After a strong start to the year, rallies in US equity markets and the dollar appear to be nearing exhaustion this morning. S&P 500 futures are pointing to a flat open and the greenback is inching higher on a stabilization in ten-year Treasury yields above the 4.1-percent threshold. The Canadian dollar is drifting lower as traders brace for a cautiously-dovish central bank decision tomorrow.
The Japanese yen is modestly stronger after the Bank of Japan left policy settings intact yet signalled a move out of negative rates territory was still in the offing. Policymakers left the short-term benchmark rate at -0.1 percent, kept yield curve control settings unchanged, and lowered the fiscal year inflation forecast to 2.4 percent from 2.8 percent, noting that the certainty of hitting price targets was gradually increasing. In the post-decision press conference, Governor Ueda said an eventual rate increase would be designed to remain economically stimulative while avoiding market disturbance – language that suggests, to us, that the Bank intends to raise rates into narrowly positive territory in the first half of the year, but that it is likely to maintain some aspects of the yield curve control framework that keeps long-term rates anchored.
Chinese asset prices are rebounding after Premier Li Qiang called for “more forceful and effective measures to stabilise the market and boost confidence,” adding weight to rumours of ongoing official intervention efforts. According to Bloomberg News, the government might instruct state-owned enterprises to redeploy roughly 2 trillion yuan in offshore holdings and another 300 billion in onshore funds into domestic equity markets. If previous efforts are any indication, this sum could help put a floor under markets into the Lunar New Year, but is unlikely to pull the economy out its longer-term malaise – that would require deeper structural adjustments and an eventual easing in Xi Jinping’s hold on the reins of power. The yuan climbed a quarter percentage point overnight, but is down roughly 1 percent on a year-to-date basis.
The euro is slightly weaker despite updated numbers showing credit demand weakening more slowly. The European Central Bank’s lending survey – closely watched as an indicator of monetary policy effectiveness – pointed to a slight easing in credit conditions in the fourth quarter of 2023, with both realized and expected measures of loan demand bouncing off their lows. This should help lend credence to Madame Lagarde’s repeated efforts at convincing markets rate cuts won’t begin until June or later.
Today’s North American data calendar looks remarkably light, but we think the New Hampshire primary bears watching. A decisive win for Donald Trump would put him on course toward clinching the Republican nomination, bringing the prospect of another round of upheaval in global trade relations much closer. Political changes are always difficult to hedge, but given the scale of the potential disruption, implied volatility in currency markets looks far too low.
One-year implied volatility, 21-day averages
Still Ahead
WEDNESDAY
The Bank of Canada is almost-universally expected to leave benchmark borrowing costs unchanged for a fourth consecutive meeting, but considerable uncertainty remains around the rate trajectory through the remainder of 2024. We think language in the accompanying statement, Monetary Policy Report and press conference will disappoint market participants expecting an imminent pivot toward easier policy, with Governor Macklem and his colleagues likely to emphasize the inflation risks posed by ongoing population growth and a generalized loosening in financial conditions, even as they acknowledge continued weakness in the real economy. The loonie might gain some altitude. But we could be wrong: a sharp downgrade in growth expectations, perhaps paired with hints of a plan to slow the pace of quantitative tightening could trigger renewed softness in the currency. (09:45 EDT announcement, 10:30 press conference)
THURSDAY
No one expects the European Central Bank to adjust policy at this week’s meeting, but markets will nonetheless pay rapt attention to Christine Lagarde’s comments during the post-decision press conference. We think Chief Economist Philip Lane’s comments in last week’s Corriere della Sera interview are fairly representative of the underlying message she will want to deliver, with the first rate cut most likely to land in June – defying market conviction in a March rate cut. Euro area inflation could prove stickier than expected in coming months, but the economy has suffered a rapid deterioration in recent months, suggesting that current policy settings are too tight. (08:15 EDT)
The US economy probably decelerated in the fourth quarter of 2023, expanding a little less than 2 percent after growing 4.9 percent in the prior three-month period. Strong consumer spending likely offset inventory drawdowns and more cautious investment from businesses in the quarter, nudging the full-year growth rate close to the 2.8-percent mark. The handoff into the first quarter of this year looks quite uncertain, with many underlying fundamentals pointing to a softening in consumer demand, even as survey data and the housing market support the case for a rebound. (08:30 EDT)
FRIDAY
The Federal Reserve’s favourite inflation indicator – the core personal consumption expenditures index – is believed to have accelerated slightly on a month-over-month basis in December, up 0.2 percent from the prior month. Fed chair Jerome Powell’s favoured “supercore” measure – core services excluding rents – should come in under the 2-percent threshold on a three-month annualized basis, suggesting that the central bank has largely achieved its inflation mandate, and helping set the stage for an easing in policy settings in the coming months. Consumer spending, partly driven by rising incomes and falling energy prices, but also boosted by easing financial conditions, likely grew more quickly, with total outlays rising 0.5 percent on a month-over-month basis. (08:30 EDT)