Equity markets are doing their best impression of Jason Kelce at a Buffalo Bills game, roaring into the week with strong gains in pre-open futures trading. Several major indices are flirting with record highs, commodity prices are up modestly, and Treasury yields are holding steady, with the ten-year paying close to 4.1 percent, up sharply from the beginning of the year.
The dollar continues to outperform as Federal Reserve expectations shift rate differentials in a more favourable direction. After a series of hotter-than-anticipated data releases and a concerted jawboning effort from policymakers, markets are now assigning sub-40-percent odds to a rate cut at the March meeting, and see just 135 points in easing by year-end, down from almost 170 a few weeks ago.
A communications blackout ahead of the Fed’s January 31 decision should help reduce the noise level in markets this week, forcing investors to focus on fundamentals as they assess the likely policy trajectory. Thursday’s gross domestic product number and Friday’s personal income and outlays report look like the most obvious catalysts for an adjustment in rate projections, and we suspect that pressure on yields should generally intensify as evidence of slowing economic momentum begins to accumulate in the coming months.
But markets are still struggling with how to quantify political risks going into this autumn’s US presidential election, and we think the dollar could be poised to benefit. We suspect that implied November volatility in the Mexican peso and Canadian dollar – currencies particularly exposed to Donald Trump’s proposed universal tariff plan – should rise shortly after tomorrow’s New Hampshire primary if he moves closer to securing the Republican nomination, with the dollar gaining in spot markets.
Odds on a move at tonight’s Bank of Japan meeting are near zero. Cost-push inflation is fading, aggregate demand remains weak, an earthquake in early January has depressed industrial output, and Governor Kazuo Ueda has clearly telegraphed a desire to postpone a decision on lifting rates out of negative territory until the outcome of early-spring wage negotiations between unions and businesses is known. The yen is down almost five percent year to date and speculative positioning has turned negative as investors have grown more skeptical on the likelihood of a dramatic narrowing in rate differentials – and we suspect this could prove durable as it becomes clear that inflation rates will ultimately settle well below the two-percent threshold. One caveat: if officials explicitly flag the yen’s descent as a growth and inflation risk, traders might move to hedge against possible currency intervention just beyond the 150 mark against the dollar.
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)
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)
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)