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New Year, New (Thinner) Dollar

The greenback appears to be following its New Year resolutions rather well, on course to end the week at a lower weight after investors received confirmation of easing price pressures in the United States and evidence of surprising resilience in other major trading blocs. The trade-weighted dollar is down almost 1.5 percent this week, and has fallen more than ten percent from its September highs.

Yesterday’s inflation numbers were almost precisely aligned with median economist forecasts, but markets reacted nonetheless. Yields jumped and the dollar spiked higher in the moments after the release, and then round-tripped lower less half an hour later when the Philadelphia Fed’s Patrick Harker responded by saying quarter-point interest rate hikes would be appropriate in coming months – helping assuage market fears of a larger move at the central bank’s February meeting.

Japan’s yen is gathering no moss as it rolls toward the 125 mark against the dollar. Market participants are increasingly convinced the Bank of Japan will lift its yield curve control cap again by June, and the exchange rate is up almost 2.5 percent on the week. This looks justified on the fundamentals—the yen had fallen to terribly undervalued levels as interest rate differentials widened last year—but with inflation pressures showing signs of ebbing (and remaining extremely weak relative to other economies), there’s a fairly substantial risk of disappointment at next week’s central bank decision. The currency could suffer a reversal if Governor Kuroda and his colleagues choose to draw a firm line against further policy changes in the near term.

Gross domestic product climbed unexpectedly in the United Kingdom last month, suggesting that a widely-forecast recession might not materialize until later in 2023. Data released by the Office for National Statistics showed a 0.1 percent expansion in November as spending on World Cup festivities offset a decline in the manufacturing sector and slower activity in sectors impacted by labour strikes. This lifted the pound by running counter to the Bank of England’s pessimistic forecasts, and could help tip the balance in favour of tighter policy on the rate-setting committee.

The euro experienced a modest rollback overnight, but is also sitting on nice gains, having rallied almost 1.5 percent this week. The exchange rate has risen almost 11 percent since November on a stabilization in US rate expectations, stronger-than-feared domestic fundamentals, and the prospect of renewed export growth generated through China’s reopening.

US import prices are seen dropping 0.8 percent in December from the prior month as easing logistics issues and falling commodity costs put pressure on inflation rates.

Economists think spirits continued to brighten after the holidays, with the University of Michigan’s preliminary consumer sentiment index expected to hit 60.7 in early January from 59.7 in December.

Federal Reserve speakers include Patrick Harker, who yesterday set the stage for a slower pace of rate hikes in the months ahead, and the erstwhile dove Neel Kashkari, who recently said markets “are going to lose the game of chicken, I can tell you that”.

Next week will kick off in a subdued manner with trading closed for the Martin Luther King holiday in the United States. Tuesday will bring the latest Canadian inflation numbers, which are expected to firm the case for a final rate hike from the Bank of Canada. Later in the week, retail sales figures will land for both the US and Canada, and the Bank of Japan will release its latest policy decision. Throughout, we will be inundated with ultimately-meaningless headlines when billionaires and politicians gather in Davos, Switzerland for their annual backslapping event.

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