Weekly Overview: Do Soft CPI and Retail Sales Signal an End to Rate Hikes and Stabilize the Dollar?

In the latest financial developments, markets are undergoing adjustments following the late 2023 surge in rates and the dollar’s strength. The anticipated first Federal Reserve rate cut, initially expected in March, has now been delayed, with the likelihood of a cut in May dropping to its lowest point since the previous November. The forecast for rate reductions in 2023 has been scaled back significantly, now projecting approximately 4.5 quarter-point decreases (around 112 basis points), a notable decline from the six cuts anticipated a month earlier.

Similarly, expectations for the European Central Bank (ECB) rate cuts have been adjusted downward to about 114 basis points, a reduction from 160 basis points at January’s end and 190 basis points in late 2023. The Bank of England’s outlook has also shifted, with projections now set for three rate cuts this year (75 basis points), nearly 100 basis points less than predictions at last year’s close. Furthermore, the anticipated extent of rate cuts by the Bank of Canada for this year has been reduced by half to less than 80 basis points from 160 basis points in late December 2023.

These adjustments suggest that the cycle of interest rate cuts may be nearing its end. Upcoming economic indicators, such as the soft US CPI (Consumer Price Index) and a potential downturn in retail sales reports next Tuesday and Wednesday, could further influence US rates, potentially marking the conclusion of the dollar’s rally since the New Year.

The upcoming Consumer Price Index (CPI) report from the UK on February 14th is poised to draw significant attention. Thanks to a base effect from a 0.6% drop in January 2023, even if there’s a 0.3% decrease in prices for the last month, the year-over-year inflation rate is expected to edge upwards to between 4.2% and 4.3%. Yet, the broader narrative extends beyond the UK, touching both the eurozone and Canada, where inflation witnessed a sharp uptick from February to May last year. As these figures cycle out of the 12-month comparisons, we’re likely to see a dramatic decline in the year-over-year inflation rates across these regions.

In other economic news, both the UK and Japan are set to release their Q4 2023 GDP figures. The UK’s economy is anticipated to have contracted slightly, marking the second consecutive quarter of shrinkage. On the other hand, Japan, which ranks as the third-largest economy globally, is expected to have returned to growth following a nearly 3% annual contraction in Q3. This rebound is likely supported by recoveries in consumer spending and capital expenditure, both of which saw declines in the second and third quarters of 2024.

Labor market reports from the UK and Australia are also on the horizon, with both nations preparing to unveil new figures. In the UK, wage growth is moderating, and the economy is likely to report a loss of full-time positions for the second month in a row come January. Meanwhile, Australia’s employment landscape appears even more bleak, especially considering last month’s report, which showed a loss of 106,000 full-time jobs – a figure that stands out as one of the worst records outside of the pandemic period. These various economic indicators will undoubtedly provide valuable insights into the current state and future direction of global economic health.

United States

Recent economic data and official statements have adjusted market expectations regarding the Federal Reserve’s interest rate policies. Initially high confidence in a rate cut by May has diminished, with current expectations at about 73%, a notable decrease from the 90% confidence level following recent employment data. This reassessment reflects the robust economic momentum observed early in 2024, despite potential overreliance on early-quarter metrics like the Atlanta Fed’s GDP tracker, which indicates a 3.4% growth rate.

The market has revised its outlook to anticipate approximately 4.5 rate cuts from the Fed this year, a significant reduction from the over six cuts expected as of mid-January. It’s becoming clear that the Fed’s May decision will not hinge on January’s economic data alone, despite the attention on upcoming CPI, retail sales, and industrial production figures.

Fed Chair Powell, in his post-FOMC press briefing, highlighted a half-year of favorable inflation data, a trend that seems to be extending into the current year. The expected rise in headline CPI by 0.2% in February would, due to base effects, potentially lower the year-over-year rate to 3.0%-3.1% from 3.4%, with forecasts even suggesting a drop to 2.9%. The core inflation rate’s consistent increase further underscores the nuanced inflationary landscape.

Retail sales in January, affected by weaker auto sales, suggest a tepid start to consumer spending in 2024, contrasting with the more vigorous growth seen in the third quarter of 2023. Industrial production, however, is expected to show an uptick, indicating a potential strengthening in this sector, albeit with manufacturing possibly remaining stagnant.

