US Dollar Comes Back Better Bid

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Marc Chandler
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Overview: Although the US January CPI was in line with expectations, the year-over-year rate was a little firmer than expected. Still, the measure that Fed Chair Powell has underscored, core services, excluding shelter, moderated with a 0.3% month-over-month gain. US rates shot up and this lent the dollar support, while weighing on equities and risk sentiment. The US two-year note yield rose to almost 4.64% yesterday, the highest in three months. The greenback is higher with the Australian and New Zealand dollars knocked the most (~1.3% and 0.9%, respectively). Softer UK inflation is taking a toll on sterling (~-0.8%).

The large bourses in Asia were mostly lower, with India a notable exception. Europe's Stoxx 600 has shrugged off the global headwinds and is posting a minor gain. It is up for the sixth session in the past seven. US index futures are 0.2%-0.4% lower. Ten-year UK Gilt yields are off 10 bp, while core eurozone yields are down a couple of basis points, with Italy, Spain, and Portugal are lagging. The 10-year US Treasury yield is flat near 3.74%. March WTI is consolidating at lower levels after reports indicate API figures showed an 11 mln barrel build of US stocks, which if confirmed by DOE data today, would be the largest rise in five weeks and bring holdings to their highest level since June 2021. Separately, IEA boosted its forecast for global demand by 500k barrels in Q1 as the Chinese economy re-opens. World consumption is seen up 2 mln barrels a day this year to 101.9 mln. Still, it sees the global oil market in surplus in H1 and notes the resilience of Russian supplies.

Asia Pacific

Japan reports its January trade figures first thing tomorrow. The strong seasonal pattern is clear. Japan's trade balance typically (19 of the past 23 years) improves in December and deteriorates in January (without fail since 2000). True to form, economists anticipate significant deterioration to almost JPY4 trillion (~$30 bln) more than twice the shortfall in December (JPY1.45 trillion). Even the seasonally adjusted measure is likely to blow out to a new record of JPY2.4 trillion (from JPY1.72 trillion in December). Foreign demand has weakened, and Japanese exports may have fallen year-over-year last month for the first time since February 2021. In May and again in August last year, Japanese imports approached a 50% increase year-over-year. A combination of falling prices and the recovery of the yen has seen import growth fall slightly below 21% in December and may have remained there in January.

As widely expected, China kept its medium-term one-year lending facility rate steady at 2.75%. It has been there since last August when a 10 bp cut was announced. Although the data from the Lunar New Year holiday was constructive, continued weakness in the property market and foreign demand (exports have fell on a year-over-year basis in each of the last three months of 2022) suggests that more support for the economy may be provided later this year. The steady MLF rate means there is little chance for the loan prime rates to fall next week (1-year rate at 3.65% and the 5-year rate at 4.30%). The PBOC provided for a net injection via the MLF of nearly CNY200 bln (~$29 bln). Meanwhile, note that China's 10-year bond yield cannot keep pace with the backing up of US rates. Earlier this month, the US premium had fallen to 50 bp and now is approaching 90 bp. It finished last year around 105 bp, after making an extreme in October and November around 150 bp.

The US dollar edged up to almost JPY133.50, its best level since January 6. It has recorded higher lows consistently this week. Important resistance is seen near JPY135, which has not been seen since the December surprise. Initial support is seen around JPY133.00 and then JPY132.50. The inability of the Australian dollar to sustain the momentum above $0.7000 yesterday was disappointing and may have encouraged some sales today. Central bank Governor Lowe defended the need for higher interest rates. His seven-year term expires in September, and it is not clear that he will get an extension as his previous two predecessors did. Tomorrow, Australia reports January employment figures and a bounce back after soft December numbers is expected. The Aussie is holding slightly above this week's low set Monday near $0.6890. A break of it targets last week's low around $0.6855. The greenback reached CNY6.8490 today, which it has not seen since January 6. There are options for nearly $2.2 bln struck at CNY6.85 that expire today. While Chinese figures show foreign investors bought a record amount of Chinese equities last month (~$27.7 bln) the proverbial bloom is off the rose and the CSI 300 has been trending lower for the past couple of weeks and the index that tracks Chinese shares in Hong Kong is off 10% from its late January peak. Today's reference rate for the dollar was set at CNY6.8183, tight against expectations (Bloomberg survey) for CNY6.8189. 

Europe

With the eurozone's Q4 GDP confirmed yesterday at 0.1% and 1.9% year-over-year (2.1% US), today's December data was not so important. The takeaway, which was already more or less known, was that the regional economy finished last year on a weak note. Early this month, we learned that retail sales fell a dramatic 2.7% in December. It was easily the weakest report of last year and was the second decline in Q4. Today, we learned that industrial production fell by 1.1% in December, rather than the 0.8% expected. However, the sting may have been lessened by the upward revision in the November figures to show a 1.4% gain instead of 1.0%. Still, it was the second monthly decline in Q4. The eurozone experienced a terms of trade shock last year, but the worst was in Q3. The decline in natural gas prices and oil, coupled with the recovery of the euro on a trade weighted basis (recouping last year's decline in full) has helped the eurozone's external balance improve in Q4. Today's December figures showed an 18.1 bln euro deficit bringing the Q4 shortfall to 80.75 bln euros from 122.4 bln in Q3.

