Weekly Overview: China Reopens and Flash PMI Takes Center Stage Following Extension of US Rate Adjustments

The US Consumer Price Index (CPI) and Producer Price Index (PPI) for January outperformed expectations, fueling a rise in US interest rates and supporting the dollar’s strength. However, this data is not anticipated to alter the Federal Reserve’s current policy stance. The validity of this view will be tested by statements from at least seven Fed officials in the upcoming days. With several important reports pending before the data-driven Federal Open Market Committee (FOMC) convenes again in roughly four weeks, the situation remains fluid. The Personal Consumption Expenditures (PCE) deflator, the Fed’s preferred inflation gauge, is expected to show more moderate behavior due to its distinct weights and methodology. Nevertheless, the yield on two-year Treasuries surged past 4.70% recently, hitting a new three-month peak. The dollar has appreciated against most major currencies in the early weeks of the year, with notable exceptions. The Japanese yen has weakened for seven consecutive weeks, and despite concerns of potential intervention by Japan’s Ministry of Finance (MOF), this trend has continued unabated. Conversely, the Australian dollar and Scandinavian currencies have seen gains for two successive weeks, potentially influenced by a surge in risk appetite that propelled the S&P 500 and NASDAQ to record highs, along with near-record levels for Europe’s Stoxx 600 and Japan’s Nikkei.

In the realm of US commercial real estate, the largest publicly traded company in this sector reported earnings that exceeded expectations and provided a positive outlook, offering a much-needed boost to the sector. This news contributed to a 3.5% increase in the KBW index of regional banks, reversing a two-week, 8.5% decline. Federal Reserve Vice Chair for Supervision, Barr, has indicated that regulators are closely scrutinizing commercial real estate loans and have heightened supervisory ratings downgrades for some lenders. Among other developments to watch, the upcoming week’s highlight is the preliminary February PMI. It would require a substantial deviation from expectations to alter the prevailing sentiment of US economic strength, especially after Japan and the UK reported economic contractions in the fourth quarter of 2023. Following its extended holiday, China is poised to re-enter the fray, with optimism for a consumption recovery buoyed by reports of robust domestic travel. Chinese authorities are expected to continue their stimulus efforts, potentially starting with a cut to the one-year benchmark interest rate early Monday, although the impact of the last cut in August 2023 has yet to fully permeate to prime rates.

United States

The main wave of significant January data has concluded, with existing home sales on the horizon, although they typically don’t significantly sway the market. Notably, existing home sales have decreased in 20 of the last 24 months up to the end of 2023, reaching levels seen in 2010 (3.8 million Seasonally Adjusted Annual Rate – SAAR) in December, with an anticipated increase of nearly 5% last month. This rise is hoped to be spurred by lower mortgage rates. After a 24% drop in 2022, housing starts rebounded by 7.6% last year. Additionally, the preliminary February Purchasing Managers’ Index (PMI) is set to be released, contributing to discussions on the economy’s re-acceleration. January saw the manufacturing PMI climb to 50.7, its peak since September 2022, while the service PMI has increased for four months straight to 52.5, the highest since the previous June. The composite PMI matched its second-half 2023 high at 52.0 in January, up from 50.1 in February 2023.

Moreover, the minutes from the Federal Open Market Committee (FOMC) meeting last month, scheduled for release on February 21, are awaited. During this meeting, Fed Chair Powell strongly countered the speculation about a rate cut in March. Following the meeting, most Fed officials have mirrored Powell’s view that confidence in achieving the 2% inflation target is growing. Currently, it seems unlikely there will be any dissent in the Fed’s potential decision to maintain rates in March. The January CPI’s slight exceedance was not balanced by declines in retail sales and industrial production. Post the firmer PPI, the likelihood of a May rate cut dropped to about 37%, significantly down from prior expectations. The market’s outlook is increasingly aligning with the Fed’s, moving from anticipating six quarter-point cuts to now foreseeing three, with a nearly 60% chance of a fourth.

The Dollar Index has seen a rally from just below 102.75 before the January employment data to almost 105.00 following the January CPI, then pulling back to around 104.20 before the PPI pushed it to about 104.65. The Index has risen in six out of the first seven weeks of the year, with only a minor 0.1% decrease in one week. Despite momentum indicators being stretched for the past four weeks, there’s yet no clear signal that this uptrend is concluding. However, a soft finish ahead of the weekend, marking new three-day lows, could indicate initial support around the 103.70-85 range.

