Three macro events
highlight the week ahead. The US February CPI will be reported on March 14. The
UK's Chancellor of the Exchequer Hunt will deliver the spring budget on March
15. The ECB meets the following day. A 50 bp hike is discounted not only for this
meeting, but that is the bias for the May meeting as well. It seems that
US interest rate adjustment that began early February (jobs data and strong
gains in the service ISM) and helped fuel the dollar's recovery seems complete.
Concerns about the implications and ramifications of
the $620 bln (estimated by FDIC) of unrealized losses from banks' bond
portfolios coupled with more evidence that January's "hot" data will
not be repeated helped ease market anxiety about a more aggressive Federal
Reserve. A 50 bp hike later this month never seemed particularly likely to us,
but even less so now. The US two-year yield, which slipped below 4.05% in early
February. peaked near 5.08% on Powell, but finished the week near a little
below 4.60%, a drop about 50 bp in the last two sessions. To appreciate the
swing in psychology, consider that after Powell's testimony ended the January
2024 Fed funds futures contract implied a yield of about 11 bp less than the
implied yield of the September 2023 contract. That differential was near 40 bp
before the January jobs report in early February. It reflected the unwinding of
rate expectations in Q4 from high confidence to less than a 50/50 proposition. Amid
the banking concerns and after the jobs report, the differential settled at 35
bp, as a rate cut gets priced back into the futures and swaps market.
United States: Few doubt that US CPI has peaked. The issue at hand is
the pace of decline. The year-over-year measure of CPI has slowed every month
since last June when it peaked at 9.1%. It slowed by an average of 0.3% a month
in Q3 22 and by 0.6% a month in Q4 22. The improvement slowed to 0.1% in
January. For the next few months, with the exception of April, the slowdown
looks set to accelerate. A 0.4% rise in CPI last month would see the
year-over-year pace slow to about 6%. Recall that in March last year, the CPI
jumped by 1%. Making a conservative assumption that it will be replaced by a
0.5% gain, it would bring the year-over-year pace to around 5.5%. In Q2 22, CPI
rose by an annualized rate of slightly more than 10%. If the monthly average is
around 0.5% through Q2, the CPI could be near 4.5% at mid-day, halved in
12-months. The median forecast in Bloomberg's survey sees CPI finishing the
year at 2.5% (the median forecast for the PCE deflator is 2.3%, while the
median Fed projection in December was 2.5%).
There are a few other reports that will also be
tracked closely as investors and businesses try to decipher the underlying
economic signal. The February jobs data supports ideas that the surge in
activity in January was not sustainable, even if more than just a fluke created
from benchmark and methodological changes, seasonal adjustment distortions
since Covid, and unseasonably warm weather. Retail sales jumped by 3% in
January, after falling by 1.1% in November and December. Economists look for a
small gain, but there may be scope for disappointment. Indeed, the measure used
in some GDP models, which excludes auto, gasoline, building material, and food
services is expected to fall by 0.3%, which makes the heady gain of 1.7% in
January look like the anomaly--the only gain in four months. After falling 1.8%
in December, manufacturing output jumped 1% in January, the most since February
2022. We note that the manufacturing PMI and ISM are remain below the 50
boom/bust levels. Industrial output as a whole had been dragged down by a
record slum in utility output (-9.9%, which is unlikely to have been repeated.
Mining output rose by 2% in January despite the decline in oil and gas well
drilling. The rig count fell by 8 in January and 18 in February, which was the
most since June 2020. Lastly, the index of Leading Economic Indicators likely
fell for the 11th straight month in February. The six-month annualized decline
of 7% is consistent with recessions in the past half century and might not have
changed much last month.
Meanwhile concerns about the risks that may be
associated with the large bond portfolios of US banks has emerged as a potent
market force, unwinding the hawkish "read" of Fed Chair Powell's
testimony. The FDIC reported recently that US banks have roughly $620 bln in
unrealized losses on their securities portfolios. Higher rates drive the
losses. At the same time, banks, reluctant to pass on higher rates to savers,
are seeing deposits flee to money markets and US T-bills. The net effect of the
drop in US rates helped cap the Dollar Index in front of 106.00, though it did
make a new marginal high for the year (almost 105.90). Note that the (38.2%)
retracement of the Dollar Index decline since last September's peak is around
106.15. A break now of support a little below 104.00, which held before the
weekend, would strengthen the technical case for a top being in place.
