USD drifts lower again with no fresh catalyst

USD: Momentum helping to extend dollar depreciation

After the dollar rebounded at the end of last week and stabilised on Monday, renewed selling took hold yesterday as the push-back rhetoric from the Federal Reserve after last week’s slide failed to have much impact on yields. Friday’s bounce in the 2-year UST bond yield has failed to extend while the 10-year yield remained close to the lows recorded last week. The reality for the Fed is that pushing back on the idea of rate cuts will prove difficult if the inflation readings continue to fall faster than expected. If that was to be the case, investors would increasingly fear the Fed has over-tightened and that will act to depress yields further. For now it would appear, rhetoric from the Fed on pushing back on the idea of say a March rate cut will only get investors to act if there is the data to back it up. Housing starts data from the US yesterday was much stronger than expected, gaining 14.8% m/m, only the third time post-pandemic that there has been a gain of such magnitude. Fed President Bullard also gave some clear views, pushing back on a March rate cut arguing (with some logic we think) that there simply will not be enough available information by the time of the March meeting to cut rates. Bullard argued that taking that first step is crucial as once that step is taken it is more difficult to reverse it if deemed afterwards to have been premature. So more time and information is required before cutting for the first time. He estimated a cut by mid-year was more plausible. Fed President Barkin also spoke and concurred that rate cuts will be possible if inflation progress continues. He was less explicit on the timing but expressed his view that inflation could prove more stubborn in moving fully back to target than now assumed.

The US dollar sell-off was certainly helped by the communications from the RBA yesterday with the minutes from the meeting on 5^th December highlighting a rate hike remains a close call with demand-driven inflation increasingly adding to the risk that inflation would not return to target in a timely manner. If you consider what has unfolded globally and in the financial markets in Australia since then, the risks of another hike have surely risen. The 2-year yield is 10bps lower, the 10-year is 30bps lower and the equity market is 6% higher! The OIS pricing is marginally biased to rate cuts in Q1 next year which seems excessive given the RBA risks. In Canada yesterday the inflation data was also stronger than expected, helping CAD strengthen versus USD.

The US PCE inflation data on Friday remains the key piece of data and really the final key data of the year and an upside surprise is required in order to give the Fed’s push-back attempts a bit more credibility. If an upside surprise does not materialise, it will be difficult for the Fed to thwart expectations of a March rate cut which will reinforce the dollar selling momentum, possibly through the quiet holiday period and into the start of 2024.

IT’S HARD FOR THE FED TO PUSH BACK MARKET EXPECTATIONS WHEN CORE PCE INFLATION CLOSE TO AVERAGE SINCE 1990 & 2% TARGET

Source: Macrobond

GBP: Inflation downside surprise as the UK follows

The dollar is performing better today after GBP just lurched lower in response to the much weaker than expected inflation data from the UK. The rhetoric from the BoE this week has been understandably far more cautious and indicated much greater concerns over the inflation backdrop in the UK. However, the sharp drop in the YoY headline CPI rate from 4.6% to 3.9% (expected 4.3%) in November will be very welcomed by the BoE. The weakness looks broad-based as well with the core YoY rate 0.5ppt weaker than expected at 5.1%, down from 5.7%, helped by weaker services CPI which fell from 6.6% to 6.3% - the market expected it to remain unchanged.

The data is now starting to come in much weaker than the BoE assumed in its latest inflation forecasts published on 2^nd November. The BoE estimated inflation at 4.8% in October and 4.6% in November so this is by far the biggest undershoot relative to BoE forecasts since the global inflation shock began to unfold in 2021.

The broad-based nature of the slowing in inflation is what really stands out in the November data. There were notable MoM declines to help fuel the slowing in YoY rates. Seven of the twelve categories recorded MoM declines with Transport the largest decliner, down 1.7%. Two further categories were unchanged with only three recording gains – Food & Non-Alcoholic Beverages; Housing & Household Services; and Restaurant & Hotels.

The ONS stated that the main driver of the decline in YoY inflation – reflected in transport costs – was the decrease in fuel prices after an increase in the same month last year while food prices increased at a much slower pace than a year ago. There were also price declines for a range of household goods and the cost of second-hand cars.

No doubt the BoE still has plenty of reason not to jump the gun and shift their rhetoric suddenly. The services inflation reading of 6.3% is still far too high and some news on wages this week were less favourable than today’s CPI print. Data from research group XpertHR, reported in the Financial Times, revealed a median basic pay award increase of 6.0% in the three months to November. Another research group, IDR, also reported a pay increase of at least 5% for staff in 2024.

New BoE Deputy Governor Breeden gave her first speech yesterday and appears well aligned with the ‘higher for longer’ mantra of the BoE, expressing concern over wage growth being “several percentage points” above where it should be. All that said, the scale of the downside surprise in today’s CPI will likely prove telling, possibly not immediately, but as we proceed through Q1 next year. Before today, the OIS market implied the first rate cut would be in June. That is likely to be brought forward now and lower yields will keep GBP pressured to the downside for now. The market view of divergence of the BoE relative to the Fed and the ECB has been undermined by this CPI report but wages will need to show some big downside surprises too to prompt a big dovish shift from the BoE.

3MTH & 6MTH ANNUALISED SERVICES INFLATION IS FALLING SHARPLY

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	Current Account	Oct	27.0B	31.2B	!
UK	09:30	House Price Index (YoY)	--	0.0%	-0.1%	!
EC	10:00	Construction Output (MoM)	Oct	--	0.45%	!
US	12:00	MBA Mortgage Applications (WoW)	--	--	7.4%	!
US	13:30	Current Account	Q3	-197.0B	-212.1B	!!
SZ	14:00	SNB Quarterly Bulletin	--	--	--	!
EC	14:00	ECB's Lane Speaks	--	--	--	!!!
US	15:00	CB Consumer Confidence	Dec	103.8	102.0	!!!
US	15:00	Existing Home Sales	Nov	3.78M	3.79M	!!
US	15:00	Existing Home Sales (MoM)	Nov	--	-4.1%	!!
EC	15:00	Consumer Confidence	Dec	-16.5	-16.9	!
US	18:00	20-Year Bond Auction	--	--	4.780%	!!
CA	18:30	BOC Summary of Deliberations	--	--	--	!!

 

Source: Bloomberg