Week Ahead: Attention Turns Back to Inflation

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Marc Chandler
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The terribly mixed US jobs report spurred dramatic intraday swings in exchange and US interest rates. But at the close, the dollar was little changed against most major currencies, and expectations for Fed policy was nearly unchanged. The futures market has about a 70% chance of a cut at the March meeting. The Dollar Index was off by less than 0.1%. Job growth held up better than expected in December, the unemployment rate held steady, and average wages rose slightly more than expected. However, there were again downward revisions to past job growth (-71k), the participation rate fell to 62.5% (from 62.8%), and the work week slipped (34.3 hours from 34.4 hours). There is little doubt that the labor market is slowing. Job growth in Q4 23 averaged 165k, the lowest since the post-Covid expansion began. On the heels of the jobs report was the ISM services index which was considerably weaker than expected driven by the employment component (43.3 vs. 50.7), the lowest since mid-2020.

The focus turns to inflation. In the coming days, the world's three-largest economies, the US, China, and Japan will report inflation measures. In the US, the market will likely look through a tick up in the headline CPI and focus on what is expected to be additional slippage in the core rate. Tokyo's headline and core rates are seen continuing to ease and that will underscore the lack of pressure on the BOJ, especially in the aftermath of the recent earthquake, to change policy. China is expected to report slightly less deflation than in November. Still, the economy needs more support and a cut in the benchmark one-year Medium Term Lending Facility later this month seems increasingly likely. Australia's month CPI print for November is expected to show inflation moderating to 4.5% year-over-year, down from 8.4% at the end of 2022. The futures market does not have the first RBA cut fully discounted until August. Lastly, Mexico's headline CPI may tick up in December but provided that the core rate ticks down, market expectations for a rate cut in Q1 will likely remain intact. 

United States:  The most important high-frequency data point in the coming days is the US December CPI. The median forecast is the headline and core rates to rise by 0.2% month-over-month. Due to the base effect, the year-over-year rates will continue to converge. The headline rate is expected to tick up to 3.2% from 3.1%, while the core rate is seen slowing to 3.8% from 4.0%. A 0.2% rise in headline CPI means that in Q4 23, CPI rose an annualized pace of about 1.2%, down from 4.8% in Q3 23 and 2.8% in Q2 23. The 0.2% rise expected in the core rate translates into a 2.8% annualized rate. Core CPI rose at an annualized pace of 3.0% in Q3 23 and 4.0% in Q2 23. Other data releases include December PPI, where disinflation conditions persist. Due to the base effect, the 0.2% rise in headline producer prices will lift the year-over-year rate to about 1.4% from 0.9%, but at an annualized rate producer prices likely fell in Q4 23. Core producer prices may have risen for the first time since September and a 0.2% increase will keep the year-over-year rate stable at 2.0%. The US also reports the December budget deficit. In the first 11 months of 2023, the US recorded an average monthly shortfall of about $150.4 bln compared with a $121.3 bln average monthly deficit in the January-November period in 2022.

The Dollar Index extended its gains after the stronger than expected jobs and earnings growth. It met the (61.8%) retracement target of the losses seen since the last employment data near 102.90 and stalled near 103.10. The details of the jobs report including hours worked and a poor household survey, coupled with a disappointing ISM services report saw the Dollar Index give back the session’s gains. Support was found around 101.90. Despite trading in range that engulfed the previous day's range, the close was neutral, practically unchanged on the day. Near-term consolidation looks the most likely scenario. 

China: The soft PMI readings mean that the world's second-largest economy is not mustering the strength to lift prices. Yet, this conventional interpretation does not do justice to the fact that food prices, and especially pork prices, are largely responsible for the negative CPI readings. Bloomberg's economists estimate that food prices took 0.8% off headline CPI, pushing it to -0.5% in November. Service prices increased by 0.4% year-over-year. Demand is soft but it is not collapsing. Indeed, China reported that retail sales rose by 7.2% year-over-year in the year through November. Fixed asset investment rose 2.9% in the same period. Chinese producer prices have been falling on a year-over-year basis since October 2022. Recall that Chinese producer prices were falling on a year-over-year basis in H2 19, before Covid struck. Deflationary pressures may have eased slightly in December. Nevertheless, we think there is a reasonably good chance that the PBOC cuts its benchmark one-year Medium-Term Lending Facility rate on January 15 by 10-20 bp. China also reports December lending figures and new house prices. New house prices rose in the first few months of 2023, which stemmed a decline that began in September 2021. However, the decline did not just resume but in the six-months through November, house prices fell by 1.62%, the fastest in any six-month period since the slump began. China will also report its December trade figures. In dollar terms, China's trade surplus fell by almost 3% in the first 11 months of 2023, but in yuan terms, it rose by nearly as much. Trade tensions between the US, Europe, and China may deepen and broaden in the coming months. However, the "de-risking" and diversifying away from China may have unintended consequences. The US has replaced China, for example, for the first time in two decades, as the biggest destination of South Korean exports.

