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

[PocketOption]

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

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. 

  

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