rates will have to wait until the summer.

This week´s ECB meeting offers the central bank an opportunity to clarify where it stands and what it needs to see in the data before it can start cutting rates. We think that the bank will again strike a rather hawkish tone, and say that now is not the time to start thinking about cuts. We could also see a rather more direct message on rates from President Lagarde, who last week said that she didn’t expect the bank to start easing until the summer.

JPY: Tuesday’s Bank of Japan policy meeting is shaping up to be highly important for the Japanese yen. Investors have once again pushed JPY towards the 150 level on the dollar so far this year, as they doubt whether the BoJ will begin tightening policy until later in 2024. The bank will stand pat during its meeting this week, and we suspect that policymakers will again stress the importance on upcoming data on wages and inflation. The first outcomes of the ‘shunto’ wage negotiations will be released in mid-March, and it is highly unlikely we’ll see any change in policy, or big shift in guidance, until then. A first hike in April remains in play (more than 50% priced in by markets) but, as stressed, the BoJ is not yet ready to indicate as much.

Aside from the highly important Bank of Japan announcement, investors will be keeping close tabs on a handful of economic data releases this week. This includes the December trade data (Tuesday), and the Tokyo inflation report for January (Thursday).

CAD: CAD closely tracked the US dollar last week, ending trading on Friday roughly unchanged, and the best performer in the G10 alongside the greenback. Last week’s modest rally in oil prices can partly explain this outperformance, as can the move higher in Canadian bond yields, which rose broadly across the curve. Last week’s December inflation data showed a rare contraction in monthly prices, and the largest in a year, although this was fully priced in by markets. Friday’s retail sales report (-0.2% MoM in November vs. 0% consensus) was a disappointment, although this had minimal impact on the dollar.

This Wednesday’s Bank of Canada rate announcement will be closely watched by market participants. With no change in rates seen, any changes in the accompanying rhetoric will be important. We think that the BoC may claim that progress is being made on inflation, although it may also indicate that there remains some way to go before it can starting cutting rates.

CNY: The Chinese yuan sold off against the broadly stronger US dollar last week, with the USD/CNY pair rising to its highest level in around two months, just below the 7.20 mark. Against other currencies, however, CNY showed resilience, outperforming almost all G10 and most emerging market currencies. To some extent, this may be a consequence of the PBoC’s surprise decision to keep the MLF rate unchanged last Monday. It may also be a function of the cheapness of the Chinese currency.

However, this resilience is quite surprising, particularly given that economic data from China released last week was not particularly encouraging. While the economy met authorities’ GDP target, growing by 5.2% in 2023, it entered into 2024 on shaky legs. The detailed data for December paint a picture of a still struggling real estate sector (characterised by falling home prices, sharply shrinking real estate investment and residential sales) and weak consumer demand (retail sales grew by only 7.4% YoY, less than expected). Apart from today’s LPR announcement, which confirmed no change in rates, the only reading this week is the industrial profits data for December, which will be published on Saturday