Drivers for the Week Ahead

  • The US economy is in better shape than the market feared but it will take more than one strong reading to get the dollar rally back on track
  • FOMC minutes will be released Wednesday
  • Powell did some serious damage control that was a 180 from the December FOMC meeting
  • The UK Parliament returned from recess today
  • Bank of Canada meets Wednesday and is expected to keep rates steady at 1.75%
  • China reports December money and loan data this week; US trade delegation has arrived in Beijing

The dollar is broadly weaker against the majors as the week begins in risk-on mode.  Swissie and the euro are outperforming, while the Loonie and yen are underperforming.  EM currencies are mostly firmer.  IDR and CLP are outperforming, while TRY and MXN are underperforming.  MSCI Asia Pacific was up 1.8%, with the Nikkei rising 2.4%.  MSCI EM is up 1.1% so far today, with the Shanghai Composite rising 0.7%.  Euro Stoxx 600 is down 0.5% near midday, while US equity futures are pointing to a lower open.  The US 10-year yield is down 3 bp at 2.64%.  Commodity prices are mostly higher, with Brent oil up 2.2%, copper down 0.1%, and gold up 0.4%.

The stronger than expected December US jobs data can be parsed in many ways but the takeaway is that the US economy is in better shape than the market feared.  That said, there has been enough mixed data for the Fed to be more cautious.  We can assume the Fed will likely stand pat on January 30, March 20, and May 1 in order to see how the economy develops.  June 19 could be the “make or break” meeting in terms of a potential hike, but a lot can happen between now and then.

It will take more than one strong reading to get the dollar rally back on track.  As we’ve been warning for a while now, a US recession (when it happens) will be the game-changer for the dollar and would likely push it into a multi-year downtrend as the Fed cuts rates and the budget deficit blows out.  Until fears of a US recession ease further, we think it will be hard for the dollar to get traction.  The only thing limiting the dollar’s losses recently is that things in the rest of the world aren’t looking too good either.  And the dollar still benefits from risk-off impulses.

FOMC minutes will be released Wednesday.  Before Friday, we thought markets would be very interested to see the extent to which the Fed discussed equity markets movements.  The message that Powell sent during his press conference was one of little concern.  Not anymore.  Why?

Last Friday, Powell did some serious damage control that was a 180 from the December FOMC meeting.  Where to start?  First, he said the Fed flexible and prepared to adjust policy quickly.  He said the Fed is listening closely to market concerns.  Next, he said the Fed would change its balance sheet runoff policy if needed.   Powell said no meeting with Trump is scheduled and added that he wouldn’t resign if the President asked him to.  Basically, Powell addressed all the major criticisms and issues that the market has had with the Fed recently.

There are several Fed speakers this week.  Bostic speaks on both Monday and Wednesday.  Evans and Rosengren also speak Wednesday.  Barkin, Bullard, Evans, and Clarida all speak Thursday.  We expect them all to follow Powell’s lead and stay on message that the Fed really cares what markets think.  The Powell Put is been triggered and this is likely to weigh on the dollar and boost equity markets and risk near-term.

US December CPI data will be reported Friday.  After the stronger than expected December jobs data Last Friday, inflation data will hold some interest.  Headline inflation is expected to ease to 1.9% y/y from 2.2% in November, while core is seen steady at 2.2% y/y.  The implied yield on the January 2020 Fed Funds futures contract ended the year at 2.38% and sank further to 2.22% in the new year before bouncing back to 2.32% today.  This still suggests Fed rate cuts this year and clearly seems way too dovish.  When (if?) US rates back up further, the dollar should gain some further traction.  Until that happens, however, the greenback is likely to remain vulnerable to further selling.

As the jobs data would suggest, the US economy remains firm.  December Chicago PMI came in stronger than expected at 65.4.  The Atlanta Fed’s GDPNow model is tracking Q4 growth at 2.6% SAAR ca. 2.7% previously, while the New York Fed’s Nowcast model is still tracking 2.5% SAAR growth.  Not too shabby.  While growth is admittedly slowing sequentially from the 4.2% SAAR peak in Q2 2018, it remains above trend (~2%).

