USD strength fades despite doubts over FOMC March cut

USD: Stronger CPI but disinflation trend likely intact

The US dollar initially advanced yesterday in response to the US CPI data for December and the passing of time increases the urgency of validating with economic data the market pricing of the rate cutting cycle commencing in March. The data was stronger than expected but in our view it was not a data set that will prove enough to alter the current consensus of the trend of disinflation continuing. This was reflected in the FX markets by the full retracement of the initial US dollar strength, helped in part also by Fed official comments.

After a sustained period of disinflation for a number of elements of inflation, it was inevitable that we would arrive at a point when that fades, at least for a period. We may have arrived at that point although there is still plenty of reason to think further disinflation lies ahead. The three key takeaways from the data are that core goods inflation remains weak (unch m/m in Dec after 6mths of declines); rent inflation remains elevated; and ‘supercore’ has picked up a bit. On the latter point this of itself becomes less of an issue if the rent inflation starts to turn. ‘Supercore’ CPI – core services, excluding shelter – amounts to about 25% of the basket – not insignificant, but if/when rent inflation turns more notably lower, the markets aren’t likely to give the ‘supercore’ CPI gauge as much focus.

So it really is about the rent inflation component and this remaining elevated is reducing the scope for further disinflation. OER makes up 75% of the ‘Rent of Shelter’ component and as you can see above has begun to decelerate in line with the actual rental inflation backdrop as measured by Zillow. It’s a slow process but it is pretty clear that this component will see considerable further disinflation this year. Highlighting this elevated rent inflation issue is the core CPI, ex-shelter measures. Both the 3mth and 6mth annualised measures picked up in December (1.5% to 2.0% & 1.2% to 1.6% respectively) but remain at levels consistent with price stability.

The outlook is also favourable based on simple base effect calculations. The core CPI MoM rate over the first five months of 2023 came in at 0.5% in Feb and 0.4% in the other four months over that period – so the bar is high for the YoY rate accelerating through most of the first half of this year. With shelter disinflation, MoM rates matching the levels in 2023 seems very unlikely. PPI data today will help shape expectations for the core PCE inflation reading but with housing/rents a smaller weighting, the PCE MoM reading should be more subdued.

Market participants seem to have focused on these aspects as well. The 2yr UST bond yield down about 4bps yesterday while the 10yr was unchanged. The OIS implied probability for the March meeting didn’t change much, and is at 18%. But from an FX perspective, we likely will not need US yields to jump as the US dollar sell-off into the end of last year was overdone relative to rates and hence a status-quo scenario in yields will at some point provide scope for the dollar to advance modestly from here.

US CPI OWNER EQUIVALENT RENTS YOY CHANGE VERSUS ACTUAL RENT YOY CHANGE – MORE DISINFLATION TO COME FROM RENTS

Source: Macrobond & Bloomberg

USD: US & UK attack on Houthis underline likely Fed caution

One of the key geopolitical risks for the year ahead is the risk of the Israel-Hamas conflict escalating throughout the Middle East and last night’s attacks by the US and the UK on Houthi rebel targets in Yemen will certainly intensify those risks. Predictably, the crude oil market is where we have seen immediate reaction with Brent crude oil up over 2.0% in response. President Biden justified the attacks based on Houthis attacks in the Red Sea endangering lives, jeopardizing trade and the freedom of navigation. The attacks were specifically aimed at where these Red Sea attacks come from and President Biden confirmed that he would direct further measures “to protect our people and free flow of international commerce” when necessary.

Iran was quick to condemn the US and the UK stating it was a breach of international law. The Houthi rebels were also quick to state that attacks on vessels will continue. Iran has also become more active in attacking or ceasing ships as well with Iran confirming it ceased an oil tanker off the coast of Oman while the US navy acknowledged an attack (“by a one-way Iranian drone”) a few days earlier on a ship some distance away in the Indian Ocean suggesting a potential wider campaign of disruption.

At this juncture a further escalation seems more likely than not which will extend the time of ships avoiding the Red Sea and add a further risk premium to crude oil prices. It seems a difficult backdrop for the Fed to shift its rhetoric in order to provide guidance on a possible Fed rate cut in March. The next FOMC meeting on 31^st January will be a difficult platform for the Fed to communicate any change in stance ahead of March if elevated geopolitical risks in the Red Sea region are raising concerns over supply disruption and energy prices feeding into higher inflation.

WORLD CONTAINER FREIGHT INDEX – RED SEA DISRUPTIONS STARTING TO HAVE AN IMPACT ON PRICE

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
CH	10:00	M2 Money Stock (YoY)	--	10.1%	10.0%	!
CH	10:00	New Loans	--	1,400.0B	1,090.0B	!!
CH	10:00	Outstanding Loan Growth (YoY)	--	10.8%	10.8%	!
CH	10:00	Chinese Total Social Financing	--	2,200.0B	2,450.0B	!
CA	11:00	Leading Index (MoM)	Dec	--	-0.01%	!
EC	12:30	ECB's Lane Speaks	--	--	--	!!!
UK	13:00	NIESR Monthly GDP Tracker	--	--	-0.1%	!!
US	13:30	Core PPI (MoM)	Dec	0.2%	0.0%	!!
US	13:30	Core PPI (YoY)	Dec	1.9%	2.0%	!
US	13:30	PPI ex. Food/Energy/Transport (MoM)	Dec	--	0.1%	!
US	13:30	PPI (MoM)	Dec	0.1%	0.0%	!!
US	13:30	PPI ex. Food/Energy/Transport (YoY)	Dec	--	2.5%	!
US	13:30	PPI (YoY)	Dec	1.3%	0.9%	!
US	15:00	FOMC Member Kashkari Speaks	--	--	--	!!

Source: Bloomberg