A key issue facing
businesses and investors is whether the US January data reflects a
reacceleration of the world's largest economy or whether it was mostly a
payback for extremely poor November and December 2022 data and seasonal
adjustments and methodological distortions. Given the centrality of the US
economy and rates, it is not simply a question for America, the Federal
Reserve, and investors, but the implications are much broader. The issue is unlikely to be resolved in the week ahead, but it may begin
pointing to the direction ahead.
To believe in the now much-touted
"no-landing" or "soft landing scenario" requires the bold
and dangerous claim that this time is different. That the
inversions of the yield curve, including the 3-month bill and its 18-month
forward, which Federal Reserve Chair Powell cited partly to play down the
earlier inversion of the 2-10-year curve, do not mean what they have in the
past. The roughly 7.0% decline (annualized pace) of the index of leading
economic indicators is giving its first false signal in a half-of-a-century.
The rise of business failures, the rising default rate on car loans, and the
tightening of lending criteria can be largely ignored. While this is all
possible, it seems patently unlikely. Expect the February data to begin
casting shade on the January-spurred optimism.
US: Our
working hypothesis is that the January data will not be repeated. It was
mostly a function of a bounce back from dismal November and December activity
and a statistical quirk caused by benchmark, methodological, and seasonal
adjustments. February data are going to look considerably softer. It already
seems apparent in some survey data, including the Philadelphia Fed's February
business activity outlook and the preliminary PMI. The January reports next
week include durable goods orders and the advanced merchandise trade balance.
They pose headline risk. More importantly, will be the ISM February services.
The January report was released shortly after the employment data, and the
intraday charts from that day (February 3) suggest services; ISM spurred the
outsized market reaction. Auto sales, which do not receive the attention they
ought to, perhaps due to the manner of release (company's report throughout the
session), are expected to pull back by almost 5% after surging by a little more
than 18% in January. The early estimates for February non-farm payrolls (March
10) are 200k. After the revisions, the average monthly jobs growth last year
was 401k. The Treasury sells only bills next week; no coupons and the schedule
of public appearances of Fed officials is light.
The Dollar Index is closing in on last month's high
near 105.65. Above, there is the 106.00-50 area that houses the (38.2%)
retracement of the sell-off from last September's high (~114.80) and the
200-day moving average. The momentum indicators are stretched but have not
begun to turn. Initial support now is in the 104.50-60 area.
Japan: The
market is continuing to game out the possibility of a surprise by Bank of Japan
Governor Kuroda at his last board meeting on March 10, shortly before the US
(and Canada's) employment report. After being surprised in December (by the
widening of the 10-year yield band) and February (no action), no one wants to
be surprised again. The most important high-frequency data in the coming days
will be the February Tokyo CPI, which offers important insight into the
national figures, which are reported will cause a longer lag. We have warned that a
combination of the appreciation of the yen on a trade-weighted basis, the drop
in energy and wheat prices, and government subsidies should see inflation begin
falling soon. It could start with the February readings. BOJ Governor
nominee Ueda told the Japanese Diet the same thing before the weekend. Ueda clearly signaled no immediate substantive policy change. A Bloomberg survey found 70% expect a rate hike by early Q3. Two
other observations are notable. First, the divestment by Japanese investors of
foreign bonds continues to be discussed, but so far, they have been net buyers and replaced about 20% of the bonds sold last year. Second, the correlation between changes in the exchange rate and
the US 10-year yield has continued to tighten after falling sharply in
December and January.
The dollar posted a bullish outside up day ahead of
the weekend, sparked by Ueda's seeming commitment to the current framework and
the rise in US rates. It reached JPY136.50 before the weekend, the best level since
the December surprise. The JPY136.65 area corresponds to the (38.2%)
retracement of the drop since last October's peak (~JPY151.95), and the 200-day
moving average is a little above JPY137.00. The momentum indicators are
over-extended, and the Slow Stochastic has flatlined slightly below last
October's peak. The JPY135 area should now offer support, but it may take a break
of JPY134 to suggest a top is in place. The risk in the next couple of weeks may extend toward JPY140.00.
Eurozone: The
preliminary February CPI will be reported on March 2. The monthly reading fell
for three months through January. The year-over-year pace will likely fall
sharply in February and March as the jump (0.9% and 2.4%, respectively) drops out of the 12-month comparison. This and more robust February survey data set the stage for the March 16 ECB meeting. A 50 bp hike
has been signaled (lifting the deposit rate to 3.0%), and the key question is
what happens in Q2 and Q3. The hawks may push for another 50 bp hike at the May
4 meeting. The terminal rate is seen between 3.50% and 3.75%.
The euro was sold through $1.06 in the second half of
last week and traded to about $1.0535 ahead of the weekend. Since $1.07 broke,
we have been warning of risk into the $1.0460-$1.0500 area. This still seems
reasonable. How the euro responds to the weaker US economic data we expect
starting next week may help shape expectations about the extent of a further
correction. Note, for example, that the (50%) retracement of the euro's rally
from last September's low (~$0.9535) is near $1.0285, and the 200-day moving
average is around $1.0330. The $1.06 area may now offer the nearby cap.
China: The
February PMI is the economic highlight. The economy appears to be recovering
after a particularly weak Q4 22 when the composite PMI was stuck below the 50
boom/bust level. Of note, the manufacturing sector recovery does not seem as
robust as the non-manufacturing sector. Weaker foreign demand for Chinese goods
is a headwind, and the domestic economy, including construction, has helped
lift the tertiary sector. In January, the non-manufacturing PMI was at 54.4
compared with 54.1 on the eve of the pandemic. Note that the National People's
Congress first session is scheduled for March 5. New state appointments will be
made. It is at the Congress that Xi will be formally given a third term as
president. A new PBOC Governor will also be announced as will a new party
secretary to the central bank.
The yuan is a closely managed currency and official
are not resisting the dollar's upward pressure. The greenback set a new
two-month high near CNY6.9600 amid a wider surge ahead of the weekend. The next
important area is at CNY7.0, which the dollar has not traded above since February 2.
The CNY7.01 area corresponds to a (50%) retracement of the dollar's pullback
from the high set earlier last November near CNY7.3275. Weakening exports, the
larger discount to the US 10-year yield, and the anticipation of more Fed hikes
for longer provide the fundamental fodder.
United Kingdom: Stronger
than expected January retail sales (0.5% vs. median forecast in Bloomberg's
survey of -0.3%) coupled with an upside surprise in the flash PMI (composite jumped
to 53.0 from 48.5, the highest since last June and the first about 50 since
last July) provides more fodder for arguments of a short and shallow recession.
It also supports ideas that the Bank of England will deliver a quarter-point
hike at next month's meeting (March 23) to bring the base rate to
4.25%. The terminal rate is seen at 4.50%, with a slight risk of 4.75%. However, the data in the coming days, primarily about financial variables (January
consumer credit, mortgage lending, and money supply), are typically not the
stuff that moves sterling.
The outside up day for sterling last Tuesday proved
for naught. That was the peak, a little shy of $1.2150, and the drop ahead of the
weekend took it to the 200-day moving average ($1.1930). Earlier this month, sterling recorded a low near $1.1915. A break of the January low (~$1.1840)
would undermine the medium-term outlook and warn of a potential loss toward
$1.1250 (the measuring objective of a possible double top pattern). That said, the (38.2%) retracement of the sterling's recovery from the record low last
September is near $1.1650, and the next retracement (50%) is about $1.1400. The
$1.2000-50 area may provide initial resistance.
Canada:
The Canadian dollar is vulnerable on two counts. First, the Bank of Canada
remains the only G10 central bank to declare it is pausing its tightening
cycle. The major central banks are not there yet, though several seem one or
two hikes away. Second, the Canadian dollar is particularly sensitive to the
risk environment, reflected in its correlation with the S&P 500. The
rolling 60-day correlation is around 0.73. By comparison, the Australian dollar
is the closest, around 0.63, and the yen is about 0.25. The market has not entirely given up on another Bank of Canada hike, perhaps in Q3, but the December and Q4 GDP, the upcoming data highlight
(February 28), are unlikely to be very impactful on expectations. The Bank of
Canada's March 8 meeting is largely a non-event, but the February employment
data on March 10 will draw attention after the dramatic 121k increase in
full-time positions in January.
The US dollar has risen sharply against the Canadian
dollar over the past two weeks. It recorded a low near CAD1.3275 on February 14
and surged to CAD1.3665 ahead of the weekend. Last month's high was set early
by CAD1.3685. The December peak was slightly above CAD1.3700, which also marks
the (61.8%) retracement of the greenback's downtrend since peaking in the
middle of last October (~CAD1.3975). The momentum indicators are getting
stretched, but the cautionary signal is that the US dollar closed above its upper
Bollinger Band (two standard deviations above the 20-day moving average) found
near CAD1.3615. Support is seen in the CAD1.3500-20 band.
Australia: When the Reserve Bank of Australia meets on March 7, it will have
Q4 GDP and January CPI (March 1) in hand. It will also see the January trade
figures (March 6). The markets favor another 25 bp hike, but it is not
completely discounted. The Australian dollar was the weakest G10 currency last
week, falling by about 2.25%, bringing the month's loss to nearly 4.75%. It will
be the first monthly loss since last October. A possible head and shoulder
topping pattern has been formed, though we are less convinced. Yet, the
measuring objective would roughly correspond to the (61.8%) retracement
objective of the rally off the mid-October low (~$0.6170) that is found around
$0.6550. The January low was set on the second trading day of the year, slightly
below $.6690. The low set before the weekend was slightly below $0.6810. The lower Bollinger Band is near $0.6735, and the Aussie closed
below it for the first time since last July. The $0.6780-$0.6800 may limit
initial attempts at recovery.
Mexico:
The Mexican peso has performed impressively. It traded at its best level in
five years, and pullbacks have thus far been limited. Its 2.25% gain makes the
peso the best-performing currency this month and it leads the emerging market
currencies here in 2023 with a 5.8% gain. Attractive interest rates and stocks
(the Bolsa is up about 8.5% this year, while Brazil's Bovespa is off nearly 3%,
and the MSCI Emerging Market equity index is up about 3.4%). Direct investment
inflows also appear to be helping to underpin the peso. Mexico reports the
January trade balance (February 27), when it typically (past 11 years)
deteriorates. It did report its first monthly trade surplus in nine months in
December. Worker remittances will be reported on March 1 and remain an
essential source of capital inflows, averaging $4.8 bln in 2022 (~$4.3 bln in
2021). The US dollar carved a base last week at five-year lows against the
Mexican peso around MXN18.30. Previous support near MXN18.50 has become
resistance and checked the greenback's pre-weekend bounce, and once again, the greenback was sold into the modest bounce. A move above the
MXN18.53 area could signal a correction toward MXN18.65-MXN18.68. The momentum
indicators have stalled in oversold territory. We have not given up on our call
for the greenback to test important support around MXN18.00 and the 2018 low
(~MXN17.94).
Disclaimer
Reviewed by Marc Chandler
on
February 25, 2023
Rating:
