Soft US CPI Today Paves Way for Fed Pivot Tomorrow

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Marc Chandler
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Overview: The US dollar is trading softer against all the G10 currencies ahead of what is expected to be a soft November CPI report, which paves the way for a pivot by the FOMC tomorrow. It is expected to signal that policy may be sufficiently restrictive and anticipate being able to cut rates next year more than it thought in September, even if not as much as is priced into the market. Among emerging market currencies, central European currencies are leading the way higher on the back of the euro that has moved above $1.08 in the European morning. The softer dollar and lower interest rates are helping gold stabilize after falling to almost $1975 yesterday (peak last week was a record ~$2135). 

European benchmark 10-year bond yields are mostly 4-6 bp lower. A larger than expected moderation in UK wage growth is helping Gilts outperform. The 10-year yield is off almost 10 bp (to ~3.97%). Despite weakish reception as yesterday's Treasury auctions, US rates are softer. Today, the 10-year US Treasury yield is down four basis points to about 4.19%. The two-year yield is about three basis points softer at 4.68%. The S&P 500 closed yesterday at a new high for the year, helping set the tone for today's gains in Asia Pacific Hong Kong's nearly 1.1% rally led the region higher today and nearly all the large bourses participated. Europe's Stoxx 600, on the other hand, is slightly softer., after rallying 1% over the past two sessions. US index futures are trading with a firmer bias. Lastly, an attack on an oil vessel in the Red Sea initially lift crude prices, with the January WTI trading a four-day high (slightly below $72). It has given back those gains and is near session lows a little above $71.

Asia Pacific

The funding scandal in the Abe faction in the LDP may be giving beleaguered Prime Minister Kishida an opportunity for a major cabinet reshuffle. There could be implications for next year's LDP leadership contest. Although some observers suggest it could impact the outlook for monetary policy, we are less sanguine. Last week’s market reaction to BOJ Governor Ueda meeting with the prime minister and comments by his deputy playing down the adverse impact of higher rates was exaggerated, and it began correcting the same day. With Tokyo's November CPI weaker than expected and Q3 GDP's contraction larger than expected, there does not appear to be an urgent need to change policy next week. The yen is well off its lows and the 10-year JGB yield is near 0.75%, around 20 bp off its recent high, suggesting little pressure to act. We have argued that acting when it does not have to puts officials in a stronger, less defensive posture. Yet, this does not seem be Japan's way. Meanwhile, we note that the correlation between the exchange rate and interest rates is stronger with the US two-year yield (30 days, ~0.50 and 60 days ~0.48) than the 10-year yield (30 days ~0.40 and 60 days ~0.35). The correlation is also higher with US Treasuries than Japanese government bonds. 

The dollar made a marginal new high in the North America yesterday near JPY146.60. The drop in US rates ahead of today's US CPI has seen the dollar slip back to around JPY145.25. It may find support around JPY145, ahead of yesterday's lows (~JPY144.80). The Australian dollar looks comfortable consolidating in the range set last Thursday roughly between $0.6525 and $0.6620. It reached $0.6600 in late local trading before backing off to $0.6580, perhaps giving a "running start" to try the topside again. The greenback is consolidating in a narrow range at slightly softer levels against the Chinese yuan, as top officials meet to decide next year's economic targets. The dollar's low yesterday was near CNY7.1740 and today it slipped to CNY7.1720. It has not been much above CNY7.1785. The PBOC set the dollar's reference rate at CNY7.1174 (CNY7.1163 yesterday). The average in Bloomberg's survey was CNY7.1762.

Europe

UK average wages growth slowed more than expected, but it is unlikely to be sufficient for the BOE to validate an early rate cut when it meets later this week. The three-month year-over-year increase in October slowed to 7.2% (from a revised 8.0% September) and 7.3% excluding bonus payments (from 7.8%). They both stood at 6.1% in October 2022. Meanwhile, November payrolls fell by 13k after averaging a little more than a 34k gain in the previous two months. The claimant count rose by 16k, the most since June. After the data, the swaps market moved to fully discount the first cut by the end of Q2, up from a little less than a 75% chance yesterday. Tomorrow, the UK reports October GDP and a small contraction is expected after a 0.2% expansion in September. The drag from industrial production is unlikely to be offset by better services output, while construction and net exports may also be drags. The UK economy was flat in Q3 and the median forecast in Bloomberg's monthly survey expect it remain flat this quarter and the next.