Eurozone

The Eurozone’s economic performance remains lackluster, presenting a stark contrast to the United States. The upcoming preliminary February Purchasing Managers’ Index (PMI), a crucial indicator for the week, is not expected to significantly shift investor sentiment. The composite index, which had hit its lowest point in October of the previous year at 46.5, showed a slight improvement to 47.9 in January but remains indicative of weak growth dynamics. Compared to February 2023, when the composite PMI stood at 52, the current figures reflect subdued growth impulses with little to suggest a turnaround. The European Central Bank’s (ECB) projections are pointing towards another year of growth barely reaching 1%.

The euro experienced a decline for the fifth week in a row, despite fluctuating within the range established the week prior. It started last week just above $1.08 but dipped below $1.07 for the first time in three months following the release of the US CPI data. However, in the final three trading sessions, the euro saw its close at the higher end of its daily range, with incremental increases in the lows on both Thursday and Friday. From a technical standpoint, for the euro’s recent downturn to be considered significant, it would need to break through a resistance zone ranging from approximately $1.0810 to $1.0830. Considering the euro’s decline this year, following a roughly 4.4% rally in the fourth quarter of the previous year, and the recent rise in US interest rates, indicators of a sustainable low are being closely monitored. A breach above this resistance level would signal such a change.

United Kingdom

The UK’s economy saw a contraction in the fourth quarter of 2023, marking the second consecutive quarter of decline. However, robust retail sales in January and the forthcoming preliminary February Purchasing Managers’ Index (PMI) might ignite optimism for a stronger outset in 2024. The service sector PMI has been on an upward trajectory for four consecutive months, reaching 54.3 in January, its peak since the previous May. Conversely, the manufacturing sector remains in a slump, with the PMI not surpassing the 50 mark since July 2022. The composite index, reflecting both manufacturing and service sector output, has risen consistently throughout the fourth quarter of 2023 and into January, currently standing at 52.9, the highest since last May, slightly below its February 2023 level of 53.1.

A surprising drop in the headline Consumer Price Index (CPI) last month led to sterling dropping to approximately $1.2535 on February 14, marking the week’s low point. Market participants appeared to largely overlook the Conservative Party’s losses in the recent byelections, and the expectation is for a similar outcome in the upcoming byelection on February 29. Sterling then recovered, moving back into its prior range of $1.26 to $1.28 before the weekend. Resistance in the near term is identified around the $1.2625 to $1.2650 range.

China

As mainland markets reopen following the extended Lunar New Year celebrations, there is anticipation for new initiatives aimed at bolstering the economy, potentially including measures to stabilize the equity market. Upcoming data releases, such as Q4 2023’s current account, new house prices, and the yuan’s representation in SWIFT transactions, are not expected to significantly influence the market. The reliability and consistency of Chinese data have long been subjects of skepticism, with some attributing political motives to the selective presentation of data points, thereby crafting narratives without producing testable hypotheses. This skepticism is further compounded by Beijing’s hesitation to abandon the outdated Soviet-era Material Product System in favor of the United Nations’ System of National Accounts.

The People’s Bank of China (PBOC) is set to determine the benchmark rate for the one-month Medium-Term Lending Facility (MLF), currently at 2.50%. While a reduction appears appropriate, the full benefits of the previous cut in August 2023 have yet to be passed on by Chinese banks, which are often perceived as executing the PBOC’s directives in the foreign exchange market. Any decision to lower the MLF rate may come with the expectation or agreement that banks will this time transmit it through the loan prime rates, which are determined on Tuesday.

Optimism is somewhat bolstered by reports of increased domestic travel during the Lunar New Year holiday, suggesting a potential uptick in demand. This optimism contributed to a 2.7% rally in the index for mainland shares traded in Hong Kong before the weekend. While these developments may support the yuan, the nearly 1% drop in the Japanese yen since the holiday’s start and the almost 0.4% increase in the Dollar Index pose challenges to the yuan’s value, according to our analysis of factors influencing the exchange rate within the band set by the PBOC’s daily reference rate. It’s also noted that the offshore yuan remained relatively stable while the mainland markets were closed, with the dollar fluctuating near CNH7.2150 at the holiday’s onset and closing last week around CNH7.2200.

Japan

Japan’s trade balance traditionally weakens in January, a trend that has persisted unfailingly since the early 1970s. Remarkably, Japan recorded a monthly trade surplus in December, marking only the third time this has occurred since July 2021. Back in 1984, Japan’s exports constituted about 14% of its GDP. This percentage was considered excessive by some policymakers behind the tariffs introduced during Trump’s tenure, which the Biden administration has largely maintained. Their concerns contributed to the Plaza Agreement in 1985, which aimed at coordinating efforts to sell the dollar. By 2023, Japan’s exports had risen to nearly 22% of GDP. Despite this, like in the US, Japanese firms primarily meet foreign demand through sales by overseas branches and affiliates, far exceeding the value of exports. This approach, driven by a historically strong yen and foreign protectionist measures, has led to significant portions of industries, such as automotive, relocating abroad.

