Week Ahead: Will Soft US CPI and Retail Sales Mark the End of the Interest Rate Adjustment and Help Cap the Greenback?

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Marc Chandler
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The markets are still correcting from the overshoot on rates and the dollar that took place in late 2023. The first Fed rate cut has been pushed out of March and odds of a May move have been pared to the lowest since last November. The extent of this year's cuts has been chopped to about 4.5 quarter-point move (~112 bp) from more than six a month ago. The market has reduced the extent of ECB cuts to about 114 bp (from 160 bp at the end of January and 190 in late 2023). The Bank of England is now expected to cut rates three times this year (75 bp), which is nearly 100 bp less than was discounted at the end of last year. The extent of Bank of Canada rate cuts this year has been halved to less than 80 bp from 160 bp in late December 2023. We suspect that the interest rate adjustment is nearly over. A soft US CPI and weak retail sales report next Tuesday and Wednesday could help cap US rates and signal the end of the dollar's New Year rally. 

The UK reports CPI on February 14, and given the base effect (-0.6% in January 2023), even a 0.3% decline in prices last month, the year-over-year rate is likely to rise (to 4.2%-4.3%). However, the bigger story for the UK, the eurozone, and Canada is that inflation rose sharply in the Feb-May period last year, and as these drop out of the 12-month comparisons, the year-over-year rates will fall dramatically. The UK and Japan will report Q4 23 GDP. The UK economy likely contracted slightly for the second consecutive quarter. Japan, the world's third-largest economy, likely returned to growth after contracting at an annual rate of almost 3% in Q3. Consumer spending and capex fell in Q2 and Q3 24. Both likely recovered. The UK and Australia report new labor market figures. In the UK wages are moderating and the economy likely lost full-time positions for the second consecutive month in January. It is difficult to image a worse employment data than Australia reported last month. It lost 106k full-time jobs, which, outside of the pandemic, looks like the worst on record. 

United States:  The data and official guidance have pushed out expectation of the first Fed cut and reduce the extent to this year's cut. The market's confidence (~73%, down from 90% after the employment data) of a May move still seems too high given the apparent momentum the economy enjoys in early 2024, even if we do put too much emphasis on the Atlanta Fed's GDP tracker (3.4%) this early in the quarter. The market has about 4.5 Fed cuts discounted this year, down from more than six cuts as recently as mid-January. The May decision is unlikely to be determined by January data. That counts even this week's highlights of CPI, retail sales, and industrial production.

At his post-FOMC press conference, Fed Chair Powell called attention to "six months of good inflation." This looks to have continued into this year. The headline CPI rate is seen rising by 0.2% (February 13), which, given the base effect (0.5% in January 2023), would see the year-over-year rate fall to 3.0%-3.1% from 3.4%  Yet, the median forecast from the nine economists that participated in Bloomberg's survey (by end of last week) see it falling to 2.9%. The core rate is expected to rise by 0.3% for the third consecutive month and the fifth time in six months. That may be more important that the softer year-over-year rate (~3.7% vs 3.9%). 

January retail sales (Feb 15) may have been dragged down by disappointing auto sales (15 mln SAAR, down from 15.83 mln in December). Consumption would appear be off to a slow start after retail sales rose by an average of 0.2% in Q4 23 after a blistering 0.7% average gain in Q3 23. The median forecast is for a 0.2% decline in headline retail sales (+0.6% in December). On the other hand, industrial production (Feb 15) appears to have accelerated and the 0.3% increase the median in Bloomberg's survey is looking for would be the strongest in six months. However, manufacturing itself may be flat. Other high frequency data points include producer prices (year-over-year rates are below 2%), housing starts and permits (small gains expected), and a number of early regional Fed surveys. Of note, the Empire State Manufacturing Survey crashed in January (-43.7 from -14.5) and a sharp snap back is expected in February. On balance, the data is likely to be consistent with the US economy expanding somewhat faster than what the Federal Reserve believes is the long-term non-inflation pace (1.8%). 

The big outside day for the Dollar Index after the US employment data on February 2 saw follow-through buying at the start of last week. It reached 104.60, the highest level since the middle of last November and spent the rest of the week consolidating above 103.95. A move above the 104.80 is needed to reignite the upward momentum. Despite the stretched momentum indicators and the proximity of the upper Bollinger Band (~104.50), there is little technical sign of a top. That said, given the nearly 4% rally off the late December lows, this is the area where we are beginning to look for a reversal pattern.

Eurozone:  Details for Q4 23 GDP (flat and 0.1% year-over-year) will be released with the revisions on February 14. It may be interesting for economists, but the general thrust is sufficiently known for businesses and market participants. The eurozone economy is stagnating or worse. In the last five quarters through Q4 23, in aggregate, there has been no growth. Still, the details of fourth quarter GDP saps much interest in high frequency data from the end of last year. More importantly is the momentum at the start of the new year and the data so far have been limited to some surveys and a preliminary estimate of January CPI (-0.4% month-over-month and minus 3.2% at an annualized rate in the last three months). There seems to be little reason to expect new growth impulses, leaving this quarter to be flat to +0.1%.

The euro's low for the year was set at the start of last week slightly below $1.0725. The subsequent recovery stalled in the $1.0790-95 area, meeting the (38.2%) retracement objective from the Feb 2 high set shortly before the US January jobs report. The momentum indicators remain stretched, as one would expect, given the five weeks of losses in the first six weeks of the year. And if there is a more of a recovery, the $1.0810-40 area may offer stiff resistance. The 20-day moving average, which the euro has not closed above since January 2 is found at the upper end of that band. Note that there are options for 2.5 bln euro at $1.0725 that expire Monday and options for 1.5 bln euros at $1.07 expire shortly after the US CPI report on February 13.  There is another 1.4 bln euro s at $1.07 that expire Wednesday. 

Japan:  In each of the past six years, the Japanese economy contracted in at least one quarter (in 2018 and 2022 there were two contracting quarters). Last year, it was the third quarter, when output fell by 0.7% (quarter-over-quarter). A stabilization in consumption and a recovery in private investment, both of which fell in Q2 23 and Q3 23, likely helped return the world's third largest economy to growth. Exports also increased. The GDP deflator appears to have peaked in Q3 23 at a 5.3% year-over-year pace. On the back of firmer US Treasury yields and comments by BOJ officials that downplayed the likelihood of a tightening cycle even after negative interest rate policy is jettisoned, the dollar rose to nearly three-month highs against the yen (~JPY149.60). Although Japanese officials have not expressed concern about the price action in the foreign exchange market, the yen's six-week drop is the kind of one-way market that is resisted. The November high was near JPY149.75, in front of the psychologically important JPY150 level. There are $1.4 bln in options at JPY150 that expire shortly after the US CPI report on February 13. A move above JPY150 brings last year's high near JPY152 into view.

United Kingdom: It is an important week for UK data and the jobs report and the CPI, in particular will likely impact expectations for interest rate policy. Average weekly earnings have slowed for four consecutive months through November and look poised to continue to slow as the labor market cools. The key message on UK CPI is that it will fall sharply starting the February report and running through May. In those four months in 2023, UK CPI rose by an average of 1.0% a month. In the last four months, through January, the UK's CPI rose by an average of 0.2% a month. Due to 0.6% decline in January 2023 UK CPI, the 0.3% decline expected for last month's CPI will translate into a small increase in the year-over-year rate. But that is not the signal. Even if UK's inflation averaged 0.4% in the Feb-May period this year, the headline year-over-year rate would still slip below 2% (from 4% in December). The core rate is firmer, but the direction is lower. It peaked at 7.1% last May and finished the year at 5.1%. The UK also reports Q4 23 GDP. Recall that the monthly print showed a 0.3% contraction in October followed by 0.3% growth in November. It is seen contracting by 0.2% in December. That would likely translate to a 0.1% contraction quarter-over-quarter for the second consecutive quarter. Surveys suggest manufacturing remains weak while the services are finding traction. The swaps market has about a 70% chance that the first cut is delivered by midyear. Three cuts and about a small chance of a fourth cut is discounted for this year. 

Sterling broke out of its $1.26-$1.28 trading range to the downside at the start of last week, largely on follow-through selling after the US jobs report on February 2. It bottomed near $1.2520 and recovered to settle above $1.26 for the past three sessions. Sterling's recovery stalled near $1.2645, the (50%) retracement of the losses from February 2 high (~$1.2770). The next retracement (61.8%) is around $1.2675, which is also where the 20-day moving average is found.

Australia: The January employment data will be reported early on February 15. It is difficult to imagine a worse report than December's, even though the unemployment rate held at 3.9% (up from 3.5% at midyear). Australia lost a stunning 106.6k full-time posts, which wiped out half of the increase reported in the Jan-November period (~211k). Part of the reason that the unemployment rate did not rise was that the participation rate fell by a sharp 0.5% to 66.8%. At the same time, other hard data have been poor. Remember December retail sales tumbled 2.7% in the face of expectations of a 0.5% gain. November gain itself was revised lower by nearly as much as economists had forecast a December gain (1.6% vs. 2.0%). Building approvals dropped 9.5%. Here, too, economists (median in Bloomberg's survey) forecast a 0.5% increase. November's 1.6% gain was revised to 0.3%. There may be scope for the market to bring forward the first rate cut by Reserve Bank of Australia to June from August. 

The Australian dollar recorded a new low for the year last Monday near $0.6470, its lowest level since mid-November as it extended the post-US jobs data drop. However, it stabilized and largely traded in a range mostly between $0.6480 and about $0.6540. The upper end of the range corresponds to the (50%) retracement of the decline from the pre-jobs data high a little above $0.6600. The next retracement (61.8%) is near $0.6555, and the 20-day moving average, which the Aussie has not closed above since January 3 is a little higher (~$0.6560).

Canada:  Canada has a light economic diary in the coming days. January existing home sales and housing starts, and Canada' portfolio investment account (December) rarely moves the market in the best of times. In terms of drivers, the 30- and 60-day correlations with the changes in the exchange rate seem to be the general direction of the dollar (DXY) and risk-appetites (S&P 500). The Canadian dollar seems less sensitive to oil and two-year rate differentials (less than 0.2 correlation for both period). The US dollar took out the January high marginally and rose to about CAD1.3545 early last week before consolidating at lower levels ahead of the Canadian employment data reported before the weekend. The Canadian dollar strengthened initially on the news, even though full-time jobs fell for the second consecutive month. The greenback found support ahead of CAD1.3400 and recovered back to set new session highs near CAD1.3480. The risk seems to be on the upside. 

Mexico:  After the January CPI figures and the central bank decision to hold policy steady, there may not be market-moving economic data February 22 with another look at Q4 23 GDP (0.1%), first half of February CPI, and minutes from the Banxico meeting. The central bank raised quarterly inflation forecasts through Q3 but left the Q4 24 projection at 3.5%. The target is 3%, +/- 1%. The dollar initially moved higher in response, but the upticks (to ~MXN17.17) were short-lived. The greenback settled last week below MXN17.10, to post its second consecutive weekly decline. The MXN17.00 area had been approached before Mexico's CPI and central bank meeting. It has not traded below there since January 16, but it could if the US CPI and retail sales data are soft and cap US rates.