Before the weekend, the dollar closed the old gap from mid-December that extended to almost CNY7.1710. The post-US jobs data dollar pullback pushed it briefly below CNY7.14. With falling stocks, the PBOC may have tried to slow the dollar's rise. The broad range seems to be CNY7.10-CNY7.20 and is has been largely in the range since late November. 

Japan:   Tokyo's CPI has proven to be a reliable and early read on national price patterns. The December reading is due January 9. Headline Tokyo inflation stood at 2.7% in November, the lowest since July 22. The core rate, which is targeted at 2%, excludes fresh food, slowed to 2.3% in November, matching the lowest since mid-2022. Services prices are firm and processed food prices have been a significant source of price pressures. Government subsidies for electricity and gas are estimated to shave 0.5% off headline inflation nationwide and will continue until the end of April. Most economists look the negative policy rate (-0.10%) to be abandoned in April, but some still hold out the possibility of the shift at BOJ meeting at the end of the month. Japan will also report November household spending and labor earnings. Household spending in Japan is chronically weak and it does not receive nearly the attention of China's consumption. On a GDP basis, Japanese consumption contracted in the middle two quarters of 2023. Household spending fell on a year-over-year basis in the first ten months of 2023 but February. It is expected to have fallen by 2.2% year-over-year in November. The recent decline began in November 2022. However, note household consumption fell on a year-over-year basis in the last three months of 2019, before Covid and it fell in three of the last four months of 2018. Through October, labor cash earnings rose an average of 1.3% over 2022, down from 1.5% in the 10-months through October 2022. Adjust for inflation, real labor earnings have been falling on a year-over-year basis since April 2022. Note that real labor earnings were negative even before the Covid-era inflation increase. In 2019, real labor earnings fell on a year-over-year basis every month but September. 

The greenback shot up from around JPY140.80 in the last week of December and peaked near JPY146 shortly after the US jobs report. The high was slightly shy of the (50%) retracement objective from last year's high set in mid-November of almost JPY152. The dollar reversed sharply lower as participants focused on the weaker details of the jobs data and a poor ISM services report. It fell to almost JPY143.80. before settling little changed (~JPY144.70). The five-day moving average crossed above the 20-day moving average for the first time since mid-November. Still, consolidation may be in order between JPY143.50-JPY146.

Eurozone: The eurozone sees November retail sales and unemployment reports in the coming days. These are not typically market moving data points and are unlikely to impact rate expectations. Eurozone retail sales fell each month in Q3 23 before edging up by 0.1% in October. The broader measures, household consumption, fell by 0.4% in Q3 23. Although consumption is expected to have bounced back in Q4 23, the median forecast in Bloomberg's survey is that in aggregate the regional economy likely contracted by 0.1%. National reports from Germany (trade, factory orders, and industrial production) and France (trade, industrial production, and consumer spending) will help economists fine-tune GDP forecasts. Separately, the eurozone's unemployment is bright spot in the otherwise desert of constructive economic data. The unemployment rate has been bouncing between 6.5% and 6.7% since May 2022. At the end of 2019 and early 2020, before Covid, the unemployment rate was 7.5%.

The euro met the (61.8%) retracement objective of its rally from the December 8 low (~$1.0885) initial reaction to the US jobs data before rebounding smartly to almost $1.10 before settling little change around $1.0950. Near-term consolidation may be likely as short-term participants collect their wits after being shaken by the dramatic price action before the weekend. The five-day moving average crossed below the 20-day moving average, and the euro closed below both. This coupled with the falling momentum indicators, suggests the downside correction may not be over.

United Kingdom: A quiet week for British economic news ends on Friday with the November GDP and details. Recall that the UK economy contracted by 0.1% in Q3, mostly due to a sharp contraction in next exports. The economy is off to a poor start in Q4, contracting by 0.3% in October (median forecast in Bloomberg's survey was for a 0.1% decline). The economy has not contracted in back-to-back months since the early days of Covid. In October, industrial production, services output, and construction activity contracted. The trade deficit widened sharply (GBP4.48 bln vs. GBP1.57 bln deficit in September). The median forecast in Bloomberg's survey sees a flat Q4 23 GDP, which implies some better number in November and December.

