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Market Briefing: Risk appetites – and the dollar – jump into a new year

Happy new year, and may all our market troubles last as long as our resolutions. Investors are in a relatively ebullient mood to kick off 2023, with most major equity indices pointing to a stronger open, while bond yields on both sides of the Atlantic slip. The Canadian dollar and Japanese yen are eking out small gains, but the greenback is almost a full percentage point higher on a year-to-date basis as traders trim excessive bets on the euro.

The Japanese yen is slightly weaker after pushing through the 130 mark against the dollar in yesterday’s thin trading conditions. Investors are overwhelmingly bullish on the currency after the Bank of Japan raised its cap on 10-year bond yields to 0.5 percent from 0.25 percent, raising bets on an eventual rise in interest rates. On most fundamental measures, the yen remains undervalued and a push beyond the 125 mark looks likely, but bearish risks remain – if domestic inflation fades in the coming months or the Fed continues its hikes for longer than expected, gains could prove more limited.

Onshore markets are rallying and subway traffic volumes are picking up in China as infection counts peak in major cities, but sentiment indicators are pointing to a major near-term downturn. Data dropped on Sunday showed the country’s official manufacturing purchasing manager index falling to 47 in December from 48 in November, and the non-manufacturing index, which measures activity in the construction and services sectors, sliding to to 41.6 from 46.7 in the prior month.

There are no major economic events on the North American calendar today, but the tempo of activity will accelerate into the end of the week.

Tomorrow’s December manufacturing purchasing manager index from the Institute for Supply Management is likely to show growing weakness in the factory sector. Market participants are bracing for a print under the 48.5 mark – down from 49.0 in the prior month, and below the 50 threshold that separates contraction from expansion.

The number of job openings posted in November probably dropped back below the 10 million mark as employers grew more cautious – but the ratio between vacancies and available workers likely remained historically elevated. This could add weight to Federal Reserve Chair Jerome Powell’s belief that rates will need to climb further and remain high for a considerable time before aggregate demand weakens sufficiently.

Meeting minutes, due for release tomorrow afternoon, will provide insight into considerations that led Fed officials to raise terminal rate projections by more than expected in early December. Inflation numbers released during the meeting showed clear signs of deceleration, but other data are consistent with an economy running on all cylinders, and a number of policymakers are likely to express discomfort with the strength of underlying demand.

Friday’s non-farm payrolls report could prove meaningful ahead of the January Federal Open Market Committee meeting. If job creation numbers, hourly earnings, and the unemployment rate soften in a more pronounced manner than currently expected, central bankers could opt to communicate a more cautious path forward – but we think this is unlikely. Labour market conditions remain extraordinarily tight, adding to the income gains supporting US consumption and lifting overall inflation pressures.

Europe’s major economies are set to release their latest consumer price index numbers throughout the week, culminating with a euro area-wide release on Friday. Data out this morning should show inflation in Germany slowing sharply in December as the government made energy offset payments to shield households and businesses – although there is some uncertainty around how statistical agencies will treat the fiscal transfers. France is expected to post a modest acceleration when data lands tomorrow, and Italy might see a slight softening in month-over-month numbers on Thursday. Inflation across the euro area is seen declining to 9.6 percent year-over-year in December, down from 10.1 percent in November. Stronger-than-expected prints could lift expectations for rate increases from the European Central Bank in the early months of the year.

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