The
dollar peaked last September/October and trended lower until the January jobs
report and strong service ISM on February 3. These reports and firm inflation
readings, owing, at least in part, to benchmark and methodological changes,
helped spur the greenback's recovery. However, we learned last week that auto sales
and the service ISM prices paid decelerated in February, and this week, we will
learn that job growth has slowed considerably. If accurate, the median forecast in
Bloomberg's survey of 200k would be the least since the end of 2020. We look
for the February employment report to mark a string of softer economic data,
including CPI (March 14), which may slip below 6% for the first time since
September 2021. This may help stabilize US interest rates and expectations of
the terminal Fed funds rate, which is now seen closer to 5.50% than 5.25%.
China reports trade and inflation gauges,
but these reports do not often spark much movement in the closely managed
exchange rate. That said, China's export growth is slowing, and economists
expect this to continue. The other highlights of the week include Bank of Japan
Governor Kuroda's last meeting before retiring next month. The local press has
played down the likelihood of a surprise move, and Kuroda's successor, Ueda, seems to be in no hurry to alter policy. Next, the Reserve Bank of Australia meets, and the futures market favors (~80%) another 25 bp hike, bringing the
target rate to 3.60%. Finally, the Bank of Canada meets, but this is a non-event since
it declared a pause at the end of January. Still, another strong employment
report (March 10) could support market ideas that there may still be another
rate hike cycle.
United States: The February employment report is the most important high-frequency
data point in the week ahead. January's 517k
increase was likely a one-off statistical quirk. However, the labor market remains
strong and too strong for the Federal Reserve to have confidence that
inflation will fall fast enough. Still, the softer jobs report and the slower
auto sales should set the broad tone for the data in the coming weeks. Fed
Chair Powell appears before the Senate Banking Committee to deliver
his semi-annual update on March 7. He answers questions from the House Financial Service Committee the following day. The indications suggest that the median dot
later this month will likely validate market expectations of a 5.50% terminal
rate, up from 5.125% in December. Separately, the US trade deficit narrowed in
the second half of last year (~$69 bln average vs. almost $89 bln in H1), but
the deficit will likely begin widening again as the new year gets underway. The futures market has stabilized, showing a terminal rate near 5.50%. The next big input into expectations will be the
February CPI on February 14, and the pace should resume its trend slowdown. Moreover, the easing of price pressures will be even more notable with the
March report. In March 2022, CPI rose 1%. This will be dropped out of the
12-month comparison. Making a conservative assumption, the year-over-year rate
may slow to about 5.5% at the end of Q1. It was at 8.5% in March last year.
The Dollar Index snapped a four-week
advance with a modest 0.5% pullback last week. It stalled ahead of the early
January high near 105.65. The week's low (March 1) held above 104.00 and
the 20-day moving average. The momentum indicators suggest it is topping, and a
break of 103.80-104.00 lend credence to the view. Still, given the
sensitivity to the inflation report, barring a dramatic shock on the jobs
report, the 103.25 area may offer support.
Japan: Governor Kuroda's last meeting at the helm
of the Bank of Japan will be a few hours before the US jobs data on March 10. Fears of a surprise have lessened, and Kuroda's successor Ueda has signaled
continuity until the inflation is judged to be sustainably at the 2% target. Tokyo's February CPI fell to 3.4% from 4.4% in January, likely presaging a
similar fall in the national figures (March 23). Ueda's comments in the Diet
reinforce our sense that he represents a substantial degree of continuity of
Japanese monetary policy. However, he is pragmatic, and policy will be adjusted when the economic assessment
changes. The Bank of Japan's forecasts (to be updated
at the April 27-28 meeting) has the core CPI (excludes fresh food) at 1.6% at
the end of the year from 3.0% in December 2022.
As the impact of December's surprise waned, the correlation between changes in US interest rates and the exchange
rate increased. However, the correlation is tighter at the shorter end of
the coupon curve rather than the 10-year yield, which appears to reflect the
sensitivity of the dollar to the shift in Fed expectations. As US rates peaked
last week, so did the dollar a little above JPY137.00 and held below the
200-day moving average (~JPY137.30) and the high from just before the December 20 BOJ surprise (~JPY137.50). A move above this area would bring our JPY140
target into view. That said, the momentum indicators look ready to turn down, with an initial test on the JPY134-JPY135 area.
China: The February trade balance and
inflation gauges will be reported in the coming days. Trade, of course, is the more
politically sensitive of the high-frequency data. Exports appear set to
continue the trend lower than they began last year. Judging from some figures from
its regional trading partners, imports also are soft. Still, the trade balance
is not a key driver of the exchange rate. Meanwhile, the
re-opening of the economy, illustrated by the strong jump in the
non-manufacturing PMI (56.3 vs. 54.4, the highest since April 2012), is likely
to increase price pressures. That said, core inflation (excluding food and
energy) rose 1% year-over-year in January. Producer prices have been falling year-over-year for four months through January. Deflation may not have
ended here but should over the next few months. Chinese officials seem
content on letting the exchange rate tracks the dollar against the yen (the 30-day
correlation of changes is near 0.50, roughly twice the correlation at the end
of last year, after peaking in late February near 0.65, the highest since
mid-October 2021) and the euro (0.55 correlation for the past 60 sessions,
essentially from the end of last year). The yuan rose last week for the first
time in five weeks. The yen rose for the first time in seven weeks.
