Having moved past the puking stage, traders have moved from the bed to the sofa, and are now ordering McDonald’s for delivery. Equity futures are setting up for modest gains at the North American open, Treasury yields are stabilizing, and pro cyclical units are climbing across currency markets as post-New Year positioning adjustments near completion.

Minutes taken during the Federal Reserve’s December meeting seemed consistent with three rate cuts this year, beginning later than March. Policymakers broadly agreed that easing could prove necessary this year, noting “the downside risks to the economy that would be associated with an overly restrictive stance,” but also maintained a hawkish bias, observing that the “economy could evolve in a manner that would make further increases in the target rate appropriate,” with several warning that “circumstances might warrant keeping the target range at its current value for longer than they currently anticipated”.

Markets are expecting a far more aggressive approach. Futures pricing suggests that the odds on a cut at the March meeting are holding around 63 percent, with five more expected before the end of the year.

We consider a wider reappraisal of the Fed’s trajectory almost inevitable. Market expectations for six rate cuts in 2024 have never been congruent with bets on a soft landing, and last month’s loosening in global financial conditions has made a smooth deceleration in inflation much less likely. If we’re right, traders will eventually suffer a crisis of confidence, and a generalized dollar decline could be punctuated by at least one violent rally in the first half.

Data out yesterday showed US labour markets remaining relatively tight, with vacancies coming down modestly and the quits rate nearing historically-elevated pre-pandemic levels. Separate manufacturing sector numbers from the Institute for Supply Management showed activity coming off a bottom, with an expected decline in US borrowing rates helping bolster corporate investment and factory production levels.

Higher oil prices are lending limited support to the Canadian dollar. Supply issues in Libya and an explosion at a gravesite bombing in Iran are adding to the geopolitical risk premia embedded in global energy prices, but concerns surrounding tomorrow’s employment report are keeping gains in the loonie capped. A downside surprise could put the conditions in place for a more dovish statement from the Bank of Canada later this month, with rate differentials vulnerable to a re-widening if markets come to see the central bank matching the Fed in delivering rate cuts through the rest of the year.

China’s services sector showed signs of life last month, yet markets remain convinced the People’s Bank of China will soon ease policy. The Caixin services purchasing manager index climbed to 52.9 last month from 51.5 in the prior month. This might suggest that domestic demand is helping to offset weaker exports, but with the country’s enormous factory sector facing a steep decline in foreign buying, the effect isn’t large enough to change the overall economy’s direction. Government bond yields are holding near a three-year low as investors brace for rate cuts and further reductions in bank reserve ratios in the months ahead.

Harmonized consumer prices rose by less than expected last month in France, setting the stage for a softer-than-forecast euro area-wide print tomorrow. Prices rose 0.1 percent from a month earlier in December, below the consensus 0.2-percent forecast,

Odds on a rate cut at the European Central Bank’s March meeting are holding near the 60 percent mark. From a fundamental perspective, this seems well justified – the economy is mired in near-recessionary conditions and faster wage growth is doing very little to arrest the slide in inflation. But in a series of post-unification cycles, officials have kept policy settings too tight, bowing to the wishes of a (typically German) group of hawks in prioritizing monetary stability over growth. The recently-passed Jacques Delors once said “Not all Germans believe in God, but they all believe in the Bundesbank,” and there’s little to suggest that they are willing to support a more nimble approach in this cycle.

 
Still Ahead

THURSDAY

Weekly jobless claims should remain consistent with data released in late December, meaning that the four-week moving average will likely hold close to 215,000. The continuing claims number might continue to creep up, exhibiting signs of increasing strain as skills mismatches limit the employment uptake in an economy that is generating jobs in an ever-narrower subset of sectors. (08:30 EDT)

Although forward guidance provided at the time was largely unchanged, Mexico’s central bank likely turned more dovish in December, with the meeting record expected to exhibit a willingness to follow the Federal Reserve in cutting rates early this year. If, as we expect, domestic inflation continues decelerating, and the US economy loses momentum, the conditions should be in place for a relatively steady unwind in rate hikes through the year – and we think officials are looking at the same writing on the wall. (10:00 EDT)

FRIDAY

Euro area inflation rates likely staged a counter-intuitive rebound in December, with last year’s on-time energy offset from the German government generating unfavourable base effects. Core price growth probably continued slowing however, with services costs beginning to fade more aggressively in the face of ebbing demand. Markets expect the core price measure to slip to 3.4 percent year over year from 3.6 percent in November. (05:00 EDT)

2023’s final non-farm payroll report should show job generation slowing from November’s level, with the unemployment rate creeping back up. Seasonal hiring could deliver an upside surprise, but consensus estimates suggest 170,000 new jobs were created in the month, with the jobless rate climbing to 3.9 percent from 3.7 percent previously – exhibiting a worrisome direction of travel, but one not yet consistent with recessionary conditions. Revisions could play an interesting role however – if prior months are revised in a negative direction, market bets on a harder landing could come back into vogue. (08:30 EDT)

With population growth outpacing job creation, Canada’s labour market may have loosened further in December. Market consensus is aligned around a circa-10,000-position job gain in the month, but the unemployment rate is seen ticking up to 5.9 percent, setting the stage for another cautionary statement from the Bank of Canada on January 24th. (08:30 EDT)

The US services sector probably slowed in December, with the Institute for Supply Management’s services index slipping from November’s 52.7 level as consumers and businesses turned more cautious into year end. Overall activity should remain strongly positive however, pointing to continued resilience in household spending – which we expect will begin fading in the months ahead. (10:00 EDT)