Eurozone:
The hawks are in control of the European Central Bank's monetary policy. The
elevated inflation readings and the new cyclical high in the core rate while
economic activity appears to be picking up, has quieted the resistance by those
inclined for more accommodative policy. At the same time, fiscal policy is
looking less strict. The Stability and Growth Pact thresholds were suspended
due to the pandemic and then Russia's invasion of Ukraine. They are to enforce
again starting next year, but now other social goals seem to encourage some
flexibility. Formal EC proposals are at least a few weeks away, but talk
suggests that provided a commitment to reforms, pursuing the EU's strategic
goals (digital transition, environmental sustainability, and expanding defense
capabilities) may be taken into account. This speaks to more customized budget
plans and the creditor countries will resist "too much flexibility."
At the ECB meeting, the staff will update its economic
forecasts. In December, the forecast had seen CPI falling from 8.4% last year
to 6.3% this year, 3.4% in 2024 and 2.3% in 2025. The market is more
optimistic. The median forecasts in Bloomberg survey see CPI at 5.6% this year,
2.4% next, and 2.1% in 2025. The ECB forecast the region's economy will grow by
0.5% this year and 1.9% next followed by 1.8% in 2025. Here the market is less
confident. The median forecast is for the economy to expand by 0.4% this year
and only 1.2% next year and 1.5% in 2025. After falling to two-month lows near
$1.0525, the euro rebounded. The euro kissed $1.07 before the weekend but was
unable to sustain it and settled a little below $1.0645. A convincing move
above $1.07 would boost the likelihood that a low is in place. Last week's low
could have been the new low we were looking for, but we saw risk toward
$1.0460-$1.0500.
United Kingdom: The spring budget will be announced on March 15. The
somewhat better growth puts Chancellor Hunt in a better position than a few
months ago. However, room to maneuver is very limited, especially relative to
demands. Prime Minister Sunak's two predecessors are pushing to drop the
corporate plan increase (to 25% from 19% starting next month). These efforts
are likely to prove ineffective. However, the compromise position in clear.
Extend the break for capital investment and, possibly boost the threshold for
the new levy to exempt more small and medium sized businesses. Meanwhile,
public sector strikes continue and a pay package, perhaps with one-off payouts
in excess of 3.5% the government has offered on average would require more funds.
Defense will also be looking more funds, some of which is to help fund assist
Ukraine. Lastly, the extension of household energy guarantee (at GBP2.5k for
typical household instead of rising to GBP3 bln in April) will cost an
estimated GBP3 bln.
The budget is unlikely to have much impact on the
outlook for the Bank of England, which meets on March 23, the day after the
FOMC meeting concludes. A quarter-point move is largely discounted. Such a move
would bring the base rate to 4.25%. The terminal rate in the swaps market is
about 4.75%. There had been some market talk of a pause after this month's
hike, but the swaps market has more than 3/4 chance of another 25 bp hike at
the May 11 meeting discounted. The focus will be on the wage growth reported in
the jobs report on March 14. Sterling fell to a four-month low just ahead of
$1.1800. The technical damage was quickly reversed, and sterling rose to
$1.2115 ahead of the weekend, encouraged by both the broader setback of the US
dollar and better than expected January GDP (0.3% vs. expectations of 0.1%
after a 0.5% contraction in December). Sterling settled higher for the second
consecutive week and begins the new week with a three-day advance in tow.
Despite the failure to close above $1.2100, it did manage to close above the
20-day moving average (~$1.2015) for the first time since February 1. A break
above $1.2125 could spur a test on more formidable resistance around $1.2200.
China: The
National People's Congress appears to have doubled down on the trend toward
more centralized control of the world's second-largest economy. While it has
potential to strengthen the implementation of policy emanating from Beijing, it
makes checks and balances more difficult and boosts the risk of group think. At
the same time, having the National Public Complaints and Proposals
Administration and the China National Intellectual Property Administration
report directly to the State Council elevates those functions. The
restructure of the Ministry of Science and Technology, which was listed as the
top item in the new government plans, ahead of financial oversight, recognizes
the significance of the US, Europe, and Japanese efforts to increasingly
restrict technology sales to China.
However, in the week ahead, the rebound in the Chinese
economy amid the re-opening will be the chief focus. Retail sales and
industrial output should confirm the recovery seen in the PMI and anecdotal
reports. The contraction in completed investment in real estate (property
investment) may moderate for the first time since peaking two years ago. New
home prices were unchanged in January, the first month that they have not
declined since August 2021. A small gain would also help lift sentiment.
Meanwhile, the central bank appears in no hurry to ease monetary policy
directly and the one-year medium-term lending facility rate is expected to be
held steady at 2.75% (where it has been since last August) and lending volumes
may be reduced for the second consecutive month. The greenback rose by about
0.5% against the yuan last week, but the broader dollar pullback ahead of the
weekend suggests that the CNY7.0 will hold. The greenback held a little above
CNY6.90. The next area of support is around CNY6.86. A break would see another
1.0%-1.5% dollar decline.
