Treasury yields are down, equity futures are up, and the dollar is retreating as traders take positions ahead of this morning’s inflation report. Economists think core consumer prices accelerated modestly while the headline measure remained broadly unchanged last month, giving the Federal Reserve room to begin unwinding its tight policy settings. Yesterday, the New York Fed’s November Survey of Consumer Expectations showed year-ahead inflation expectations falling by 0.2 percent to 3.4 percent, marking the lowest reading since April 2021.

The yen is softer after bets on an abrupt change in the Bank of Japan’s policy framework suffered another setback last night. Wholesale prices rose just 0.3 percent from a year prior in November, down sharply from 0.9 percent in October, reinforcing expectations for a continued moderation in underlying inflation as commodity prices come down and global supply shocks fade. According to a Bloomberg report earlier yesterday, central bankers see no urgency to raise rates. Options traders are increasingly betting next week’s meeting will come and go without much fanfare – implied volatility levels are subsiding from last week’s peaks.

The British pound is lagging gains in other currencies against the greenback after updated labour market figures showed wage growth slowing at the fastest pace in almost two years, giving central bankers room to move onto a more dovish footing. According to the Office for National Statistics, average earnings excluding bonuses rose 7.3 percent in the three months through October compared with a year ago, down from the 7.8-percent pace hit at the end of September. But the exchange rate is still holding above the 1.25 threshold against the dollar, suggesting that traders are bracing for a relatively hawkish message from Governor Bailey and other Bank of England policymakers on Thursday.

Oil prices are edging up after Houthi rebels in Yemen fired a missile at a ship in the Red Sea, but the moves have been relatively contained thus far – suggesting that traders don’t expect disruptions to upset the balance in over-supplied markets.

The Canadian dollar is trading sideways, failing to gain momentum from a generalized convergence between economic surprise indices in the US and Canada. Although the US economy continues to outperform its poorer, less productive northern cousin, the gap between expectations and reality has narrowed somewhat over the last month, and risk appetite has generally improved. From a technical perspective, we think the loonie should be trading several cents higher than it is today – although we remain bearish on its longer term prospects.

 
Still Ahead

TUESDAY

Consumer price growth likely continued to cool in the United States last month, helping ratify expectations for a prolonged hold from the Federal Reserve. Consensus estimates suggest headline inflation remained flat on a month-over-month basis in November, with tumbling energy costs helping bring the year-over-year rate down to 3.1 percent from 3.2 percent. The core measure could appear more stubborn, holding near the 4 percent threshold year-over-year, but this will be somewhat deceptive: in the last six months, ex-food and energy prices have risen less than 3 percent on an annualized basis. (08:30 EDT)

WEDNESDAY

The Federal Open Market Committee will almost certainly leave rates unchanged for a third consecutive meeting, but the accompanying economic projections could shift considerably, impacting financial market assumptions. Turbulence could be unleashed across a number of asset classes if the “dot plot” fails to reveal a dramatic 75-basis-point drop in the median forecast for end-2024 policy rates – or, if the number of expected rate cuts exceeds what is currently priced in. We’re not sure whether Governor Waller’s perspective—that the Fed should begin providing accommodation once inflation has fallen for a three- or four-month period, even if the underlying economy remains strong—is widely shared across the committee, and suspect some policymakers are still clinging to the “higher for longer” message that seemed so fashionable a few months ago. Either way, the potential exists for considerable volatility. (14:00 EDT)

THURSDAY

With key inflation metrics remaining far from target, the Bank of England is likely to maintain a rhetorically-hawkish bias at its December meeting, retaining the option to raise rates again if price growth fails to continue its descent. Policymakers could choose to buck global trends in decisively pushing back against the easing in financial conditions that has occurred since October, but in the UK, as elsewhere, markets are unlikely to take this seriously. Global investors believe inflation is on the wane, with interest rates expected to follow suit, and there’s simply not a lot policymakers can do to convince them otherwise. (07:00 EDT)

Virtually no one thinks the European Central Bank will raise borrowing costs again in this tightening cycle, yet there’s significant disagreement around how quickly and aggressively policymakers will begin cutting interest rates next year. Inflation is subsiding quickly and recent commentary from Governing Council members—most influentially, Isabel Schnabel—has turned remarkably dovish, convincing markets to assume at least five rate cuts through the course of 2024. We think price growth could make a modest comeback in the early new year as government energy caps expire, and suspect investors expect too much flexibility from a notoriously slow-moving institution. (08:00 EDT)

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)