Weekly Overview : Global Markets Resilient Amid Conflicts and Economic Shifts

In a world rattled by increasing conflicts, notably the deepening crisis in the Middle East and China’s continuous air incursions near Taiwan during its election period, the stock and commodity markets have surprisingly held their ground. Remarkably, despite these global tensions, the price of West Texas Intermediate (WTI) for February only fell by about 1.7% last week, and March Brent crude saw a mere 0.65% dip. The shifting dynamics, including the avoidance of the Red Sea for shipping, are driving up costs, signaling potential challenges for global supply chains. Despite these upheavals, the MSCI index for developed equity markets managed a rebound, rising nearly 1.8% last week and recovering from a slump that had persisted for nine weeks. In contrast, the MSCI emerging market equity index has seen a decline of roughly 3% at the outset of the year, with China being a significant contributor to this downturn.

Despite the US December CPI showing a firmer-than-expected increase, including a 0.4% rise in the core measure excluding housing (noted by some Federal Reserve officials including Chair Powell at 3.9% year-over-year), it didn’t significantly sway market perspectives. Contrary to expectations of an early rate cut, the futures market actually reflected a higher likelihood of a March cut, estimated at about 85% post-January 5 jobs report, up from 75%. Currently, the market is factoring in roughly 6.5 rate cuts for this year in the futures and swap markets, a stance that seems overly aggressive to us. This is especially so considering that real sector data might indicate the US economy continued to grow beyond the 1.8% pace in Q4 2023, which is considered the non-inflationary threshold by the Fed.

Looking globally, China, set to report its Q4 GDP soon, isn’t showing signs of a collapse either. In fact, its growth rate is outpacing that of Japan, the Eurozone, and the UK combined, which is notable for a nation often criticized in Western narratives for its economic model.

In the currency markets, the US dollar, after experiencing a significant decline in the last two months of 2023, has now stabilized, showing mostly narrow fluctuations last week and ending within about +/- 0.25% against the G10 currencies. Despite this stabilization, we remain unconvinced that the dollar’s corrective uptrend has concluded.

United States

The first week of the new year centered around the labor market. We observed a gradual deceleration in job growth, with initial estimates often being revised downwards. However, average hourly earnings in Q4 2023 still showed an increase of 4.0%-4.1%, a slight decrease from the 4.2%-4.3% in Q3, yet continuing to outpace inflation. The second week shifted focus to inflation, and now, in the third week, attention turns to the real economy, with retail sales and industrial production taking center stage.

Retail sales, which constitute just over a third of consumer spending, are critical, especially considering that auto sales make up about one-fifth of retail sales. December saw vehicle sales exceeding expectations, reaching a 15.83 million unit seasonally adjusted annual rate. This figure was second only to April’s 15.91 million pace, the highest since May 2021. This uptick is expected to positively impact December retail sales, with predictions in Bloomberg’s survey suggesting a 0.4% increase following November’s 0.3% rise. However, consumer spending, a key component of GDP, appears to be slowing down in Q4, after having risen by 3.1% in Q3.

Industrial output, on the other hand, is facing challenges. The end of the auto strike led to a slight recovery in November (0.2%), following a 0.9% drop in October. However, indicators like the manufacturing PMI and ISM suggest ongoing weakness in the sector. Expectations are that industrial production and manufacturing output dipped by 0.1% last month, potentially marking the first quarterly contraction in manufacturing since Q4 2022.

In the housing market, despite softer interest and mortgage rates, a significant change isn’t anticipated for last month. Following a substantial 14.8% surge in housing starts in November, a decrease is likely for December, with forecasts predicting a 9.2% drop. Conversely, existing home sales are expected to remain steady, mirroring November’s 0.8% increase.

Finally, a critical date looms on January 19, when the first set of temporary federal government spending authorizations expire. Without congressional action, this could lead to a partial government shutdown. The remaining spending authorizations are set to expire on February 2, adding to the urgency for legislative action.

Following the employment data release on January 5, the Dollar Index experienced limited fluctuation, mostly confined to a range of about 35-40 pips around a 102.40 settlement. This sideways movement has started to impact some momentum indicators, indicating a pause in the currency’s directional trend.

It appears that the market might be overly optimistic about an imminent rate cut, possibly as early as March. However, forthcoming data from the real sector in the next few days could prompt investors to reassess and potentially scale back these aggressive bets.

A crucial point to watch is the 103 level on the Dollar Index. If this level is surpassed, it could trigger a move towards testing the 200-day moving average, which currently lies near 103.40. Should this momentum continue, we might even see the index push towards the 103.80-104.00 range. This scenario hinges on how market sentiments evolve in response to upcoming economic data and how they might influence expectations regarding interest rate movements.

Eurozone

The upcoming release of aggregate November industrial production and trade figures is unlikely to significantly alter market expectations. Investors and policymakers are already aware that the regional economy in Europe is either stagnating or experiencing a slight contraction. Modest improvements in industrial production from Germany and France may balance out the declines reported by Spain and Italy. The ZEW survey could indicate that while Germany, Europe’s largest economy, may be past its worst phase, it’s still struggling to gain substantial momentum.

On another note, it seems the European economy is gradually adapting to the shocks caused by the response to Russia’s invasion of Ukraine and the strategic shift regarding China. The Eurozone’s trade surplus has reemerged, although it remains much smaller than the pre-Covid levels. In the first ten months of last year, the eurozone reported a 28.75 billion euro trade surplus, compared to a 31 billion euro trade deficit in the same period of 2022, and a significant 169.2 billion euro surplus in the Jan-Oct 2019 period.

The European Central Bank (ECB) will publish the November survey results on one- and three-year inflation expectations. Previously, in October 2023, these stood at 4.0% and 2.5%, unchanged from September.

In terms of currency movements, the euro remained within the $1.0875-$1.1000 range last week, following the trend set after the US jobs report on January 5. The euro has been fluctuating, alternating between gains and losses over the past eight sessions, and is down about 0.5% for the year so far. Despite poor economic news from the eurozone, the US two-year premium over Germany has narrowed by about 25 basis points to around 161 basis points, the lowest in six months. This narrowing, along with the US two-year yield falling from near 4.50% to about 4.12%, may have supported the euro, easing the downward momentum. A push above $1.10 could lead to further gains, yet the upcoming ECB meeting on January 25 might limit its upside potential, even though there’s about a 45% chance of a rate cut in March according to market expectations.

Overall, the risk seems to lean towards a further decline in the euro, which would be indicated by a break of the three-month trendline, starting around $1.0915 at the beginning of the week and ending closer to $1.0945. The 200-day moving average sits around $1.0850, and support below that could be found near $1.08.

United Kingdom

The swaps market currently indicates that the first Bank of England (BOE) rate cut is not fully expected until June, though there’s about an 80% probability of a cut as early as May. This anticipation, coupled with the likelihood of earlier rate cuts by the Fed and ECB, may partly explain the recent relative resilience of sterling. However, upcoming data releases could potentially shift these expectations, and it seems there might be a risk of an even earlier rate cut.

The UK labor market is showing signs of slowing, and wage pressures are gradually subsiding. Despite this easing, some BOE officials remain concerned, particularly as the CPI, though having peaked, is projected to decrease significantly in the upcoming months. The December CPI figures, due on January 17, are expected to show a slight decrease from November’s 3.9% rate. While January’s CPI might see a minor increase, it’s essential to remember that from February to May 2023, the UK’s annualized CPI inflation rate was nearly 11.5%. In contrast, the annualized rate for the three months through November was about 1.2%, and it was flat in the preceding three months. This trend suggests that the moderation in UK inflation will be more pronounced in the early part of this year, with the possibility of a slowdown or even a stall in the latter half.

At the end of this week, the UK will also report its December retail sales. On a volume basis, UK retail sales have averaged a 0.1% gain in both the three- and twelve-month periods through November. In 2022, however, retail sales declined by an average of 0.6% per month.

In currency markets, sterling is the only G10 currency to have gained against the dollar in the first two weeks of 2024, albeit modestly by about 0.15%. It has been fluctuating within a narrow two-cent range between $1.26 and $1.28. Notably, for the first time since mid-September, the UK two-year yield is slightly above that of the US. Sterling approached the upper end of its range against the dollar, reaching a new two-week high near $1.2785 before the weekend. However, given that this upper range has been tested and held previously, the principle of alternation suggests a potential test of the lower end of the range might be forthcoming. A near-term support level has been established around the $1.2675-1.2680 area.

China

In the coming days, there are three significant developments to watch for in China. First, at the beginning of the week, the People’s Bank of China (PBOC) is likely to reduce the rate of the one-year Medium-Term Lending Facility (MLF) from the current 2.5%. Although the MLF is technically the benchmark, the government had already provided loans at the end of last year at a lower rate of 2.4%. The MLF rate was reduced by a total of 25 basis points in two steps during 2023, with the most recent adjustment being a 15 basis point cut in August. However, it’s expected that the volume of MLF loans will be significantly reduced from CNY1.45 trillion in November and December to around CNY900 billion.

Second, China will be the first major country to report its GDP for Q4 2023. The growth rate is anticipated to have decelerated to just below 1% quarter-over-quarter, compared to 1.3% in Q3. This would imply that China, despite the ongoing challenges in its property sector, managed to achieve around 5.2% growth for the entire year of 2023, a commendable feat if accurate. China’s growth rate, despite its economic issues, remains faster than most G10 and many emerging market economies.

Third, China will release detailed economic data for the last month, including retail sales and fixed asset investment (capex). It’s notable that retail sales have been growing at double the pace of capex; capex is increasing at just under 3%, while retail sales expanded by 7.2% in the first 11 months of last year compared to the same period in 2022.

Regarding the currency, the stability of the US dollar last week allowed the PBOC to maintain a steady daily dollar fix, with little change throughout the week (around CNY7.1005-CNY7.1085). The PBOC’s approach to managing the exchange rate appears largely reactive, aligning with broader movements of the US dollar. The correlation between changes in the CNY/USD exchange rate and the Dollar Index is currently around 0.63, with last year’s high near 0.67 and a low in October 2023 of about 0.25.

Considering the likelihood of a rate cut in China and the diminishing probability of a Fed cut in March, the US dollar may gain strength against the Chinese yuan. The next target for the USD/CNY exchange rate could be in the CNY7.1880-CNY7.1930 range.

Japan

The release of Tokyo’s December CPI last week somewhat overshadowed the anticipation for Japan’s national inflation figures, which are due on January 19. It’s expected that both the headline and core year-over-year inflation rates will slightly decrease by about 0.1%-0.2%, while the measure excluding fresh food and energy might remain unchanged.

Looking ahead, the Bank of Japan (BoJ) has its meeting scheduled for January 23. There had been some speculation about a potential policy adjustment, but recent events, such as the earthquake, seem to have pushed these expectations to at least April. Additionally, Japan will release its final estimate for November’s industrial production. The preliminary figures indicated a 0.9% decline, largely offsetting the 1.3% increase seen in October. Throughout the first 11 months of last year, Japan’s industrial output declined by an average of 0.1% per month, compared to a flat rate in the January-November 2022 period. More broadly, while Japan’s economy contracted in Q3 2023, indications suggest it may have stabilized in Q4.

In the currency market, the yen has been the weakest among the G10 currencies in the first two weeks of the new year, depreciating about 2.6% against the US dollar. The US dollar reached its peak against the yen near JPY146.40, the highest level in a month, following the US CPI figures released on Thursday. However, it then reversed, dropping to around JPY144.35 before the weekend, and later recovering to JPY145. If US yields don’t provide further support, the dollar might weaken further against the yen, with the next target potentially being in the JPY143.35-65 range.

Despite this, the prospect of the greenback’s upside correction is not yet dismissed. Should the USD/JPY surpass the JPY146.50 mark, it could pave the way for reaching the JPY147.50 level.

Canada

In Canada, the pace of job growth has decelerated, with less than 45k jobs added in Q4 2023, marking the slowest growth since Q3 2022. Despite this slowdown, stronger wage growth could likely deter the Bank of Canada from becoming one of the first G7 countries to lower interest rates. The upcoming week, leading to the Bank of Canada’s meeting on January 24, will see a focus on the December Consumer Price Index (CPI) and November retail sales figures.

Due to base effects, it’s anticipated that the year-over-year CPI rate will increase for the first time in four months, potentially climbing from the 3.1% observed in October and November. In December 2022, Canada experienced a significant 0.6% drop in CPI, the largest monthly decrease since April 2020. This figure will likely be replaced by a smaller decline of about 0.2%-0.3% last month, nudging the year-over-year rate towards 3.4%-3.5%. However, this uptick is expected to be temporary, with base effects suggesting a continued moderation in inflation in the early part of this year. In the first four months of last year, Canada’s CPI grew at an annualized rate of around 6.3%, but in the three months through November, the increase was just about 0.3%. The core measures, which remained steady at 3.4%-3.5% in November, might have experienced a slight decrease.

Retail sales in Canada showed robust performance in September and October, registering the best two months of sales growth at 1.2% last year. However, indications are that consumer spending may have slowed in December.

In currency markets, the US dollar achieved a peak of nearly CAD1.3465, its highest since December 14, following the US CPI report. Although it struggled to close above CAD1.34 on that day, it managed to do so ahead of the weekend. This movement supports the view that the US dollar’s upward correction against the Canadian dollar is not yet complete. The exchange rate may continue to rise, potentially reaching the CAD1.3480-CAD1.3500 range.

Australia

In the futures market, the first rate cut by the Reserve Bank of Australia (RBA) is fully anticipated for August, with expectations not quite extending to two cuts by the end of the year. The primary focus in the upcoming week will be on the December employment report, as the Australian labor market exhibits signs of gradual slowing.

Throughout 2022, Australia generated an average of 44k jobs per month, with 46k of these being full-time positions (either new jobs or part-time roles converted to full-time). However, in the first 11 months of 2023, the average monthly job creation dipped slightly to around 40k, with about half of these being full-time roles. The unemployment rate in Australia reached historic lows of 3.4% in late 2022 but increased to 3.5% by mid-2023 and further to 3.9% in November. Additionally, the participation rate has climbed from 66.7% at the end of 2022 to 67.2% in November, indicating a workforce expanding more rapidly than job creation, partly fueled by immigration.

The Australian dollar fluctuated within a range established on January 5, roughly between $0.6640 and $0.6750, last week. The currency tested the lower boundary of this range successfully, with its gains halting near $0.6735. It’s noteworthy that the Aussie dollar rose in nine of the final 11 weeks of 2023, gaining about six cents. However, it has since declined by approximately 2.3 cents from its late December peak. The currency ended the week softly, settling below $0.6700. The trend suggests a potential further decline, possibly towards the $0.6575-0.6585 range. However, if the Australian dollar reverses its course and strengthens, it might find room to grow towards $0.6780 to $0.6820.

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