Firm Start for the Greenback

by
Marc Chandler
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Overview: The US dollar begins the new year on a firm note. It is recovering against nearly all the G10 and emerging market currencies today after depreciating in the holiday-thin markets over the past couple of weeks. Japanese markets are on holiday until Thursday. The yen and Swiss franc are the poorest performers among the G10 currencies. Among emerging market currencies, the Mexican peso, Hungarian forint, and South African rand are bucking the trend to post minor gains against the greenback. The Chinese yuan is off by about 0.5% for its biggest loss in at least six months. 

Equities are mixed while bonds have sold off. In Asia Pacific, Hong Kong and mainland Chinese equities tumbled by 1.3%-1.5% to lead the regional decline, but Korea and Australia, and a handful of other smaller markets rose. Europe's Stoxx 600 finished last year on its highs and is trading with a slightly firmer bias today. It pushed above the 480-level for the first time since January 2022. US index futures are nursing small losses. Ten-year benchmark yields are jumping higher today. Eurozone yields are 7-9 bp higher, while the yield of the 10-year Gilt is up a dozen basis points. The 10-year US Treasury yield is 6.5 bp higher to almost 3.95%. If sustained, this would be the largest rise in the US 10-year yield since the last jobs report on December 8. Geopolitics and the heightened tension in Red Sea are seeing gold buck the pressure of a stronger US dollar and higher yields and is trading with a firmer bias near $2075. It settled near $2063. February WTI has also come back bid after falling by nearly $4 a barrel in the last three session of 2023. It is trading around $1.75 higher near $73.40.

Asia Pacific

Tokyo's markets were closed today and tomorrow for national holidays as the country is dealing with aftermath of a powerful and deadly earthquake that struck yesterday. Thursday sees the final Japanese December manufacturing PMI will reflect a sector that remains challenged. The preliminary reading of 47.7 matches the low for the year. November industrial output, reported last week, fell by 0.9% Industrial production contracted at an annualized rate of about 2.8% in Q3. The Bank of Japan reduced the number of bond-buying operations for the long end of yield curve. It also reduced lower end of range of 1-10-year JGBs it will purchase. Governor Ueda seems to be preparing the market for a hike in April, the start of the new fiscal year, the end of the government electric and subsidies (estimated to have lowered headline CPI by around 0.5%), and the conclusion of the spring wage round. The swaps market anticipates that several G10 central banks will cut rates in March or April.

There are three things to note in China. First, the December PMI was reported. The contraction in the manufacturing sector deepened (49.0 vs. 49.4 in November). It is the third consecutive decline and matches the lowest reading since May. The non-manufacturing PMI (services and construction) firmed slightly to 50.4 from 50.2. The composite PMI slipped to 50.3 from 50.4, which is the lowest 2024 reading. The Caixin manufacturing PMI unexpectedly edged higher to 50.8 from 50.7. Second, before Christmas, large Chinese banks cut deposit rates by as much as 25 bp for some tenors. It is seen as a sign of confidence of easier PBOC monetary policy. There have been some changes in the central bank's senior management team, and a more formal reduction in its authority and power. Few observers regarded it to be independent in the first place, so downgrade needs to be understood within context of Xi's undermine of any alternative power center and the strengthening of the CCP's presence throughout Chinese government and society. Third, apparently in retaliation for escalating US efforts to deny China older generation semiconductor technology and threats to increase the tariff on Chinese-made electric vehicles (not limited to Chinese brands), Beijing has banned the export of rare earth processing technology and some types of rare earth magnets. This is on top of the export restrictions on gallium, germanium, and graphite that was previously announced.

The US two- and 10-year yields fell in four of the past five weeks to end 2023. This, coupled with ideas that the Japan will again be out of sync with other G10 central banks and raise rates in 2024, helped lift the yen to five-month highs (~JPY140.25) in late December. However, we suspect the market has gotten a bit ahead of itself. Higher US rates are helping the dollar trade firmer today. The session high was set in Europe slightly above JPY141.75. Near-term potential extends to JPY141.80-JPY142.00. The Australian dollar rallied six cents from the year's low set in late October (~$0.6270) to briefly poked above $0.6870 late last week. Resistance is seen at the double high set last June and July closer to $0.6900. The momentum indicators are stretched a look poised to turn lower. In quiet turnover, it is in about a fifth of a cent range around $0.6820. After peaking in early September at almost CNY7.35, the greenback slipped below CNY7.10 last week to record a six-month low. This effectively retraced more than a third of last year's gains. The greenback's recovery today has seen it climb to around CNY7.1365. The roughly 0.5% gain would be the dollar's largest rise in at least five months. The offshore yuan is an attractive funding currency, with low and possibly lower rates and low volatility. We look for some near-term backing and filling that could see the US dollar recover toward CNY7.15-CNY7.17.

Europe

The final December EMU manufacturing PMI was revised to 44.4 from the preliminary estimate of 44.2 that was unchanged from November. It has not been above the 50 boom/bust level since June 2022. It bottomed at 42.7 in July but remains stuck in the trough. It finished 2022 at 47.8. The highlight this week is the preliminary December CPI. The median forecast in Bloomberg's survey is for a 0.2% increase month-over-month. Yet, due to the base effect (CPI fell by 0.4% in December 2022), the year-over-year rate is likely to bounce to 3.0% from 2.4% in November. It could rise a bit more in January, but the moderation of price pressures will resume in the February-April period, when it rose by an average of a little more than 0.7% a month in 2023. ECB President Lagarde warned of the impact of energy and officials may take comfort in the core measure, which is expected to slow to 3.4% from 3.6%. It was at 5.2% at the end of 2022.

The UK's final December manufacturing PMI was revised to 46.2 from 46.4 initial estimate. It was at 47.2 in November and 45.3 in December 2022. The slippage in December ended three months of improvement. At the end of November, the swaps market had almost 15 bp of easing discounted by the end of H1 24. At the end of December almost 56 bp of easing was priced into the swaps curve in H1. The yield on the UK's two-year note fell by a little more than 60 bp last month to slip below 4%.

The year-end rally lifted the euro from around $1.0725 on December 8 to almost $1.1140 on December 28. It frayed the upper Bollinger Band. The stretched momentum indicators look poised to turn lower. The euro has been sold to slightly through $1.10 in the European morning. Initial support is likely near $1.0980, and a break could spur a move toward $1.0920-30. Sterling poked slightly above $1.2825 last week, its best level in four months. The high, which pushed through the upper Bollinger Band, was not confirmed with new highs in the momentum indicators. A base seemed to have been forged in the holiday markets since Christmas near $1.2685. It is probing the $1.27 area in Europe. There looks to be near-term potential toward $1.2625-50.

America

The futures market is pricing in nearly three quarter-point rate cuts by the Federal Reserve by the end of the first half. At the end of Q3 23, about 13 bp of easing was discounted. About half the adjustment was seen in October and November, and the other half in December. One would think the sky is falling, but no. The Atlanta Fed will update its tracker today. As of December 22, it put Q4 GDP at 2.3% annualized, which is somewhat faster than the Fed thinks is the non-inflationary speed limit of the economy (1.8%). A case can be made for a higher threshold as productivity alone has averaged 1.6% for the past 10 and 20 years. The labor force is growing by about 0.5%. That puts this simple model estimate of the non-inflationary speed limit to be a little more than 2%. In any event, the data highlight of this holiday-shortened week will be the auto sales report, which speaks to demand and the December jobs report. Nonfarm payrolls are seen rising by 170k. The unemployment rate may tick up to 3.8% from 3.7%. A 0.3% rise in average hourly earnings would see the year-over-year pace slip to below 4% for the first time since mid-2021.

Canada also reports its December employment data at the end of the week. Its labor market growth appears to be slowing faster than in the US. The US dollar recorded the year's high against the Canadian dollar on November 1 near CAD1.39. A base may have formed last week around CAD1.3175. The momentum indicators are stretched and look set to turn up. The greenback has risen to about CAD1.3260 so far today. A move above CAD1.3280 could signal corrective gains toward CAD1.3350, and possibly CAD1.3400. We had suggested that the Mexican peso was an attractive place to park funds ahead of the holiday season. Last month, between the spot appreciation and carry, the peso returned above 3.35%. The US dollar finished November near MXN17.3850 and saw almost MXN16.86 last week. The peso is trading about 0.25% higher today, making it among the strongest emerging market currencies today. Yet, we suspect it is vulnerable to a dollar recovery and see near-term potential extending back into the MXN17.00 area. Mexico reports November worker remittances today, the IMEF December surveys, and sees the S&P manufacturing PMI. The Mexican economy appears to be slowing, and will moderating price pressures, the swaps market favors a rate cut in Q1 24.