UK CPI slowed last month but remains at a double-digit. Still, the 0.6% decline on the monthly print is the first decline since last January and matches the largest decline since January 2019. The year-over-year rate fell to 10.1%, a little lower than expected from 10.5% in December. The core rate eased to 5.8% from 6.3%. Today's CPI report has essentially offset the impact from the strong labor market report earlier this week. The swaps market shows about 23 bp of tightening is priced in for next month's meeting, down from nearly 29 bp yesterday, and little changed from the end of last week. 

Tomorrow's an important day in Poland. EU judges are expected to hand down their non-binding opinion about the estimated $17 bln of foreign currency (mostly Swiss franc) mortgages. The banks are seeking relief or face collectively, according to Polish regulator last October, PLN100 bln (~$22.5 bln) hit (though the franc has depreciated by about 6% against the zloty since the end of last September). The case is being watched closely. Separately, Poland's President Duda threw a splinter into the government's hope of freeing up around 35.5 bln euros of EU recovery funds by changing the judicial measures that the EC found objectionable. Duda requested that Poland's high court reviews the legislation. The risk is these holds up the process and that the EU funds will not be freed up ahead of the parliament election (seen in October-November).

The euro briefly traded above $1.08 yesterday for the first time since February 6. It was unable to sustain the move. It settled slightly below $1.0740 yesterday and was sold to $1.07 before findings a bid in late Asia Pacific turnover. Sellers emerged in the European morning near $1.0730. Options for 1.44 bln euros expire today at $1.07. We suspect these may be challenged in the North American morning rather than the 775 mln euros in expiring options at $1.08. Initial support below $1.07 is seen near $1.0670-80. Sterling rejected the push above $1.2250 yesterday and is under pressure today. It is probing the $1.2070 area in the European morning. It held $1.2030 at the start of the week, but a break of $1.20 could see sterling return to last week's low near $1.1960. The 200-day moving average is found closer to $1.1945.

America

The markets responded dramatically to the January CPI figures, where the month-on-month changes met expectations, but the year-over-year rates were a little firmer than expected, even if lower sequentially. Shelter contributed to about half the increase (and accounts for about a 1/3 of the CPI basket). It is widely acknowledged that the methodology lags behind what is actually happening, and there will likely be some catch-up around mid-year). Food and energy prices were also firm. Unexpectedly used vehicle prices fell, and more broadly, durable goods prices fell by 0.1% (after having fallen by 0.8% in November and December). The Federal Reserve will see another CPI report before it meets later next month. In February 2022, CPI rose by 0.7% and by 1.0% in March. The Q2 22 increase was also dramatic:  it rose by 0.4% in April, 0.9% in May, and 1.2% in June. The futures market has 5.25% Fed funds priced in early H2. The December contract now yields 15 bp less than the September contract. It peaked a month ago near 34 bp, showing that the market has dramatically scaled back "bets" of a rate cut this year, but has not given it up entirely. 

Although parts of tomorrow's PPI report will help fine-tune forecast for the January PCE deflator (due February 24), the focus today shifts back to the real sector. Recall that the US economy was particularly weak as last year wound down. Retail sales fell by 1% in November and 1.1% in December. We will likely learn that consumers returned last month. The median forecast in Bloomberg's survey is for a 2% rise. Autos and gasoline likely accounted for nearly half the gain. January industrial production will also be reported. It fell every month in Q4 22. Manufacturing itself fell by 1.1% in November and 1.3% in December. Both are expected to have recovered last month. The median forecast in Bloomberg's survey sees a 0.5% increase in industrial output led by a 0.8% rise in manufacturing. Capacity utilization peaked last April near 80.2%. It was at 78.7% in December, the lowest since of the year, but it likely recovered back above 79%. The housing market has been exceptionally weak, contracting at an annualized pace of around 25% in both Q3 and Q4. January housing starts will be reported Thursday. The four-month decline to finish 2022 may have been extended last month, but permits are thought to have risen for the first time since last September. Anecdotal reports suggest more housing traffic, and mortgage rates have pulled back. January existing home sales (released February 21) likely rose for the first time since January 2022.

The risk-off mood that has weighed on the Antipodeans today has also knocked the Canadian dollar lower. The greenback is hovering near CAD1.34, the high for the week after bouncing from CAD1.3275 yesterday. There are options for almost $700 mln at CAD1.34 that expire today. Last week's high were around CAD1.3475. Still, the intraday momentum indicators are stretched, suggesting last week's high may be safe. The US dollar briefly traded below MXN18.50 yesterday for the first time in four-and-a-half years. It has bounced back smartly today and returned to yesterday's high of almost MXN18.6750. However, sellers emerged in the European morning, pushing it back to MXN18.6150. Initial support is seen in the MXN18.58 area.