Can the US CPI Break the Dollar out of its Consolidation?

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Overview: Stocks and bonds are trading higher, and the dollar is narrowly mixed ahead of the December US CPI report. Most of the large bourses in Asia Pacific advanced, led by Japan to new 30-year-plus highs. Hong Kong's Hang Seng snapped seven-day slide to post its first gain of 2024. Europe's Stoxx 600 is up about 0.33%, to recoup most of its losses in the past two sessions. US index futures enjoy a modest upside bias. Benchmark 10-year yields in Europe are off 3-6 bp, with the peripheral premiums narrowing slightly. The 10-year US Treasury yield is off four basis points to slightly below 3.99%. The yield has remained in the range set after last Friday's jobs report and soft ISM services (~3.95%-4.10%). The futures market has about a 70% chance of that the first Fed cut is delivered in March. 

The dollar's broad consolidative tone has continued into today. It is sporting a slightly softer profile against the G10 currencies. Of note, after surging against the yen yesterday, the dollar has stalled today. The euro and sterling edged a little higher before being sold in early European turnover, where they have steadied. Emerging market currencies are mixed, but central and eastern European currencies are underperforming. The South Korean won, and Philippine peso are recovering from their recent declines. Gold is trading quietly and remains within the range set on Monday (~$2017-$2047). February WTI is inside yesterday's range (~$71-$73.60) and remains within the range set on Monday as well.  

Asia Pacific 

China will report December CPI and PPI tomorrow. 

The deflationary forces are seen easing slightly. In November, consumer prices were 0.5% lower than a year ago. The CPI is expected to have finished last year at -0.4%. The risk is that the smaller decline in pork prices and gains in fresh produce prices produces less deflation. Excluding food and energy prices, the core CPI may be little changed around 0.6% year-over-year, where was in October and November. Producer prices have been falling on a year-over-year basis since October 2022. Downside pressure has eased since the middle of last year when the PPI was -5.4% year-over-year. The PPI was -3.0% in November and may have moderated.

Australia's November goods trade surplus jumped to A$11.4 bln (from A$7.7 bln) to $7.3 bln in October. It was than 50% higher than expectations and is the largest surplus since March. the goods surplus fell last year. Through November, the average monthly surplus was about A$10.1 bln. In the first 11 months in 2022 the average trade surplus was A$11.5 bln. Still, it is well above the A$5.77 bln average in the Jan-Nov 2019 period pre-Covid. Exports have fallen on average 0.6% a month in through November last year. They rose by an average of 1.1% a month in 2022. These figures are by value not volume, so they are reflective of price changes as well as volumes. Australia's good imports plunged by 7.9% in November and are off an average of 0.2% a month through November. In 2022, imports rose an average of 1.0% a month. Exports of coal, coke and briquettes rose by almost 7%, likely reflected Chinese demand. The decline in imports appears to reflect consumer goods, which may speak to weakening domestic demand. 

The dollar extended its gains in the North American session to almost JPY145.85 but is holding below it today. Recall that the high set after last Friday's jobs report was near JPY146.00. That area also corresponds to the (50%) retracement of the greenback's slide from the high set in the middle of November (~JPY151.90). Above there, the next retracement (61.8%) is slightly below JPY147.50. The Australian dollar is more typical of the consolidation seen in the foreign exchange market this week. It remains well within the range set before last weekend (~$0.6650-$0.6750). It has found support this week around $0.6680. It has not traded above $0.6735. The Chinese yuan is snapping a three-day decline to post minor gains. The dollar opened lower and fell to almost CNY7.1550 before finding bids that lifted it back toward CNY7.1635. The dollar's reference rate was set at CNY7.1087 (CNY7.1055 on Wednesday). The average in Bloomberg's survey was CNY7.1696 (CNY7.1625 previously). The gap is among the largest in recent weeks.

Europe

Recent news that European Council President Michel will leave his post early if he is elected to the European Parliament has renewed speculation about the European Commission. 

