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Caution Prevails, Keeping Currencies Rangebound

The dollar is performing in a mixed manner relative to its major rivals this morning as risk appetite fades amid a lack of definitive trading narratives.

Investors are taking dovish comments from the Bank of Portugal’s Governor with a huge helping of salt. The euro-dollar exchange rate remained effectively unchanged after Mario Centeno told an interviewer “I don’t think we have to wait until May” to make a decision on cutting rates, “I don’t see any sign that second-round effects on wages have materialised or will materialise or that wages will put additional pressure on prices”.

Odds on the European Central Bank cutting rates before the Fed have fallen, despite a far more worrisome economy backdrop. Updated purchasing manager numbers show the powerhouse German industrial sector mired in near-recessionary conditions, bloc-wide credit growth is practically non-existent, and consumer sentiment is seeing only modest signs of improvement. But with unemployment holding near historic lows and wage growth holding up, underlying inflation pressures remain sticky and officials are seen taking the more cautious approach outlined by Governing Council member Boris Vujcic who yesterday said “We’re not talking about cutting interest rates now, and probably won’t before summer”.

The yen is modestly weaker after inflation in the world’s most-populous metropolitan area slowed for a second month in December. Consumer prices excluding fresh food – Japan’s measure of “core” inflation – in Tokyo rose 2.1 percent over the year prior in December, down from 2.3 percent in November as imported goods and energy costs subsided. The city’s numbers typically foreshadow national data, and are seen as providing a relatively accurate measure of underlying price dynamics.

In the background, traders have largely abandoned bets on a policy shift at the Bank of Japan’s January meeting. Although markets remain convinced the world’s longest-running negative rates experiment will come to an end this year, the likelihood of an imminent decision has given way in the face of declining inflation prints, a decidedly-dovish communications campaign from officials including Governor Ueda, and last week’s earthquake. The Bank is now seen making a move in March, or later.

“Higher for longer” is gradually giving way to “lower and sooner” in Fed communications. In a speech yesterday, Governor Michelle Bowman said “Should inflation continue to fall closer to our 2 percent goal over time, it will eventually become appropriate to begin the process of lowering our policy rate to prevent policy from becoming overly restrictive”. In a separate appearance, Atlanta’s Raphael Bostic said “Inflation has come down more than I expected”.

This dovetails with the data. Thursday’s numbers are expected to show year-over-year core price growth slowing to 3.8 percent in December from 4 percent in the prior month. Both major oil benchmarks remain tightly rangebound. Global goods costs are coming down as China’s supply-side stimulus efforts drive production higher. And year-ahead inflation expectations in the New York Fed’s latest survey, published yesterday, are at the lowest levels since December 2020.

But markets risk overdoing it. Echoing earlier statements from other officials, Bowman warned there is a “risk that the recent easing in financial conditions encourages a reacceleration of growth, stalling the progress in lowering inflation, or even causing inflation to reaccelerate”. As we have previously suggested (probably too many times), we suspect that easier financial conditions will ultimately force the Fed into providing less easing than investors currently anticipate, forcing a capitulation in financial markets at some point this year. The dollar’s bear trend is highly likely to resume in the coming days or weeks, but several significant reversals are likely.


Markets are braced for a modest re-acceleration in US headline inflation in December’s data, with the month-over-month increase in prices moving up to 0.2 percent from 0.1 percent in November. Higher gasoline costs are seen pushing annual price growth to 3.2 percent from 3.1 percent prior, but the core basket should slow to 3.8 percent from 4 percent prior. An above-consensus print could force markets into lowering the number of rate cuts expected over the next year, while a weaker number might drive a doubling-down on the “soft landing” thesis that lifted global asset prices in November and December. (08:30 EDT)


The British economy is seen bouncing back from October’s -0.3 percent contraction in November, but a modest 0.2 percent gain is unlikely to fully offset recessionary risks. Signs of improvement are appearing – consumer confidence and retail sales have risen in recent months, and purchasing manager surveys are pointing to a stabilisation in business investment – but output may have shrunk another -0.1 percent in the fourth quarter of 2023, and could remain in contractionary territory for months yet. If inflation follows current consensus in falling precipitously, the Bank of England is likely to begin a rhetorical pivot imminently. (02:00 EDT)

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Higher for (even) longer