Sterling traded the entire week's range ahead of the weekend. It initially fell to almost $1.2610 before reversing higher to reach $1.2770. It was the strongest G10 currency on Friday, gaining about 0.3% against the dollar. It will begin the new week with a three-day advance in tow. With one exception (December 29), sterling has been in a $1.26-$1.28 range since December 14. In the options market, the one-week risk-reversal swung from favoring sterling calls in the last week of 2023 to favor puts. The five-day moving average did slip below the 20-day moving average. Still, prudence would suggest assuming the range hold until it proves wrong. 

Canada: The chief high-frequency report in the coming days is Canada's merchandise trade balance (January 9). Canada has experienced a sharp deterioration in its trade balance in 2023. In the first ten months of the year, it reported a merchandise trade deficit of C$1.5 bln. Small beer, but it had recorded a C$19.3 bln surplus in the January-October 2022 period. Not only has the merchandise trade surplus practically disappeared, but on a net basis, foreign portfolio inflows have nearly dried up. In the first ten months of 2023, net foreign purchases of Canada's bonds and stocks fell to about C$5.2 bln from C$104 bln in the same period in 2022.

The optics of Canada's employment report were weaker than the US, but the greenback's volatility drove the exchange rate. The recovery off the lows from last year (~CAD1.3175) extended to CAD1.3400. The sell-off carried it slightly below CAD1.3290 before buyers stepped in and the US dollar returned to almost CAD1.3375. The disappointing Canadian job growth in December was seemingly offset by the increase in wages, leaving the odds of a cut near 30% (vs. ~70% chance of a Fed cut). Nevertheless, the greenback's upside correction does not look over. A break of CAD1.3400 could signal CAD1.3480-CAD1.3500, which houses the 200-day moving average and (50%) retracement of the November-December slide.

Australia:   Australia reports November retail sales, CPI, and trade in the days ahead. November retail sales likely bounced back after the unexpected 0.2% decline in October. Australia's trade balance deteriorated. The surplus has fallen to A$99.7 bln in the first ten months of 2023 from A$114.4 bln in the Jan-Oct 2022 period. Exports have fallen by an average of 0.8% a month while imports have risen by an average of 0.7%. Australia's monthly CPI rose by 4.9% year-over-year in October, down from 5.6% in September and 7.0% in October 2022. It matches the lowest reading since January 2022. The fact that the RBA was not as aggressive as most other G10 central banks, leaving aside Japan, in 2023, the stickiness of its inflation contributes to the market looking for considerably less aggressive easing in 2024.

The Australian dollar was offered, and the US jobs reports saw it spike down to almost $0.6640. It met the (38.2%) retracement of the gains from last year's low set in late October and the (61.8%) retracement of the leg up from the last US employment data. Both were found slightly above $0.6655. The momentum indicators are still falling, and the five-day moving average is poised to fall below the 20-day moving average at the start of next week. A period of consolidation is likely, and we know that initial support is around the pre-weekend low. A break of targets the $0.6580 area. On the topside, a move above $0.6760-85 likely signal the end to the downside correction.

Mexico:  The most important data point from Mexico in the coming days is the November CPI on January 9. Mexico's inflation has been slowly moderating. However, given the base effect (last December's 0.38% increase) and no month in H2 23 was below it, the risk is that the headline measure ticks up for the second consecutive month. It would be the first back-to-back increase since December 2022/January 2023. In recent comments, a few of the central bankers seemed to have put more weight on the core measure, and here the base effect (0.65% rise in December 2022) allows an extension of the downtrend. The year-over-year core measure has fallen since January 2023 (8.45%) to stand at 5.3% in November. The bi-weekly core measure was at 5.2% in mid-December. Mexico also reports November industrial production. It rose 0.6% in October, led by a 1.1% rise in manufacturing output. Vehicle output fell by slightly more than 12% in November, and the surveys were mixed (manufacturing PMI edged up, while the IMEF manufacturing survey slipped by most since March). The swaps market is fully pricing in a rate cut in the first quarter.

The peso was one of the few currencies in the world to have risen against the dollar last week (the Hungarian forint and Indian rupee were the others). The big move took place after the US jobs data. The peso rose by about 0.6% before the weekend. It had been up about 0.2% going into the US jobs report before the weekend. The greenback stalled in the middle of last week near MXN17.1035, seen before Christmas. It fell to slightly below MXN16.87 before the weekend to approach the four-month low from the end of last year (~MXN16.8615). Last year's low (set in late July) was about MXN16.6260. The momentum indicators are mixed, and the dollar has fallen for the past three sessions. We had thought the US dollar was carving out a bottoming pattern, but this seems to less sure now, but the dollar looks technically more vulnerable now.