The US Dollar and Rates Rise Further

Overview: The US dollar and interest rates have continued to rise after the strong employment report before the weekend helped drive home the Fed's message at last week's FOMC meeting. The greenback has been bid to new highs for the year against the G10 currencies but the Canadian dollar. The dollar also rose to a marginal new high for the year against the Chinese yuan. Interest rates are jumping, and the market has downgraded the chances of a May Fed cut to about 75% from slightly more than 90% before the weekend. Before the employment data, the Fed funds futures had almost 34 bp of cuts discounted by the end of May and now 19 bp. The US two-year yield was at 4.13% last Thursday and is now 4.44%. The 10-year yield is up six basis points today to bring its three-day advance to more than 25 bp. European yields are mostly 2-4 bp higher. The 10-year JGB jumped five basis points and the BOJ stepped in to steady the market with its first unannounced operations in seven months. 

Equities are mixed. Japanese and Taiwanese equities rallied, but most of the large markets in the region fell. China had another volatile session and despite the Shanghai and Shenzhen composites tumbling the most in the region, the CSI 300 rose by 0.65%. The price action lends support to the claims of state-owned funds being called into action. Europe's Stoxx 600 is edging higher. It rose 3.1% last week, the most since early November. US index futures are trading with a softer bias. Higher rates and a stronger dollar have dragged gold to a five-day low near $2020. Despite the heightened Middle East tensions and broadening conflict, March WTI is extending last week 7.4% slide. It is about 0.65% lower near $71.80. If the losses are sustained, it would be the fourth consecutive losing session.

Asia Pacific

Caixin's January service and composite PMI were little changed from December at 52.5 (from 52.6) and 52.7 (from 52.9), respectively. Many foreign observers are critical of two areas of Chinese policies: politics and economics. Beijing is also not content with the economic performance and more stimulus is expected after the Lunar New Year celebration that begins at the end of this week and shutters mainland markets this Friday and for all next week. The highlight this week is the January CPI and PPI on February 8. Deflationary forces persist. Separately, over the weekend, China's Securities Regulatory Commission promised to prevent "abnormal" market fluctuations and intended to guide more medium- and long-term investment funds into the market. The CSI 300 rose but both the Shanghai and Shenzhen composite indices fell (1.0% and 3.9%, respectively). 

Japan's final service PMI rose to 53.1 (52.7 flash and 51.5 in December), a four-month high and the second consecutive monthly improvement. It was at 52.3 in January 2023. The composite PMI was above the 50 boom/bust level in Q3 23 even though the economy contracted. It did dip below 50 last November but recovered to 50 in December and 51.1 in January (51.1 flash). It is also the highest since last September. More important data are due tomorrow:  labor earnings and household spending. Labor cash earning may have risen by around 1.2% in the year through December. While that is higher than November's 0.7% gain, it is weak compared with the previous year. Cash earnings rose 4.1% in the year through December 2022. More important still is the fact that real wages continue to fall. The -1.5% decline 2023 compares to a 0.6% decline in 2022. In fact, real cash earnings have fallen for five consecutive years. Not coincidentally, so has household consumption. 

Australia's economy continues to struggle. The services PMI spent H2 23 below the 50 boom/bust level except for September. It rose from 47.1 in December to 49.1 in January (47.9 flash). The composite PMI was 48.5 in January 2023 and 49.0 in January 2024 (preliminary estimate 48.1), after bottoming last October at 47.6. Last week, we learned that December retail sales plunged 2.7% (median forecast in Bloomberg's survey was -1.7%), and November's increase was trimmed to 1.6% from 2.0%. December building approvals collapsed 9.5% (median forecast was for a 0.5% gain) and November's 1.6% gain was revised to 0.3%. Separately, Australia reported an A$11 bln December goods trade surplus, which is about the 2023 monthly average. That is about 15% lower than the 2022 average. The RBA's meeting concludes first thing tomorrow. 

The dollar's roughly two-week correction after rallying from around JPY140.80 in early January to about JPY148.80 on January 19 is over. Last week's low slightly below JPY146 marked the end. The next leg higher began with the surge to nearly JPY148.60 in response to the US jobs data. The dollar made a marginal new high for the year earlier today slightly above JPY148.80. Near-term potential may extend toward JPY149.20-JPY149.75. The combination of a weaker yen and higher JGB yields renews pressure on the BOJ. The BOJ announced the first unscheduled bond purchases since last July. The Australian dollar was turned back ahead of the weekend after approaching the 20-day moving average near $0.6610. It reversed lower and recorded a new low for the year, near $0.6500 to meet the (61.8%) retracement of the Q4 23 rally. Follow-through selling pushed the Aussie to almost $0.6485 today, a new low since last November. The near-term risk extends toward $0.6450. It is possible that a head-and-shoulders pattern has been forged. The neckline is about $0.6525, and if the pattern is rotated it, an objective of around $0.6175, which seems a bit much given the position of the momentum indicators. In our understanding, the sell-off in the yen (and euro) ahead of the weekend pointed to a weaker Chinese yuan today, and the PBOC did not disappoint. The dollar firmed to a marginal new high for the year near CNY7.1985. It has not traded above CNY7.20 since late last November. The PBOC set the dollar's reference rate a bit higher at CNY7.1070 (CNY7.1006 on Friday). The average in Bloomberg's survey was for CNY7.2053 (CNY7.1670 on Friday). The dollar did not set a new high for the year today. It reached CNH7.2235. The high for the year was recorded on January 17 near CNH7.2320.

Europe

The final eurozone PMIs will not change investors' or policymakers' views. The services PMI was confirmed at 48.4, and three-month low. It has not been above 50 since last July. The composite PMI has not been above 50 since last May. It was at 50.3 last January and stood at 47.9 last month. The new information came from Italy and Spain. Last week, we learned that while Germany contracted in Q4 and France stagnated, Italy grew by 0.2% (median forecast in Bloomberg's survey was for a flat report) and Spain's economy grew 0.6% (median forecast was for a 0.2% increase in output). Today the January PMI showed Italy's composite rising for the third consecutive month to 50.7 from 48.6, the first above-50 reading since last May. Spain's composite PMI rose to 51.5, the highest since last July. Moreover, we note that Italy's inflation (EU harmonized) was 0.9% year-over-year in January. Germany's was 3.1%, France, 3.4%, and Spain 3.5%. 

According to the UK's monthly GDP calculation, the economy contracted by 0.3% in October and grew by 0.3% in November. So, the fact that January composite PMI is at 52.9 from a 52.5 preliminary reading (52.1 in December), the highest since May 2023, is somewhat less impressive. The UK reports December and Q4 GDP next week. Economists (median in Bloomberg's survey) expect the British economy to have stagnated last quarter and this one. At last week's BOE meeting, the central bank lifted this year's growth forecast to 0.25% from flat. The IMF is more optimistic with a 0.6% projection.

The euro could not get much closer to $1.09 than it did a few hours before the US employment report last Friday. In the first 15 minutes after the surprising data, the euro tumbled to about $1.0810. It took it the next several hours to find the low near $1.0780, matching the year's low set the previous day. After the low was recorded, the euro was unable to trade above $1.08. Recall that $1.0795 area is the halfway mark of the Q4 23 rally (~$1.0440-$1.1140). It has fallen to $1.0750 in the European morning. The (61.8%) retracement is slightly above $1.0710, while the December low was near $1.0725. Sterling is being sold through the bottom of the $1.26-$1.28 trading range that has dominated since mid-December. It almost covered the range before the weekend. The nearly 1.6-cent range was the second largest this year, after January 5, which was also a US jobs report day. We see initial support now near $1.2550-65, and then, possibly $1.2500. In terms of retracements, the $1.2525 is the (38.2%) retracement of the Q4 rally, while the $1.2430 is the next (61.8%) retracement.

America

The cottage industry that makes a living hawking criticism of Fed policy worried that just like the central bank was too late to tighten, it will be too late to ease after Chair Powell pushed as hard as imaginable against speculation of a March rate cut. Yet since the meeting, investors learned that the September manufacturing PMI was revised higher, ISM's measure of new orders in January surged to its highest since May 2022 (52.5 vs. 47.0 in December), and December construction spending rose by 0.9%, nearly twice as much as expected, and the November gain was revised to 0.9% from 0.4%. And then there was the jobs report. To say it surprised on the upside is understatement. Payroll grow was almost twice what was expected, and the past two months were revised to show greater jobs growth. Hourly earnings were also stronger than expected. Moreover, amid concerns in some quarters about the breadth of job growth outside of government and health care, manufacturing added 23k jobs in January (median expectation in Bloomberg's survey was 3k). Over the past three months, the US has added 57k manufacturing jobs, the most in a three-month period since October 2022. The decline in hours worked and even the higher average earnings may have been distorted by the weather than prevented the most from working in three years. 

The final PMI services and composite readings are due, and ISM services will be released. Both tell a similar story. The economy enjoys good momentum at the start of the year. Even if it is too early in the data cycle to take seriously the Atlanta's Fed GDP tracker of 4.2% growth in the current quarter, forecast of US growth may have to be revised up. The median forecast in Bloomberg's survey is for Q1 24 GDP to be 1.0%. The KBW index of regional banks snapped a three-day slide ahead of the weekend (+0.20%), but the results of the senior loan officer survey later today will be of interest. The US Treasury is selling more than $350 bln in bills and coupons this week. Almost $150 bln in bills will be sold today and the quarterly refunding kicks off tomorrow with the sale of $54 bln three-year notes (and $80 42-day cash-management bill).

The US dollar found support in the CAD1.3360-5 in the second half of last week. It settled at a six-day high, slightly below the 200-day moving average (~CAD1.3475). Follow-through buying has lifted the greenback to almost CAD1.3500 today. The January high was around CAD1.3535-40, which corresponds to the (50%) retracement of the greenback's slide from high set early last November near CAD1.39. The next retracement (61.8%) is near CAD1.3625. The Mexican peso was at its best level in about two-and-a-half weeks before the US employment report. The US dollar recovered from around MXN17.0380 to MXN17.1820. It has been bid to nearly MXN17.1985 today. The 200-day moving average is a little below MXN17.33, and the greenback has not closed above it since the middle of last November. The January high was recorded around MXN17.3855-60. The week's key events, January CPI and the central bank meeting are Thursday. In Bloomberg's survey of 14 economists, only three see a rate cut this week. 

Disclaimer