Last week witnessed three notable developments in the financial landscape.
- Firstly, gold experienced a significant fluctuation with a $135 range on Monday. It marked a crucial downside reversal, concluding the week below the $2000 mark after reaching a record high just above $2135.
- Secondly, January WTI approached $80 on December 1 but plummeted to below $69 on December 7, reaching its lowest level in five months. This seven-week decline matches the longest since July/August 2015.
- Lastly, the dollar faced a decline of slightly over 2.1% against the Japanese yen on December 7. Market apprehension led to speculations that the Bank of Japan (BOJ) might raise rates in the coming weeks, resulting in a trading range of approximately JPY141.70 to JPY147.30 that day.
The greenback briefly dipped below the 200-day moving average for the first time in seven months. Despite softening inflation, a substantial contraction in Japan’s Q3 GDP, and feeble consumption in the early stages of Q4, the BOJ is under little pressure to take immediate action. A resounding 94% of economists polled by Bloomberg anticipate no policy changes until the next year, with about half of them expecting a move in April coinciding with the new fiscal year and the expiration of energy subsidies.
Looking ahead, the upcoming week is brimming with central bank meetings.
Notable G10 central banks, including the Federal Reserve, the European Central Bank, the Bank of England, the Swiss National Bank, and Norway’s central bank, are set to convene. No policy changes are anticipated, but the market has been forward in pricing in cuts starting early next year for the Fed, ECB, and SNB.
The question now is how steadfastly officials will push back against these market expectations. Among these G10 central banks, the Norges Bank is viewed with suspicion by the market, as the swaps market remains unconvinced that its tightening cycle has concluded. The Fed and ECB are expected to update their economic forecasts, which should be considered a part of their communication and forward guidance. In September, the median Fed forecast projected one cut below the current target for 2024, while the market is pricing in four cuts. Additionally, several emerging market central banks, including those of Mexico and Brazil, are scheduled to meet. Brazil is expected to continue its easing cycle with a 50 bp cut, bringing the Selic rate to 11.75%, while Banxico is anticipated to maintain its stance at 11.25% but appears to be gradually preparing the market for a cut in Q1 2024.
This week stands out as one of the busiest in the quarter, with the focal point being the FOMC meeting where Federal Reserve officials will provide updates on the Summary of Economic Projections. It is highly unlikely that the Fed will take any immediate action, and Chair Powell’s comments are expected to align closely with his recent statements on December 1. Despite Powell’s pushback against speculation on rate cuts, the market initially reacted in the opposite direction, but yields showed some recovery last week, though not entirely. The September dot plot envisioned two cuts in the following year, assuming one more hike this year. The median projection anticipated the headline CPE deflator at 2.5% by the end of 2024 and the core rate at 2.6%, slightly above the target but approaching it. The potential decline in bank reserves due to the recent decrease in the use of the reverse repo facility may bring attention to the unwinding of the Fed’s balance sheet.
At the previous meeting, a notable concern was the tightening of financial conditions, with Powell emphasizing that such moves need “persistence” to be significant from a policy-making standpoint. However, the tightening has largely reversed, presenting the Fed with a contrasting scenario. Since the November 1 meeting, the 10-year yield has dropped approximately 50 basis points, the two-year yield nearly 40 basis points, the S&P 500 has risen over 9%, and a trade-weighted measure of the dollar has declined by around 2.6%.
Prior to the FOMC meeting, the focus will be on the November CPI (Consumer Price Index) and PPI (Producer Price Index) reports. Headline CPI may remain unchanged or show a 0.1% increase after a flat October report, allowing the year-over-year rate to ease to 3.1%. The core rate is expected to be more resilient, with a median forecast of a 0.3% increase (0.2% in October) and a steady year-over-year rate at 4.0%. PPI is anticipated to rebound slightly after a 0.5% decline in October, potentially easing the year-over-year rate toward 1%. After the FOMC meeting, softer retail sales are expected in the U.S., while the resolution of the labor dispute may support industrial output after the 0.6% decline in October. The U.S. economy is showing signs of slowing after the robust 5.2% surge in Q3, and the focus now is on the extent of this slowdown, with many anticipating it as the leading edge of a contraction.