Ahead of Thursday's ECB meeting, there are two high-frequency data points. The first is today's German December ZEW survey. Despite the new fiscal crisis and elevated strains in the governing coalition, the expectations component improved for the fifth consecutive month, rising to 12.8, the highest since March from 9.8. Recall that it peaked in February, as the threat of a winter energy crisis subsided, but fell to -14.7 by July. The current assessment improved marginally for the second consecutive month. It had fallen from May through October. It stands at -77.1 from -79.8 in October. It was at -61.4 at the end of last year and -8 before Russia's invasion of Ukraine. The second report, due tomorrow, is October's aggregate industrial production. Given the national readings, a 0.2% decline is expected. It follows the 1.1% decline in September and would be the first back-to-back decline this year. 

The euro was practically flat yesterday after falling for seven of the past eight sessions. It has hardly been able to sustain an uptick since the weaker than expected preliminary November CPI was reported (November 30 at 2.4%). The euro is approaching last Thursday's high just shy of $1.0820. A close above $1.0800-25 is needed to improve the technical condition. That said, the intraday momentum indicators are stretched. Initial support may be around $1.0780. Sterling's five-day moving average is crossing today below the 20-day moving average for the first time since early November, reflecting the recent pullback. It was probing the $1.2725 area in late November/early December and fell to nearly $1.25 before the weekend. It had held below the $1.2615 area in the second half of last week. A close above there would suggest a near-term low is in place. 

America

Price pressures are easing faster than expected in the US and this be confirmed by today's November CPI and likely acknowledged by the Federal Reserve tomorrow. Headline CPI is expected to be unchanged for the second consecutive month. That would put the three-month annualized rate around 1.6%, down from 4.0% annualized for the previous three-month period. The core rate is firmer. The median forecast in Bloomberg's survey calls for a 0.3% increase after the 0.2% rise in October. That would translate into a 3.2% three-month annualized rate, up from 2.8% in the previous three months. In the big picture, goods prices have been falling, partly encouraged by the unwinding of inventory accumulation. Many economists look for shelter costs to be the next force driving inflation lower.

Meanwhile, inflation expectations have also moderated. The preliminary University of Michigan's survey, out at the end of last week, saw the sharp drop in the one-year inflation outlook to 3.1% from 4.5%. The 5-10-year expectation eased to 2.8% from 3.2%. Yesterday, the NY Fed's survey of one-year expectations slipped to 3.36% from 3.57% in October. It has not been lower since April 2021. The three-year outlook was unchanged at 3.0%, where it has been since August. When the Fed met last month, the 10-year breakeven was slightly above 2.40%. Now it is in near 2.20%. The five-year/five-year forward was near 2.80% and has fallen around 20 basis points. 

The Canadian dollar does not look to be going anywhere quickly. The greenback appears stuck in a fairly narrow range (~CAD1.3550-CAD1.3620) for another day or two. The broader risk appetite and US dollar direction may be the important near-term considerations. The daily momentum indicators favor an eventual upside resolution. Against the Mexican peso, the US dollar continues to trade in the range set last Thursday (~MXN17.2670-MXN17.5420). From another perspective, in the top side, the 200-day moving average is near MXN17.5550 and on the downside is a two-week uptrend that is near MXN17.3150. The attractive rates and relatively modest vol (one-month implied vol slightly below its 100-day moving average (~12.5%) make it a candidate to park funds for year-end purposes. Still, the market may be wary ahead of the FOMC meeting and Banxico on Thursday. Mexico reports October industrial production figures today but the broad dollar's movement in response to the CPI is more important. Meanwhile, a downtick IPCA inflation report from Brazil (~4.7% vs. 4.8%) will reinforce expectations of a 50 bp cut in the Selic rate tomorrow.