Japan: With
Governor Kuroda's last policy making meeting behind it, the market's attention
turns back to real sector data. Three reports stand out in the coming days: the
February trade balance and the final read of January industrial output, and the
tertiary industry index. There are often strong seasonal influences on Japanese
trade. While the balance regularly deteriorates in January, it always (without
fail since at least 1994) improves in February. Moreover, the January trade
deficit (~JPY3.5 trillion or ~$26 bln) was a record shortfall. Contrary to
references to Japan's "export prowess", it has been running a trade
deficit on a 12-month rolling basis since November 2021. The shift to a deficit
does not appear to have changed domestic class relations as some observers
would have anticipated (See my review here).
Japan initially reported industrial output fell by a dramatic 4.6% in January.
Economists (median in Bloomberg's survey) had anticipated a 2.9% contraction.
Real household spending continued to contract on a year-over-year basis. Recall
that the January manufacturing PMI was unchanged at 48.9 (and fell to 47.7 in
February). It was last above the 50 boom/bust level last October. On the other
hand, the tertiary industries index fell by 0.4% in December (though the
services PMI rose to 51.1 from 50.3 in November). In January, the services PMI
rose to 52.3 and February's 54.0 reading matches the highest from last year.
The dollar peaked last week slightly above JPY137.90,
to pierce the 200-day moving average for the first time since last December's
surprise widening of the 10-year yield band. The intraday move was not
sustained, and as US rates tumbled in the last two session, they took the
dollar with it. The greenback was sold back to the lower end of the recent
range near JPY134.00, but it held, and the dollar recovered to settle slightly above JPY135.00. The dollar closed below its 20-day moving average for the first
time since February 1. A break of JPY134 points to a near-term top being in
place well short of our JPY140 target. The momentum indicators have rolled
over. It would target JPY132.
Australia:
The central bank's forward guidance last week underscored the importance
of the upcoming data to determine "whether and by how much" interest
rates still need adjust. That puts a heavy emphasis on the February employment
report due on March 16. The Australian labor market has been decelerating in recent
months and posted a net loss of full-time position in January for the first
time since last July. The February report will show whether it was a fluke.
Recall that in February 2022, Australian full-time employment jumped by 120k.
The unemployment rate rose to 3.7% in January, up from the record low of j3.4%
last October. Still, in February 2022, it was at 4.0%. Meanwhile, expectations
for the terminal policy rate peaked in late February near 4.35%. It is now near
4% (the new cash target rate is 3.60%). The Australian dollar made a new
four-month low ahead of the weekend (~$0.6565), holding above the $0.6550 area
that marks the (61.8%) retracement of the gains since the mid-October low near
$0.6170. On the back of a weak US dollar, it recovered to $0.6640 before the
weekend but settled poorly (~$0.6580). A break of the $0.6550 area could target
the $0.6400 area.
Canada: The
Bank of Canada made good in "conditional pause,” and this weighed on the
Canadian dollar, which fell to new lows since last October. The sharp downside
reversal of US rates amid the banking concerns did the Canadian dollar no
favors as it apparently was overrun by the risk-off and sharp losses in the
equity markets. The US dollar set a new five-month high before the employment
reports near CAD1.3860. Although the US created more jobs than expected it was
mired by a fall in the work week, slower earnings growth, and rising in the
unemployment rate. Canada reported another solid rise in full-time employment
and wage growth (permanent workers) accelerated to 5.4% from 4.5%. The US
dollar fell to approach CAD1.3765, holding above important support near
CAD1.3750 and recovered to settle near CAD1.3830, near the previous day's high.
The momentum indicators are stretched but have not begun turning. There seems
to be little on the charts to deter a run into the CAD1.39-CAD1.40 area.
Mexico:
We have been concerned that the high-flying peso was in need of
consolidation/correction after rallying to five-year highs. Still, on March 9,
the peso rose to a marginal new high (since 2017), with the dollar briefly
falling through MXN17.90. However, the shunning of risk assets amid concerns
about the unrealized losses at US banks, saw dramatic short squeeze that lifted
the greenback to MXN18.44 to record a bullish key reversal. Follow-through
buying ahead of the weekend saw the approach MXN18.60. While there may be some
pent-up corporate demand for pesos, who did not want to chase it and could
afford to wait. However, the jump in volatility and broader concerns may see
carry-trade strategies be put on hold for the time being. The dollar's high met
the (50%) retracement objective of the slide of the leg down since February 6
high (~MXN19.29). The next retracement (61.8%) is near MXN18.76. The momentum
indicators have turned higher. The peso's nearly 3% loss made it the worst
performing emerging market currency last week, leaving it up about 5.4% for the
year, and slipping into second place behind the Chilean peso, which rose nearly
0.85% last week. It has appreciated by 6.8% year-to date.
Disclaimer
Reviewed by Marc Chandler
on
March 11, 2023
Rating:
