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Christmas comes early to financial markets

The dollar plunged yesterday when the policy elves at the world’s most powerful central bank met markets halfway, indicating they expect to cut rates at least three times next year, and four times in 2025. Perhaps more importantly, a jolly Jerome Powell chose not to fight back against an ongoing loosening in financial conditions in the post-meeting press conference, instead pointing to a series of indicators showing the economy achieving a soft landing and suggesting inflation could come down without a rise in unemployment.

Some of the fervour is cooling this morning, but not much. With markets now pricing in around 160 basis points in rate cuts over the next year, two-year yields are down by the most since regional banks began collapsing in March, equity futures are climbing, and oil prices are higher.

The Canadian dollar is trading well above yesterday morning’s levels after smashing through resistance at the 1.3550 threshold. Traders are back to expecting the Bank of Canada to cut rates more slowly than its southern cousin, with the swaps curve pointing to 130 basis points in reductions through the course of 2024 – although that pricing could prove vulnerable when Governor Tiff Macklem addresses Toronto’s Canadian Club later this morning.

In this morning’s decision, the Bank of England avoided anything resembling the Fed’s pivot, leaving rates unchanged and keeping additional hikes on the table for next year. Officials led by Governor Andrew Bailey said “There is still some way to go,” warning that policy would likely remain tight for an “extended period of time,” with further possible firming possible if “evidence of more persistent inflationary pressures” presents itself. Gilt yields climbed and the pound briefly broke above the 1.27 mark against the dollar before fading. Investors expect four rate cuts in 2024, down from the five priced in ahead of the decision.

The trading day is far from done: Europe’s monetary mandarins are likely to keep policy settings unchanged in a few minutes, with updated projections showing growth and inflation decelerating more quickly than previously anticipated through the first half of 2024. Headline US retail sales for November, out at 8:30, are expected to fall -0.1 percent from the prior month, with the control group performing modestly better. Jobless claims are seen holding steady at 220,000 in the week ended December 9. Later in the session, Mexico’s central bank should hold rates steady while issuing marginally more dovish forward guidance. And China will provide an update on growth in industrial output, fixed-asset investment, and retail sales – all of which are likely to remain consistent with lacklustre domestic demand and persistent disinflationary pressures in the world’s second-biggest economy.

And further volatility is likely. With the number of important data releases set to diminish materially in coming weeks, new economic trading narratives are unlikely to emerge. Existing price trends should continue to gain strength. But markets are now priced for a pace and scale of monetary easing that has previously only been seen during recessions or periods of extreme financial stress. We suspect today’s rally will ultimately collapse under its own contradictions, triggering another round of turbulence in the currency markets.

THURSDAY

Control-group retail sales – critical in assessing the strength of US consumer demand – are seen eking out a small gain in November, rising just 0.1 percent month-over-month on a comparatively anemic increase in holiday outlays. But American households remain the most powerful force in the global economy, and we don’t rule out another month of growth-defying spending. (08:30 EDT)

The Banxico should follow through on its forward guidance, holding its benchmark rate at 11.25 percent for a sixth consecutive meeting. Although the economy is showing signs of vulnerability as the US begins to slow, the first rate cuts are expected to begin late in the first quarter, and are seen coming incrementally so that interest differentials with the Federal Reserve remain strongly positive – meaning that carry traders should remain confident in high returns for now. (14:00 EDT)

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