There has been talk for several months that former ECB President Draghi is keen. The current head of the European Commission von der Leyen is thought to be interested in a second term, though there also had been some talk of interest in NATO. Michel's term ends in November. If he wins a seat in the European Parliament, he would like to resign in July. After the election, there is much deal making to form the new European Commission and a few other senior posts. In that melee the follows the European parliament election deals are struck and that could involve a replacement for Michel. If that fails, the role could be filled by Hungary's Prime Minister Orban, which holds the rotating six-month EU presidency in H2 24.

The UK reports November GDP figures early tomorrow. The economy appears to have recovered after contracting by 0.3% in October. Next week's employment and inflation report will likely have bigger impact on sterling, rates, and expectation for the Bank of England. The Bank of England meets next on February 1. There is practically no chance of a move. The swaps market has about a 72% chance of a cut in May and has nearly about 1 1/2 cuts (~37 bp) priced in for the end of H1. For the entire year, the swaps market is discounting about 120 bp of cuts.

The euro has not ventured outside of the range set last Friday (~$1.0875-$1.1000), though it did make a new high for the week in early Asia Pacific turnover near $1.0990. However, sellers knocked it down to $1.0960, where it has found support in the European morning. There are options for about 1.5 bln euros struck at $1.10 that expire tomorrow. A trendline connecting the November and December lows caught last Friday's low. The trendline is slightly above $1.09 today and rises to about $1.0945 by the end of next week. Sterling, too, has remained mired in last Friday's range (~$1.2610-$1.2770). It was nicked earlier today, with sterling rising to almost $1.2775 before being sold to $1.2735 in early European turnover. Options for GBP430 mln at $1.2790 expire today. Sterling has not settled above $1.28 since the end of last July.

America

The US CPI has become among the most important high-frequency data points. The Fed targets the PCE deflator, which is considerably more predictable after the CPI report, which Fed Chair Powell cited during the tightening cycle that ended last year. There is not just a debate about what inflation will do this year, but there is disagreement about what drove prices higher in the first place. Most observers seem to agree on drivers but disagree on the weight of them individually (such as supply chain disruptions, "excessive" demand, and money printing), the role of central bank policy and the tightening of financial conditions.

The market is looking for a 0.2% rise in the December US CPI. That would translate into a 1.2% annualized rate in Q4 23. It would match the lowest quarterly pace since Q2 20. However, given the base effect (a 0.1% rise in December 2022), the headline rate may edge higher (3.2% vs. 3.1%). The year-over-year rate bottomed at 3.0% in June 2023 but making some conservative assumptions could be around 2.5% in February. The core rate continues to be stickier. The anticipated 0.3% increase in December would mean a 3.2% annualized pace in Q4, the same as in Q3. Given the base effect, the year-over-rate is likely to continue to trend lower through the most of H1 24. The year-over-year rate is expected to have slipped below 4% for the first time May 2021. The core rate may ease toward 3.5% by mid-year. Of course, there are other ways to slice and dice the CPI, but they seem to tell the same general story. Price pressures have eased, faster than expected, and there is scope for further moderation in the coming months.

The US dollar has frayed the upper end of last Friday's range against the Canadian dollar (~CAD1.3400), but it has not settled above there. Still, it knocks on it, and the greenback bulls have not given up on it. A break could spur a move toward CAD1.3445-80. It holds the next retracement objective, a chunk option that expires tomorrow for about $700 mln (CAD1.3445), and the 200-day moving average. Initial support may be a little below CAD1.3350. The greenback has recovered since setting a four-month low on Monday against the Mexican peso (~MXN16.7850). Yesterday, it approached the 20-day moving average (~MXN17.03), which it has not settled above in a month. Last week's high was slightly above MXN17.10. We assume that the $580 mln options at MXN17.00 that expire today have been neutralized, but there is another stack at MXN17.05 for almost $700 mln that also expire today. Mexico reports November industrial production today. The median forecast in Bloomberg's survey is for a 0.2% rise after October's 0.6% gain. The average monthly gain through October was 0.40%. In the comparable 2022 period, Mexico industrial output rose by an average of 0.35%.

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