Chinese authorities are suggesting that they intend to catch up with the time lost during the zero-COVID experiment by buoying consumption, and the direct beneficiaries of higher Chinese demand are celebrating.
Commodity currencies, like the Australian, New Zealand and Canadian dollars were the best performing G10 currencies last week, while the rest of them traded in narrow ranges. Latin American currencies continue to shine, and all of the majors are up sharply against the dollar so far in 2023, led by the Brazilian real and the Colombian and Chilean pesos, as investors flock to commodity producing economies.
Focus this week will be almost entirely on central bank meetings. The Federal Reserve leads the way
Wednesday, with the European Central Bank and the Bank of England following suit the next day. Markets
expect a downshift in Fed tightening to 25bps, while the ECB and BoE are forced to hike by 50bs due to the lack of any downward trend in core inflation in either economic area. The ECB meeting will be preceded by the Eurozone flash inflation report for January, which is unlikely to show a meaningful easing of core inflation pressures, in contrast with the clear downtrend we are seeing in the US. All in all, expect a volatile week of currency trading.
A spate of uncharacteristically poor macroeconomic data dragged sterling down last week. The PMIs of
business activity for January underperformed expectations, largely due to weakness in the UK’s key services sector. Moves in the pound were, however, relatively modest under the circumstances, and all eyes are now on the Bank of England meeting on Thursday. The MPC appears to have executed the latest of many turnarounds in mindset in this hiking cycle, and seems to be leaning towards hawkishness, as data hold up better than expected and core inflation pressures refuse to go
A 50bp hike is expected, but the reaction in sterling will be highly dependent on the voting split among committee members, the updated economic projections and guidance for the next meeting. Another three-way split vote appears highly likely, although we expect a few more dovish dissenters than at the December meeting.
The Eurozone PMIs of business activity jumped sharply in January and are now consistent with modest
expansion, confirming that the Eurozone is unlikely to enter a recession any time soon. This will enable the ECB to focus squarely on the inflation issue at its meeting on Thursday. A 50bp hike is universally expected, but the key will be the guidance for the next meeting. A clear dove-hawk split has developed among council members, across the national lines as one would expect, but we think that the hawks will carry the day and another 50bp hike in March will be signalled by President Lagarde.
With Federal Reserve official communications restricted by the blackout period before next week’s meeting, attention in the US was mostly focused on the PCE inflation report. Since this came in line with expectations and the earlier CPI report, the US dollar traded mostly off of news elsewhere. Interest rates were mostly flat, and risk assets continued their 2023 rally.
With a 25bp hike universally expected, the key to the Fed meeting next week will be Powell’s communications during the post-meeting press conference. The economy has given mixed signals lately, but with jobless claims near an all-time low, and little sign that job market tightness is easing, we expect Chair Powell to suggest that terminal rates will be at or above 5%. However, the positive trend in inflation means that the Fed will be able to adopt a wait-and-see attitude very soon, unlike its counterparts across the Atlantic.
In line with our expectations, the Bank of Canada signaled a pause to its hiking cycle following its policy
meeting last week. Rates were raised by another 25bps, though the bank explicitly noted that it plans to hold the policy rate at current levels. In its communications, the BoC attempted to sound as hawkish as possible, although we believe that this was largely an attempt to calm the market reaction, rather than signal additional hikes may be on the way. Canadian inflation has eased markedly, and the BoC has revised lower both its
inflation and growth projections, which limits room for additional tightening.
CAD held up rather well last week, despite the dovish pivot, and managed to rally against the US dollar amid optimism over higher global commodity demand. November GDP data (Tuesday) runs on a lag, so we don’t expect too much volatility around its release. The monthly manufacturing PMI on Wednesday will also likely be overlooked in favor of the Fed’s latest policy announcement on the same day.