The broader economic indicators, including producer prices, housing starts, and regional Fed surveys, suggest an economy growing at a pace slightly above the Federal Reserve’s long-term non-inflationary target. The Dollar Index’s recent performance, achieving its highest level since November and maintaining strength, reflects this economic backdrop. Despite signs of overextension in market momentum, technical indicators have yet to signal a definitive peak, suggesting that traders are watching for potential reversal patterns after the recent rally.

Eurozone

The forthcoming release of the Q4 2023 GDP details and revisions on February 14th may hold academic interest for economists, yet the overarching narrative of a stagnating eurozone economy is well-acknowledged among businesses and market participants. The lack of growth over the last five quarters, with aggregate expansion essentially flat, underscores the challenges facing the eurozone. Despite this backdrop, the focus shifts away from the high frequency data of late last year to the early indicators of 2024, which so far include some surveys and a preliminary January CPI estimate showing a decrease of 0.4% month-over-month. The annualized rate for the last three months stands at -3.2%, suggesting subdued inflationary pressures and little expectation for new growth drivers in the current quarter.

The euro experienced its lowest point of the year early last week, dipping just below $1.0725, before encountering resistance around the $1.0790-95 mark. This movement aligns with the 38.2% retracement level from the high reached just before the U.S. January jobs report. Given the currency’s recent trajectory—marking five weeks of losses in the first six weeks of the year—momentum indicators are predictably extended. Any further recovery may confront significant resistance in the $1.0810-40 range, with the 20-day moving average, a threshold the euro hasn’t surpassed since January 2, located at the higher end of this spectrum.

Market dynamics around the euro are also influenced by significant option expiries, including €2.5 billion at $1.0725 expiring Monday, and €1.5 billion at $1.07 following the U.S. CPI report on February 13. An additional €1.4 billion at $1.07 is set to expire Wednesday, potentially adding to the currency’s volatility and resistance levels in the near term. These financial instruments and their expiration could sway trading patterns, especially in the context of the euro’s recovery attempts and broader economic indicators.

United Kingdom

This week is pivotal for UK economic data, with the jobs report and Consumer Price Index (CPI) being particularly crucial in shaping expectations for the Bank of England’s interest rate policy. The trend in average weekly earnings, which has been decelerating for four months through November, is anticipated to persist, reflecting a cooling labor market. A significant focus is on the UK CPI, expected to notably decrease from the February report onwards through May. This period in 2023 saw the UK CPI increase by an average of 1.0% monthly, whereas the last four months up to January witnessed a more modest average monthly rise of 0.2%. Despite a forecasted 0.3% drop in last month’s CPI, and considering a 0.6% decrease in January 2023, the year-over-year rate might slightly increase. However, the underlying message indicates a downward trajectory. Even with a 0.4% average inflation in the February-May timeframe this year, the headline year-over-year inflation rate is projected to fall below 2%, down from 4% in December. The core inflation rate remains somewhat more stable but is also trending downwards, having peaked at 7.1% in May before closing the year at 5.1%.

The UK’s Q4 2023 GDP is also on the agenda, with previous monthly data showing a contraction of 0.3% in October, followed by a 0.3% growth in November, and an anticipated 0.2% contraction in December. This sequence suggests a potential 0.1% quarter-over-quarter contraction for the second consecutive quarter. Survey data indicates ongoing weakness in manufacturing, whereas the services sector appears to be gaining some ground. The swaps market currently places a 70% probability on the Bank of England delivering its first rate cut by mid-year, with three cuts priced in for this year and a slight chance of a fourth.

On the currency front, Sterling experienced a notable shift, breaking below its $1.26-$1.28 trading range in the wake of the US jobs report on February 2. It found its footing near $1.2520 before climbing back above $1.26 in the subsequent sessions. The recovery of Sterling faltered near $1.2645, corresponding to the 50% retracement of the losses experienced since the February 2 high of approximately $1.2770. The next key level, the 61.8% retracement, lies around $1.2675, coinciding with the 20-day moving average, indicating critical resistance points for future trading activity.

China

It is holiday in China this week.

Japan

Over the last six years, Japan’s economy has shown a pattern of contraction in at least one quarter each year, with 2018 and 2022 experiencing two quarters of contraction. The most recent contraction occurred in the third quarter of last year when the economy shrank by 0.7% quarter-over-quarter. This downturn was influenced by declines in consumption and private investment during the second and third quarters of 2023. However, a stabilization in consumer spending and a rebound in private investment, along with an increase in exports, likely facilitated a return to growth for Japan, the world’s third-largest economy.