The short-term outlook for the Dollar Index appears positive. Momentum indicators are on the rise, and the five-day moving average has crossed back above the 20-day moving average for the first time in a month. A move above 104.35 sets the stage for an initial target range of 104.75-00, with further potential towards 105.35 and possibly 106.00.
The Eurozone economy finds itself entrenched in a trough, displaying signs of stagnation with virtually flat GDP growth over the past six quarters. The growth impulses continue to be weak, with the median forecast in Bloomberg’s survey anticipating a flat Q4 and a modest 0.1% expansion in Q1 2024. The upcoming ECB meeting on December 14 takes center stage, mirroring the Federal Reserve, as it is expected to maintain the status quo and provide updated forecasts.
In September, the ECB projected a 0.7% GDP growth for this year, 1.0% in 2024, and 1.5% in 2025. The IMF shares similar forecasts for this year but is slightly more optimistic about 2024 (1.2%) and 2025 (1.8%). In terms of inflation, the ECB anticipated a decline from 5.6% this year to 3.2% in 2024 and 2.1% in 2025. The IMF aligns closely with these projections (3.3% and 2.2% CPI in 2024 and 2025, respectively). However, softer-than-expected CPI figures may influence the new forecasts.
The swaps market indicates about a 65% probability of the first ECB rate cut by the end of Q1 2024, with two-and-a-half cuts fully priced in by the middle of next year. By the conclusion of 2024, the swaps market reflects expectations of more than 125 basis points in cuts. Despite the euro firming up a bit and lower oil and natural gas prices since the late October ECB meeting, ECB President Lagarde may challenge the market’s aggressive pricing in of rate cuts. Additionally, EU finance ministers convene on December 14-15 to explore modifications to the Stability and Growth Pact before the old rules return in the coming year.
The euro, which hit a low near $1.0450 on October 3 and reached slightly above $1.1015 at the end of November, has experienced a decline this month. The five-day moving average dropped below the 20-day moving average, and momentum indicators are trending lower. After the US jobs data, the euro reached around $1.0725, meeting the 50% retracement objective. The next retracement objective (61.8%) is in the vicinity of $1.0668.
The Bank of England is scheduled to meet on December 14, and a status quo in interest rates is the most likely outcome. Given the sluggish economy and moderating inflationary pressures, there appears to be no compelling reason to tighten monetary policy, despite the presence of a couple of hawks on the Monetary Policy Committee (MPC). However, with inflation still relatively high at 4.6% headline and 5.7% core, a rate cut is not anticipated. The swap market indicates a greater than 90% chance of a cut by mid-year, with expectations of around two-and-a-half cuts in 2024, following the lead of the Federal Reserve and the ECB.
Leading up to the BOE meeting, investors and policymakers will scrutinize the latest employment data, October monthly GDP, and associated details. The UK economy showed stagnation in Q3 and is projected to remain flat in the current and next quarters. Notably, the BOE’s forecast suggests no growth next year, in contrast to the IMF’s more optimistic projection of 0.6% growth and the median forecast in Bloomberg’s survey calling for a 0.4% expansion. In a parliamentary vote on Tuesday, the government’s plan to send asylum seekers to Rwanda will be discussed. Internal divisions among Tories regarding the proposed legislation led to the resignation of the immigration minister last week. However, Prime Minister Sunak is not treating it as a confidence vote, avoiding the risk of a government collapse in case of a loss.
Sterling experienced a setback, ending a three-week advance and losing around 1.3% last week. While the five-day moving average has not yet fallen below the 20-day moving average, there are indications that it may do so in the coming days. Momentum indicators have turned downwards, and sterling seems poised to dip below the 200-day moving average (~$1.2490) and test the (38.2%) retracement of its rally from the early October low (~$1.2035) around $1.2365. The subsequent retracement (50%) is situated around $1.2393.
It’s a significant week for Chinese data, with the most crucial information expected towards the end of the week. Despite the likelihood of other data showing strength, the early December 9 report on stronger deflationary forces may prompt a policy response. The Consumer Price Index (CPI) fell by 0.5% year-over-year after a 0.2% contraction in October, and producers are now 3% lower than a year ago, down from -2.8% previously. While it seems unlikely, there’s a possibility that the People’s Bank of China (PBOC) may cut its benchmark one-year Medium-Term Lending Facility rate, currently at 2.50%. The rate was last cut by 15 basis points in August, but the full pass-through by banks via the loan prime rates has not occurred. The PBOC has recently shown a focus on quantities rather than prices, but continued deflation in both consumer and producer goods, coupled with the anticipation of aggressive rate cuts by several G10 central banks, might create room for a rate cut. However, the overall expectation leans towards a cut in reserve requirements before a rate cut. The impact of Beijing’s numerous announced measures is expected to manifest in real-sector data outside the property market. Sequential improvements on a year-to-date year-over-year basis are anticipated in industrial output and retail sales, with fixed asset investment likely showing a slight uptick. Property investment and residential property sales, however, remain significant drags on the overall picture.
Last week, the dollar rose against the yuan for the first time in four weeks, recording the largest gain in three months at around 0.60%. There is potential for additional near-term gains, with a move above CNY7.1865 indicating the possibility of reaching CNY7.2080 and possibly CNY7.23. Given the yen’s volatility and the upcoming BOJ meeting, it’s suspected that the offshore yuan (CNH) may be utilized again as a funding currency (borrowed and sold) for carry trades into early 2024, seeking higher yields or more volatile assets.
Following last week’s central bank meeting, Q3 GDP release (0.2%), and October trade balance (A$7.5 billion vs A$12.2 billion in October 2022), Australia’s economic calendar appears relatively light. While a few surveys are expected, the Australian dollar is likely to be influenced more by broader developments in the capital markets. Market sentiment suggests that the Reserve Bank of Australia (RBA) may lag behind other major central banks in the upcoming easing cycle starting next year. The first rate cut is not fully priced in until late Q3 or early Q4.
After experiencing a decline for the first time in four weeks and only the second time in eight weeks, the Australian dollar faces a near-term resistance around $0.6620. A move above this level could signal a retest of the $0.6700 area. Conversely, a close below $0.6560 indicates the potential for a deeper correction following the rally that commenced with the year’s low in late October near $0.6270. The (38.2%) retracement reached around $0.6530 last week, rebounding nearly a cent before encountering resistance. Falling momentum indicators and the possible crossing of the five-day moving average below the 20-day moving average in the coming days suggest a cautious outlook for the Australian dollar.
The Bank of Canada has shifted closer to the possibility of a rate cut by removing the reference to upside risks of inflation and acknowledging a loosening labor market. Despite the market pricing in a higher chance of the Fed easing before the Bank of Canada, the two-year US premium remains near 60 basis points, the highest in nine months. Canada’s housing starts, surprisingly, have held up well, showing about a 10% increase in the September-October period at a seasonally adjusted annualized rate. October’s figure of 274.7k (SAAR) was the best since June, compared to around 264.4k in October 2022. Existing home sales, however, experienced a four-month consecutive decline through October, with a 5.6% drop in October, the largest monthly decline since May 2022. October portfolio flows will also be reported, with foreign appetite for Canadian securities declining sharply this year to nearly C$20.5 billion. In the first nine months of 2022, net foreign portfolio inflows were slightly over C$95 billion. The Canadian dollar appears more responsive to the risk environment (S&P 500 proxy) and the general movement of the US dollar (trade-weighted index) than crude oil.
Against the Canadian dollar, the US dollar saw its first rise in four weeks and seems technically poised for further gains in the near future. Momentum indicators are on the rise, and a move above CAD1.3620 could signal a potential move toward CAD1.3660-90 initially. This move would likely push the greenback’s five-day moving average back above the 20-day, serving as a proxy for signals generated by trend-following models.