The UK Parliament returned from recess today.  UK Prime Minister May reportedly been in talks with EU officials over the Christmas break, and is clearly trying to line up further concessions from the EU ahead of the planned vote later this month.  However, the EU has made it clear that no significant concessions will be made to secure UK parliamentary approval.  As such, May is fighting for support as the debate in Parliament begins this Wednesday ahead of the planned vote next week.

In terms of UK data, November trade, IP, construction output, and GDP will all be reported Friday.  Last week, firmer than expected December PMI readings were reported, though there were likely some distortions due to business planning for the March Brexit.  Sterling has faltered last week after its inability to break above $1.28, but broad-based dollar weakness is setting up another try.

Germany reports November factory orders Monday, IP Tuesday, followed by trade and current account data Wednesday.  Last week, eurozone CPI was reported at 1.6% y/y vs. the expected 1.7% and down from 2.0% in November.  This is the lowest reading since April and will continue to cast doubts on the ECB’s ability to lift rates after the summer.  Final December eurozone PMI readings were also released last week that showed continued weakness in the economy.

The euro’s technical tone had deteriorated after its failure to break above $1.15.  However, support near $1.13 coupled with the softer dollar outlook has seen the single currency bounce back and it seems likely to test $1.15 again soon.  It has not traded above this level since October 22 and a break would set up a test of the October 16 high near $1.1620.

Bank of Canada meets Wednesday and is expected to keep rates steady at 1.75%.  Previously, the market was basically split between no hike and a 25 bp hike.  CPI rose 1.7% y/y in November, the lowest since January but within the 1-3% target range.  Data have been coming in soft of late, and so we see agree with the dovish shift in the markets.  Ahead of the decision, Canada reports December Ivey PMI today and November trade Tuesday.

USD/CAD traded at a new high for this move near 1.3665 on December 31 before reversing lower.  Now, a clean break below the 1.3355 area would set up a test of the December 3 low near 1.3160.

Japan reports November cash earnings data Wednesday.  November current account data will be reported Friday.  Japan so far has reported soft data for November and December.  The unemployment rate ticked up to 2.5% in November, while December Tokyo CPI eased to 0.3% y/y vs. 0.5% expected and 0.8% in November.  This suggests downside risks to national CPI when it is reported January 17.  November retail and supermarket sales also came in weaker than expected.

Next BOJ meeting is January 23.  The BOJ just affirmed its commitment to keep stimulus in place until at least 2021 and will likely reaffirm it at the next meeting too.  Meanwhile, the yen remains firm after USD/JPY traded below 105 last week for the first time since last March.  The return of risk-on sentiment should help limit a further fall in USD/JPY.

Australia has a busy data week.  November trade will be reported Tuesday, followed by building approvals and job vacancies Wednesday.  Retail sales will be reported Friday.  Next RBA meeting is February 4.  With growing headwinds, market expectations for RBA tightening have been pushed out to early 2020 from late 2019 previously.  AUD has rebounded after taking it on the chin and trading below .68 last week for the first time since 2009.  A break above .7145 would set up a test of the December high near .7395.

China reports December money and loan data this week, but no date has been set.  CPI and PPI will be reported Thursday.  Last week, official manufacturing PMI fell to 49.4 in December from 50.0 in November.  This was the first sub-50 reading since July 2016 and the lowest since February 2016.  Caixin data confirmed this as its manufacturing PMI fell to 49.7, the first sub-50 reading since May 2017.

The US trade delegation has arrived in Beijing.  President Trump has been dropping hints of a possible thaw in US-China relations.  Vice Premier Liu reportedly showed up unexpectedly at the first day of talks today, feeding into market optimism that a deal will be struck.  Liu is very senior and is a top economic advisor to President Xi.

While we remain negative on EM this year, the combination of a more flexible Fed and signs of improving US-China relations are too much to ignore.  Powell has given the market a green light to load up on risk, and that means EM should benefit from investor flows that had been largely underweight this asset class.  However, global growth is slowing and so longer-term, we remain very cautious on EM.