Eurozone: Sticky inflation and an economy
that appears to have dodged the worst scenarios, coupled with the shift in Fed
expectations, have encouraged speculation of higher for longer in the eurozone
too. The market has begun warming up to the idea of a 4.0% terminal rate from
3.50% at the end of last year. The ECB meets on March 16, and a half-point hike
(from 2.50%) is as done of a deal as these things get. The swaps market sees an
80% chance of another half-point hike (rather than a quarter-point) at the
following meeting on May 4. The eurozone reports January retail sales (March 6)
but may draw some market interest as only France of the large members, have
reported January consumption figures. Germany and Italy report January retail
sales on March 8 and Spain on March 10. Separately, the downward
revision of Germany's Q4 GDP (to -0.4% from -0.2%) warns of downside risk with
the revisions to the aggregate figure. Initially, Eurostat estimated growth of 0.1%.
The euro may be forging a near-term bottom, and the Slow Stochastic has turned higher, while the MACD looks poised to do
the same. The euro tested the $1.0535 area to start the week, and we thought if
$1.05 gave way, the next target would be near $1.0460. The initial hurdle on
the upside is the 20-day moving average ($1.0665), which it has not closed
above since February 2, the day before the powerful US employment figures,
and the March 1 high a little shy of $1.07.
United Kingdom: Perceptions of the left-hand tail
risk in the UK have also eased. The labor market remains strong, January retail
sales unexpectedly rose, and the composite February PMI jumped to an
eight-month high of 53.0 (from 48.5 in January). Still, we know that the
economy contracted in December (-0.5% vs. median forecast in Bloomberg's survey
for -0.3%) and will report January GDP on March 10. Growth in January will
likely make economists pare estimates of a 0.3% contraction (in Q1 and Q2). Sterling seemed to outperform in recent days as the bulls appeared to be
encouraged by the "Windsor Framework," which, if approved, would resolve
the problems with the Northern Ireland protocol, would finally give some closure
to Brexit, and lay the groundwork for improved relations with the EU.
Sterling bumped against its 200-day moving
average (~$1.1915), but it held on a closing basis. However, the bounces off it
seemed less pronounced, though it advanced last week for the first time in three
weeks. Sterling is encountering resistance around the 20-day moving average
(~$1.2045), which, like the euro, has not closed above it since February 2. It tested this area ahead of the weekend. From
a slightly different perspective, a new trading range has emerged over the last
couple of weeks, roughly $1.1915 on the downside and $1.2150 on the
upside. The sideways movement has left the momentum indicators
flattish.
Canada: There is little doubt that the Bank
of Canada will stand pat at the March 8 meeting. The economic data have been in
line with expectations, and the lack of surprises allows the Bank of Canada to
make good on the pause it indicated in late January. While the strong January
employment data may not have been a game-changer for the Bank of Canada,
another one on March 10 would be harder to shrug off. The swaps market shows a
bias toward another hike in Q3 and has completely unwound thoughts of a cut
this year. Still, the "higher for longer" meme, especially in the US
and eurozone, put the Canadian dollar at a disadvantage. The Canadian dollar
underperformed last week, falling against the greenback as most G10
currencies rose. Also, the correlation between changes in the exchange rate and
the S&P has eased, while the correlation with the 2-year rate differential
between Canada and the US has increased. Still, all last week, the greenback
was confined to the range set on February 24 (~CAD1.3525-CAD1.3665). The
momentum indicators look toppish, but the weekly settlement near CAD1.36 looks
constructive. It was the highest weekly close since mid-December.
Australia: Outside of somewhat better trade
relations with China, the news stream has not been particularly favorable. The
labor market was weak in January, the composite February PMI remains below 50,
and the housing market is cracking under the weight of indebtedness amid rising
interest rates. At the same time, Q4 22 GDP was robust, and the current account
was well above expectations (A$14.1 bln vs. median forecast of A$5.5 bln in
Bloomberg's survey), and the Q3 deficit (A$2.3 bln) was revised to small surplus
(A$800 mln). The Reserve Bank of Australia meets on March 7, and the futures
market shows about an 80% chance of a quarter-point hike has been discounted. If the RBA were to hike by 15 bp (to bring the overnight cash rate 3.50%), many
would conclude that it is the last hike before a pause. The Aussie snapped a
four-week decline with a gain of about 0.25% last week. The week's range was
set Wednesday (~$0.6695-$0.6785). The momentum indicators look poised to turn higher but do not rule out another test probe below $.0.6700. It takes a move
above $0.6800 (200-day moving average is around $0.6790) to lift the technical
tone, and ahead of the weekend, the Aussie finished near session highs around $0.6770.
Mexico: The dollar broke down afresh last week and
traded below our medium target of MXN18.00 and approached the 2018 low (MXN17.94). The pace of was quicker
than we anticipated. Tesla's investment plans added fresh fuel to the peso's advance. A break of the MXN17.90 area could spur a move toward the MXN17.50
area, last seen in Q3 17. On the margins, the political
backdrop is deteriorating. A fight with the US over Mexico's steel exports,
AMLO's efforts to weaken the election watchdog, and AMLO's push to nationalize
lithium mines may not set well with some groups of investors. Although Mexico
has the ninth largest known lithium deposits, the only mine expected to
be operational this year is operated by a Chinese company in Sonora. Still, the
substantial carry, and flows into the Bolsa and direct investment (illustrated
by Tesla's $5-10 bln project) continue to drive the peso. The peso's 2.5% gain
last week was the largest advance in over six months. The
momentum indicators are over-extended but do not appear poised to turn higher. Initial
resistance may be found in the MXN18.07-MXN18.10 area.
Disclaimer
Reviewed by Marc Chandler
on
March 04, 2023
Rating:
