Tomorrow's News Today

There are three important economic events tomorrow.    The UK will release its December employment report and November weekly earnings data.  The US reports December CPI.  The Bank of Canada meets, and is widely expected to be the first central bank from a high income country to cut rates this year.  

Sterling has lost 5.6% against the dollar since December 28.  The key factor is that the economy is slowing, which pushes further out in time a Bank of England rate hike.  Anxiety over the EU referendum has not helped matters.  

Sterling is posting an outside down day today, having traded on both sides of yesterday's range and will likely close below yesterday's low (~$1.4240).  Tomorrow's labor report is unlikely to reserve the bearish sentiment.  In contrast to the US employment report, which showed the largest increase in nonfarm payrolls for all of 2015, the UK labor market has turned.    The claimant count has increased for four months through November and is expected to have increased again in December.  

Average weekly earnings had been rising sharply from mid-2014 through May 2015, peaking at a 3.3% (three-month average year-over-year).  This is why some many had expected a BOE rate cut.  The pace slowed to 2.4% in October and was expected to have slowed to 2.1% in December.     

On Thursday, the UK reports retail sales figures.  The risk is on the downside.  While the fundamentals do not encourage picking a bottom to sterling, much of the bad news seems to have been discounted.  One sign of a potential bottom is if sterling sells off on poor data and then recovers.  

II

Lower oil prices and a strong dollar are supposed to conspire to depress US inflation.  And so they have, but what goes unacknowledged is that despite this, US core CPI has steadily increased over the course of 2015.  Core consumer prices rose 1.4% in 2014.  Tomorrow's December print is expected (Bloomberg consensus) to rise to 2.1%.  This would be the largest increase since July 2012.   The consensus expects the core rate to rise 0.2% for the fourth consecutive month, which indicates that core CPI may be accelerating faster than the year-over-year rate suggests.

When the Fed decided not to hike rates in September, they cited two factors.  The first was the global capital markets and the second was market-based measures of inflation expectations.   A change at the January meeting was never really in the cards.  

Whatever the Fed means by gradual, it does not mean a hike at to consecutive meetings.  Or perhaps better phrased, the bar to a hike so soon after the first one is quite high.  It is also too early to believe that the volatility in the first two weeks of the year will have any bearing on the rate decision in the middle of March.   

Although we fundamentally disagree with the Fed's contention that the 10-year break-even is a good predictor of inflation, we note that today the 10-year break-even tested the low made last September near 139 bp.    

Previously the Fed put more weight in survey data, seemingly recognizing some of the theoretical and practical problems of interpolating from the break-even to inflation expectations.  At the end of last week, the University of Michigan's survey of long-term (5-10 year) inflation forecast was published.  It rose to 2.7% from 2.6%.  This matches the 24-month average.  The 36-month average is 2.8%.  It bottomed in October at 2.5% 

III

The Bank of Canada is widely expected to cut its overnight rate by 25 bp tomorrow.  Unlike the ECB or the Sweden's Riksbank that are easing policy an attempt to arrest lowflation or deflationary forces, the challenge for Canada is growth.  The economy has been hit with a significant terms of trade shock and the collapse of WTI and Brent has been more than duplicated by Canada's benchmarks.   

The woes of the energy producers have bled into the broader economy, and the price of oil has fallen by a quarter since the Bank of Canada last met. The economy unexpectedly contracted in September and stagnated in October, the latest monthly print.    That contraction was a blow to sentiment.  After the economy had contracted January through May last year, it found better footing in the June through August period.   Other economic data, including surveys and credit conditions, have worsened. 

A rate cut would not be surprising.   However, subjectively we see a modest chance that with the new government pursuing a more accommodative fiscal policy that the central bank bides its time.  It also may not want to be seen panicking in response to the market turmoil over the last couple of weeks, which has included a 4.7% decline in the Canadian dollar, which is tantamount to some degree of easing.  

Given trade ties, it is no wonder that the Canadian dollar's performance against the US dollar drives the TWI.   The Canadian dollar may snap a 12-day declining streak today.  This is the longest losing streak since the end of Bretton Woods.   Even now, the Canadian dollar bears have not been broken, as the greenback is a big figure off the early lows.  

Even if the Bank of Canada chose to ease policy, it might prefer to launch an asset purchase program instead of pushing the overnight rate any lower (currently at 50 bp). Governor Poloz has already suggested that he would consider an asset purchase program.  Launching an asset purchase program while the policy target rate is at 50 bp is what the Bank of England did.    Arguably a bond-buying program may have greater impact that a 25 bp rate cut. The takeaway from this thumbnail sketch of the BoC meeting is that there still is scope for the Bank of Canada to surprise the market.  

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