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Markets Hold Losses as “Bad News is Bad News” Dynamic Returns

Risk appetite remains weaker across the financial markets this morning after a slew of data releases pointed to a slowdown in the world’s largest economy. Equity futures are setting up for more selling at the open, commodity prices are down, and ten-year Treasury yields are back to levels last hit in September. The Canadian dollar is experiencing a bout of round-number bias, clinging to the 1.35 mark after dropping nearly a cent during yesterday’s trading session.

According to the latest numbers published yesterday, US retail sales fell a seasonally-adjusted 1.1 percent in December from the prior month, and were revised lower for November, dragging the three-month rolling average downward. Year-over-year producer price growth slumped to 6.2 percent, down sharply from 7.3 in November, and 11.7 percent in March. Manufacturing output suffered its biggest drop in nearly two years. And the Federal Reserve’s Beige Book survey showed American businesses were bracing for a downturn, even as they remained hesitant to lay off employees.

A narrowing in expected growth differentials is beginning to push the greenback toward the bottom of the “dollar smile”. Under this theoretical framework, the United States’ combined roles – major economy, global safe haven, and recycling center for international capital – mean that the dollar tends to strengthen both when the US is growing more quickly than its global counterparts, but also, counter-intuitively, when it is growing much more slowly (especially during recessions or financial crises). When growth rates converge – as they are now – bad economic news in the US becomes bad news for the dollar as money tends to flow out into global markets in pursuit of higher yields.

But the dollar could smile once again if the debt ceiling nonsense returns with a vengeance. Consider yourselves warned.

The euro is modestly stronger after European Central Bank Governing Council member Klaas Knot said interest rates would continue to climb in 50 basis-point increments. In an interview with CNBC on the sidelines of the World Economic Forum in Davos, the consistently-hawkish Knot said “Our president has already announced that most of the ground that we have to cover we will cover at a constant pace of multiple 50 basis-point hikes… core inflation has not yet turned the corner in the euro area”. This comes after several others on the council had hinted at a coming deceleration in the pace of tightening, putting pressure on front-end yields. Speculative traders remain very long euro, raising the risk of a violent position adjustment if dovish views become more widespread in coming weeks.

Japan’s yen is back near levels that prevailed ahead of Tuesday’s policy decision. Market participants still think an abandonment of the Bank of Japan’s yield curve control framework is a matter of “when”, not “if” – but timing the trade remains dangerous, with the next policy meeting seven weeks away, and current Governor Kuroda not due to step down until April. The anchor for global bond yields could continue to sway for months to come.

Initial claims for unemployment benefits are expected to rise to 215,000 in the week ended January 14, up slightly from 205,000 one week earlier, but still far below levels that would indicate stress in the jobs market.

Housing starts are seen falling to an annualized 1.36 million in December, down from 1.427 million in the prior month as higher rates weaken activity across the real estate sector.

Federal Reserve speakers include two of the intellectual leaders of the current crop of policymakers – Lael Brainard will provide an economic update at 1:15 this afternoon, followed by John Williams at 6:30 in the evening. Tomorrow’s speech from Governor Chris Waller could also prove market-moving: Waller is also considered one of the most influential members of the central bank’s rate-setting committee, having been among the first to signal an end to quantitative easing in 2021, and consistently arguing for tighter policy over the last year.

USD doldrums continue
Canadian jobs growth tops expectations, but details point to slowdown ahead
The peso’s bull run has run out of steam.
The fiscal outlook still looks favourable.
Canada's economy is slowing.
Nearshoring hopes look overdone.