Japan is also set to release its preliminary February PMI, indicating ongoing challenges in manufacturing. The manufacturing PMI briefly surpassed the 50 mark last May, indicating expansion, but this was an anomaly, with the index remaining below 50 since November 2022. Conversely, except for one instance, the service PMI has stayed above 50 since the end of Q1 2022. The composite PMI reached 51.5 in January, its highest level since the previous September, and was at 51.1 in February of last year.

The US dollar has strengthened against the yen for seven straight weeks. Japanese Ministry of Finance (MOF) officials have hinted at possible intervention to curb rapid currency movements, including actions outside their usual operational hours. Despite these warnings, the dollar only slightly retreated following their statements. It further weakened after disappointing US retail sales and industrial production data but recovered towards the week’s end following a strong PPI report. The dollar peaked near JPY150.90 last week, with its lowest point just above JPY149.55, closing above JPY150 for the first time since November of the previous year. With last year’s high around JPY152, the charts suggest a potential test of this level. Notably, the Nikkei’s 15% rally this year translates to a 7.7% gain for unhedged dollar-based investors, outperforming the returns from the S&P 500 or NASDAQ.

Canada

In Q4 2023, Canada’s Consumer Price Index (CPI) experienced an annualized decrease, indicating a forthcoming significant slowdown in inflation rates. This is largely due to the base effect, as the initial months of the previous year saw inflation rates surge to an annualized rate of just over 6.3%. As these figures are phased out from the 12-month comparison, a moderation in headline inflation is anticipated. Nonetheless, this moderation was not significantly evident last month. On February 20, Canada is set to release its January CPI data, with expectations, according to Bloomberg’s median forecast, for a 0.4% month-over-month increase, potentially reducing the year-over-year rate to 3.6% from 3.7%.

A challenge for the central bank lies in the stagnation of core inflation measures. The trimmed mean CPI remained at 3.5% in Q4 and ended the year at 3.7%, unchanged since June 2023. The weighted median CPI decreased to 3.5% in October 2023 but rose to 3.6% in November and December. These softer underlying inflation rates, combined with consecutive losses in full-time employment, may prompt earlier expectations for a rate cut. Additionally, December retail sales data, due to be reported on February 22, showed a notable 0.8% increase in December, marking the largest rise since April. However, this increase primarily reflects higher prices, as volumes only grew by 0.2%.

The US dollar saw a rally from CAD1.3440 to CAD1.3585, reaching a new yearly high, following the US CPI report. It then spent the next three days trimming those gains, with a low near CAD1.3460 observed before the weekend. Despite a modest weekly gain (less than 0.2%), this marked the sixth increase in the past seven weeks. The week it declined (ending February 9) saw a slight drop of less than 0.1%. The US dollar has yet to breach a significant technical level or form a reversal pattern. Trend line support for the coming week starts near CAD1.3445 and rises to CAD1.3475 by week’s end. Looking upwards, the next technical target lies in the CAD1.3600-25 range.

Australia

Australia’s upcoming flash Purchasing Managers’ Index (PMI) stands as a key data point, showing more promise than the eurozone’s performance but not quite matching the strength of the US. Breaking a 10-month trend of sub-50 readings, Australia’s manufacturing PMI climbed to 50.1 in January from 47.6 in December, marking the most significant increase since September 2021. However, the service PMI lingered below the 50 threshold for the fourth consecutive month at 49.1 in January, compared to 50.7 the previous February. The composite PMI ended 2023 at 49.1, reaching a four-month peak. Nonetheless, the lackluster January employment figures (with unemployment rising 0.2% to 4.1% and only 11k full-time jobs added following a loss of 109k in December) might dampen the positive outlook.

Despite these mixed signals, the Australian dollar demonstrated resilience. Following the release of the US CPI data, it dipped to a new three-month low of around $0.6440 but then recovered steadily, reaching a slight two-week high of near $0.6545 before the weekend. The 20-day moving average is positioned at about $0.6540, a level the Aussie hasn’t closed above since January 3. The 200-day moving average stands at approximately $0.6565. The momentum indicators for the Australian dollar are showing positive signs, hinting at potential for further resilience or recovery.

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