Inflationary pressures, as measured by the GDP deflator, seemed to have reached their peak in Q3 2023, hitting a year-over-year pace of 5.3%. The financial markets have also responded to global and domestic economic signals. The Japanese yen weakened against the dollar, reaching near three-month highs of around JPY149.60. This movement came amid firmer US Treasury yields and comments from Bank of Japan (BOJ) officials, who have been downplaying the chances of entering a tightening cycle, even as the negative interest rate policy is expected to end.

Despite the yen’s depreciation over a six-week period, Japanese officials have yet to express explicit concern over the currency’s movements. Nonetheless, the market’s one-directional trend against the yen is typically something authorities are keen to avoid. The currency approached a significant psychological threshold near JPY150, a level it neared back in November when the high was around JPY149.75. With $1.4 billion in options at the JPY150 mark set to expire shortly after the US CPI report on February 13, the yen’s trajectory could be influenced significantly. Should the yen breach the JPY150 level, it could potentially revisit last year’s peak near JPY152, marking another critical juncture for Japan’s currency in the forex markets.

Canada

Canada’s economic calendar appears relatively light in the upcoming days, with January’s existing home sales and housing starts, alongside December’s portfolio investment account data, not typically stirring significant market movements. The Canadian dollar’s exchange rate dynamics currently show a stronger correlation with the general direction of the U.S. dollar (as indexed by DXY) and broader risk appetites, as indicated by the performance of the S&P 500. Interestingly, the Canadian dollar exhibits a diminished sensitivity to traditional drivers such as oil prices and the differentials in two-year interest rates, with correlations for both under 0.2 over the last 30 and 60 days.

In recent trading activity, the U.S. dollar surpassed its January peak, reaching approximately CAD1.3545 early last week. This surge was followed by a period of consolidation at lower levels, pending the release of Canadian employment data. Despite a second consecutive month of declines in full-time employment, the Canadian dollar initially strengthened following the announcement. However, the U.S. dollar found support just ahead of CAD1.3400 and managed to recover, hitting new session highs near CAD1.3480 subsequently.

Given these movements, the implication is that there may be upward pressure on the U.S. dollar against the Canadian dollar in the near term. This dynamic could be influenced by several factors, including changes in global risk sentiment, variations in commodity prices, especially oil (a significant export for Canada), and shifts in monetary policy expectations from both the Bank of Canada and the Federal Reserve. As always, investors and analysts will closely monitor these developments to gauge potential impacts on currency valuations and the broader financial landscape.

Australia

The Australian employment data set for release on February 15th will be closely watched, especially following December’s surprisingly negative report. Despite maintaining an unemployment rate of 3.9%, up slightly from 3.5% at mid-year, Australia experienced a significant reduction in full-time employment, losing 106.6k positions. This loss effectively halved the gains made from January to November, which amounted to approximately 211k jobs. The unemployment rate’s stability, despite these losses, can be partly attributed to a notable decline in the participation rate, which fell by 0.5% to 66.8%.

Further compounding the economic outlook, other key indicators have shown weakness. December’s retail sales unexpectedly fell by 2.7%, a stark contrast to the anticipated 0.5% increase. Additionally, the previous month’s gain was downwardly revised, further dampening sentiment. Building approvals also fell significantly by 9.5%, defying forecasts for a modest increase. These developments have led to speculation that the Reserve Bank of Australia (RBA) may advance its timeline for the first rate cut, potentially moving it from August to June.

In the currency markets, the Australian dollar reached a new low for the year last Monday, dropping to its lowest point since mid-November at around $0.6470, following the U.S. employment report. The currency has since found some stability, trading within a range of $0.6480 to approximately $0.6540. The upper boundary of this trading range aligns with the 50% retracement level from the decline observed after the pre-jobs data high, just above $0.6600. A further retracement point at 61.8% is situated near $0.6555, with the 20-day moving average—a level the Aussie hasn’t surpassed since January 3—slightly higher at around $0.6560.

Given these developments, investors and policymakers will be keenly awaiting the upcoming employment report, as it will offer crucial insights into the Australian economy’s health and potentially influence future monetary policy decisions.

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