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Currency Volatility Continues to Fall

Good morning. With a barrage of economic data releases and central bank speeches scheduled in the days ahead, traders remain unwilling to take big directional positions. Treasury yields are little changed, equity futures are setting up for a flat open, oil prices are down slightly, and the dollar is holding last week’s gains.

Volatility in the currency markets continues to drift lower, and it’s admittedly difficult to see what might break this dynamic.

3-month at-the-money implied option volatility

We count at least fourteen appearances from Fed policymakers on the schedule this week, but most are likely to follow in Governor Christopher Waller’s rhetorical footsteps. In a speech given last Thursday, he said January’s “high reading on consumer price index inflation may just be a bump in the road, but it also may be a warning that the considerable progress on inflation over the past year may be stalling”. He said this “has reinforced my view that we need to verify that the progress on inflation we saw in the last half of 2023 will continue and this means there is no rush to begin cutting interest rates to normalize monetary policy,” suggesting that “at least another couple more months” of data would be needed to put the conditions in place for rate cuts.

Markets seem well prepared for an acceleration in price growth when January’s personal consumption expenditures number drops on Thursday. After this year’s dramatic pivot, investors and Federal Reserve officials are the most closely aligned in months. Just three rate cuts are now priced into the forward curve, matching the median forecast embedded in the central bank’s last “dot plot” summary of economic projections, and limiting the likelihood of a violent reaction to a hotter-than-anticipated report.

Inflation prints in Japan and the euro area seem unlikely to deliver significant upside surprises, with domestic demand conditions in both economies looking far from overheated, while exogenous shipping and energy prices remain well-contained .

But foreign exchange markets do have a tendency to defy forecasts and deliver nasty surprises when they’re least expected. A slew of risks, from an imminent government shutdown to signs of weakness in US labour markets, could collapse the current consensus and trigger unexpected moves. As Warren Buffett put it in Berkshire Hathaway’s annual letter, published Saturday, “Neither Greg (Abel), nor I believe we can forecast market prices of major currencies. We also don’t believe we can hire anyone with this ability”.

My career plans have thusly been derailed, but yours needn’t be. If past is prologue, hedging your organization’s exposures while markets are at their most placid can prove enormously useful in staying afloat. To quote Buffett again (in a shameless attempt to get him to hire me), “Predicting rain doesn’t count, building arks does”.


Still Ahead

WEDNESDAY

Canada’s December Survey of Employment, Payrolls, and Hours is unlikely to move markets, but will be closely parsed for evidence of cooling in the labour market, with job openings and wage growth numbers coming in for particularly close scrutiny. (08:30 EDT)

Quarterly inflation projections from Mexico’s central bank should remain consistent with a gradual easing in price pressures over the next three quarters, but growth forecasts could be revised down more sharply. The economy began losing momentum in the fourth quarter of last year, and domestic demand is showing clear signs of softening. Minutes taken during the Banxico’s last meeting showed policymakers narrowly favoured cutting rates in March, but if more recent hawkish signals from the Federal Reserve can be trusted, a delayed move is possible – from what we can tell, officials remain committed to maintaining a circa-600 basis point spread above the Fed Funds rate. (13:30 EDT)

THURSDAY

After a hotter-than-anticipated consumer price index reading earlier this month and this speech from Vice Chair Jefferson last week, markets expect the Federal Reserve’s preferred inflation indicator – the core personal consumption expenditures index – to print close to 0.4 percent on a month-over-month basis in January, up from 0.2 percent in December. Base effects should nonetheless put year-over-year price growth on track to slow to 2.8 percent in January from 2.9 percent in the prior month, with further progress coming in the months ahead. Although spending growth almost certainly slowed as consumers suffered the typical post-holiday hangover and grappled with colder-than-normal weather, personal income growth likely accelerated, powered by gains in labour market wages and social security adjustments. (08:30 EDT)

The Canadian economy likely dodged recession in the last quarter of 2023, with household consumption, residential construction, government spending, and exports helping offset weakness in business investment and inventories. A quarter-over-quarter print in the 0.4- to 0.6-percent range – which would lift year-over-year growth close to 1.6 percent from the previous 1.1 percent – shouldn’t shock markets, but a positive early estimate for January could partially nullify last week’s softer-than-anticipated inflation release in pushing expectations for the first Bank of Canada rate cut back out toward June. (08:30 EDT)

FRIDAY

Following a steady drumbeat of country-specific prints in the preceding days, Eurostat is expected to report a further deceleration in region-wide inflation during the month of February, which might help ratify bets on earlier easing from the European Central Bank. Estimates collected from economists by Bloomberg and Reuters suggest that core price growth slowed to 2.9 percent year-over-year, down from January’s 3.3 percent as a softening in domestic demand offset a modest rise in energy costs – but there is considerable uncertainty around the services component, with other indicators pointing to a rebound in consumer sentiment over the same period. Policymakers are likely to wait for more evidence before cutting rates, but a stronger than forecast print could easily add support to a still-nascent recovery in the euro. (05:00 EDT)

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Higher for (even) longer